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The Canadian family: Deep in debt, net worth slipping Add to ...

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What the Canadian household looks like Three reports today paint a picture of a post-recession Canadian consumer with fat debts and shrinking net worth. And some could run into trouble making ends meet as interest rates continue to rise, forcing them to cut back, in turn pulling down the growth of overall consumer spending.

"The household balance sheet is expected to head down a bumpy road over the next few quarters," said Toronto-Dominion Bank economist Diana Petramala. "Stock prices have since recovered most of the losses experienced over the second quarter - but remain flat when compared to the beginning of 2010. Meanwhile, existing home prices have fallen 3.7 per cent since April of 2010 and this will start to weigh on real assets. We expect asset growth to be tepid through the coming quarters."

OECD warns on high debt levels The first report today came from the Organization for Economic Co-ordination and Development, which warned warned about high levels of consumer debt and the increasing threat to some people who may be in over their heads as interest rates rise. At the same time, it said, household income growth will probably slow.

As a proportion of disposable income, household debt rose markedly over the past decade, reaching close to the OECD average by 2008, the group said in its annual review of Canada. Levels continued to climb during the recession, driven largely by mortgage debt given the rebound in the housing market.

"Healthy credit expansion" was a goal of the Bank of Canada to fight the recession, and record low interest rates have brought down the proportion of disposable income needed to service debts, the OECD noted. "That being said, the upward trend in the debt ratios implies that households have a growing vulnerability to additional adverse shocks," it added. "For example, if households continue to borrow at the same pace as they did recently and interest rates increase as expected, by mid-2012 about 7.5 per cent of Canadian households could have so much debt that they would be 'financially vulnerable,' up from 6.1 per cent in 2009 ... This group is likely to include many young, first-time home buyers that have been profiting from low mortgage rates."

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Net worth falls for first time since recession The second report came from Statistics Canada, which noted that the net worth of Canadian families fell in the second quarter for the first time since the depths of the recession, pushed down by declining stock prices on North American. Household net worth dipped 0.6 per cent, or $34-billion, to $5.9-trillion, marking the first decline since the first quarter of last year, Statistics Canada said today. "Increases for some financial assets, especially deposits, were more than offset by declines in equities, foreign investment and life insurance and pension assets," the statistics gathering agency reported. "Households equity holdings declined for both marketable shares as well as mutual funds."

Statistics Canada noted the 6.2-per-cent drop in the S&P/TSX composite index, after four quarters of increases.

It noted that liabilities, largely mortgages and consumer credit, increased, though the ratio of household credit market debt-to-personal disposable income fell for the first time since early 2006, to 143.7 per cent. The debt-service ratio also fell, both due partly to an increase in personal disposible income. But debt-to-net worth rose after falling for four quarters. That will be felt in broader terms, economists say.

"Weak asset growth in combination with still strong liability growth will likely have households feeling buried under more debt than they ever have," said Ms. Petramala. "Households will likely feel a need to constrain spending and repair the damage done to their balance sheets. As such, quarterly consumer spending growth is expected to remain in a range of 2-2.5 per cent over the next year, well below the 3.5-4 per cent growth registered over the last five years. "



Many living pay to pay The third report came from the Canadian Payroll Association, which published a survey showing that six in 10 Canadians are living paycheque to paycheque. Fifty-nine per cent of Canadian workers say they would be in financial trouble if their paycheque was delayed by just a week - the same proportion as last year when the economy was still mired in a downturn, according to the poll of 2,766 people.

Did the Bank of Canada fuel house price appreciation? The Bank of Canada may have fuelled the run-up in Canadian house prices with loose monetary policy over the course of the last decade, the Organization for Economic Development and Co-operation says. In its annual review of the Canadian economy, released today, the group notes the increase in house prices, along with the price-to-income ratio, since the late 1990s, with a time out starting in June 2008 when costs fell, but only briefly. Some markets, the OECD says, are still overpriced despite the recent softening in the market, though real estate is expected to soon cool further.

"The price of an average home recently reached five times average household after-tax income, which is 35 per cent higher than the long-term average of 3.7," the OECD says. "... One factor that may have fuelled the sustained appreciation is relatively loose monetary policy over the 2000s, though this hypothesis is controversial ... On the other hand, some studies suggest that the sustained house-price appreciation represented a catching up of prices with their long-term determinants and that they are now broadly in line with fundamentals."

On the controversial part, the OECD cites what a formula known as the Taylor rule, or Taylor's rule, which was built by Stanford economist John Taylor. The Federal Reserve Bank of San Francisco says the rule was developed to provide recommendations for how central banks should peg short-term interest rates as conditions change. Without going into details of the complex formula, the idea is to meet central bank goals for both stabilizing the economy in the short run and containing inflation in the long term.

"OECD research has found that conventional monetary easing, when interest rates are brought well below Taylor rates and are maintained there for an extended period of time, is frequently followed by the build-up of financial imbalances in housing markets," the OECD said. "... While the correlation is only suggestive, the time during which the Bank of Canada maintained its policy rate significantly below the Taylor-rule rate for an extended period lines up perfectly with the period of sustained real house price appreciation over the last decade ... It must however be noted that from 2002 to 2008, monetary conditions were tightening due to the sustained Canadian-dollar appreciation."

The real estate sector has been softening but Ottawa may need to do more to cool the mortgage market, the OECD added. It added that it expects house prices to "come under downward pressure" soon as interest rates and income growth slows. "Like other OECD countries, Canada is probably entering a fairly long period of relatively slow household income growth," the group said.

The Bank of Canada would not comment on the OECD report but pointed to a statement last April, when it cited the fact that it lowered its benchmark interest rate quickly to a record low over 2008 and into early 2009, and provided markets with a conditional commitment to keep it there. "This unconventional policy provided considerable additional stimulus during a period of very weak economic conditions and major downside risks to the global and Canadian economies. With recent improvements in the economic outlook, the need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus."

