July 23, 2014

Economics Group

Special Commentary

Eugenio J. Alemn, Senior Economist

eugenio.j.aleman@wellsfargo.com (704) 410-3273
Zachary Griffiths, Economic Analyst
zachary.griffiths@wellsfargo.com (704) 410-3284

Will Credit Help the U.S. Consumer in H2-2014?

Executive Summary
The recovery of the U.S. economy from the Great Recession has been a tough one, especially from
the labor point of view and from the performance of income. Much of the effort to consume has
come from the new jobs created in the economy and from a draw-down of accumulated savings
during the recession and weak recovery. Credit on the other hand, which has been fundamentally
a cyclical variable, has remained extremely weak during the recovery from the Great Recession.
In this report, we will look at the possibility that credit may start contributing a bit more to So far, the credit
economic growth through the lens of personal consumption expenditures (PCE) during the recovery has
second half of the year as there are indicators that could be pointing to some strengthening of been very
consumer credit during the past several months. Because we are examining the effect of consumer uneven across
credit on PCE, we are leaving out the mortgage market, as that plays into residential investment. loan types.
The Feds G19 report on consumer credit excludes mortgages and home equity loans, as does the
majority of our analysis. So far, the credit recovery has produced a very uneven performance with
nonrevolving credit (student and auto loans) growing, but revolving credit (credit card loans)
stagnating.
Having said this, consumer credit as a percent of disposable personal income is at an all-time high
(Figure 2), which could become an issue going forward, especially if interest rates start to
increase, as we expect, starting in the second half of 2015. On the other hand, however, we are
likely to see stronger income growth, which could keep this measure close to current levels.
Figure 1 Figure 2
Consumer Credit
Excludes Mortgages, Home Equity Loans & Auto Leases Consumer Credit
As a Percent of Disposable Personal Income
20% 20%
26% 26%

15% 15% 24% 24%

22% 22%
10% 10%

20% 20%

5% 5%
18% 18%

0% 0% 16% 16%

Consumer Credit as % of Disposable Income: May @ 24.8%

Year-over-Year Percent Change: May @ 6.6%
14% 14%
-5% -5% 90 92 94 96 98 00 02 04 06 08 10 12 14
62 66 70 74 78 82 86 90 94 98 02 06 10 14

Source: Federal Reserve Board, U.S. Department of Commerce and Wells Fargo Securities, LLC

Interest Rates Remain Supportive

For now, there are some indicators that could actually be pointing to a potential recovery in credit
and thus in personal consumption expenditures in the coming quarters. The most important of
these indicators is the debt service ratio, which is the amount of disposable personal income that

This report is available on wellsfargo.com/economics and on Bloomberg WFRE.

 Will Credit Help the U.S. Consumer in H2-2014? WELLS FARGO SECURITIES, LLC
July 23, 2014 ECONOMICS GROUP

households need to use to cover principal and interest payments on household debt. Today, that
number is at an all-time low of 9.9 percent. The debt service ratio is a cyclical series and when
troughs have been reached in the past, they are usually followed shortly after by periods of
leveraging, or an increase in the debt service ratio (Figure 3). While one of the main contributors
to the recent fall in debt payments by households is tighter credit standards following the Great
Recession, lower interest rates have also clearly contributed, as shown by the decline in personal
interest expense as a percent of disposable income (Figure 4). With the household debt service
ratio at an all-time low and personal interest expense also at historical lows, it seems that credit
growth could be poised for a comeback.
Figure 3 Figure 4
Household Debt Service Ratio
Debt Payments as a Percent of Disposable Personal Income Personal Interest Expense
13.5% 13.5% As a Percent of Disposable Income
3.5% 3.5%
DSR: Q1 @ 9.9%
13.0% 13.0%

12.5% 12.5%
3.0% 3.0%

12.0% 12.0%

11.5% 11.5% 2.5% 2.5%

11.0% 11.0%

10.5% 10.5% 2.0% 2.0%

10.0% 10.0%
Personal Interest Expense: May @ 2.0%
1.5% 1.5%
9.5% 9.5%
92 94 96 98 00 02 04 06 08 10 12 14
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

Source: Federal Reserve Board, U.S. Department of Commerce and Wells Fargo Securities, LLC

What Type of Credit Is Growing?

