Wednesday, March 26, 2008

Canadian households dodge U.S.-style credit woes - No Sub-Prime Crisis in Canada

Hi All,

Here is confirmation of what I have been saying since the sub-prime situation arose in the US. Canada is not going to have a sub-prime mortgage crisis because sub-prime mortgages were never allowed here in Canada. Read on and let me know your thoughts.


Globe and Mail Update

Canadians have dodged the severe credit woes gripping the U.S., where the collapse of the mortgage market has triggered rising delinquency and foreclosure rates and left households saddled with debt, says a report from CIBC World Markets.

The author's report, CIBC senior economist Benjamin Tal, maintains that the credit crunch has not affected the Canadian household credit market in a significant way. And although he expects the U.S. economic downturn will spill across the border and curb consumer spending, Canada will escape the bulk of the carnage.

“It would be naive to assume that the Canadian consumer will totally escape this U.S. credit crunch and weakening American economy, especially in Ontario and Quebec,” Mr. Tal said in an interview. “But it is a question of degree. The likelihood of a consumer-led recession in Canada is very, very remote at this point, because consumers did not get into the same kind of trouble as in the U.S.”

In his mind, the reasons for Canada's more solid credit situation is twofold. “First of all, the Bank of Canada has been very active in cutting interest rates, which has eliminated some of the damage coming from the credit crunch,” Mr. Tal said. “So, if you are a regular person with relatively reasonable risk profile, you probably don't feel the credit squeeze because the rates have not changed in a significant way.”

The other reason is that in the U.S., the kind of high-risk borrowing that characterized the subprime mortgage market made up a significant portion of the credit landscape. In Canada, that type of borrowing was small and has had only a marginal impact on the overall housing market and consumer credit situation.

To date, Canada's mortgage market has stayed defiantly healthy, with the pace of growth in overall residential mortgages outstanding rising by 13 per cent last year, up from 10 per cent growth in 2006, the CIBC report said. Furthermore, data suggest that activity levels remain “very strong” in the first two months of 2008, a direct contrast to the sharp downturn in the United States.

But with economic growth and the housing market set to cool from last year's strong levels, Mr. Tal expects that the overall growth in mortgages outstanding in 2008 will be roughly 8 to 9 per cent.

The U.S. is in the throes of the first consumer-led recession since 1992, Mr. Tal said. The collapse of the housing market, which has been an extremely important factor for the U.S. economy and consumer spending, and the falling stock market are both lowering the wealth effect.

At the same time, the “quality of borrowing in Canada has stayed much better than in the U.S.,” Mr. Tal said.

The arrears rate on mortgages in Canada, which is still “extremely low” at 0.26 per cent, is also forecast to trend higher in the next year. However, a strong jobs market will underpin the economy so that the rate will likely remain low by historical standards, Mr. Tal said.

There has been a rebound in both direct loans and personal lines of credit recently. Overall growth in consumer credit remains strong, rising nearly 11 per cent in 2007, with personal lines of credit dominating growth, the report said. It noted, however, that delinquency rates in the direct loans portfolio are starting to show a “modest” tick higher.

“When adjusted for inflation, credit growth during this cycle was not as strong as in previous cycles,” Mr. Tal said in the report. “This means that any softening in the pace of household borrowing in 2008 will not be as dramatic as in the past.”

Canadian households are juggling higher levels of debt. Overall debt rose 3 per cent in the fourth quarter of 2007 while personal disposable income climbed 1.6 per cent.

The recent drop in stock markets, combined with a slower pace of increase in home valuations, led the debt-to-asset ratio to climb in the fourth quarter of 2007 to 17.1 per cent, its first increase since early 2006, the CIBC report said. Over the past year, the debt-to-income ratio in Canada edged up from 122 per cent to 130 per cent.

“At the same time, the debt service ratio, as measured by debt interest payments as a share of disposable income is still about 30 basis points higher than it was in 2006,” Mr. Tal said. “With widening credit spreads offsetting the declines in both prime and government bond rates, debt interest payment will remain relatively stable over the next few months.”

The number of consumer bankruptcies, which climbed by a mere 1 per cent during the year ending January 2008, is forecast to pick up by as much as 5 per cent this year as the slowing U.S. economy impacts growth in Canada, according to the CIBC report.

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