Canada’s banks brace for possible wave of loan defaults. Why that matters – National

Earnings week for Canada’s largest banks saw the country’s major lenders move in step ahead of an expected recession, with each putting more money into preparation for possible rising credit losses.

Experts say rising borrowing costs and potential unemployment in Canada could catch up with households, pushing more households into default, but the worst of debt pain will be at least a year away. Some people think that it is more likely to come first.

Canada’s six largest banks – TD Bank, RBC, BMO, Scotiabank, CIBC and National Bank – all reported first fiscal quarter earnings this week with similar results. All firms reported lower profits as they set aside more funds to handle credit losses.

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Digging into the bank’s financial reports reveals alarming economic conditions at the heart of these moves.

BMO’s filings show that the surge in loan loss reserves in the last quarter “reflected a worsening economic outlook,” but continued improvement in the business environment after the peak of the pandemic meant these He points out that this offsets some of his concerns.

The Montreal-based bank also pointed to a rapid rise in interest rates.The Bank of Canada has hiked rates by a cumulative 425 basis points over the past year, with the next decision made on Wednesday.Putting the burden on customers. There is

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“A high interest rate environment could have a direct impact on customers through higher borrowing (such as mortgage rates) and debt service costs,” BMO wrote in Tuesday’s filing.

But just because banks prepare for more credit losses doesn’t mean they will, says Angelo Merino, an economics professor at the University of Toronto.

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A healthy amount of government aid offset business and consumer default rates when banks raised provisions in 2020 after expecting heavy losses during the pandemic, Merino told Global News.

But some of the concerns of three years ago are being realized today.

Overall business and consumer bankruptcy filings in January were up 13.5% from the previous month and 33.7% higher than a year ago, according to the Bankruptcy Administration. The data show that the number of bankruptcies increased by 55.4% year-on-year.

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Merino said banks are noticing a rise in bankruptcies as pandemic-era stimulus has dried up and companies are being forced to consider the new operating environment.

“A lot of the companies that were hanging there can no longer do it,” says Melino. “So there is a lot going on from the pandemic on top of everything else going on in the economy.”

Merino said the bank’s loan-loss reserve hikes essentially confirm a recession outlook that has led to recession calls from forecasters inside and outside of Bay Street.

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Loan repayments will be harder for Canadians this year

While loan loss reserves have increased amid rising interest rates and economic uncertainty, Veritas Investment Research analyst Nigel D’Souza said those numbers are still below pre-pandemic levels. , said it is now in the process of “normalizing”.

Nonetheless, D’Souza told Global News he sees signs of a significant deterioration in the credit situation for many Canadians in the coming months.

Rising interest rates will push up debt service costs for many Canadians with outstanding loans, he said, predicting those numbers could “potentially reach record highs” later this year. He added that there are

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Canadian consumer debt rose 7.3% in the third quarter to $2.36 trillion, according to Equifax

Calculating these costs includes disposable income. Rising unemployment and accompanying income declines could push this figure even higher.

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Canada’s labor market added 150,000 jobs in January as the unemployment rate stabilized at a record low of 5.0% and has yet to show any noticeable signs of weakening.

But Bank of Canada Governor Tiff Macklem has warned that low unemployment will not keep inflation down to the central bank’s 2% target. The Congressional Budget Office forecast in its Economic Outlook this week that the unemployment rate will rise to 5.8% by the end of 2023.

Merino said if unemployment starts to rise, it will lead to more losses for banks to absorb consumer debt.

“What happens to the labor market this year will be very important for consumer loans,” he says.

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Higher debt service costs have historically resulted in credit losses within two years, explains D’Souza. That means a wave of credit losses continuing from late 2023 through 2024, he says, due to a surge in debt service costs this year.

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“I think that’s going to be an important level to pay attention to in determining the risk of increasing credit losses over the next year or two,” says D’Souza.

What does this mean for mortgages?

One of the significant sources of debt on the books of Canadian banks is in their mortgage portfolios.

While the segment is already under some stress, D’Souza said the main hit from rising mortgage rates was mainly around 12% of mortgages renewed in any given year. pointing out.

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Even if Canadians default on their mortgages, those losses don’t tend to have a large impact on bank credit losses, D’Souza adds. Because these loans are backed by the property itself, they are usually well secured in case of default, he says.

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“If you look at past cycle losses, the majority of credit losses are not driven by the[mortgage]portfolio. The elements are the driving force,” he says.

Most of the bank’s mortgages are insured by the Canadian Mortgage and Housing Corporation (CMHC), Merino said, so any losses here would affect taxpayers more than the banks themselves. .

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Banks may have set aside balances to cover potential increases in credit losses, but D’Souza said these effects would not come suddenly and would take time to accumulate. I warn you it will.

While there are “signs of stress”, he said, such as rising credit card delinquency rates and the strain on variable-rate mortgage holders, D’Souza sees growth in bank balances, and broader. Says a hit to the economy could be the way to go. still off.

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“It’s not that there are no signs of stress. “It’s not something that can be done overnight.”

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