Household Credit Analysis May 9, 2012

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1 Credit Analysis May 9, 1 Economics Avery Shenfeld (1) 9-73 avery.shenfeld@cibc.ca Benjamin Tal (1) 9-39 benjamin.tal@cibc.ca Peter Buchanan (1) 9-73 peter.buchanan@cibc.ca Warren Lovely (1) 9-1 warren.lovely@cibc.ca Emanuella Enenajor (1) 9-7 emanuella.enenajor@cibc.ca Andrew Grantham (1) andrew.grantham@cibc.ca h t t p : / / r e s e a r c h. cibcwm.com/res/eco/ EcoResearch.html Highlights by Benjamin Tal The pace of growth in household credit is no longer a reason for the Bank of to move from the sidelines any time soon. s should get credit not only for notably slowing the pace at which they accumulate debt in an environment of historically low interest rates, but also for managing their debt in the most optimal way on record. As of March 1, household credit was rising at the slowest pace since. Consumer credit outstanding actually declined in March, and on a smoothed basis it is now rising at the slowest monthly pace since the early 199s. For the first time in more than a decade consumer credit in is rising more slowly than in the US. Soft credit card activity is largely behind the softening in overall growth in consumer credit. And here, we see increased optimization of the debt burden with active transfer of balances from credit cards to lines of credit. Term loans are still healthy due to strong demand for auto loans. Recently we have seen some increase in the delinquency rate in the lines of credit portfolio, in part probably due to a transfer of risk from the card portfolio. Overall, however, the delinquency rate is still very low. As of March 1, mortgage outstandings rose by.3% on a year-over-year basis a rate that is well below the average rate of growth seen in the past two years (7.3%), and well below the pace seen during the past decade. The recent modest softening in mortgage activity is coinciding with a reduction in the mortgage arrears rate, which as of January 1, stood at under.% after reaching close to.% during the recession. There is no debate about the fact that the housing market is overshooting. The only question is what will be the nature of the adjustment. It appears that we are at a turning point in the real estate market. Recent signals from the market suggest that activity is slowing down. We continue to call for a gradual softening in the market, with prices potentially falling by around 1% in the coming year or two. With personal disposable income rising by 1.3% in the fourth quarter and household credit rising by 1.3%, the debt-to-income ratio in the fourth quarter of 11 was little changed. Interest payments on debt have accounted for 7.3% of disposable income, roughly the same ratio seen in the previous two quarters. And in all likelihood this ratio will be little changed in the first quarter. Note that mortgage interest payments as a share of disposable income are at the lowest point since late-. The number of consumer insolvencies continues to fall. As of November 11 personal insolvencies fell by 9.% (yearover-year). Looking ahead, it is difficult to get too excited about the consumers' near-term prospects. Source: Bank of Statistics Industry CBA CREA CIBC World Markets Inc. Equifax CIBC World Markets Inc. PO Box, 11 Bay Street, Brookfield Place, Toronto, MJ S WGEC1 (1) 9-7 C I B C W o r l d M a r k e t s C o r p 3 M a d i s o n A v e n u e, N e w Yo r k, N Y ( 1 ) -, ( )

2 CIBC World Markets Inc. Credit Analysis - May 9, 1 Credit Chart 1 Credit Regardless of how you measure it, there is a clear slowing trend in the pace of growth in household credit. On a year-over-year basis, credit is now rising by just over % the slowest pace since. Ditto for the (smoothed) month-over-month rate that is now rising by only.% the slowest rate since mid-1 (Chart 1) m/m % chg -mo moving average Consumer Credit Key here is the rapid softening in the pace of consumer credit. As of March 1, overall consumer credit outstanding rose by only.3% on a year-over-year basis the slowest pace since the early 199s. On a monthover-month basis, credit was actually down in March the slowest showing since May 11, and on a smoothed month-over-month basis consumer credit is now rising by only.1% the slowest pace since 1993 (Chart ). Interestingly, for the first time since consumer credit in is rising more slowly than in the US (Chart 3). Note that as opposed to popular perception, consumer credit in rose much faster than in the US during the past decade. In fact, during the leveraged period of between and, consumer credit in rose twice as fast as in the US. After the crisis, with growth in consumer credit in the US reaching negative territory, consumer credit in continued to expand and, in fact, accelerated. Recently, however, these dynamics have changed dramatically. While US consumer credit is now expanding at its pre-recession rate of.3% year-overyear, growth in consumer credit in has softened dramatically Chart Consumer Credit m/m % chg -mo moving average The slowing in consumer credit is largely due to the softening performance of the credit cards market. Overall growth in card balances is now marginally in negative territory, with both classic and premier cards showing a similar performance (Chart ). While the dramatic softening in activity during the recession was in part due to supply factors, today s slowing is driven more by demand considerations, as well as an active shifting of card balances to lines of credit. This trend is very visible in the most recent uptick in activity in the lines of credit portfolio, which we believe is mostly a transfer of balances from the credit card portfolio (Chart ). Chart 3 Consumer Credit: vs. US US The Big Crossover

