Household Credit Analysis December 2, 2014

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1 Credit Analysis December, 1 Economics Avery Shenfeld (1) 9-73 avery.shenfeld@cibc.ca Benjamin Tal (1) 9-39 benjamin.tal@cibc.ca Peter Buchanan (1) 9-73 peter.buchanan@cibc.ca Warren Lovely (1) 9-1 warren.lovely@cibc.ca Andrew Grantham (1) andrew.grantham@cibc.ca Nick Exarhos (1) 9-7 nick.exarhos@cibc.ca Highlights by Benjamin Tal credit growth is no longer decelerating. Third quarter growth was the strongest since early 13 but still miles below the long-term average. Consumer credit is accelerating rising at the fastest pace in almost two years. Supply-driven increases in credit card balances are largely behind this trend. Auto loans are still strong and lines of credit activity is no longer falling. Mortgage market activity is much weaker than suggested by current levels of housing activity. The gap between real activity and credit growth can be explained by factors such as increased principal payments; reduced refinancing activity and home equity withdrawal; a lower share of high-ratio mortgages; and possibly increased average down payments due to a growing role of foreign investors in the market and a rising share of home buyers that are already home owners. Another factor that might contribute at the margin to this phenomenon is the possibility that unregulated alternative lenders are playing a more significant role in the market than currently perceived. This might mean that more mortgages are simply not included in the official statistics. The debt-to-income ratio has stabilized. Interest payments are at a record low relative to income. Principal payments are much larger than officially estimated by the Bank of Canada. Net worth position is at a record high. The negative correlation between personal bankruptcies and interest rates might break in the coming cycle. Sources: Bank of Canada Statistics Canada Industry Canada CBA CREA CIBC World Markets Inc. Equifax Canada h t t p : / / r e s e a r c h. cibcwm.com/res/eco/ EcoResearch.html CIBC World Markets Inc. PO Box, 11 Bay Street, Brookfield Place, Toronto, Canada MJ S WGEC1 (1) 9-7 C I B C W o r l d M a r k e t s C o r p 3 M a d i s o n A v e n u e, N e w Yo r k, N Y ( 1 ) -, ( )

2 CIBC World Markets Inc. Credit Analysis - December, 1 Credit credit growth is no longer decelerating. During the third quarter of the year, total household debt outstanding rose by.3% on a year-over-year basis a touch above the pace seen in the second quarter and the fastest pace of growth since early 13. The monthly figures reveal the same trend. This is not the first time in recent years that the decelerating trajectory in credit growth was interrupted, but at close to % (y/y) growth, the likelihood is that growth in household credit has reached a floor for the current cycle. Note that at the current level of activity, the pace of debt accumulation is still notably lower than its long-term average. Chart 1 Credit Chart Credit m/m % chg -mon moving average Inflation-Adjusted Increase in Outstanding HH Credit Cons. Credit Residential Mtg Long-Term Average Current (Sep 1) Source: Bank of Canada, CIBC Source: Bank of Canada, Statistics Canada, CIBC Consumer Credit The key here is the recent acceleration in the pace of growth in consumer credit. During the third quarter of the year, consumer credit rose by.% (y/y) the fastest pace in close to two years. Auto loans continue to rise strongly, expanding by close to % on a year- over-year basis. This however is not a new development. Chart 3 Consumer Credit Chart Lines of Credit and Auto Loans Lines of Credit 3-mon moving avg Dealer's Plan Source: Bank of Canada, CIBC Source: Bank of Canada, Statistics Canada, CIBC

3 CIBC World Markets Inc. Credit Analysis - December, 1 What s new is the recent acceleration in the pace of growth in credit card balances. After declining for most of 13, growth in this portfolio has returned and accelerated notably in the first half of 1. Note that this growth is highly correlated with the rebound seen in non-auto retail sales in Canada. In all likelihood the recent improvement in credit utilization here is due to a significant supply push by credit providers. Accordingly, the recent improvement in retail sales might be more leveraged than perceived. In this context, the recent rise in credit card balances might suggest that the process of debt transfer from cards to lines of credit is slowing. If so, that might lead to some increase in the risk profile of the card portfolio in the coming year. Note that the earlier process of debt transfer to lines of credit had also resulted in risk transfer. Delinquency rates in the lines of credit portfolio have risen in the past few years while the delinquency rate in the credit card portfio has fallen. Chart Retail Sales vs. Credit Cards Chart Delinquency Rates: Credit Cards vs. PLCs , 3-mon moving avg Retail sales ex autos (L) Credit cards (R) % 1.7% 1.% 1.% 1.% 1.3% 1.% 1.1% 1.%.9%.%.7% Q Credit Cards Total Balance Delinquencies Q Q 7Q Q 9Q 1Q 11Q 1Q 13Q.3%.%.%.1% Q Lines of Credit Total Balance Delinquencies Q Q 7Q Q 9Q 1Q 11Q 1Q 13Q Source: Statistics Canada, CIBC Source: Equifax, CIBC Chart 7 Personal Term Loans 1 Outstanding 3-mon moving avg 1.% 1.% Term Loans Total Balance Delinquencies 1.7% % Q Q Q 7Q Q 9Q 1Q 11Q 1Q 13Q Source: Bank of Canada, Equifax, CIBC 3

