Higher for Longer Rates Mean No Escape From the Debt Squeeze

Earlier this month, New Zealand’s Fletcher Building Ltd. lowered earnings guidance because of a slowdown in its main housing markets. As consumers cut back, American Airlines Group Inc. and Ryanair Holdings Plc both said in recent weeks that they misjudged demand.

Bank of Montreal shares plunged on loan-loss concerns, prompting analysts at Scotiabank to respond that “the ‘higher-for-longer’ rate scenario is a reality.” It “appears to be impacting credit performance” more than analysts or management expected, they said.

From weekly shopping to mortgages and big deals in the world of finance, there are examples around the world of the pressures from higher borrowing costs.

US

Credit card rates and a rise in debt levels have emerged as a soft spot for the world’s biggest economy, with younger people in particular feeling the pain.

For Gen Z, almost one in seven are maxing out their credit cards every month to cope with the rise in living standards, according to a study by officials at the Federal Reserve Bank of New York. On top of that, there are fears that the rise of Buy Now Pay Later is masking the full extent of consumer distress.

On the mortgage side, households are largely insulated after locking in low fixed rates, but many families are at the edge. US consumers have added $3.4 trillion in debt since the pandemic, and much of that is subject to higher interest rates. As of March, 3.2% of outstanding debt was in some stage of delinquency. That’s 1.5 percentage points lower than the fourth quarter of 2019, but it’s ticking up, particularly for credit cards.

In response, there are signs that consumers are watching budgets more carefully. At Target Corp., one of the largest US retailers, comparable sales have fallen for four straight quarters and the company responded by saying it would cut prices on about 5,000 frequently shopped groceries and other essentials.

“The consumer is under pressure, especially the lower-income households,” Melanie Boulden, chief growth officer at Tyson Foods Inc., said on a conference call in May. Elevated inflation has made people “more cautious, price-sensitive.”

The pain comes after households exhausted pandemic-era savings, hurting subprime borrowers in particular. In subprime auto asset-backed securities, there’s been a general deterioration in performance, but 60+ day delinquency rates are especially high for deals done in 2022, the year after stimulus checks ended, according to Fitch Ratings. Some lenders have tightened underwriting standards in response.

Canada

Record low borrowing costs helped drive one of the world’s biggest housing booms. Now persistently higher ones threaten a lengthy hangover.

During the pandemic, emergency rates spurred an unprecedented home buying frenzy, while at the same time luring existing mortgage borrowers to take advantage by refinancing. But because almost all Canadian home loans must be renegotiated every five years, an estimated 76% of outstanding mortgages will come up for renewal by 2026.

That will take a bite out of household budgets. And Canadians could already be facing the largest drop in living standards in about 40 years as income declines that began in the second quarter of 2019 continue, according to the Fraser Institute, a think tank.

Particularly exposed will be mortgages with a variable rate but fixed monthly payments. Borrowers who took these types of loans when rates were at their lowest in February 2022 could see their monthly payments rise 54% by 2027, according to a study last year from the central bank.

UK

Debt-fueled private equity deals are in focus in the UK, where the Bank of England is reviewing the dangers posed by higher borrowing costs. It will publish an assessment in June amid concerns about the risk the industry poses to the financial system.

The analysis comes after private equity managers snapped up British companies in the aftermath of the Brexit vote, paying for them with huge amounts of floating-rate debt because credit was so cheap. They’ve since been hurt by the surge in borrowing costs after monetary policy tightened.

Many of the businesses acquired by PE firms were in the consumer sector, an industry whose customers have been hit hard by inflation. Retail sales volumes have been on a downward trend for almost two years and are below their pre-pandemic level.

For PE funds, interest rate increases have also made it harder to raise investment, putting downward pressure on asset values, the BOE said in March, adding that default rates on debt linked to PE firms have increased.

“The complexity and interconnectedness of the sector make assessing financial stability risks difficult and mean that risks need to be managed carefully,” it said.

Australia

In Australia, one in 13 hospitality business could fail over the coming year, the highest rate since 2019, according to financial data provider CreditorWatch Pty Ltd., as downbeat sentiment and high interest rates hurt the industry.

Discretionary spending has been shrinking, in part because more than 80% of home loans in Australia have variable rates that move largely in line with central bank levels.

With household debt at 185% of income, each of the Reserve Bank’s rate hikes has ratcheted up the pain on property owners, leaving them with less money for meals out and leisure activities. Median rents have also soared to a record, hurting those who missed out on the real estate boom.

“The outlook for hospitality businesses is not likely to improve until we see a lift in consumer spending. And that is not going to happen until the impacts of one or two rate cuts filter through to households,” said Patrick Coghlan, chief executive officer at CreditorWatch. “We don’t anticipate that being felt until at least the second half of next year.”

While hospitality is the industry most vulnerable to a consumer pullback, there are also signs of wider troubles. Business-to-business payment defaults are at a record high after rising almost 70% year-on-year as firms struggle to pay their invoices, CreditorWatch’s data shows.

Brazil

The number of Brazilian agricultural growers filing for bankruptcy protection surged sixfold in 2023, according to credit data provider Serasa Experian, an alarming rate in a country where agribusiness has been expanding rapidly.

That risks hurting retail investors who invested in Fiagros, funds that provide credit to the growers, on the promise of high returns and exposure to the fastest-growing sector of the economy. The money raised was used to fund a boom in output, but a drop in crop prices means farmers are falling behind on their payments.

Retailers are also struggling, with many burdened with floating-rate borrowings they took on when interest rates were low. To boost sales, some businesses also extended credit to their customers, who are now struggling to repay the money.

President Luiz Inacio Lula da Silva has already rolled out a program that refinanced about 53 billion reais ($10.2 billion) in loans for more than 15 million indebted households. The government also capped interest rates for revolving loans, in a country where credit card companies were previously charging as much as 454% in interest annually.

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