In a divergence from the past, many households will emerge from the recession in better financial shape than when they entered, with higher savings and wealth. Anthony Okolie speaks with Ksenia Bushmeneva, Economist, TD Bank, about how Canadian households have managed to navigate the turbulent waters.
- Ksenia, you recently published a report on the state of Canadian household finances today. And one thing that caught my attention in that report is that you say that many households are in better financial shape now than prior to the pandemic. So can you explain why, and also walk us through where we were and where we are today.
- Hi, Tony, absolutely. So, just to take a step back I guess to start from where we were about a year ago. About a year ago at the end of 2019, consumer insolvencies had been rising briskly in Canada. And so were the debt servicing costs. In fact, debt service ratio, which is an average of how much Canadian households spend to service their debt, which we know is quite significant. So that ratio has reached an all time high in the second half of 2019. And that has obviously been squeezing household finances, how much they could save for a rainy day and how much they could spend.
So, fast forward to today. Consumer insolvencies have actually dropped by about 30% last year instead of rising, which is quite remarkable by how much they have dropped off. And so did the debt service ratio, which has actually declined substantially on the back of lower interest rates. So that's obviously one way in which we know households are feeling perhaps less pressure on average.
On the other hand, we've also seen households accumulate significant savings over this period of time over the course of last year. And the reasons for that are obviously several. The government income support programs have helped to support income of households who lost their jobs. We've also seen households reduce their spending on things like vacations, eating out. Non-essential store activity has been disrupted multiple times. So all that allowed households to amass significant savings last year. And last but not least, they've also continued to increase their household wealth, which rose by about 10% last year on the back of strong equity gains on the stock market, but also gains in the housing market, with home prices and home sales rising by double digits.
- So, most households are saving more. But let's take a look at the debt side. What trends are you seeing there?
- Mm-hmm. Absolutely. So even though households have more cash in their bank accounts, they still continued to borrow last year, with household debt increasing both in absolute and also in per-capita terms. So in absolute terms, that is up by about 4% compared to the end of 2019. But if we look at the debt relative to disposable income, which essentially measures how leveraged households are, that ratio had actually improved last year because again, disposable income had seen a boost through government transfers. Although that improvement is also expected to be temporary, in fact, the debt to income ratio had already begun to increase higher, and based on our projections for household income and debt, we do expect that it's going to reach its pre-pandemic level or even surpass it in the coming quarters.
- And so what's driving household debt higher?
- In one word, it's mortgages. So really, mortgage credit had contributed to all the increase in household debt and then some. Because again, the home prices and home sales have been rising so quickly over the last year. And if you look at consumer credit, households have actually paid back their balances, how much consumer credit they hold, particularly in the area, such as credit cards and unsecured lines of credit, where balance is about 15% lower than they were a year ago.
Again, the reasons, I've already mentioned some of the reasons there. So, excess savings allowed households to stay current on their credit card bills. But also reduced spending on things that we typically put on credit cards, such as vacations, eating out, gas when we travel by car, and things like that.
- The pandemic has revealed a real financial divide. Can you talk to us a little bit about that?
- Lower income Canadians have been disproportionately impacted by job losses during this pandemic. And this is largely because they tend to work in areas and industries that have been most affected by the lockdown measures and other restrictions.
Fortunately the government income support programs have really helped to reduce the pain in for these households, in many cases more than replacing the wage income which they typically bring home. So low income households on average have actually seen a boost to their disposable income. And the income gap between the lowest income households and the highest income households in Canada had actually fallen last year. Again, that's the average household that I'm talking about.
And if we look at the debt accumulation and wealth transfer of these households, to some extent they largely mimicked the trends seen in the general population. So they reduced their holdings of consumer credit and they increased their holdings of mortgage debt. And they've also seen slightly higher than average gains in household wealth.
But while those developments are certainly encouraging, the fact that we have seen those things improve last year, if we take a longer view, those households still continue to hold disproportionately low amount of wealth relative to higher income households. And those inequities have changed very little last year.
That being said, again, thanks to the government income support programs, at least they have not become worse.
- And going forward, what's your outlook on Canadian household debt in the near term and the longer term?
- In the near term, we expect that household debt will continue to grow quite briskly, again, just from what we're seeing in the housing market. And mortgages will drive the bulk of it. Longer run, we do expect growth in household debt to moderate a little bit, just as the growth in mortgage debt will slow down. And again, there are some reasons for that, such as very low affordability in the housing market. There could also be some macroprudential policy response by policymakers to kind of attempt to cool the housing market. And eventually, again, the mortgage rates will be going higher.
On the other hand, we do expect consumers to rotate towards consumer credit more going forward. Again, as the pace of vaccination picks up and the pandemic moves in the rear-view mirror, we do expect that households will resume more normal pace of their activities. They will start traveling again and going out, and that will eventually lead to stronger growth in consumer credit. However, significant savings mean that it will take quite some time for the households to rebuild their credit-card balances to the level that they were prior to the pandemic.
- Ksenia, thank you very much for your time.
- You're very welcome Tony.