Key Takeaways
- As financial conditions worsened throughout 2022, so did the Financial Fragility Indicator (FFI). Its fourth-quarter 2022 reading (1.10) was its highest since the 2008-2009 financial crisis, signaling the increasingly vulnerable state of private-sector balance sheets, particularly those of U.S. nonfinancial corporates.
- The FFI for nonfinancial corporates surged to 1.25 during the fourth quarter, as higher leverage and liquidity risk continued to fuel the indicator's rise.
- The FFI for households also jumped, but a healthy jobs market and nominal wage gains were still helping households withstand inflation and higher interest rates.
The Financial Fragility Indicator (FFI) deteriorated in fourth-quarter 2022 to its highest level since the global financial crisis as higher prices and interest rates damaged private-sector balance sheets. After crossing the zero line--its historical average--in third-quarter 2022, the FFI reached 1.10 in the fourth quarter (that is, 1.10 standard deviations above its mean), indicating the vulnerability of the U.S. private sector (see chart 1).
Financial conditions are likely to weaken further, both because monetary policy works with a lag, and because the economy will continue to slow down amid ongoing stress in the banking sector. We expect U.S. GDP to decline by 0.3 percentage points from its peak in first-quarter 2023 to its third-quarter trough. Such a recession would be the shallowest going back to 1960.
Both the household sector and the nonfinancial corporate sector experienced deteriorating financial conditions in fourth-quarter 2022. The FFI for the nonfinancial corporate sector crossed the one-standard-deviation threshold (the upper bound) into vulnerability territory (see chart 2). The household FFI also rose, but it remained below its vulnerability threshold.
Chart 1
Nonfinancial Corporates
The FFI for the U.S. nonfinancial corporate sector surged over 33% in the fourth quarter to 1.25--the highest reading since June 2009. (It was 0.93 in the third quarter.) Higher leverage and liquidity risk fueled the jump, primarily as short-term debt (which must be refinanced at potentially higher interest rates) rose and as market value declined while the stock market turned bearish.
At the same time, businesses have been increasingly less able to pass costs through to consumers while more people shop for value and trade down for cheaper substitutes. Business demand for workers has remained hot, which has pushed the cost of labor higher. And rising costs overall have weighed on corporates' profitability, which inevitably pushed their interest coverage ratios higher, as well.
Chart 2
Leverage risk
Leverage indicators in the fourth quarter worsened from the quarter before. The exception was the interest coverage ratio, which increased to 10.1%, better than its previous high of 9.7% at the end of September 2022. As a result of increased leverage, net debt to EBIT worsened to 2.7x--its highest level since the summer of 2020--from 2.61x in the previous quarter, while the debt-to-asset ratio dipped modestly from the quarter before, to 22.4%.
Liquidity risk
Liquidity conditions for nonfinancial corporate entities improved slightly in the fourth quarter, with the ratio of liquid assets to short-term debt inching up to 75.9% from a four-year low of 73.6% in the previous quarter. U.S. companies are increasingly facing liquidity risk as interest rates rise. Meanwhile, short-term debt as a share of total debt widened in the fourth quarter to 33.0% from 32.7% in the previous quarter.
Other composite and indirect indicators
The return-to-asset ratio edged lower in the fourth quarter to 3.3% from 3.6%, further signaling the rising financial vulnerability of nonfinancial corporates. The market-to-book ratio, however, remained steady at 1.28 from the previous quarter, pushing the FFI higher as the average net worth of corporates declined.
Households
The FFI of U.S. households jumped to 0.84 in the fourth quarter--its highest level since March 2008--from 0.51 in the previous quarter (see chart 3). Leverage, liquidity, and net worth showed signs of deterioration. Balance sheets were solid through the first half of 2022, but they have weakened since because of higher interest rates and elevated inflation. The household FFI stayed just below the upper bound, however, helped by a still-tight jobs market with year-over-year wage gains, in nominal terms.
Chart 3
Leverage risk
The debt-to-disposable personal income ratio inched lower in the fourth quarter, to 1.01, but it was also up 1.3% year over year. The charge-off rate on consumer loans continued to climb, reaching 1.7% in the fourth quarter, while the loan-to-value ratio edged higher by 40 basis points, to 26.7%.
At the same time, the debt service ratio remained steady in the fourth quarter, at 9.7%. The ratio is up from its all-time low of 8.5% in first-quarter 2021, and it's in line with the 9.7% reading from first-quarter 2020. Overall household debt climbed in fourth-quarter 2022 by $394 billion (or 2.4%) to $16.9 trillion, a multidecade high, on increases in mortgage, credit card, and auto loans. Mortgage loans accounted for over 64% of total debt, down from 80% in the previous quarter.
About $254 billion in debt was issued in the fourth quarter, down from $282 billion in the third quarter. Notably, credit card loans jumped to $61 billion, the highest since the second quarter of 2003--a sign that higher interest rates and elevated inflation are fueling U.S. households' credit card debt.
Liquidity risk
On a positive note, the ratio of liquid assets to short-term liabilities edged higher to 9.2--the highest reading since the first quarter of 2022--after falling to 8.8 in the previous quarter. Short-term debt as a percentage of total debt inched down to 32.9% from 33.1% in the quarter before.
Wealth effect
The household net worth-to-debt ratio rebounded to 7.62 at the end of December 2022 after falling in each of the previous two quarters. The stock market's recovery from its second- and third-quarter freefall largely offset the rising debt levels. Even though household net worth took a hit because of the bearish equity market, it remained well above its long-term average, suggesting that households' balance sheets are still healthy.
Moreover, while average cumulative household savings have declined since 2021--when they were $2.5 trillion above 2019 levels--they're still about $1 trillion above the 2019 amount. With help from a still-healthy jobs market that is keeping wages elevated, households have a cushion of significant excess savings that is being depleted--but slowly.
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 Indicator, see "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 Ratings' economics group, which is separate from but provides forecasts and other input to S&P Global Ratings' analysts. S&P Global Ratings' analysts use these views in determining and assigning credit ratings in ratings committees, which exercise 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 |
| Research Contributor: | Debabrata Das, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Mumbai |
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