Growing debt loads make Canadian banks vulnerable, says Moody's

Rising consumer debt loads aren’t a problem for Canadian banks yet, but they soon could be, according to a new report from rating agency Moody’s.

In a report released Tuesday morning, the agency warns that the credit quality of Canada’s biggest lenders is becoming more vulnerable thanks to longer terms on auto loans, and a majority of Canadian mortgages will come up for renewal this year in a time of rising interest rates.

The majority of Canadian mortgages are now uninsured, which means that lenders are on the hook for them if they turn bad and borrowers default on them.

That wasn’t the case five years ago, and while delinquency rates on mortgages are still at record lows — less than three out of every thousand borrowers are more than three months behind on their mortgage — the possibility of that number increasing means the banks need to be aware of that risk, Moody’s said.

Higher interest rates could be a trigger for that admittedly unlikely event.

The Bank of Canada has hiked its benchmark interest rate three times since the start of 2017, and expectations are for at least two more this year.

“Almost half of outstanding mortgages will have an interest rate reset within the year, which will increase the strain on households’ debt-servicing capacity,” Moody’s analyst Jason Mercer noted. More than half of Canadian home owners having to renegotiate their mortgages at rates higher than they are used to is something to keep an eye on.

But it’s not just mortgages. The Moody’s report also sounded the alarm on car loans, which are getting longer and longer.

While it’s true that for now there’s no indication that people aren’t managing to stay on top of them (the delinquency rate there is a healthy 1.5 per cent) but the report summed up the worst case scenario succinctly:

“Longer consumer auto loan 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,” the report said. 

“This shortfall is often rolled into the initial balance of a new car loan, compounding the negative equity and credit risk.”

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