While US equity prices push ebulliently towards their next level of Nirvana, financial conditions continue to tighten for American businesses.
For the first time since April 2009, 3-month LIBOR - one of the most important reference rates for business financing - topped 1.00% today.
We documented the real world implications of this in "Forget The Fed’s 0.25%, Short-Term Rates Have Already Risen By 1% For The Real World"
While blowing out unsecured funding rates may no longer be a flashing red flag, a question has emerged as a lot of debt references Libor, debt ranging from household debt to non-financial business debt: some $28 trillion of it, to be specific, and just in the US. The question is just how concerned will the borrowers of said debt be once they get their next due balance.
Here is Goldman with the calculation:
Complete data on loan terms for all borrowers are not available, but we can make some rough approximations of the share indexed to LIBOR by combining a few datasets. For households, fixed-rate home mortgages account for the bulk of outstanding debt. Adjustable rate mortgages (ARMs)—which typically reference LIBOR—account for 20% of the value of loans outstanding and 15% of the value of new issuance, according to our mortgage strategy team. Additionally, ARMs are skewed toward higher dollar value loans, usually made to better credit quality borrowers (e.g. ARMs account for only 12% of the number of mortgage loans outstanding). Home equity lines of credit (HELOCs)—which account for 5-6% of household mortgage debt—typically reference the prime rate.
The remainder of consumer debt references a mix of benchmark rates. Government-provided student loans reference the 10-year Treasury yield (with infrequent resets), while private student loans frequently reference LIBOR. Interest rates on virtually all credit card debt are based off the prime rate, and auto loans are usually structured as fixed-rate term loans (with an average maturity of just over five years). Combined, the share of household liabilities referencing LIBOR likely ranges from 15% to as much as 20%, depending on how we classify loans in the “other” categories (Exhibit 1, left panel). In many of the loan categories there will be exceptions to norms, so this estimate should be considered only a rough approximation.
We find slightly higher numbers for the nonfinancial business sector (Exhibit 1, right panel). As of Q1 of this year, capital market borrowing accounted for 44% of business sector liabilities, with loans the remaining 56% (we exclude trade payables, taxes payable, FDI, and “miscellaneous liabilities” from the Flow of Funds Accounts’ definition of total liabilities). Although the Flow of Funds Accounts do not provide a detailed breakdown of these liabilities, we can make some rough inferences using the Fed’s Survey of Terms of Business Lending (STBL). According to this report, only about 13% of bank loans are now based off the prime rate—a fraction which has declined significantly over the last 20 years. Based on academic research which uses more detailed loan-level data, we assume the remaining loans typically use LIBOR as a benchmark. Construction and land development loans—a subset of commercial mortgages—are usually floating rate, and may be tied to LIBOR as well. Altogether, we estimate that roughly 25-30% of business lending is LIBOR-based.
The breakdown of nonfinancial debt referencing Libor is as follows: it amounts to just over $28 trillion, with trillions more added if one adds the financial Libor-referenced debt.
What is the real world implication of this? Simple: financial conditions are getting dramatically tighter, and just the recent spike in Libor rates across the curve, which amounts to roughly 50 bps for the 3M tenor, indicates that both households and businesses will have to pay up some $140 billion more, and substantially more if their contracts reference longer Libor maturities.
And while it means higher profits for the issuers of variable rate debt, it means less cash will be spent on discretionary purchases, something the Fed has been desperate to avoid by keeping rates near zero. In fact, the recent split between the Fed Funds rate and Libor suggests that the Fed's policy is now only partially operational. But what it certainly suggests is that, as noted earlier this week, "the US consumer that is acknowledged to be the last string the expansionary economy hangs by, has been dealt a de facto 1% tightening." That this is happening just as the consumer may be rolling over (according to BofA internal credit and debt card data), is a warning sign that the US economy, which in Q1 avoided a contraction only thanks to consumer spending, may be about to suffer an even greater slowdown once those who have Libor-tracking debt get their next payment invoice.