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Special Report Is Canada’s household leverage too high — or on the low side? Economics and Strategy January 11, 2018
Special ReportIs Canada’s household leverage too high — or on the low side?
Economics and Strategy
January 11, 2018
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Special Report
January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
Is Canada’s household leverage too high — or on the low side?Household debt in Canada is seen by some as unsustainably high and a source of vulnerability for the financial system. But the international evidence suggests that Canadian household leverage and home prices are not abnormal. Drawing on Statistics Canada research to analyse the factors entering into household debt, and on comparisons with other countries, we estimate that given Canada’s fundamentals, the ratio of household debt to disposable income is relatively conservative.
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Canada: The economy continues to do wellReal GDP
Index, 2007=100
NBF Economics and Strategy (data via Datastream)
1 Canadian GDP growth since early 2007 has surpassed that of all other G7 economies. Yet, some market pundits remain worried about the soundness of our country’s financial system.
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
The negative perception of the Canadian outlook is mostly due to housing. Home prices in Canada’s largest cities have increased sharply in recent years.
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Home prices: Irrational exuberance in Canada?Resale price of existing home
NBF Economics and Strategy (data via Teranet-National Bank and Datastream)
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Even after this rise, the price of a comparably sized downtown apartment in Vancouver and Toronto does not seem extreme by international standards.
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World: Home prices do not seem extreme in CanadaPrice per square feet in USD for downtown living* (summer 2017)
* For a 645 sq.ft. apartmentNBF Economics and Strategy
USD
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
True, Canada’s debt-to-disposable-income ratio is at a record high. Yet many OECD countries have higher ratios. Is Canada’s ratio excessive in relation to its fundamentals?
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HUN LAT SLO POL CHI CZE SVK EST ITA AUT DEU FRA USA BEL GRC ESP FIN JAP PRT USA GBR CAN IRE SWE SWI AUS NOR NLD DNK
World: Perspective on household leverageHousehold debt as a percentage of net disposable income (major OECD countries)
% disposable income
NBF Economics and Strategy (data via OECD) U.S. adjusted to Canadian definition
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International comparisons of household indebtedness can be complex. In Canada, the household sector also includes noncorporate businesses. Adjusting the U.S. data in order to conform to the Canadian definition increases the level of debt-to-disposable-income in that country from 104% to 141%.
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U.S. data must be adjusted before comparing with CanadaDebt-to-disposable income in the U.S.
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(Household debt + Nonfinancial noncorporate business debt) / Disposable income
141%
104Household debt / Disposable income
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
We then need to account for country-specific fundamentals that underpin leverage. According to Statistics Canada, the main determinants of Canadian household debt, after controlling for income, are type of employment and age of employees, home ownership, immigrant status and education.
Canada: Household debt determinants according to Statistics CanadaTobit model description from Household debt in Canada (2012)
Statistics Canada (“Household Debt in Canada”, March 2012)
Total household debt ═ β1Income + β2Employed + β3Tenure+β4Immigrant Status + β5Education
Key findings:
Employed: An employee has $93K more debt than a retiree and +$37K more debt than others.
The age profile of employees is also important (+$52K more debtfor younger workers vs. others).
Home Tenure: A homeowner has $100K more debt than a renter
Immigrants: Foreign born population has more leverage than natives (+$34K)
Education: Postsecondary education = +$26K more debt than less educated
After controlling for income, here are some determinants of household leverage identified
by statistics Canada
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A key driver of labour income and borrowing capacity is labour-force status. The share of the Canadian working-age population with jobs is the second-largest in the OECD.
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GRC ITA ESP BEL FRA PRT SLO POL HUN FIN SVK LAT IRE CHI AUT CZE JAP DEU EST DNK USA GBR NLD SWE AUS NOR CAN SWI
World: Perspective on employment rateWorkers as a percentage of population 15+
NBF Economics and Strategy (data via OECD, Statistics Canada)
%
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
Type of job tenure is of course also important for household borrowing capacity. Fortunately, employment growth in Canada is driven mainly by full-time employment.
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Perspective on key driver of labour incomeFull-time employment: Canada vs. the U.S.
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The solid performance of the labour market has coincided with a rise in the homeownership rate, which exceeds that of the United States.
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Canada: Perspective on homeownership rateHomeownership rate in Canada and United States
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
Yet Canada’s homeownership rate is not that high by international standards.
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SWI DEU AUT DNK NLD FRA SWEAUS USA GBR CHI BEL FIN CAN IRE ITA GRC PRT SLO NOR CZE EST ESP LAT POL HUN SVK
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World: Perspective on homeownership rateHomeownership rate
NBF Economics and Strategy (data via OECD, Statistics Canada)
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So why is our debt-to-disposable-income ratio somewhat higher than would be suggested by home tenure? Here it is not enough to look at the overall homeownership rate. We need to look at the percentage of households carrying a mortgage. For Canada it is 40%, fourth highest in the OECD and similar to the U.S. percentage.