3 CIBC World Markets Inc. Credit Analysis - May 9, 1 Chart Credit Cards Outstanding Chart Delinquency Rates: Credit Cards vs. PLCs y/y % change Standard / Classic Premier 1.% 1.7% 1.% 1.% 1.% 1.3% 1.% 1.1% 1.%.9%.%.7% Q1 Credit Cards Total Balance Delinquencies Q1 Q1 7Q1 Q1 9Q1 1Q1 11Q1.3%.%.%.1% Q1 Lines of Credit Total Balance Delinquencies Q1 Q1 7Q1 Q1 9Q1 1Q1 11Q1 Chart Lines of Credit Chart 7 Personal Term Loans 3-mos moving avg 1 Outstanding 3-mos moving avg 1.% 1.% Term Loans Total Balance Delinquencies % 1.7% % Q1 Q1 Q1 7Q1 Q1 9Q1 1Q1 11Q1 This fact helps to explain the recent increase in the delinquency rate in the lines of credit portfolio, against a background of falling delinquency rates in the card portfolio (Chart ). Note that growth in balances outstanding on personal term loans has stabilized at just over 1% (y/y) over the past year or so, largely reflecting strong demand for auto loans. This strong growth was accompanied by a relatively stable delinquency environment (Chart 7). 3

4 CIBC World Markets Inc. Credit Analysis - May 9, 1 The Housing and Mortgage Markets Turning to the mortgage market, here as well, we are starting to see some early signs of moderating activity. As of March 1, mortgage outstanding rose by.3% on a year-over-year basis a rate that is well below the average rate of growth seen in the past two years (7.3%), and well below the pace seen during most of the decade. The softening trend is much more evident in the smoothed month-over-month growth rate, which at.% is the slowest since late 1 (Chart ). The recent modest softening in mortgage activity is coinciding with a reduction in the mortgage arrears rate, which as of January 1, stood at under.% after reaching close to.% during the recession. Note that the current rate is still double the rate seen before the recession but is significantly below rates we have seen in previous recessions. Note that the arrears rate in Alberta is by far the highest in the nation. This reflects the fact that, on average, homeowners in Alberta are younger and less established. As well, the pre-recession period in Alberta had seen activity surging rapidly leading to a higher percentage of consumers overextending themselves to speculative investment activity and excess (Chart 9). As for the housing market (Table 1), there is no debate about the fact that the market is overshooting. The only question is what will be the nature of the adjustment. It appears that we are at a turning point in the real estate market. Recent signals from the market suggest that activity is slowing down. The number of unit sales is now rising by a smoothed year over-year rate of just over 3% the softest showing since mid-11 while the smoothed average price (y/y) is rising by only 1% the slowest rate of increase since late 1. Preliminary numbers for April suggest that this trend of softening is intact (Chart 1). The most visible slowing in MLS activity is in Manitoba, followed by Quebec and BC respectively (Chart 11). In the absence of a trigger for a violent correction, we do not see such an outcome in the near future. We continue to call for a gradual softening in the market, with prices potentially falling by around 1% in the coming year or two. Other factors that will work to soften activity in the market are ongoing changes in the mortgage market with increased scrutiny from regulators regarding risk management practices, as well as the increased use of full-scale appraisals as part of the adjudication process. Accordingly we see mortgage market growth softening Chart The Mortgage Market Chart 9 Mortgage Arrears m/m % chg -mos moving avg BC By Province as of Jan 1 Man/ Sask Alta Table 1 National Residential Housing Data by Province For March 1 Dollar Volume Unit Sales New Listings Average Price Ratio of Unit Sales to New (sa) ($s) ($) Listings CANADA 1,3,77,3 73, 37,1. ATLC 17,7 1,97,9 11,1. QUE 1,791,311,17 13,37 9,.1 ONT,9,713 17,73 3,1 39,3.9 MAN,79 1,17 1, 3,.7 SASK 33,7 1,1, 7,3. ALTA 1,31,19,11,9 3,9.7 BC 3,1,37,1 1,1,3. Source: CREA as a % of total portfolio Ont Que Atl

