One-third of Canadian households hold three-quarters of the debt

TORONTO, Jan. 26, 2012 /CNW/ - The surge in Canadian borrowing over the last five years has been driven by the country's most indebted households, finds a new research report from CIBC World Markets Inc. 

The report notes that while much concern has been raised about the record level of Canadian household debt, now at a debt-to-income ratio of 151 per cent, little analysis had been done to determine the distribution of the debt and what is driving its growth.

The CIBC research found that Canada's debt-to-income ratio is topped by only seven other developed economies. Within Canada, the research found that households heavily reliant on borrowing, those with a greater than 1.6 debt-to-gross income ratio, now hold 73 per cent of all household debt in Canada.

"Our new analysis found that all of the rise in debt since 2007 has been driven by borrowing from those with a high debt-to-gross income ratio," says Avery Shenfeld, Chief Economist at CIBC, who co-authored the report with Benjamin Tal, Deputy Chief Economist. "The growth in debt-to-income ratios has come from a piling on of debt by those with high debt burdens, rather than from less indebted households getting drawn to the punchbowl by the promise of low rates. Some 34 per cent of households that have debt are now in the high-debt-burden category and they account for nearly three-quarters of household debt outstanding."

Mr. Shenfeld says that, not surprisingly, the share of those with high debt-to-income ratios is greater in the provinces of B.C., Alberta and Ontario where housing is the most expensive. What he found more surprising was the growth in Canadians over the age of 45 who hold a high-debt-burden. The share of heavy borrowers in this age group has climbed from 36 per cent in 2007 to 44 per cent in 2011.

"A rising share of the highly indebted are over 45 years old, an age where accumulating net assets ahead of retirement should be paramount. Canadians nearing retirement who should be in their prime savings years are, instead, getting themselves deeper into debt. We are already seeing an uptrend in bankruptcies for those 50 and over, but the more material impact will be that this group's ability to spend could be severely squeezed upon retirement."

He notes that the root of recent debt growth has been the combination of ultra-low interest rates and weak growth in household real incomes. "Borrowing is what fills the gap between what we want to buy and our incomes, particularly for lumpy expenditures like houses, vehicles and other durable goods. Strong growth in real incomes can therefore reduce the reliance on debt by the household sector."

In recent years income growth has been weak. Not only was there a sag in nominal incomes during the recession, but in the recovery, consumers faced a much quicker snapback in inflation than in average wages, driven by a jump in global energy and food commodity prices.

Real disposable income fell by 0.1 per cent during the first three quarters of 2011. On that score, 2012 looks to be better for the average worker, as a leveling off in energy prices and a likely cooling in food inflation brings the consumption deflator closer in line with sluggish wage gains. But employment growth is likely to remain sluggish.

The report also examined the differences between the spending habits of heavy and non-heavy borrowers. Controlling for family composition and age, the research found that households with lower debt-to-income ratios appear to devote the lower costs they face on debt service to savings, rather than consumption.

The result is that high-debt-load Canadians are also being hurt relative to other families in terms of their accumulation of assets. While their debts have grown by 18 per cent since 2007, high debt-to-income Canadians have seen their assets accumulate by less than four per cent over the same period. This compares to a roughly 10 per cent growth in assets for those with more moderate debt-to-income burdens.

Mr. Shenfeld does not think Canada is on the precipice of a sharp run-up in household bankruptcies, which have thus far eased dramatically from the recession's high. "Many Canadians still have room to borrow and take advantage of low rates, as they have eschewed that temptation in recent years. The trigger for a sharp jump in bankruptcies would have to be sharply rising interest rates and a steep climb in unemployment, neither of which seems likely, particularly in combination, given that the Bank of Canada has inflation under wraps.

"But it does raise the spectre of a further deceleration in Canadians' appetite and room for additional debt, as more reach the constraints of their ability to service debt. We have already seen a deceleration in consumer debt. Housing might be next to feel the same pinch, with new construction and prices leveling off in the year ahead.

"That will leave Canada more at the mercy of the global environment, which remains clouded by the impacts of fiscal tightening across much of the developed world."

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/eijan12.pdf

CIBC's wholesale banking business provides a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.