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LAT SLO SVK POL GRC CHI CZE ITA HUN EST DEU AUT FRA IRE ESP PRT GBR AUS FIN BEL SWI DNK USA CAN NLD SWENOR
World: Perspective on mortgage holdersHomeowners having a mortgage as a percentage of total households (2014 or latest)
NBF Economics and Strategy (data via OECD)
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
The relatively high proportion of Canadian households with mortgages is explained by demographics. The prime-age workforce (25- to 54-year-olds — the people most likely to buy homes and use leverage) is enjoying full employment.
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Canada: The prime-age workforce at full employment
Employment/population ratiofor people aged 25-54
Labour force participation rate forpeople aged 25-54
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In Canada the number of employed people aged 25-54 hit a new record last month. In the U.S. the number of employed people in that all-important age cohort is barely higher than it was in the early 2000s. The divergence is partly explained by the much higher labour-force participation rate of prime-age women in Canada.
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Perspective on the prime-aged workforceEmployment for people aged 25-54: Canada vs. the U.S.
NBF Economics and Strategy (data via Statistics Canada and BLS via Datastream)
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
But also by the growth of the prime-age population, which remains impressive. In the U.S., prime-age population has been flat over the past decade.
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Prime-age population growing in Canada, stalling in the U.S.Population aged 25-54: Canada vs. the U.S.
NBF Economics and Strategy (data via Statistics Canada and BLS via Datastream)
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Population growth is of course a key factor in household formation, leverage and home prices. Canada’s population growth is the fastest in the OECD (matured economies). About 70% of this growth is from immigration.
Canada: Leading OECD countries in terms of population growth2017 population growth, natural vs. caused by migration
NBF Economics and Strategy (data via Statistics Canada and U.S. Census)
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JAP DEU GRC POR ITA DEN FIN FRA NLD AUT GBR SWI BEL ESP NZL SWE USA NOR AUS IRE CAN
Natural Migration Total
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
More than 20% of Canada’s population is foreign-born, one of the highest proportions in the OECD.
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World: Perspective on foreign-born populationShare of population born abroad
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This proportion is set to increase. Canada receives about 300,000 new permanent immigrants annually, the fourth largest inflow in the OECD in absolute terms — an immense pool of new talent. The Canadian government announced last November that it will raise the annual immigration intake by 13% by 2020.
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World: Inflows of permanent immigrantsPermanent immigration in OECD countries in 2016 (2015 if not yet available)
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
According to the OECD, more than 60% of this annual inflow of permanent residents are “economic category” admissions — people selected for “their ability to become economically established.” For the U.S. this proportion is 13%, for Germany a minuscule 4%.
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Canada: Immigration policy is key for labour markets“Economic category” admissions to permanent residence as a share of total immigration
NBF Economics and Strategy (OECD data https://data.oecd.org/migration/permanent-immigrant-inflows.htm#indicator-chart)
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So in absolute terms, more than 170,000 people who became permanent residents of Canada in 2015 were “economic category” admissions — well above the absolute number of economic-category admissions to the U.S., a country 10 times our size, and about equal to the combined intake of the rest of the G7 (Germany, France, Italy, Japan and the U.K.)!
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LX KR FI CH NO SE IE BE AT PT DK MX NL NZ IT FR DE ES JP GB AU US CA
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Canada: Highest inflow of workforce-ready immigrants in the OECDAnnual “economic category” admissions to permanent residence (2015)
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
These are the immigrants most likely to find jobs, form households and, ultimately, buy homes. And more than 60% of Canada’s foreign-born population has post-secondary education, the largest proportion in the OECD.
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Canada: foreign-born population is highly educatedPercentage of foreign-born 15-64 with post-secondary education
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There is an association between household debt and education (higher and less uncertain income stream over life cycle). More than 60% of Canadians aged 25-34 have post-secondary education, the highest proportion in the OECD and almost 15 percentage points above that of the U.S.
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ITA HUN DEU CZE SVK PRT AUT GRC ESP EST FIN LAT SLO POL FRA BEL NLD DNK SWE USA NOR SWI AUS GBR JAP CAN
World: Perspective on educationShare of population aged 25-34 with tertiary education (2016)
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
And the more educated a population, the more likely its workers are to remain productively employed as they move through their prime years in the labour force, from 25 to 54 years old.
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Canada: An educated workforce can support higher debtShare of population aged 25-34 with tertiary education
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This education gap helps explain why the homeownership rate in Canada for people younger than 35 is almost 10 percentage points higher than in the U.S.
