COVID Response Has Kept Many Indebted Canadians from Reaching Debt Cliff

The COVID-19 pandemic threatened to provide the labour-market shock that would finally make Canadian policymakers’ longstanding concerns about high household debt a reality. It didn’t happen: government income-support programs, and banks’ decision to offer deferrals to hard-hit mortgage and credit-card holders, provided early and extensive relief. Ottawa recently announced a suite of new and amended programs that will provide another six months of relief. Meanwhile, Canadian banks’ quarterly results suggest mortgage and other consumer loan deferrals are decreasing.

Amid these developments, the debt cliff looks more like a slope. But concerns about household debt remain, especially in the oil-producing provinces and among Millennial Canadians. Already harder hit by the double blow of COVID-19 and sharply lower oil prices, households in Alberta, Saskatchewan and Newfoundland & Labrador could see an outsized impact in terms of delinquencies and insolvencies. And Canadians under 35, who’ve experienced disproportionately high job losses during the pandemic, may face an especially hard time meeting existing debt obligations or taking on debt to buy a home.

Key Points:

• Government income support and payment deferrals prevented a spike in delinquencies
• Consumer insolvencies actually fell 45% in the second quarter from a year earlier
• The extension of government support will cushion the blow of continued high joblessness
• Some Canadians that opted for debt deferrals have resumed payment
• Debt concerns are more pronounced for oil-producing provinces and Millennials
• Alberta householders were already the most indebted in Canada
• Millennial debt insolvencies were climbing pre-pandemic

Households survived (and even thrived) in the second quarter

About 3 million Canadians lost their jobs in the early part of the pandemic. As a result, employment income fell by a record $23 billion in the second quarter. However, Ottawa’s support ($500/week CERB payments that were more generous than standard EI, GST rebates for lower-income Canadians, etc.) resulted in a $56 billion increase in government transfers to households. The result was a jump in disposable income in the quarter, combined with a pullback in spending, that pushed the household savings rate up to an unheard-of 28% (from just 3% in 2019). For Canadians that still had trouble servicing their debt, banks deferred payments on more than 775,000 mortgages and nearly 470,000 credit cards. With those supports in place, delinquencies remained low and consumer insolvencies actually fell 45% in the second quarter from a year earlier. (Court closures and other disruptions likely also contributed to fewer insolvency filings.)

Debt-cliff worries pushed back

A key concern at summer’s end was that government support programs would run out before the labour market had sufficiently recovered. The jobs backdrop is certainly challenging, with employment still 5.7% below pre-pandemic levels in August. But Ottawa’s new income-support measures (a four-week CERB extension, lower eligibility requirements for EI, etc.) will go a long way to addressing debt-repayment worries. Both EI and the new Canada Recovery Benefit (which covers the self-employed and gig workers) will allow people to earn additional income (through part-time work, for example) before benefits are clawed back. These initiatives will limit the income shock that many would have faced if the more-generous CERB had simply been allowed to expire.

As for payment deferrals, Canadian banks’ latest financial results show the vast majority of clients that opted for shorter-duration deferrals have resumed making payments. As of the end of July, 12.4% of the Big Six banks’ mortgages were deferred, down from 15.2% at the end of April. For personal loans and credit cards, the average deferral rate fell to 4.3% from 8.6%.

Some borrowers could still face challenges when six-month deferrals expire in the fall. And banking regulator OSFI said last month that loans with payment deferrals granted after September 30 will no longer be eligible for special capital treatment, ending a provision put in place in late March that made it easier for banks to offer deferrals.

Canadians’ experience depends on where they sit on the income spectrum

Higher-income Canadians:

• have seen limited job losses
• accrued more “forced savings” when lockdowns limited spending
• are benefitting from lower interest rates
• have an opportunity to pay down debt

Lower-income Canadians:

• have seen significant job losses
• have a higher average debt-to-income ratio
• benefitted from relatively generous CERB payments
• will be helped the most by a $400/week floor for EI and CRB payments

Oil-producing provinces could face more debt trouble

After the 2008-09 recession, a commodities boom helped push consumer insolvency rates lower in Canada’s oil-producing provinces. That trend started to reverse during the 2015-16 oil-price shock and by 2019 insolvency rates were higher among oil-producing provinces than non-oil producers. Insolvencies per working-age population in Newfoundland & Labrador increased by nearly 1/3 over the past two years, while Alberta’s rate also jumped. Saskatchewan had fewer insolvencies but led the country in mortgage arrears prior to the pandemic (Newfoundland & Labrador and Alberta had the 2^nd and 4^th highest arrears rates, respectively).

