Don’t be so sensitive
January 2020
WHAT’S INSIDE:
We have a look at the drivers behind the increase in Canadian household debt (thanks housing market) and suggest Canadians are more rate sensitive than ever
Disposable income going to service debt is above levels last seen during the financial crisis
Over the past 2 years, debt service costs rose at a rate of 2x disposable income growth
Consumer bankruptcy proposals are up 15% year over year, thanks largely to the cost of debt
INTEREST RATE CHANGES MATTER MORE THAN EVER
We are joining the masses and beating the proverbial dead horse on the long-term implications of Canadians’ love affair with cheap debt. Much has been said lately on the rising number of consumer bankruptcies, but what leaves us scratching our heads is the fact that outside of the energy-dependent provinces (we know who we are), the Canadian economy is operating with a full head of steam. So what gives? Based on our analysis, fixed cost inflation combined with debt service costs is massively outpacing income growth. It seems Canadians are getting squeezed from both ends with disposable income to service debt shrinking while the call from the bank grows louder.
Historically speaking, borrowing rates are still very low but given the rising debt loads, Canadians are significantly more sensitive to changing interest rates. It seems the lag effect of the increase in interest rates we saw starting in July 2017 is a key driver behind the recent increase in consumer bankruptcies. This makes for an interesting setup in 2020 as the Bank of Canada looks to balance a feverishly hot housing market with knowledge that a rate hike has more rippling implications than ever before. For those keeping score, the first BoC rate decision of 2020 is tomorrow (January 22nd), with no changes expected.
Growth rates of Canadian Credit Since 2014
HOUSING MARKET LARGELY TO BLAME FOR THE INCREASE IN CONSUMER DEBT
The main driver of the rise in household consumer debt looks to be the housing market as total Canadian debt outstanding for residential mortgages (uninsured) has increased 48% since the beginning of 2017. This compares to a 15% increase in non-mortgage loans and consumer credit.
Of the roughly 10 million homeowners in Canada, 10% tapped into their home equity resulting in Home Equity Lines of Credit (HELOC) increasing over $34 Billion in 2018. 23% of those who took equity out of their home used it for debt repayment/consolidation.
The back half of 2019 saw consumer bankruptcy proposals increase over 15% from the previous year. Of those consumers that filed for bankruptcy, over 90% do not own a home (are renting) as homeowners are tapping into their equity in order to avoid filing for bankruptcy.
Disposable Income to Service Debt
RATIO IS ABOVE LAST RECESSION LEVELS
The proportion of disposable income going to service debt is now at 15%, the highest level since Canada’s last recession.
Income to service debt increased materially once the Bank of Canada began increasing borrowing rates in Q3/2017.
Debt service costs have continued to increase despite flat Bank of Canada rates since October 2018.
Income Growth and Cost of Living
DEBT SERVICE COST GROWING TWO TIMES FASTER THAN INCOME GROWTH
Over the past 2 years, average disposable income is up 8% across Canada.
Debt services costs are up 16% over the same time period while fixed costs like transportation and food expenses were up 6% each.
Debt service costs are continuing to eat a bigger piece of the pie.
Bank of Canada Rates and Posted Mortgage Rates
From a historical perspective lending rates are incredibly cheap but as Canadians continue to pile on debt, interest rate sensitivity has increased materially.
Bankrupcy proposals are a leading indicator
Bankruptcies tend to garner all of the attention but we like to track proposals as they serve as a leading indicator on filings
2019 has seen over a 15% increase in bankruptcy proposals over 2018, a number many expect to grow
National and Consumer Debt Levels vs Income
Despite flatish recent levels, consumer credit debt to annual income ratio remains extremely elevated
On average, Canadians have outstanding debt equal to ~175% annual income
Consumers Cost to Borrow
There is a reason Canadian homeowners have gone to their house for a loan – it’s the cheapest source
Interesting to see a 5% uptick in total outstanding Personal Lines of Credit over the past year
HANG ON TO YOUR HAT - THERE IS ONLY ONE WAY THIS ENDS
Canadian and American household debt ratios were tracking in sync up to the financial crisis in 2008, which is when Americans de-levered. We are nervous that cracks are starting to show on the Canadian side as debt ratios march higher and consumers are feeling the squeeze. Increases in disposable income is no longer enough to offset inflation in fixed expenditures like food, shelter clothing AND debt service costs, which are rising at twice the income rate. It appears the Bank of Canada is in a tough spot as consumer debt levels limit the ability to raise rates, while the housing market is the main contributor to those elevated levels. At some point the music will stop, let’s just hope we have some chairs to sit down on.
Sources: Statistics Canada, Diamond Willow Advisory, Mortgage Professionals Canada, Company reports, Government of Canada.
