My, How You’ve Grown!

Cause for Alarm?

Canadian consumer debt has been growing, and growing… and growing. With population growth and inflation, one expects the total dollar value of debt to rise over time, but the degree of indebtedness has also increased. Average Canadian household total debt to disposable income (TD/DI) reached an all-time high of 169%¹ at the end of 2016 (see exhibit 1), and is one of the highest in the world. This ratio is well above the U.S. peak reached just before the U.S. real estate bubble popped and triggered the credit crisis. Americans have been paying down debt ever since and the U.S. ratio is now 110%.

Ominously, Canadian real estate values fell only briefly in the credit crisis and have risen ever since. Unlike the U.S. housing bubble, when interest rates subsequently fell to soften the blow, interest rates in Canada are already at extraordinary lows. This combination of high consumer debt, housing bubble risk, and an expectation of interest rate increases is causing substantial angst among government, bankers, households and investors alike. This infographic-oriented article provides some background on this issue and Canadian households’ finances.

Household Net Worth

The TD/DI ratio is just one measure of indebtedness. It compares total household debt to annual household disposable income. Another measure of indebtedness, household total debt to total assets (TD/TA), is also shown in exhibit 1. Somewhat surprisingly, this ratio, at 16.6% at the end of 2016, is almost exactly the level it was back in 1990. Since then, TD/TA has ranged from a low of 13.8% (in 1997) to a high of 19.3% (at the worst point of the credit crisis in 2009, when asset market values were lowest).

An overview of the state of Canadian households’ finances is depicted in the net worth exhibits (2 & 3), which show household per capita total assets, total debt and net worth in 1990 and at the end of 2016.² These exhibits also show per capita disposable income and indicate how the indebtedness ratios are calculated. The final two exhibits (4&5) show the growth rate of disposable income (3.0% per year since 1990) and net worth (5.6% per year over the period).

Disposable income per capita growth, at 3.0%, has been decent and ahead of inflation over the same 1990 to 2016 period (1.8% per year). Household assets, debts, and, hence, net worth have each grown at a 5.6% annual rate since 1990 (with the result that the TD/TA ratio remained almost the same). The 5.6% growth in household net worth per capita is a great outcome. Yes, the TD/DI ratio has increased substantially, but interest rates and, hence, the carrying cost of this debt has fallen dramatically since 1990. One of the criticisms of the TD/TA ratio is that it is less stable than the TD/DI ratio (the market value of assets can decline suddenly in a tough economy while the amount of debt remains the same). Still, it provides perspective and the fact remains that, despite the worrisome debt levels, Canadians have become much wealthier over time.

Of note, the dollar figures shown are the average per capita for all households in the country. As always, the average can hide more than it reveals, as some people have substantial wealth and no debt while others are the opposite. If interest rates rise or some people lose their job, it’s the ability of each individual to meet his or her debt payment that counts – not the “average person”.

Cause for Celebration?

So far, so good for Canadian households. As we celebrate our 150^th this July 1^st, we are wealthier than ever before. Overall owners’ equity as a percentage of their owned real estate value is more than 74%, a remarkable level. This figure is aided by older homeowners with little or no mortgage debt and other homeowners who have owned their current homes for some time. It’s the younger, recent buyers that are debt heavy and more at risk, but even this may not be as bad as it seems. Many in this cohort could be “bailed out” by their parents if need be and eventually stand to inherit wealth. Tighter mortgage standards have been implemented to increase the likelihood that these recent homebuyers can still make their debt payments if interest rates rise. Today, with declining unemployment, low interest rates, and strong house prices, almost everyone is making their debt payments and growing their net worth. The unknown is how quickly this would change in a tougher economy. So, enjoy a toast on Canada Day to Canadians’ collective success in growing our net worth and hope that the trend continues!