Another cause for concern—Alberta households are the most highly indebted in Canada, with an average debt-to-income ratio of 208% in 2018 compared with 182% for the country as a whole.

Facing the dual impacts of the COVID-19 pandemic and sharply lower oil prices, Canada’s oil-producing provinces have seen some of the steepest job losses this year. Nearly 1.4 million workers from Canada’s three oil-producing provinces have relied on CERB income support, out of a total working-age population in those provinces of less than 5 million.

Our forecast assumes Newfoundland & Labrador and Alberta in particular will still have two of the country’s highest jobless rates in 2021. Unsurprisingly, households in these provinces have relied more on payment deferrals. According to CMHC, as of July Alberta had the highest mortgage deferral rate among the provinces (21%) while Saskatchewan and Newfoundland & Labrador weren’t far behind at 14.8% each. In contrast, Ontario’s was 10.1% and Quebec’s was just 5.6%.

Persistent labour market challenges and heavy reliance on deferrals suggests the pre-pandemic upward trend in delinquencies and insolvencies in Alberta, Saskatchewan and Newfoundland & Labrador is likely to continue. It doesn’t help that these provinces have generally experienced more difficult economic conditions in recent years. With home prices in these regions having trended lower since the 2015-16 oil price shock, there’s a greater risk that home owners facing difficulty keeping up with payments—particularly recent buyers—will have to sell their homes at a loss.

A potentially serious setback for younger households

Rising home prices have forced younger Canadians to take on more debt to get a foothold in the housing market. A Statistics Canada study showed that in 2016 Millennials aged 25-34 had an average debt-to-income ratio of 216%, 1.7 times that of Generation Xers when they were the same age, and 2.7 times the ratio of young Baby Boomers. Ultra- low interest rates have made servicing high debt loads easier, but a growing number of younger Canadians were having trouble keeping up with debt payments even before the pandemic. Individuals under 35 accounted for 23.5% of consumer insolvencies last year, up 2 percentage points from five years earlier. The overall insolvency rate across age cohorts hit a nine-year high in 2019.

Bank of Canada analysis of loan-level data in 2016 showed younger Canadians were more likely to have mortgages with high loan-to-income ratios (LTI >450%) and amortizations of longer than 25 years—two key risk factors in the event of an income shock. And while stricter qualifying requirements introduced in 2018 helped reduce the share of new uninsured mortgages with a high LTI, that trend started to reverse in the second half of 2019 as lower interest rates allowed borrowers to take on larger mortgages.

Younger Canadians have seen disproportionate job losses, with those under the age of 35 accounting for half of the decline in employment between February and April. Even with some improvement through August, full-time employment among Canadians aged 25-34 was still down 236,000 from pre-pandemic levels. That age cohort made up nearly 1/4 of CERB applicants, more than any other age group.

For new home owners with high loan-to-income ratios, loss of income could make keeping up with mortgage payments a serious challenge. Limited home equity (mortgage holders under the age of 35 unsurprisingly have significantly less equity than other age groups) or longer amortizations could limit options to refinance. For younger Canadians still working toward home ownership, the COVID-19 crisis could be a major setback. RBC’s previous analysis showed graduating around the 2008-09 recession has had a long-term impact on the careers and earnings of Millennials. Those that lost jobs during the pandemic and remain out of work will only have more trouble saving up for a down payment or meeting their current, non-mortgage debt obligations. And insolvency can be a major setback for households that experience it, limiting future access to credit (which may also reduce consumption) and wealth accumulation, according to the Bank of Canada.

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Josh Nye is a senior economist at RBC. His focus is on macroeconomic outlook and monetary policy in Canada and the United States. His comments on economic data and policy developments provide valuable insights to clients and colleagues, and are often featured in the media.

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