Credit Musings: Quarterly Credit Update

Feb 26, 2024


Public Trust Credit Team

Data and consumer sentiment now support soft landing.

Numerous articles over the past 6 months characterized consumer sentiment as dour, despite a strong economy. This was likely due to the warnings of an impending recession and inflation only made the feeling more pronounced. Data offered little insight, and there was no consensus amongst prognosticators. Those days are over! The robust economy is now reflected in economic data, and consumer sentiment has rebounded. It appears that the Fed has engineered the soft landing, although worldwide geopolitical turmoil/strife, the U.S. Presidential election, and the commercial real estate overhang remain. 

Bank deposits flat and market conditions are increasingly accommodative.

For the first time in over a year, bank deposits ceased QoQ declines and remained level in the most recent quarterly report. Despite the stability in deposit balances, money market fund assets continued to climb, albeit at a slower rate, as investors took advantage of the higher returns they provided. With numerous transactions being announced over the last quarter, the merger and acquisition (M&A) market appears to be thawing because of improving financial conditions and in anticipation of declines in interest rates over the medium term. As a result, banks are forecasting an improvement in investment banking revenues in anticipation of increasing deal flow. EV/EBITDA for the S&P 500 increased over the prior quarter, likely in response to the M&A transactions being considered. The Bloomberg U.S. Financial Conditions Index continues to indicate that market conditions are accommodative, which is further supported by narrow credit spreads that have persisted over the last quarter. 

The appetite for shareholder returns is divided between banks and corporates and is likely time-dependent dependent.

From December 2020 to December 2022, shareholder returns climbed 20% on an annualized basis, a rate not seen since the turn of the millennium. With corporate earnings skyrocketing, companies became flush with cash and increased dividends and buybacks. With earnings and shareholder returns declining, there was a marked difference in 2023. Early reports from earnings calls suggest that share repurchases and dividends may increase this year, with estimated low- to mid-single-digit earnings growth. Although both Japanese and U.S. banks will resume share repurchases, the historically high S&P could make for an inopportune time. As shareholder returns and earnings stabilize, 2024 could see an uptick with the Fed rate cuts supporting those decisions. There has also been an increase in net debt loads within the S&P 500 companies, although this follows a seasonal trend and not one that is likely to be sustained. With the Fed’s long-awaited rate cuts looming on the horizon, new issuance seems likely later this year.  

An uptick in PMI shows positive signs for manufacturing in 2024.

Following a relatively stagnant two years, both the manufacturing and service components of the Institute for Supply Management’s purchasing managers index (PMI) rose meaningfully from the prior quarter. The most recent readings for the services and manufacturing sectors, at 53.4 and 49.1 respectively, show that while activity in the services sector is  expanding, manufacturing is still somewhat contractionary despite a recent jump. Services have been  expanding since the end of the COVID pandemic, and the index has been above the expansionary threshold of 50 for 43 out of 44 months. Manufacturing, on the other hand, has been hit much harder by a one-two punch of rising input costs and severe supply chain congestion in recent years. The manufacturing index’s January 2024 reading of 49.1 is the highest level since October 2022 and represents 15 straight months of contraction. However, despite remaining slightly in contractionary territory, there appears to be optimism surrounding domestic manufacturing. Global supply chains have improved over the last few quarters (despite blips of geopolitical turmoil continuing to complicate freight in certain areas such as the Red Sea.) Improved supply chains have helped reduce order backlogs and enabled suppliers to deliver necessary inputs faster. Additionally, new orders entered expansionary territory for the first time in 16 months as customers’ inventory levels remain unsustainably low, which is a positive sign for new orders and future production. With respect to the broader U.S. economy, a manufacturing index above 42.5 over a prolonged period indicates that the U.S. GDP is generally expanding. The index continuing its climb away from this threshold level may help stave off recession fears and be further indicative of a “soft landing” scenario. 

Consumers continue to borrow despite high rates and tightening lending standards.

High rates have yet to take the wind out of consumers’ sails when it comes to borrowing. The slowdown in consumer credit balances beginning in July of last year appears to have reversed, and the three-month rolling consumer credit balances have risen considerably this month. The regional banking turmoil and expectations of a recession led to the tepid growth of consumer credit over the summer last year. However, while borrowing has increased so too have delinquencies with another quarter of increased 90+ day past-due payment in credit cards and a continued increase in net charge-offs for cards. Delinquencies are just above their pre-pandemic averages, and in aggregate charge-offs are sitting just below their 2019 level. In addition, it is worth noting that the data does not yet include the holiday shopping season, which could significantly boost delinquencies over the coming months. While consumers continue to borrow, banks have tightened their lending standards. The last several Senior Loan Officer surveys have  indicated that banks are tightening their lending standards across the board and are becoming more selective. This is reflected in the data as there has been a nearly universal decline in auto lending at  credit scores since last year. While autos are down, one area that continues to perplex is housing. Despite the bite of high rates, U.S. home prices continue to rise, albeit at a very mild pace and remain at all-time highs. Expectations for 2024 are that credit card borrowing will likely increase as will delinquencies, though most banks expect this to peak later this year. Rate cuts later in the year will likely add some fuel to U.S. mortgage lending and the housing market, which will keep price growth positive. This will be balanced by banks continuing with tighter lending standards against an uncertain economic backdrop. Consumer confidence may remain persistently low but credit conditions in the U.S. should remain fairly accommodative for consumers into 2024.  

Data unaudited and as of 2/26/2024. All comments and discussions presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses. 

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