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Canada: Perspective on homeownership rateHomeownership rate in Canada and United States (2016)
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
Canada’s immigration policy increases demand for housing in the large urban areas. The metropolitan areas of Toronto, Vancouver and Montreal, home to 37% of Canada’s population, now account for 79% of its employment growth.
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Canada: Job creation in the main citiesJob creation in greater Vancouver, greater Toronto, greater Montreal and rest of Canada (RoC)
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In a 2013 study of household debt-to-income ratios, the central bank of Norway drew attention to the influence of country-to-country variations in pension and welfare systems. Transfers and welfare and pension benefits are part of a household’s expected lifetime resources even if they do not show in household accounts. These factors can make a big difference in international comparisons.1
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1 “Comparison of household debt relative to income across four Nordic countries,” Norges Bank (2013).
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
Americans pay less tax than Canadians but today must devote about 20% of disposable income to health spending, a non-discretionary expense. In Canada, the share of income going to health care not covered by public insurance is about 4%. When we correct disposable income for this factor, household leverage in the U.S. turns out to be higher than in Canada, not lower.
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Of course, the stronger a country’s public finances, the more credible its welfare systems. Sound fiscal management is a criterion for household confidence.
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Canada: Sound fiscal situationGeneral government net debt and fiscal balance in 2017
NBF Economics and Strategy (data via IMF)
Fiscal balance as a % of GDP
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
The chart below shows how predictions from our cross-sectional regression compare with actual ratios of debt to disposable income in OECD countries. The model suggests that Canadian household leverage relative to fundamentals is relatively conservative (160% vs. 201% suggested by the regression).
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ITA DEU FRA ESP FIN PRT USA GBR CAN IRE SWE SWI AUS NOR NLD DNK
Household debt 2016Predicted
World: Perspective on household debtModel* prediction of household debt in 24 OECD countries in 2016 (R2=86%)
NBF Economics and Strategy (data via OECD)
Debt as a % of disposable income
*Household debt as a % of disposable income ═ C1 +β1 Mortgage holder rate + β2 Pension assets + β3 Public pension generosity + β4 Budget balance
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29 The lower-than-predicted ratio for Canada is probably due to the many macroprudential measures implemented over the last decade.
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Canada: Perspective on macroprudential measures implementedTeranet/National Bank home price index and timing of measures implemented
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Jul-08 (effective Oct)lower max amort 40Y to 35Y;inc min downpay 0% to 5%;
min credit score;new loan doc stds
Feb-10 (effective Apr)tougher qualifying for ARMs;reduce refi limit 95% to 90%;
min 20% downpay for investment properties
Jan-11 (effective Apr)lower max amort 35Y to 30Y;reduce refi limit 90% to 85%;
no insurance on HELOCs
Jun-12insured mort not eligible for covered
bond pools;OSFI guidelines on mort u/w
Jun-12 (effective Jul)lower max amort 30Y to 25Y;reduce refi limit 85% to 80%;
debt service caps;no insurance on homes >$1mln
Aug-13CMHC cap on MBS gtee
Feb-14 (effective May)CMHC increase mort insurance
premiums
Nov-14OSFI guidelines on insured mort u/w
Dec-15 (effective Feb)inc min downpay 5% to 10% for
homes >$500K;co-ord with moves at OSFI (capital)
and CMHC (fees)
Jul-16 (effective Aug)incremental property
transfer tax forforeign buyers*** BC ONLY ***
Oct-16 (effective Oct/Nov)"stress test" 5+Y fixed mort;
elim tax exemption for non-res;tighten access to port insurance;
consult on risk sharing
Jul-16OSFI tighten supervisory
expectations
Oct-17 (effective Jan)OSFI finalizes B-20
regulations, incl stresstesting uninsured
mortgages
Apr-17package of reforms inclnon-res speculation tax
*** ONT ONLY ***
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January 11, 2018 I Is Canada’s household leverage too high — or on the low side?
30 ConclusionAfter controlling for fundamentals such as employment, population growth, housing tenure, immigration, education and the solidity of the welfare system, our analysis suggests that the ratio of household debt to disposable income in Canada is relatively conservative. This probably reflects the cumulative effect of all actions taken to date to mitigate the vulnerability of the financial system to household indebtedness.
Stéfane Marion/Matthieu Arseneau
Disclosures
Economics and StrategyMontreal Office Toronto Office514-879-2529 416-869-8598
Stéfane Marion Marc Pinsonneault Kyle Dahms Warren LovelyChief Economist and Strategist Senior Economist Economist MD, Public Sector Research and Strategy [email protected] [email protected] [email protected] [email protected]
Paul-André Pinsonnault Matthieu Arseneau Jocelyn PaquetSenior Fixed Income Economist Senior Economist [email protected] [email protected] [email protected]
Krishen Rangasamy Angelo KatsorasSenior Economist Geopolitical Analyst [email protected] [email protected]
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