Debt service indicators, persons and unincorporated businesses

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• Introduction
• Persons and unincorporated businesses sector debt service ratio—definitions
• Trends in mortgage and non-mortgage interest ersons and unincorporated businesses sector debt service ratio
• Persons and unincorporated businesses sector debt service ratio
• Methodology and data sources

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Introduction

Over the past decade, household net worth has risen, reflecting the sharp appreciation of property values as well as gains in financial assets. While net worth has increased, household debt has risen to record levels in Canada as it has in many other countries. The rise in Canadian household debt, in particular mortgages, reflects both increases in home values as well as a more favourable interest rate environment making housing generally more affordable. The proportion of disposable income devoted to servicing this debt (debt service ratio) is the subject of this note.

Statistics Canada has developed estimates of both mortgage and non-mortgage interest expense which are now available through CANSIM. The estimates of the debt service ratio (DSR) for the persons and unincorporated businesses sector¹ are consistent with currently published estimates of personal disposable income² and the liabilities of the National Balance Sheet Accounts. These data cover the time period from 1990 onward, and are available on a quarterly basis.

Persons and unincorporated businesses sector debt service ratio—definitions

The persons and unincorporated businesses sector DSR measures the proportion of personal disposable income that is devoted to making interest payments³ with respect to the persons and unincorporated businesses sector’s total liabilities.⁴ The total liabilities of the persons and unincorporated businesses sector, on the national balance sheet, comprise the following categories: mortgages, consumer credit, bank loans, other loans, and trade payables. While liabilities can be sub-divided into these five groupings, the total interest expense can be reliably sub-divided into only two groups: mortgage interest and non-mortgage interest. This is because non-bank entities are not required to report a breakdown of non-mortgage interest expense. Therefore, the sector’s DSR is the sum of both mortgage interest and non-mortgage interest, divided by personal disposable income.⁵

Trends in mortgage and non-mortgage interest

In 2007, the mortgage interest expense reached its highest annual total, equalling $38.4 billion. This follows steady annual increases since 2003, reflecting the overall strength in the Canadian housing market and the accompanying growth in mortgage credit. However, excluding 2006 and 2007, the annual mortgage interest expense has generally varied within a more stable range since 1990. This reflects two largely offsetting factors, namely steadily rising levels of mortgage debt offset by the impact of a downward trend in interest rates.

Since the beginning of 2005, the level of non-mortgage interest expense has resumed the upward trend that began in 1994, after pausing from 2002 to 2004. Specifically, non-mortgage interest expense reached $31.8 billion for 2007, reflecting the increase in both non-mortgage debt and interest rates.

Chart J.1 Mortgage interest and non-mortgage interest

Further, the persons and unincorporated businesses sector’s total interest expense (both mortgage and non-mortgage) increased significantly in 2006 and 2007, which was one of the factors causing the saving rate to be near historical lows.

Chart J.2 Persons and unincorporated businesses sector interest expense and saving rate

Persons and unincorporated businesses sector debt service ratio

In 1990, the persons and unincorporated businesses sector’s DSR was at 10.5%, and subsequently trended downward to a low of 6.7% for 2004. The ratio has been generally increasing since 2005, reaching 7.8% for 2007—a level not seen since 2001. For its part, the debt to income ratio for the persons and unincorporated businesses sector has continued its upward trend. The debt to income ratio is defined as the sector’s total liabilities divided by personal disposable income.⁶ The recent levels of the sector’s DSR are, however, still relatively low on a historical basis dating back to 1990. In 2006 and 2007, growth in personal disposable income helped to somewhat offset the increases in interest expenses.

Chart J.3 Persons and unincorporated businesses sector debt service ratio and debt to income ratio

From 1990 to 2000, the persons and unincorporated businesses sector’s debt to net worth ratio⁷ trended downwards from 22% to 19% along with the debt service ratio. However, in the following years the debt to net worth ratio increased back to above 20%, due to the impact of the market correction on financial assets. The DSR continued to trend downwards until 2004, as interest rates declined.

Methodology and data sources

Estimates of the non-mortgage interest and mortgage interest were developed using a supply-side approach, within a matrix model framework. The supply-side approach derives estimates by looking at the providers of credit to the persons and unincorporated businesses sector. This is in contrast to a demand-side approach, whereby estimates would be directly obtained from a survey of the sector such as a household survey. The matrix model framework is a closed-system where, for the economy as a whole, interest payments and interest receipts are balanced. In addition, the project linked the flows of interest receipts and expenses to the financial instruments reported in the National Balance Sheet Accounts. The matrix model framework includes the four main economic sectors published in the Income and Expenditure Accounts, namely: government, non-residents, persons and unincorporated businesses, and corporations and government business enterprises.

Source data are obtained from the Quarterly Survey of Financial Statements conducted by the Industrial Organization and Finance Division of Statistics Canada. As well, for the banking sector, data are obtained from the Office of the Superintendent of Financial Institutions Canada (OSFI). Other data sources include the Canada Mortgage and Housing Corporation (CMHC), and Statistics Canada’s Public Institutions Division, and Income Statistics Division. In addition, public financial statements and various industry publications are used to further confront estimates.

Quarterly estimates are available both raw and seasonally adjusted. Seasonality was present in the mortgage interest series primarily due to the cyclical nature of mortgages, and the manner in which the data are reported.

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1. The persons and unincorporated businesses sector comprises two categories of transactors: (1) households and unincorporated businesses (including unincorporated farms) and (2) non-profit organizations which are not established for the purpose of making a gain.

2. Personal disposable income is equal to personal income less current transfers to government. Personal income is the sum of all incomes received by persons residing in Canada, including employment income, net business income, investment income, current transfers from other sectors, plus the investment income that associations of individuals accumulate on their own behalf or on behalf of persons.

3. Unlike U.S. measures of the debt service ratio, the Canadian persons and unincorporated businesses sector DSR does not include repayment of principal. The board of governors of the federal reserve system publishes the U.S. household debt service ratio, which is calculated as the ratio of aggregate required debt payments (interest and principal) to aggregate after-tax income. (Source: http://www.federalreserve.gov/pubs/bulletin/2003/1003lead.pdf, accessed September 22, 2008).

4. The Bank of Canada publishes a household debt service ratio comprised of consumer and mortgage debt in the Financial System Review. The Statistics Canada debt service ratio is broader in scope and reflects all of the liabilities of the persons and unincorporated businesses sector. This means that in addition to consumer and mortgage debt, the estimates also take into account the liabilities associated with households operations of unincorporated businesses and the activities of non-profit organizations serving households. As such, the two series have different values but generally show the same trend. (Source: http://www.bank-banque-canada.ca/en/fsr/2008/fsr_0608.pdf, accessed June 2008).

5. The persons and unincorporated businesses sector (P&UB) DSR can be represented by the following equation:

DSR (P&UB) = ( MI (P&UB) + NMI (P&UB) ) / PDI

Where

(P&UB) = persons and unincorporated businesses
MI = mortgage interest
NMI = non-mortgage interest
PDI = personal disposable income

6. The numerator used in the annual calculation of the debt to income ratio as seen in Chart 3, is the average of the four quarter-ending values of total liabilities for a given year.

7. For the calculation of the debt to net worth ratio, the average of the four quarter-ending market values for a given year are used.