4 CIBC World Markets Inc. Credit Analysis - December, 1 The Housing and Mortgage Markets In the mortgage market the most significant observation is the fact that mortgage activity has been slowing, but so far we have not seen a similar trend in real housing activity. Many factors might explain this divergence. They include, increased principal payments, reduced refinancing activity and home equity withdrawal, a lower share of high ratio mortgages, and possibly increased average down payments due to a growing role of foreign investors in the market and a rising share of home buyers that are already home owners. Another factor that might contribute at the margin to this phenomenon is the possibility that unregulated alternative lenders are playing a more significant role in the market than currently perceived. If so, that would mean that more mortgages are simply not included in the official statistics. Mortgage arrears continue to trend downward, and at just south of.3% they are at a six-year low. Arrears in Atlantic Canada are almost double the national average, while Ontario enjoys the lowest arrears rate in the nation. Chart Housing Sales Stable, Mortgage Activity Slowing Chart 9 Mortgage Arrears Mortgage credit (L) 3-mon moving avg Unit sales (R),,, 3, 3,,, 1, 1,,.7 % of total portfolio By Province as of Aug 1 Canada BC Man/ Sask Alta Ont Que Atl Source: Bank of Canada, CREA, CIBC Source: CBA, CIBC Debt Levels, Affordability and Net Worth Position The widely watched debt to income ratio has been relatively stable over the past year at close to 1%. The recent acceleration in credit growth suggests that this ratio might head up in the coming months. At 7.% of disposable income, interest payments on total debt are at record low. Mortgage interest payments account for roughly half of this ratio. Alongside falling interest payments as a share of income, principal payments are now rising faster than income. Furthermore, we estimate that Canadians pay back principal much faster than officially estimated by the Bank of Canada (see October 1, 1 issue of our Economic Insights titled Resisting Temptation ). At 1.% the share of total debt to total assets is the lowest since early. Net worth as a share of disposable income is currently at a record high.

5 CIBC World Markets Inc. Credit Analysis - December, 1 Chart 1 Interest Payments Chart 11 Principal Payments Rising Faster Than Perceived. % of hdi % of hdi Mortgage Credit (L) Consumer Credit (R) Mortgage DSR. % of disposable income $11bn of additional principal payments currently not accounted for by official estimates Source: Statistics Canada, CIBC Source: Bank of Canada, Statistics Canada, CIBC Table 1 Consumer Debt Figures and Ratios Debt Consumer Credit** Mortgage Credit** Disposable Income+ Interest Payments Debt* Consumer Credit Mortgage Credit Interest Payments ($Mil) ($Mil) ($Mil) ($Mil) ($Mil) (% of HDI) (% of HDI) (% of HDI) (% of HDI) 1:1 1,3,1 3,1 9,1 9,39 73, : 1,7,999,3 93,9 9,17 7, :3 1,9,1,19 937,7 9,77 7, : 1,1,71 9,193 9, 9,311 7, :1 1,,,99 9,7 99,7 77, : 1,,71 7, 91, 97,93 7, :3 1,1, 7,3 1,,77 9,99 77, : 1,,3 7,9 1,3,91 999,7 77, :1 1,13,99 7,7 1,33,93 1,,1 7, : 1,,9,791 1,,3 1,17,7 77, :3 1,7,33,3 1,7,3 1,9,3 7, : 1,9,93 9,33 1,,39 1,1,31 77, :1 1,7,37 9,9 1,9, 1,1,9 7, : 1,7,7,1 1,11,19 1,1,1 77, :3 1,7,1,7 1,133, 1,71, 7, : 1,7,7,9 1,1,111 1,, 7, :1 1,773,1,73 1,1,1 1,9, 7, : 1,79,3 13, 1,19,7 1,1,91 7, * On Oct 1, 1, revisions by StatCan on household credit market debt to disposable income ratio was revised upward. ** Consumer and Mortgage credit quarterly data are now sourced from StatCan + Redefinition of household disposable income as part of StatCan historical revision of the national GDP by income and by expenditure accounts

