Focus
January 26, 2024 | 13:20
How Fragile are Canadian Household Finances?
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
How Fragile are Canadian Household Finances?With the economy flirting with recession and families facing higher mortgage costs, Canadian household finances are being put to the test. How well families cope will affect both lenders and the odds of a harder landing. |
|
Two symptoms of financial stress are weak spending and low confidence. According to the Conference Board, consumer sentiment plumbed its second lowest level in the past two decades in November, surpassed only by the pandemic shutdown. Feeling more depressed than in the Great Recession, shoppers are pulling back. Real consumer spending slowed to +1.5% y/y in the third quarter, about half the two-decade mean (Chart 1). Worse, it came to a virtual halt in the summer and fall, where it will likely remain this winter. Here’s our assessment of five potential causes of financial stress: |
1. Income: Income is the backbone of spending and debt repayment. If people are working and earning a decent wage, they will pay their bills. On the surface, household income looks healthy. Propelled by sturdy job and wage gains, it rose 7.9% y/y in 2023Q3, faster than the two-decade mean (4.6%, Chart 2). But things look darker under the hood. High and rising taxes have chopped disposable income growth to 5.1%, though this is still above normal (4.5%). Much of the increase reflects torrid population growth. Per capita disposable income is up a modest 2.0%, or less than normal (3.3%). In addition, although inflation has fallen, it’s still gobbling up spending power. Per capita real disposable income fell 1.6% in the past year, compared with a normal increase of 1.2%. Lower-income workers are notably vulnerable, as the bottom-income quintile is the only group to post an outright decline in disposable income in the past year. For these reasons, the income category warrants an X mark. 2. Savings: After borrowing to the hilt and saving very little prior to the pandemic, households have become virtual misers, first due to the shutdowns and then to soaring interest rates (Chart 3). As a result, many are sitting on a stockpile of funds that could be used for debt servicing. Assuming a ‘normal’ savings rate of 5.5% (the long-run median), households may have squirreled away roughly $180 billion of extra savings since the start of the pandemic. That’s a thick cushion (equal to 12% of disposable income) to support debt payments for years to come. Much of the excess savings is still parked in bank personal deposits, which rose $403 billion from February 2020 to October 2023 (or 38%), compared with $182 billion (20%) in the prior 44-month period, an excess of $221 billion. However, upper-income households hold the bulk of savings, as the average net savings of the two bottom-income quintiles actually shrank in recent years. Still, the savings category warrants a qualified ✓ mark. 3. Wealth: Household wealth has fallen 4% from the record high set at the peak of the housing bubble in early 2022 to the third quarter of 2023, largely due to a 13% slide in home prices and sagging financial markets (Chart 4). Still, at over $16 trillion, net worth towers 31% above pre-pandemic levels, and the recent stock market rally points to an upturn. Moreover, all income groups registered wealth gains between 2019Q4 and 2023Q3, with the bottom-income quintile actually seeing the largest percentage increase (51%), though its share remains low at less than 8%. Households with substantial assets are in a better position to pay down debt. In fact, relative to financial assets, the debt ratio is no higher now than prior to the Great Recession. All in, the wealth category deserves a big ✓ mark. 4. Debt: Household credit peaked at 186% of disposable income in late 2021, before easing to 182% in 2023Q3 (Chart 5). While the ratio has risen twelve percentage points from a decade ago, it has largely stabilized since 2017. It should also decline further as credit is growing the slowest on record (back to 1990), at just 3.1% y/y in November. However, younger and lower-income families are getting pinched. The bottom-income quintile had the highest debt ratio (317%) in 2023Q3 and posted the biggest increase (35 ppts) in the past decade. Meantime, 45-to-54 year olds racked up the most debt during this period (62 ppts to 244%), climbing an ever-costlier housing ladder. Relative to financial assets, younger families have the highest debt burdens. The household debt service ratio hit a record high (back to 1990) of 15.2% of disposable income in 2023Q3, up 1.4 ppts from a decade ago and two percentage points above the long-run mean. Mortgage payments, which account for just over half of the ratio, rose $23 billion (19%) in the past year. That’s equivalent to 1.4% of disposable income, concentrated among the 36% of households with a mortgage. A survey by the Canada Mortgage and Housing Corporation found that nearly half of borrowers are adjusting their budgets due to higher mortgage payments. The CMHC estimates that about 2.2 million mortgages (or nearly half) will reset higher in 2024 and 2025. The typical payment could rise about 34% by 2027, according to the Bank of Canada, putting a further dent in spending power of just under 1%. Moreover, due to poor affordability, today’s home buyers are taking on larger debt burdens. The share of new mortgages with a debt-service ratio of at least 25% of disposable income has shot up to 34% in 2023Q3 from just 16% before the pandemic, according to the Bank of Canada. No surprise here, the debt category warrants a large X mark. 5. Delinquencies: Personal insolvencies rose 24% y/y in November 2023, returning to pre-pandemic levels (Chart 6). The rise was driven by proposals to change original payment conditions. By contrast, bankruptcies remain extremely low (unlike for businesses, but that’s a story for another day). According to the Bank of Canada, the share of indebted households at least 60 days behind on overall loan payments was just 2.2% in 2023Q3, actually a little lower than before the pandemic and little changed since 2015. For residential mortgages, the 0.2% rate of delinquencies (of three months or more) in October 2023 is half the long-run median. While some further increase in insolvencies is likely in the current weak economic climate, the delinquency category warrants a neutral mark (though close monitoring). |
|
Bottom Line: High debts and weak spending power suggest Canadian household finances are more fragile than usual, leaving many families vulnerable to high interest rates and potential job losses, and likely to continue cutting back on discretionary purchases at the very least. Lower-income households, with limited savings and substantial debt relative to income, are especially at risk. However, high levels of wealth and savings are likely to shield most families from financial difficulty, barring a worse economic storm. |