Financial institutions ramp up credit loss provisions in response
A new analysis from Morningstar DBRS has highlighted the impact of ongoing inflation and rising interest rates on the Canadian housing market, revealing a trend of increased credit provisioning by banks in response to escalating shelter costs.
In particular, the report underscores a significant shift in consumer behaviour, with higher mortgage and rent payments forcing Canadians to reassess their financial priorities, leading to an uptick in credit balances and delinquencies for retail products not tied to mortgages.
According to Josh Veenkamp, assistant vice president at Morningstar DBRS, the banking sector is navigating a period of heightened risk due to consumers being under financial duress.
"Banks and credit unions, which together underwrite over 80% of nonmortgage retail lending in Canada, remain exposed to financially stretched borrowers,” Veenkamp said. He anticipates an increase in provisions for credit losses (PCLs) for nonmortgage loans into fiscal year 2024, but the actual impact on loan losses will largely depend on the state of unemployment, which has remained relatively stable.
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The report draws attention to the increasing share of income Canadians are dedicating to housing, exacerbated by the current high-interest rate environment. This has left variable-rate mortgage holders particularly vulnerable, with a significant portion of fixed-rate mortgages yet to adjust to the higher rates.
Canada Mortgage and Housing Corporation (CMHC) estimates that around $675 billion worth of mortgage loans are due for renewal in the next two years, potentially leading to a sharp increase in payments for many homeowners.
The rental market is also facing challenges, with demand far outpacing supply and driving rents to record highs. This has resulted in the average rent in Canada soaring to approximately $2,200 in February 2024, marking a significant increase from pre-pandemic levels. As a consequence, many consumers are finding themselves having to cut back on savings and nonessential spending, with some turning to credit cards or lines of credit to cover basic needs.
Morningstar DBRS's analysis also indicates a rise in consumer delinquencies and insolvencies, suggesting that the financial pressures on Canadian households are beginning to manifest more broadly.
Even with these challenges, the report views the banks' decision to increase provisioning as a cautious yet necessary step to prepare for the potential financial instability ahead, maintaining a strong position to manage through the adverse conditions anticipated in the fiscal year 2024.
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