5 CIBC World Markets Inc. Credit Analysis - May 9, 1 Chart 1 The Housing Market Unit Sales 3-mos moving avg Avg House Price 3-mos moving avg Interest payments on debt have accounted for 7.3% of disposable income in the fourth quarter of 11, roughly the same ratio seen in the previous two quarters. And in all likelihood this ratio will be little changed in the first quarter. This relative stability, however, masks two diverging trends; with interest payments on mortgage debt still falling, only to offset the ongoing increase in interest payments on consumer credit (Chart 13). Note that mortgage interest payments as a share of disposable income are at the lowest points since late-. After rising rapidly during the recession, the debt-toasset ratio has stabilized at % in the past two years (Table 3). With credit softening and asset value rising in the first quarter of the year, we expect to see this ratio improving a fact that should see the ratio of net worth Chart 11 MLS Resales Chart 1 Credit mo moving avg As of March 1 ((y/y % chg, 3-mo moving avg) BC ALTA SASK MAN ONT QUE ATL Mortgage Credit 1 % of pdi Consumer Credit % of pdi gradually to around % (year-over-year) during the course of the year, down from the current.3% rate. Levels, Affordability and Net Worth Position With personal disposable income rising by 1.3% in the fourth quarter and household credit rising by 1.3%, the debt-to-income ratio in the fourth quarter of 11 was little changed (Chart 1, Table ). As for the first quarter, with debt rising by only 1% and income estimated to have risen by.%-.7%, the increase in the debt service ratio is likely to be minimal. Chart 13 Interest Payments. % of pdi % of pdi Mortgage Credit (L) Consumer Credit (R)

6 CIBC World Markets Inc. Credit Analysis - May 9, 1 Table Consumer Figures and Ratios Consumer Credit Mortgage Credit Total Personal (BoC*) Pers. Disp. (StatsCan+) Income Interest Consumer Mortgage Payments Credit Credit Total Personal (BoC*) (StatsCan+) Interest Payments ($Mill) ($Mill) ($Mill) ($Mill) ($Mill) ($Mill) ($Mill) (% of PDI) (% of PDI) (% of PDI) (% of PDI) (% of PDI) (% of PDI) :1 3,93 7,11 97,7 1,, 1,,9, 9, : 3,39,979 1,11,1 1,9,33 1,73, 3,17, :3 333,3 71,377 1,3,73 1,1, 1,97,79 7,3, : 3,97 71,37 1,9,3 1,19, 1,1,1 9,3, :1 3,97 737, 1,,37 1,13,11 1,1,3 9,, : 37,9 7, 1,11,7 1,1,3 1,1,3 9,1 71, :3 37, 7,97 1,1, 1,197,79 1,1,3 97, 73, : 37, 7,71 1,1,3 1,, 1,37, 91, 7, :1 3,97 3,99 1,17,97 1,,77 1,7,3 9, 77, : 39,371,9 1,,3 1,7,97 1,91,13 9,1 77, :3 3,9 7,3 1,,33 1,3,3 1,3, 9, 7, : 9,33 9,3 1,31,3 1,37,9 1,37, 99, 7, :1 1,9 97,33 1,33,317 1,33, 1,3,33 99, 71, : 3,919 91,13 1,3,7 1,37, 1,3,11 9,9 9, :3 3,3 93, 1,371,1 1,39,339 1,13,7 9,9 9, :, 93, 1,399, 1,1, 1,3,999 97,9 7, :1,3 99,33 1,, 1,3,7 1,1, 97,79 71, :, 9,39 1,,7 1,,39 1,,7 1,,99 7, :3,9 1,,39 1,7,3 1,,1 1,3,33 1,1,1 73, : 7,1 1,, 1,9,77 1,,11 1,,3 1,9,1 7, :1 7, 1,1, 1,1,73 1,,73 1,3,9 1,37,9 7, : 77,1 1,,7 1,37,9 1,,9 1,7,97 1,,1 7, :3, 1,7,79 1,9,1 1,7,91 1,97, 1,, 7, :, 1,99,397 1,3,91 1,9, 1,19,11 1,9, 7, * Bank of 's debt (referred as Credit Market by Statistics ) = Total liabilities less Trade accounts payable + Statistics 's debt = Total liabilities Table 3 Balance Sheet Data Total Assets Non- Financial Assets Financial Assets to Asset Ratio Net Worth ($Mill) ($Mill) ($Mill) ($Mill) Net Worth to Disposable Income Ratio :1,19,7,91,377 3,99,31.1,1,1.11 :,7,139,7, 3,9,93.171,193,9.19 :3,3,,7,37 3,3,1.171,3,7.17 :,,1,79, 3,,9.17,,3.37 7:1,77,79,,11 3,9,3.19,13,.3 7:,913,,9,9 3,9,97.171,733, :3 7,, 3,,99,17,.173,13,9. 7: 7,,91 3,,9,,.17,3,73.37 :1 7,9,71 3,9,9 3,999,.177,31,9.1 : 7,1,717 3,19,9,11,.17,97,3. :3 7,11,37 3,9,9 3,9,.1,79,9.9 :,3,93 3,19, 3,,.197,7,71.7 9:1,791,9 3,171,73 3,,3.,3,3. 9: 7,3,33 3,191,73 3,1,.197,,. 9: 7,37,1 3,79,9,9,.19,93, :1 7,37,73 3,317,,1,.19,9,93. 1: 7,3,13 3,37,,,11.199,9,.79 1:3 7,,77 3,3,9,17,1.197,137,13. 1: 7,9,9 3,1,33,3,.19,3,.1 11:1 7,97,9 3,1,,,.19,3, : 7,971, 3,,1,,3.197,399,.19 11:3 7,7,9 3,93,,3,1.,9, : 7,97,1 3,11,79,31,9.,3,.9