This recovery When looking at consumer credit broken out into two types, revolving and nonrevolving, this
has been a story recovery has been a story of growth in nonrevolving credit. During the recoveries from the
of growth in 1980-1981 and early 1990s recessions, credit growth was distinctly weighted on the revolving
nonrevolving credit side, likely as a result of the growing use of credit cards (Figure 5). During the previous
credit. expansion leading into the Great Recession, households increased their use of revolving credit,
however, not at nearly the rates seen in past expansions. Revolving consumer credit has barely
grown in this expansion and the level of revolving credit remains about 15 percent below the
previous peak, whereas non-revolving credit is 40 percent above the previous peak, which was
reached in July 2008 (Figure 6). Consumers seem very cautious about adding credit card debt
due to higher interest rates, and banks also have tighter lending standards.
Figure 5 Figure 6
Consumer Credit Total Level of Credit Outstanding
Year-over-Year Percent Change, 3-Month Moving Average Billions of USD
35% 35% $2500 $2500
Nonrevolving Credit: May @ 8.1% Nonrevolving: May @ $2,322,398
30% Revolving Credit: May @ 2.0% 30% Revolving: May @ $872,181

$2000 $2000
25% 25%

20% 20%
$1500 $1500
15% 15%

10% 10%
$1000 $1000
5% 5%

0% 0%
$500 $500

-5% -5%

-10% -10% $0 $0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

Source: Federal Reserve Board and Wells Fargo Securities, LLC

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Will Credit Help the U.S. Consumer in H2-2014? WELLS FARGO SECURITIES, LLC
July 23, 2014 ECONOMICS GROUP

Within the certain types of nonrevolving credit that consumers use, growth has been distinctly
concentrated in student loans and auto loans. The strong growth in auto loans seems to be driven
by a couple factors. First, growth in auto loans has been spurred by real demand in the economy
that was pent up during the downturn of the 2007-2009 recession. Consumers likely delayed
purchases during this time period, if not a bit longer. Over the past few years auto sales have
staged a strong comeback as consumers that held on to their vehicles for longer than they initially
intended returned to the market. This real demand in the economy is also being complemented by
the low-rate environment, as the current rate for a 48-month auto loan stands at 4.5 percent,
among the lowest ever seen. This has resulted in strong growth in auto sales, as the June figure
reached 16.9 million units on an annualized basis, the strongest reading since 2005. While this is
good for economic growth through personal consumption, we caution that this extended period of
low interest rates may be fostering artificially strong issuance of auto loans, which may prove to
be unsustainable. Auto loans outstanding are now 8.0 percent higher than they were when non-
revolving consumer credit peaked in Q3 2008 while total debt is actually down 8.1 percent over
that time period.
The other major driver of non-revolving credit, student loans, has become very large, reaching
more than $1 trillion in debt outstanding in recent months. At $1.11 trillion in Q1 2014, student Student loan
loan debt is now 82 percent higher than it was in Q3 2008. As previously mentioned, total debt outstanding
household debt is down 8.1 percent from that time, and student loan debt and auto loan debt are has recent
the only two categories that have grown during that time, with the decline in mortgage debt eclipsed
(down 12 percent), home equity revolving credit (down 24 percent), credit card debt (down $1 trillion, at
23 percent) and other consumer debt (down 24 percent) outweighing the growth contributions $1.11 trillion in
from these categories. The important difference between the growth in student loan debt and auto Q1 2014.
loan debt is that student loan debt is rising likely due to increases in costs for college, i.e., college
inflation, as well as due to the very difficult job market environment as many Americans are going
back to college because they cannot get a job in the post-Great Recession U.S. economy. The
average price of tuition, room and board for college education in private and public four-year
institutions has risen 23.6 percent and 37.5 percent, respectively, during the past 10 years.
Meanwhile, overall inflation, which includes college costs, has increased 25 percent during the
same period. Thus, while the price of tuition is rising, only public institutions actually are
outperforming the overall pace. The rapid growth in the amount of student loan debt may be
playing a role in the slow growth of revolving credit, as it may be crowding out other forms of
consumer borrowing.
Figure 7 Figure 8
Household Debt Non-Mortgage Household Debt
Year-over-Year Percent Change Percent of Non-Mortgage Debt Outstanding
45% 45% 40% 40%
Mortgage: Q1 @ 2.9%
40% Student Loans: Q1 @ 12.7% 40%
Credit Card: Q1 @ -0.2% 35% 35%
35% 35%

30% 30% 30% 30%

25% 25%
25% 25%
20% 20%

15% 15% 20% 20%

10% 10%
15% 15%
5% 5%

0% 0% 10% 10%
Student Loans: Q1 @ 37.5%
-5% -5%
Auto Loans: Q1 @ 29.6%
5% 5%
-10% -10% Credit Cards: Q1 @ 22.3%
Other: Q1 @ 10.6%
-15% -15% 0% 0%
03 04 05 06 07 08 09 10 11 12 13 14 03 04 05 06 07 08 09 10 11 12 13 14

Source: Federal Reserve Bank of New York and Wells Fargo Securities, LLC

How Worrisome Is the Growth in Non-Revolving Credit?

