Household Finance Numbers Are Looking Good

By Evelyn Jacks

While personal net worth has rebounded above its ten year average and Canadian savings rates are at an eight year high, considerable fiscal expansion and monetary stimulus are supporting domestic demand, which may well spell higher taxation levels in future federal and provincial budgets. Taken together with the strength of the Canadian dollar and the impact of inflation, the tax preparation and wealth planning process takes on new importance this quarter with tax season beginning again for over 24 Million Canadian taxfilers.

The following economic review follows developments at the Bank of Canada, specifically recent speeches by its Governor, Mark Carney on Current Issues in Household Finances on December 16, and in a report to the Standing Committee on Banking, Trade and Commerce, as well as recent news releases and compliance documentation from the Department of Finance, and the Canada Revenue Agency (CRA), will help advisors and their clients better anticipate what 2010 holds in store for purchasing power, savings rates, consumer spending and debt as well as taxation trends.

PART 1: CANADA IN A GLOBAL ECONOMY

Canadian economy has suffered a deep, albeit brief, recession. More than 400,000 jobs were lost and Canada suffered a $30 billion fall in output. However, it is expected that the Canadian economy will likely grow faster than the other G-7 countries in 2010.

In most major economies, the inventory cycle has turned and housing sectors are stabilizing. But according to the Bank of Canada, stronger growth in domestic consumption will be necessary to offset weak external demand for Canadian exports, given our strong dollar and the global recession.

The situation is worse for us because of the problems in the US, where the rebound in consumer consumption there is projected to be more moderate than in previous cycles. This is largely because, over the last three decades, U.S. consumer spending grew substantially faster than national income, driving the ratio of consumption to GDP from 62 per cent to a record 70 per cent.

In the same period, the personal savings rate fell from 11 per cent of disposable income to 1 per cent, while household debt doubled from 84 per cent of disposable income to 165 per cent.

This is quite unlike the trendlines in Canada:

• Canadians' Net Worth is Strong. Rebounding housing and financial markets increased Canadian household net worth to 589 per cent of disposable income by the end of the third quarter, above its 10-year average.
• Personal Savings Rate: The personal savings rate in Canada rose to an eight-year high of 5.5 per cent in the second quarter of 2009, reflecting a sharp increase in household savings and in general a responsible and precautionary reaction to the uncertainties stemming from the economic outlook and financial conditions of the past year.
• Consumer Borrowing: Consumers did and are expected to continue to take further advantage of unusually low borrowing rates, which the government's stimulative monetary policy is structured to encourage.
• Household Finance: At the same time, the Bank of Canada has warned that it is the responsibility of households to be able to service debt when fiscal stimulus measures are unwound and the marketplace produces its own results, which could include inflation and higher interest rates and taxation in the future.
• Bankruptcy Increases: While government stimulus packages hope to encourage consumer consumption to balance the economy and meet inflation targets, personal bankruptcies in Canada rose 41 per cent in the third quarter from the same period a year ago, leaving the number of bankruptcies as a proportion of the population at its highest level since 1991.
• Loan Delinquencies: Delinquency rates on loans have risen as well, with the proportion of mortgages with payments in arrears three months or more having increased by half over the past year.
• Mortgage Arrears. The current rate of mortgage arrears, remains more than one-third below its peak in the early 1990s.
• Financial institutions: Institutions have been alerted by the Bank of Canada not take false comfort from mortgage insurance and past performance of household credit, as the overall credit profile of Canadian households could well shift in a negative trend if debt continues to grow at current rates.
• Debt Service Ability: The Bank of Canada undertakes regular stress tests, to understand the vulnerability of Canadian households and their financial stability. Recent results illustrated that a hypothetical increase in unemployment could produce loan losses for financial institutions representing about 10 per cent of their Tier 1 capital. Should these simulations be accurate, by the middle of 2012, almost one in ten (9.6 per cent) Canadian households would have a debt-service ratio greater than 40 per cent, the threshold above which households are considered financially vulnerable.

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