6 CIBC World Markets Inc. Credit Analysis - December, 1 Table Balance Sheet Data Non- Financial Financial Debt to Total Net Worth ($Mil) ($Mil) ($Mil) (%) ($Mil) Net Worth as a Share of HDI 1:1 7,9,113 3,, 3,93,7 19.,,.7 1: 7,71,1 3,,3 3,9, ,9,97.3 1:3 7,, 3,,71,9, 19.,173,.3 1: 7,7,3 3,7,1,,33 19.,313,31. 11:1,1,99 3,9,79,3, ,7, :,99,71 3,7,1,33, 19.,,. 11:3,7,7 3,1,197,,91 19.,71,13. 11:,13,3 3,9,1,3,1 19.3,,9.9 1:1,13, 3,99,9,3, 19.,77,93.7 1:,, 3,999,,,3 19.,1,9.7 1:3,1,,3,,1, 19.1,9,7.7 1:,77,3,,7,71, 19. 7,1,7.7 13:1,97,1,119,37,1, ,7, : 9,,11,3,1,, ,31,3.9 13:3 9,3,71,3,,9, ,9, : 9,1,9,3,,1, ,91, :1 9,3,77,19,3,,7 1. 7,, 7.3 1: 9,9,3,11,31,379,3 1.,9, Insolvencies The number of personal bankruptcies in the economy is no longer falling. In fact it was hardly changed over the past year. At this point it is safe to assume that the bankruptcy situation will not change much in the coming year or so. However, it is possible that the coming bankruptcy cycle might be different than previous ones. In the past, the number of personal bankruptcies was negatively correlated with interest rates, since higher rates coincided with improved job market conditions. This time around, given the current debt load, the likelihood is that the impact of higher rates on debt financing (at the margin) might lead to a reversal of the typical correlation, and we might see bankruptcies rising alongside interest rates. Chart 1 Personal Insolvencies Chart 13 Personal Insolvencies by Province 3-mon moving avg on Sep 1-Aug 13 vs. Sep 13-Aug Source: Industry Canada, CIBC Atlantic 3. Canada Man/Sask Quebec BC -. Alberta Ontario % Source: Industry Canada, CIBC

7 CIBC World Markets Inc. Credit Analysis - December, 1 This report is issued and approved for distribution by (a) in Canada, CIBC World Markets Inc., a member of the Investment Industry Regulatory Organization of Canada, the Toronto Stock Exchange, the TSX Venture Exchange and a Member of the Canadian Investor Protection Fund, (b) in the United Kingdom, CIBC World Markets plc, which is regulated by the Financial Services Authority, and (c) in Australia, CIBC Australia Limited, a member of the Australian Stock Exchange and regulated by the ASIC (collectively, CIBC ) and (d) in the United States either by (i) CIBC World Markets Inc. for distribution only to U.S. Major Institutional Investors ( MII ) (as such term is defined in SEC Rule 1a-) or (ii) CIBC World Markets Corp., a member of the Financial Industry Regulatory Authority. U.S. MIIs receiving this report from CIBC World Markets Inc. (the Canadian broker-dealer) are required to effect transactions (other than negotiating their terms) in securities discussed in the report through CIBC World Markets Corp. (the U.S. broker-dealer). This report is provided, for informational purposes only, to institutional investor and retail clients of CIBC World Markets Inc. in Canada, and does not constitute an offer or solicitation to buy or sell any securities discussed herein in any jurisdiction where such offer or solicitation would be prohibited. This document and any of the products and information contained herein are not intended for the use of private investors in the United Kingdom. Such investors will not be able to enter into agreements or purchase products mentioned herein from CIBC World Markets plc. The comments and views expressed in this document are meant for the general interests of wholesale clients of CIBC Australia Limited. This report does not take into account the investment objectives, financial situation or specific needs of any particular client of CIBC. Before making an investment decision on the basis of any information contained in this report, the recipient should consider whether such information is appropriate given the recipient s particular investment needs, objectives and financial circumstances. CIBC suggests that, prior to acting on any information contained herein, you contact one of our client advisers in your jurisdiction to discuss your particular circumstances. Since the levels and bases of taxation can change, any reference in this report to the impact of taxation should not be construed as offering tax advice; as with any transaction having potential tax implications, clients should consult with their own tax advisors. Past performance is not a guarantee of future results. The information and any statistical data contained herein were obtained from sources that we believe to be reliable, but we do not represent that they are accurate or complete, and they should not be relied upon as such. All estimates and opinions expressed herein constitute judgments as of the date of this report and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, Internet web sites. CIBC has not reviewed the linked Internet web site of any third party and takes no responsibility for the contents thereof. Each such address or hyperlink is provided solely for the recipient s convenience and information, and the content of linked third-party web sites is not in any way incorporated into this document. Recipients who choose to access such third-party web sites or follow such hyperlinks do so at their own risk. 1 CIBC World Markets Inc. All rights reserved. Unauthorized use, distribution, duplication or disclosure without the prior written permission of CIBC World Markets Inc. is prohibited by law and may result in prosecution. 7