Probably anything that grows as fast as nonrevolving credit is growing today should ring alarm
bells across the credit world. As we said before, the two sectors that make up the strong growth in
novrevolving credit are auto loans and student loans. Furthermore, the fact that the loan

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Will Credit Help the U.S. Consumer in H2-2014? WELLS FARGO SECURITIES, LLC
July 23, 2014 ECONOMICS GROUP

delinquency rate for student loans is increasing also has called attention to the potential problems
within the student loan market. Student loan delinquencies are the only credit delinquency rate
that has seen increases since the end of the Great Recession. While this could be a consequence of
the still tough employment conditions in the U.S. economy, the fact that the unemployment rate
is so low for college graduates (although remains historically elevated) makes people wonder what
the reasons are for this increase. Presumably, if you have a college degree you will be employed
following the completion of your education and can pay back your student loan debt. However,
the amount of student loan debt that students are assuming these days has grown to levels that
may make it difficult for them to repay on time even if the individual obtains employment. Just
because a student graduates with a college degree does not necessarily mean the position he/she
ends up with pays well enough to pay the bills. Having said this, Figures 9 and 10 show that while
student loans delinquencies have increased, new seriously delinquent student loan balances,
which surged to almost 70 percent during 2012, have fallen considerably in 2013, which is an
encouraging fact amongst generally worrisome figures regarding student loan debt.
According to the Federal Reserve Bank of New York, student debt almost tripled between
Student debt 2004 and 2012 with a 70 percent increase in the number of borrowers as well as a 70 percent
almost tripled increase in the average balance per person during that period.1 This increase in the number of
between 2004 borrowers could be explained by the change in government policy toward higher education, which
and 2012. went from being grant-funded to student-loan funded during the past several decades. Thus,
there are good reasons for this growth in student loan debt.

Furthermore, and according to the report, the reasons for this growth in the number of borrowers
and in per-person debt include the following: more people attend college and graduate school;
parents take out student loans for their children; students stay longer in college and more often
attend graduate school; lower payment rates as borrowers delay payments through deferments
and forbearances; and discharging student debt is very difficult and the balance stays with the
borrower. Thus, it is clear that while college tuition inflation may be an issue, the increase in
student loan debt seems not only to be related to tuition inflation but also to more people
engaging in college studies than before, or at least using more student loans to finance those
studies.
Figure 9 Figure 10
Household Debt Delinquencies
Percent of Balance 90+ Days Past Due New Seriously Delinquent Balances
16% 16% Year-over-Year Percent Change
Credit Card: Q1 @ 8.5% 250% 250%
Other: Q1 @ 8.7% Mortgage: Q1 @ -17.7%
14% 14%
Student Loans: Q1 @ 11.0%
Student Loans: Q1 @ 13.3%
Mortgage: Q1 @ 3.7% 200% 200%
12% Auto: Q1 @ 3.3% 12%
HELOC: Q1 @ 3.4%
150% 150%
10% 10%

8% 8% 100% 100%

6% 6%
50% 50%

4% 4%
0% 0%
2% 2%

-50% -50%
0% 0%
04 05 06 07 08 09 10 11 12 13 14
03 04 05 06 07 08 09 10 11 12 13 14

Source: Federal Reserve Bank of New York and Wells Fargo Securities, LLC
The report also showed that, in 2005, 55.5 percent of student loan balances were less than
$10,000 while 29.8 percent of those loans were between $10,000 and $25,000. That is,
82.3 percent of all loans had balances of $25,000 or less. However, by the last quarter of 2012 the
picture had change considerably with 39.9 percent of loans having balances of $10,000 or less
and 29.8 percent of the loans holding balances of between $10,000 and $25,000. That is,

1Household Debt and Credit: Student Debt Donghoon Lee, February 28, 2013. Federal Reserve Bank of
New York.

