Canada’s big banks stand to lose on credit card debt in the next downturn: Moody’s

The next economic downturn will result in higher credit card losses at Canadian banks than the last recession due to the “unprecedented” levels of consumer debt fuelled by the housing boom, says Moody’s Investors Service.

With many Canadians already pushed to the limit by high housing costs, job losses or other “cash flow shocks” will put higher credit card balances at risk of default, the ratings agency concludes.

“When the economy turns, many consumers will struggle to meet their credit card payments because they’ll be too concerned about making their mortgage payment,” said Jason Mercer, lead author of the report published Wednesday.

Credit card portfolios tend to take the hit in times of stress because homeowners prioritize repayment of mortgages, explained Mercer, and the banks hold no collateral against credit card loans.


“Consumers are more likely to default on credit cards before their mortgage because they won’t lose an asset such as their house or their car,” he told the Financial Post. “The banks have limited recourse to a defaulted credit card borrower other than giving them a black mark on their credit history.”

During the next downturn, the ratings agency expects the losses from credit card portfolios to climb between 50 and 100 basis points above the past peak charge-offs of 5.8 per cent in 2009.

“In the event of job loss, consumers will not only prioritize mortgage and other loan payments, but may also increase their credit card borrowing to pay the bills until they find another job, resulting in higher balances at default,” the report warns. “Credit cards are also sensitive to increases in interest rates, albeit indirectly.”

If rising interest rates result in higher servicing costs when a mortgage is refinanced, this can drive credit card repayments further down the list of a homeowner’s priorities, the report explains.

The big five

Canada’s five largest banks are dominant players in the domestic credit card business, with a combined estimated market share of between 70 and 85 per cent, Mercer said. But despite their exposure to the overall segment, the Moody’s analysts note that credit cards account for only five per cent of the lenders’ total consumer loan portfolios. Mortgages, roughly half of which are insured, make up the bulk of those portfolios.

The small relative exposure to credit card debt should dull the impact of the expected fallout from a downturn, the report notes, as should the higher fixed interest rates Canadian banks tend to charge their credit card customers compared to peers in the United States and United Kingdom.

“The research suggests Canadians repay their credit cards at a higher rate than in the U.S. and the U.K. because it’s more expensive to carry a balance,” Mercer said. “The flip side is that these rates lead to higher profitability for the (Canadian) banks.”

In the last recessions in the U.S. and U.K, credit card loss rates rose to 11.5 per cent and 12 per cent respectively, according to Moody’s. That’s well above the ratings agency’s prediction of 6.3 per cent to 6.8 per cent for Canada in the next downturn.

Debt load

The expectation of additional losses is not surprising when considering Canadians’ growing debt burden. As Moody’s points out, as of March 31 of this year, just a penny shy of $1.70 was owed for each dollar earned.

That’s “nearly twice the level of 30 years ago,” the ratings agency points out, adding that the trend has been driven by a combination of low interest rates, minimal economic stress, and increasing housing prices.

Canada’s record high household debt has attracted attention and warnings from international organizations such as the Bank for International Settlements. A key ratio of credit to gross domestic product tracked by the BIS suggests Canada is among a group of developed countries most vulnerable to a financial crisis.

This week’s Moody’s report suggests high household leverage will play out differently in regions across the country. Consumers in Toronto and Vancouver, for example, are flagged as particularly vulnerable to “cash-flow” shocks such as job losses or rapidly increasing interest rates, due to more dramatic house price increases in those pockets. In the oil-producing provinces of Alberta and Saskatchewan, meanwhile, there have already been indications of an uptick in delinquencies in consumer debt portfolios in the aftermath of a slump in crude prices, the report says.

Initial unemployment insurance claims in those oil-dependent provinces nearly doubled in the latter half of 2016 from the start of that year.

“Although we expect losses to be moderate and manageable for large, geographically diversified banks, card loan performance in these Prairie provinces in coming quarters will be an illustrative first test of the ongoing strength of Canadian credit card portfolios,” the ratings agency report said.

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