Consumer credit quality ‘under threat’
Concern over credit cards, auto loans, mortgages
TORON TO • Canadian banks are seeing the creditworthiness of their customers besieged by external forces, according to Moody’s Investors Service.
“The strong credit quality of Canadian consumer loans, thanks largely to record low unemployment in recent years, is under threat on several fronts: debt- servicing costs are increasing because of interest rate hikes, the proportion of riskier uninsured mortgages is on the rise, and longer auto loan terms point to greater borrower vulnerability,” Moody’s said in a report released Tuesday.
But the ratings agency said that the real harbinger is unsecured credit card portfolios, predicting that “the first bite” into the asset quality of the banks would be taken out of that area.
“Banks will have higher losses on credit card defaults because the loss given default is higher than secured forms of lending, but the card portfolios of rated Canadian lenders are small,” the report said. “Credit cards lack supporting collateral and have a lower repayment priority than residential mortgages or auto loans; therefore, credit card loan losses tend to occur before, and are more severe, than for other forms of consumer lending.”
The report was released amid recent concerns about debt levels in Canada, including the Swiss-based Bank for International Settlements singling out the country for elevated risk indicators, such as its debt service ratio. Equifax Canada said Monday that consumers owed $ 1.821 trillion as of the fourth quarter of 2017.
Moody’s warned that debt servicing costs are likely to rise in the aftermath of the Bank of Canada’s three rate hikes since last summer, which would put consumers in a tight spot in any economic downturn.
And while Moody’s said that the current quality of credit for mortgages, autos and cards remains strong, it raised concerns about all three areas.
In home loans, Moody’s said borrowing had skewed more towards uninsured mortgages, including home equity lines of credit, which the company said was “a direct result” of the Canadian government’s moves to try to tame the housing market.
“The proportion of uninsured mortgages, including home equity lines of credit, has increased to 60 per cent from 50 per cent five years ago, with an interest rate reset looming,” said the agency. “And almost half of outstanding mortgages will have an interest rate reset within the year, which will increase the strain on households’ debt- servicing capacity.”
In auto loans, Moody’s said the longer terms were a sign of rising risk.
“Longer consumer autoloan terms increase ‘ negative equity’ – the amount by which the remaining loan balance exceeds the collateral value — because vehicle values fall faster than the loan is repaid,” said the report. “This shortfall is often rolled into the initial balance of a new car loan, compounding the negative equity and credit risk.”