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Will Credit Help the U.S. Consumer in H2-2014? WELLS FARGO SECURITIES, LLC
July 23, 2014 ECONOMICS GROUP

69.7 percent of all loans at the end of 2012 had a balance of $25,000 or less compared to
82.3 percent in 2005. Furthermore, the average student loan amount per person has increased to
almost $25,000 from a bit more than $15,000 back in 2004.
Probably the biggest issue for student loan holders is if that the failure to graduate from college
will impinge on their ability to get jobs and repay their loans. Furthermore, while having a college
degree is good for job and income prospects in the current economic environment compared to
those that do not have a college degree, having the diploma is not a panacea and is not the only
alternative for those who are having issues getting a job in this economy. Technical training,
computer training, etc., are cheaper alternatives that could land jobs.
It is difficult to know if this growth in student loans could be the next bubble to burst. However,
when people compare student loan growth to mortgage loan growth pre-Great Recession, the
comparison does not seem correct on several grounds. First, home prices dropped about When people
40 percent during the bursting of the housing bubble nationwide. How much could knowledge compare student
acquired through education drop during a recession? We always hear that discharging student loan growth to
debt is very difficult and the balance stays with the borrower. The same thing happens with mortgage loan
acquired knowledge. Education stays with you and does not depreciate, or at least will probably growth pre-
not depreciate as much as home prices did during the Great Recession. Second, spending in Great Recession,
education is an investment in the persons future ability to generate income. This future ability to the comparison
generate income cannot be flipped, transferred or sold as was the case with many homebuyers does not seem
during the housing bubble. Thus, you cannot buy your education and then sell it for a higher price correct on
and then buy another education and sell it for a higher price and pocket the difference. several grounds.
If the U.S. labor market continues to improve and the unemployment rate continues to decline,
the prospects for income growth will improve as will the prospects for students. The biggest risk
will be to those individuals who have student loans but never graduate with a college degree and
therefore cannot earn higher incomes in the future. At the same time, because the federal
government guarantees student loans, an even higher delinquency rate could mean higher fiscal
costs for the government in the future even if, as we said before, student loans are very difficult to
discharge.
Conclusion
The U.S. consumer has had a difficult time recovering its pre-Great Recession mojo. Growth in
employment, income and credit have been very slow coming out of the Great Recession. Today,
out of these three components employment looks the most promising and with employment
comes income and credit. We still have not seen much from income, but we are starting to see
some positive signs from credit, especially revolving credit, which has been the life line of U.S.
consumers since credit cards were introduced.
So far, U.S. consumers have chosen credit very strategically. Only two credit instruments have
been chosen: auto loans and student loans, or what is called non-revolving credit. This credit
segment has increased considerably and is responsible for most of the increase in credit since the
end of the Great Recession. However, we have started to see some small but positive signs that
credit card lending/borrowing is starting to thaw, which should help U.S. consumers during the
second half of the year. The prospects for credit card lending/borrowing will become more upbeat
if employment and consumer confidence continue to improve during the rest of the year, as we
expect. The only missing link, which will help in the recovery of consumer credit, will be stronger
income growth that continues to lag but is expected to start improving as the unemployment rate
continues to fall.
Thus, we remain cautiously optimistic on the outlook for consumer spending for the second half
of 2014.

5
Wells Fargo Securities, LLC Economics Group

Diane Schumaker-Krieg Global Head of Research, (704) 410-1801 diane.schumaker@wellsfargo.com

Economics & Strategy (212) 214-5070
John E. Silvia, Ph.D. Chief Economist (704) 410-3275 john.silvia@wellsfargo.com
Mark Vitner Senior Economist (704) 410-3277 mark.vitner@wellsfargo.com
Jay H. Bryson, Ph.D. Global Economist (704) 410-3274 jay.bryson@wellsfargo.com
Sam Bullard Senior Economist (704) 410-3280 sam.bullard@wellsfargo.com
Nick Bennenbroek Currency Strategist (212) 214-5636 nicholas.bennenbroek@wellsfargo.com
Eugenio J. Alemn, Ph.D. Senior Economist (704) 410-3273 eugenio.j.aleman@wellsfargo.com
Anika R. Khan Senior Economist (704) 410-3271 anika.khan@wellsfargo.com
Azhar Iqbal Econometrician (704) 410-3270 azhar.iqbal@wellsfargo.com
Tim Quinlan Economist (704) 410-3283 tim.quinlan@wellsfargo.com
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Sarah Watt House Economist (704) 410-3282 sarah.house@wellsfargo.com
Michael A. Brown Economist (704) 410-3278 michael.a.brown@wellsfargo.com
Michael T. Wolf Economist (704) 410-3286 michael.t.wolf@wellsfargo.com
Zachary Griffiths Economic Analyst (704) 410-3284 zachary.griffiths@wellsfargo.com
Mackenzie Miller Economic Analyst (704) 410-3358 mackenzie.miller@wellsfargo.com
Donna LaFleur Executive Assistant (704) 410-3279 donna.lafleur@wellsfargo.com
Cyndi Burris Senior Admin. Assistant (704) 410-3272 cyndi.burris@wellsfargo.com

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