7 CIBC World Markets Inc. Credit Analysis - May 9, 1 to disposable income rising in the first quarter. Note that an average household in currently carries a debt load of $1, versus an asset position of over $3, (of which $, is real estate). Insolvencies The number of consumer insolvencies continues to fall. As of November 11 personal insolvencies fell by 9.% (year-over-year) (Chart 1). On a cumulative basis the number of insolvencies fell by close to 9% during the year-ending November 11 versus the same period in the preceding year. All provinces have seen a decline in the number of insolvencies, with the largest drop being in Manitoba and Saskatchewan, followed by Ontario (Chart 1). Chart 1 Personal Insolvencies mo moving average What s next for the insolvency rate in? The answer does not lie only with the highly quoted unemployment rate. Clearly, a sharp rise in the unemployment rate can lead to a surge in the insolvency rate (see the most recent recession), but from a long-term perspective we find the unemployment rate to be a relatively weak explanatory variable of the insolvency rate with the unemployment rate showing no (and at times negative) correlation with the insolvency rate. In fact, between and 1 unemployment was accountable for less than 19% of insolvencies while insufficient income relative to debt accounted for more than 33% of insolvencies. In this context, the ongoing increase in the share of low-paying jobs in the Canadian labour force can be seen as a more important indicator to focus on. And looking ahead, the likelihood is that the share of low-paying jobs in the Canadian economy will rise during the course of the year. The soft economic environment suggests that growth rates in forced selfemployment and part-time jobs are likely to accelerate in the coming quarters. As well, a projected net decline in public sector employment in 1 and a much weaker hiring pace in the construction sector will act as a negative for overall income growth in the economy. Accordingly, we project that the insolvency rate in will start trending upward, if only mildly, over the course of the year Chart 1 Personal Insolvencies by Province Dec 9-Nov 1 vs. Dec 1-Nov 11 % Quebec -. BC -. Alberta -. Atlantic Consumer Spending Looking ahead, it is difficult to get too excited about the consumer s near-term prospects. With consumer credit growth slowing to a crawl, the housing market leveling off and potentially losing some ground, Canadian consumers will lose two of the main pillars of strength that made them the champion of the recent economic cycle. And while the volatility in the job market statistics will continue to confuse observers, the trend is clear: the pace of job creation in is slowing from, jobs a month in 11 to probably around 1, in 1. And the changing composition of employment is likely to work to lower the quality of employment in the country along with the bargaining power of workers limiting gains in labour income. Ontario -11. Man/Sask -1. 7

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