And in July, it projected investment in housing would weaken this year and well into next, reflecting "the significant amount of activity that was moved forward in late 2009 and early 2010 by exceptionally low mortgage rates and the recently expired home renovation tax credit, together with tighter mortgage affordability and higher house prices."



Bank stocks rally Bank stocks rallied on global markets today as investors breathe a sigh of relief over proposed new capital rules that are not as severe as some had feared. While the measures agreed to by central bankers and regulators in Basel, Switzerland, will force banks to hold significantly higher levels of capital, the phase-in period is seen to be less harsh than anticipated. "The implementation period is much longer than expected, which is generous to the sector," Credit Suisse analysts said in a research note. "The fact that the sector now has a greater degree of certainty about capital requirements going forward ought to act as a material positive catalyst."



What the new bank rules will mean Here are the views of four groups:

"Analysts say the move could increase the cost of capital and reduce profits at some banks, notably European banks that need to raise a lot more capital to achieve the higher requirements. Some banks will need to shrink their balance sheets by selling loans or some business lines or reducing lending. That said, many U.S. and Canadian banks have already raised sufficient capital to meet the requirements, and the reduction in uncertainty about the new capital rules could allow them to begin lending out their excess capital or boosting dividend payouts." Sal Guatieri, BMO Nesbitt Burns

"Regulators argue that this will give rise to a safer, sounder banking system better able to weather future shocks and thus lessen the likelihood of events like what transpired over 2008-09. US bank capital, however, was fairly solid going into the crisis. What was missing was adequate regulatory oversight, and higher capital requirements won't change that. Further, the shadow banking sector once again sidesteps the tighter regulatory push. How the risk of future financial crises can be mitigated by pushing more business away from traditional regulated entities toward unregulated players remains a contentious issue against all of the weekend trumpet playing in favour of a sounder set of bank rules. Derek Holt and Gorica Djeric, Scotia Capital

"In our view, this means a likely pick-up in acquisition activity or share buybacks by Canadian banks. We believe that [Royal Bank of Canada, Toronto-Dominion Bank and Bank of Nova Scotia]will be on the acquisition track, while [Canadian Imperial Bank of Commerce]may be more focused on share buybacks. We also believe that [Bank of Montreal]and National may participate in a combination of both. TD and BNS remain our top picks amongst the Canadian banks. " Michael Goldberg, Desjardins

"While it appears that the Canadian banks could be in compliance today, even if some provisions are tighter than they appear, this generous phase-in period means compliance will not be an issue. With the large Canadian banks trading at a healthy 11.4x our [fiscal]2011 estimates, we do not believe this issue was weighing on the shares. However, since we are nearer to the point at which the banks can begin more freely deploying capital again, we view these developments positively." Robert Sedran, CIBC

And here's what columnist Boyd Erman says today in Streetwise: "Now that the handcuffs are coming off on capital, investors will also get to see just which of the Canadian banks is feeling aggressive. An odds-on favourite to make a big acquisition is Royal Bank of Canada , which has signalled a desire to get bigger in global wealth management. A bigger wealth management arm would bring in steady fee income to offset ups and downs in the bank's trading operations -- something investors felt all to much in the most recent quarter."



Wolf to leave Magna One of the key players at Magna International Inc. is leaving the company this fall. Siegfried Wolf, a major figure in the recent growth of Magna's European business, is stepping down as co-chief executive officer and leaving the auto parts giant effective Nov. 15 to join Oleg Deripaska's holding company Basic Element. Donald Walker will now be the sole CEO. "When Oleg Deripaska recently approached us for permission for Basic Element to make an offer to Sigi, we made it clear that the decision should ultimately rest with Sigi," said Magna chairman Frank Stronach. "Magna's decentralized culture and operating principles ensure that our success is not dependent on any one person."

A spokesman for Basic Element told Globe and Mail European correspondent Eric Reguly that Mr. Wolf will take a lead role in co-ordinating the Basic Element construction projects for the Sochi winter Olympics in 2014. "His role will be bigger than cars and trucks," said spokesman Evgeny Fokin. "Sochi will be in his portfolio. His role will be strategic development of that sector and may bring in a international partner."



Analysts like BCE-CTV deal Two fresh views for shareholders today on the blockbuster takeover of CTV Inc. by BCE Inc. announced Friday:

"The Right Assets for the Right Price ... Our [earnings per share] estimates have increased by 4 cents for 2011 and 8 cents for 2012, but with rounding to the nearest dollar our target price remains unchanged at $35. We would view any knee-jerk weakness on this announcement as a buying opportunity." TD Newcrest

"We believe the deal enhances Bell's negotiation power in securing content and hedges against potential increases in programming costs. We believe BCE exercised its right of first refusal because management did not want CTV to fall into the hands of Rogers or Quebecor ... We believe BCE provides an attractive yield of 5.55 per cent and represents a relatively low-risk investment in the Canadian telecom sector as we enter a phase of increasing competition. We believe management continues to demonstrate the ability to execute on their strategic imperatives and strengthen company's businesses."



Is that the Chattanooga Choo Choo? The Tennessee city of Chattanooga - lovers of the Swing era will remember it as immortalized in song - is about to become known for something a bit more up to date. Chattanooga's utility, EPB, is announcing today that it plans to become one of the top cities in the world to offer superfast Internet service, up to a gigabit a second, The New York Times reports today. What the utility plans is 200 times the speed of the average broadband service in the U.S., the newspaper says, noting it will cost $350 (U.S.) a month. Hong Kong and some other cities now offer such service.



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