US recovery still in early stages

U.S. credit appears to be on the mend, but the recovery is still in its early stages. That is the key message of a report released today by TD Economics highlighting a number of positive developments in U.S. credit markets over recent months.

In October, responses to the Federal Reserve's Senior Loan Officer Survey showed that commercial banks' willingness to lend to consumers is hovering around its highest level in the last five years. The easing of credit standards has coincided with a drop in delinquency rates, signalling a general improvement in credit quality. Although delinquencies on real estate loans remain elevated, delinquencies on unsecured loans to consumers and businesses have seen a steady, downward trend since 2009.

"The improvement in credit quality is important," says TD Chief Economist Craig Alexander. "It could mark the beginning of a virtuous cycle where better credit quality leads to more credit growth and improved economic growth – which in turn feeds back into greater credit quality."

Developments in the market for unsecured credit – such as credit cards and student loans – do give particular cause for optimism. Unlike mortgage credit, which is secured by the value of a person's home, unsecured consumer credit is backed only by the lender's faith in the borrower's ability to repay. Unsecured lending seized up during the recession, falling 7.4 percent from its peak reached in 2008. However, the data suggests that unsecured lending is growing once again. Adjusted for charge-offs (a one-time hit that banks take on delinquent accounts that they deem unrecoverable), total consumer credit is up almost 3.0 percent from a year ago.

In general, the uptick in lending has important implications for the economic recovery. With banks more willing to lend, there are more resources available to finance investment projects that will boost output. Also, the expansion of credit, while raising the supply of money in the economy, will help counter the threat of deflation. This is particularly important because deflation erodes the value of earnings, making outstanding debt obligations more expensive to service.

Nevertheless, Alexander cautions that the picture is not all tea and crumpets. Some lenders are still reeling from a real estate mortgage delinquency rate that peaked around 10 percent during the recession – up from less than 2 percent earlier in the decade. Although the delinquency rate has inched down in recent quarters, it remains elevated by historical standards.

"Without a resolution in housing, improvement in other sectors of the economy can only push the gas pedal so far," Alexander concludes. "At the same time, the fact that credit quality is improving outside of mortgages shows that resolving issues in housing and commercial real estate could lead to a much faster pace of economic growth."

TD Economics provides analysis of global economic performance and forecasting, and is an affiliate of TD Bank, America's Most Convenient Bank®.

The complete findings of the TD Economics report are available online at http://www.td.com/economics/us.jsp under "Regular Publications."