Canadians are getting the message on cutting debt levels with growth in household credit now rising at its slowest pace since 2001, finds a new report from CIBC.

Inflation adjusted growth in household credit in the third quarter of 2010 was the slowest in nearly 10 years, while the 0.27% increase in credit during November was the softest monthly reading in more than 15 years.

“After coming through the most leveraged period of consumer spending in recent history, Canadians are getting the message that they need to cut back on their debt levels,” says Benjamin Tal, deputy chief economist at CIBC.

“After rushing back to shop in 2010, consumers will take a well-deserved break in 2011. The softening in the monthly pace of job creation from an average of 31,000 in 2010 to 20,000 in 2011 will single-handedly slow growth in personal spending by more than 0.4 percentage points.

Mortgage credit levels still rising

While overall credit growth has dramatically slowed, the CIBC report shows that mortgage credit levels are still rising at close to 7% on a year-over-year basis, although in recent months that pace has also slowed.

“A closer look at the monthly pattern reveals that the market is now growing by a monthly rate of only 0.4-0.5%,” adds Tal.

“The reduced demand for mortgage credit is more notable among first time home buyers — a trend that is already visible in the brokerage channel. The recent changes to the market introduced by the Ministry of Finance recently are not significant enough to derail the market, but are sufficiently targeted to soften marginal borrowing. We estimate that the move to shorten the maximum mortgage amortization from 35 years to 30 years will cut the growth in mortgage originations by roughly two to three percentage points in 2011. Overall we expect mortgages outstanding to rise by close to 5% in 2011 after an estimated 7.7% increase in 2010.”

The report notes that mortgage arrears appear to have peaked in February 2010 and are now stabilizing.

Consumer bankruptcies falling

After rising since early 2008, consumer bankruptcies are also now in a clear downward trend with the number of bankruptcies now falling by close to 25% on a year-over-year basis. On a cumulative basis, they are now falling by close to 19% with Ontario showing the best improvement.

Canadians’ net worth position improves

Despite softening credit growth, the report found that the debt-to-income ratio continued to rise in the third quarter of 2010. Debt increased by 1.3% while income fell by 1.5%. As a result the debt-to-income ratio climbed to a new record high of 146.

While Canadians’ debt continued to grow, Mr. Tal says that the cost of covering these debts is trending downward. “Debt interest payments now account for 7.2% of disposable income—the lowest debt service ratio since mid-2006. While debt is still rising faster than income, it is no longer rising faster than assets. The net worth position of Canadians has improved in the third quarter in absolute terms and relative to income.”

Outlook for 2011

“Our expectations that the housing market will stagnate in 2011 and might even see some softening in the second half, suggest that the estimated 8% rise in net worth in 2010 will not be matched in 2011,” says Tal. This could be a drag on consumer spending, which has driven GDP growth in recent years.

Tal sees much different and more sustainable factors driving the economy this year. “The seemingly benign 2.4% GDP growth projected for 2011 masks the dynamics of powerful economic forces pulling in different directions.

“The end result will be another year of only middling growth, but a new mix of economic activity as a vibrant business sector will gradually take over for an exhausted consumer and restrained government. Look for the Bank of Canada to start raising rates as early as May of this year, but the overall speed and magnitude of future rate hikes will be limited by the growing effectiveness of monetary policy and a modest recovery,” Tal says.

IE