Key Takeaways
- The Financial Fragility Indicator (FFI) weakened to -1.34 in March from -1.83 at the end of 2021. It's still below its historical average, suggesting near-term risks are modest, but as the Fed aggressively tightens policy through mid-2023, conditions will likely worsen.
- The nonfinancial corporate sector saw the biggest jump into riskier territory--the FFI was -0.92 in first-quarter 2022, almost half its reading of -1.52 in the previous quarter.
- All leverage indicators in the first quarter of 2022 worsened from the prior quarter, in terms of annual growth rates. Liquidity conditions for the nonfinancial corporate sector also became more stressful, as the ratio of liquid assets to short-term debt dropped to 90.1% from 99.2%.
The Financial Fragility Indicator has continued to weaken this year, to -1.34 in March from -1.83 at the end of 2021 (see chart 1). It's still below its historical average, suggesting near-term risks are modest, but with the Fed aggressively tightening monetary policy through mid-2023, financial conditions may be at an inflection point.
Both the household and nonfinancial corporate sectors contributed to the worsening financial fragility, with nonfinancial corporates seeing the biggest jump into riskier territory. By type of risks, leverage and liquidity for both nonfinancial corporates and households went up.
Chart 1
Nonfinancial Corporates
The Financial Fragility Indicator (FFI) of the U.S. nonfinancial corporate sector shot up to -0.92 in first-quarter 2022, almost half its reading of -1.52 in the previous quarter, and now within its one-standard-deviation band for the first time since first-quarter 2021 (see chart 2). Higher leverage risk and liquidity risk were the main factors behind the increase in financial fragility.
Chart 2
Leverage Risk
All leverage indicators in the first quarter of 2022 worsened from the last quarter, in terms of annual growth rates. Although the interest coverage ratio went up to 8.62 from 8.37 in the fourth quarter, its year-over-year growth rate declined, increasing leverage risk. The net debt-to-EBIT ratio also worsened, to 2.31 from 2.17, pointing to higher leverage. The debt-to-asset ratio edged up a bit to 22.4% from 22.1%.
Liquidity Risk
Liquidity conditions for the nonfinancial corporate sector also became more stressful in the first quarter, as the ratio of liquid assets to short-term debt dropped to 90.1% from 99.2% in the previous quarter. Short-term debt accounted for a larger share of total debt, at 31.4%, higher than 30.3% in the previous quarter, which increases company exposure to higher interest rates down the road.
Composite And Indirect Indicators
While the return-to-asset ratio inched up to 3.2% from 3.1%, its year-over-year growth rate came down from the previous quarter, raising the FFI. The market-to-book ratio fell sharply to 1.60 in first-quarter 2022 from 1.72 the previous quarter as the stock market collapsed, also pushing the FFI up. As U.S. stocks' descent worsened through the month (a bear market was confirmed in mid-June), the market-to-book ratio we track will only look worse in our next Financial Fragility report.
Lower growth rates of the return-to-asset and market-to-book ratios indirectly indicate higher financial fragility that may have come from liquidity or solvency, according to their positive correlations with liquidity and solvency indicators.
Households
The FFI for U.S. households also weakened, to -1.75 from -2.15 in the first quarter of 2022 (see chart 3), with leverage, liquidity, and net worth declining, according to the Fed's latest Financial Accounts release. That said, all the financial indicators remained at healthy levels, indicating households' balance sheets are still strong. But while, in aggregate, households still have cushion to absorb the back-to-back shocks, higher prices, and interest rates, we can't ignore that lower-income households, with less savings cushion, are in relatively worse shape.
Chart 3
Leverage Risk
U.S. households faced higher leverage risks in the beginning of 2022 compared with the end of last year. The debt-to-disposable personal income ratio went up to 1.02 from 1.00, while the charge-off rate on consumer loans rose for the first time since second-quarter 2020, to 0.95% from 0.94% in the prior quarter. The loan-to-value ratio declined to 27.7% from 28.3%, but at a slower annual rate than in the previous quarter, weighing on financial fragility. Finally, debt service ratio etched up marginally from 9.3% at the end of 2021 to 9.5%. Growth in consumer loans affected debt service by a greater margin than mortgage servicing. Despite the slight worsening in leverage, all leverage indicators stayed at multidecade lows.
Liquidity Risk
Liquidity worsened a bit as the ratio of liquid assets to short-term liabilities declined to 10.32 in the first quarter of 2022 from 10.76 in the previous quarter, but it was still at historical highs. Short-term debt as a percentage of total debt was 33.1%, almost unchanged from 33.3% in the previous quarter.
Wealth Effect
The net worth-to-debt ratio declined to 8.01 in the first quarter of 2022, from 8.16 in the previous quarter--its first drop since first-quarter 2020--as households took a major hit from the stock market slide. That said, net worth to debt is still near an all-time high, indicating healthy balance sheet conditions despite the slight worsening in the first quarter of 2022.
More On The Indicator
The Financial Fragility Indicator is a weighted average of indicators that reflect the financial fragility of corporates and households from different perspectives. We use principal component analysis to construct the indicator. The Financial Fragility Indicator includes not only the individual indicators at present but also their recent history to account for the possibility that financial risk may take time to mature and affect the economy. Zero represents sector financial vulnerability at historical average levels, positive values indicate higher vulnerability compared with history, and negative values indicate lower-than-historical average vulnerability. For more information on how we construct the financial fragility index, see "Economic Research: The Financial Fragility Of U.S. Households And Businesses Hit A Decade Low In The First Quarter," published July 30, 2021.
The views expressed here are the independent opinions of S&P Global's economics group, which is separate from, but provides forecasts and other input to, S&P Global Ratings' analysts. The economic views herein may be incorporated into S&P Global Ratings' credit ratings; however, credit ratings are determined and assigned by ratings committees, exercising analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.
This report does not constitute a rating action.
| U.S. Chief Economist: | Beth Ann Bovino, New York + 1 (212) 438 1652; bethann.bovino@spglobal.com |
| Contributors: | Joseph Arthur |
| Shuyang Wu, Beijing |
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