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Canadian Household Finances: Return of the Profligate Sums?

By Douglas Porter and Benjamin Reitzes, BMO Canadian household finances have come under renewed scrutiny recently, with debt ratios rising to record highs once again, and the IMF and others firing off more warning flares on a hot housing market and t

By Douglas Porter and Benjamin Reitzes, BMO

Canadian household finances have come under renewed scrutiny recently, with debt ratios rising to record highs once again, and the IMF and others firing off more warning flares on a hot housing market and the build-up of personal debt. This is the thanks consumers get for responding predictably to the incentive of record-low interest rates, and effectively backstopping the economy for the past five years. But the Klieg-light focus on debt ignores, or at least overshadows, the other half of the balance sheet. While debt has been rising to record heights, so too have financial assets, helped by the massive rebound in equity markets and an underlying rise in savings. While there is plenty of room for improvement, especially on the savings front, these factors suggest that household finances are not nearly as weak as the dire headlines would suggest.

Today’s 2014 Q4 National Balance Sheet Accounts revealed that Canadian household debt has risen to 163% of disposable income, up from 162% a year ago. This will, no doubt, set more alarm bells ringing. But, we would make a few points before the typical rounds of lecturing and scolding begin. First, the widely-cited debt/income ratio is not entirely comparable with U.S. measures; adjusted to a like-for-like basis, Canada’s debt ratio is now 153% of disposable income, versus the 165% peak the U.S. hit last decade. Second, it is far from shocking that debt levels are at record highs when borrowing costs have sunk to record lows. And, third, again this measure only narrowly looks at one side of the balance sheet, and ignores the rapid rise on the asset side of the household ledger.

Canada’s savings rate has averaged 4% over the past year, in line with the 10- and 20-year trend. While this ratio has famously dropped below U.S. levels (where it has averaged 4.9% in each of the past two years), it simply does not give the full picture behind how much Canadians are socking away. The measured savings rate narrowly looks at how much households are saving from current income, and ignores unrealized capital gains as well as returns in tax-sheltered vehicles.

A more telling measure of savings (and how most Canadians would likely tally their own financial picture) would be to look at the change in household net financial assets as a share of disposable income. This imputed measure of savings has swung wildly over the years (from anywhere as high as +50% to as low as -50% in any given four-quarter period, so we smoothed it over a five-year period), but has averaged roughly double the published savings rate. Note that the smoothed imputed savings measure has rarely dropped below the published savings rate in the past 20 years.

In other words, take all cash, deposits, bonds, stocks, life insurance and pension assets and subtract household debt to derive net financial assets. These net assets have nearly doubled from the recession lows to $3.7 trillion by the end of Q4. For reference, that works out to $104,000 per Canadian, or 187% of GDP. We could also have taken into account non-financial assets, most notably real estate, which would have flattered the totals— total net household worth rose to an all-time high by the end of last year to $8.3 trillion, with assets running roughly 4.5 times greater than the $1.9 trillion in debt. Instead, we will focus primarily on financial assets given that real estate is a) illiquid; and, b) widely expected to correct at least modestly in the medium term (in the hottest markets).

The six-year recovery in stocks from the depths of early 2009 has played the leading role in the rebound in household net worth. This highlights the growing sensitivity (vulnerability?) of Canadian household finances to the equity market. The direct share of financial assets held in stocks has more than tripled in the past 25 years, from little more than 10% in the early 1990s to a record 38% in 2014. This towers above prior decades even with the impact of the two ferocious bear markets of 2000-02 and 2008-09. Moreover, equity markets also have a less direct impact on household net worth through life insurance & pension assets, which traditionally have been even larger than direct equity holdings by households. The strong recovery in household assets has even outpaced the growth in debt, by at least some measures.

For instance, one metric highlighted by former BoC Governor Carney in a 2010 speech was the debt-to-asset ratio; “despite the buoyancy of the housing market, the debt-to-asset ratio has risen to its highest level in more than 20 years”. Of course much of the deterioration in this ratio unfolded abruptly in late 2008 as global stocks plunged (and Canadian home prices softened), again highlighting the increased sensitivity of household finances to equity markets. But, since Carney’s warnings, the ratio has steadily worked its way down towards its long-term average. The flip side of the coin is that the absolute level of household net worth has been on a rising trend, and is now 7.4 times disposable income, up from an average of five times in the 1990s. So, while household debt has been growing more rapidly than household assets in percentage terms over the past 15 years, some of that reflects the skewering assets took in late 2008, and the fact remains that assets are again growing much faster than debt in absolute terms.

The Bottom Line: Concern over the potential for Canadian household debt to start flaring higher again was likely one reason the Bank of Canada kept its rate cut campaign to one insurance move. Record debt levels may also be playing a role in dampening consumer confidence and a somewhat more subdued outlook for consumer spending this year, as well as the mounting concern among Canadian and international policymakers. However, amid the cacophony of warnings, balance sheet repair is in fact quietly underway among Canadian households thanks to a slight rise in savings and long-term equity market gains.

While debt growth has perked up again, with the Bank of Canada’s surprise January rate cut adding fuel to the fire, the expected cooling in the housing market—at least in Alberta—should cap mortgage growth. No doubt, Canadian household finances are now vulnerable to a serious shock (such as a sudden back-up in interest rates and/or broader economic weakness), so any flattening in household debt growth would be welcome. Still, the singular focus on debt portrays an overly negative picture of Canadian household finances, which have proven incredibly resilient this cycle and likely still have enough cushion to provide a soft landing for spending in the year ahead.

Douglas Porter, CFA, is chief economist and Benjamin Reitzes is senior economist, BMO Capital Markets

This article printed courtesy of BMO Capital Markets .

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