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

Earnings week for Canada’s biggest banks saw the country’s major lenders move in lockstep ahead of a projected economic downturn, with each putting more money away for a possible rise in credit losses.

Experts say the more expensive cost of borrowing in Canada and the possibility of job losses could catch up to households and push a growing number into default, though some believe the worst of the debt pain is likely at least a year away.

Canada’s big six banks — TD Bank, RBC, BMO, Scotiabank, CIBC and National Bank — all reported earnings for their first fiscal quarters this week, with similar-sounding results. All reported a dip in profits as they put more money aside to handle credit losses.

Digging into the banks’ financial filings finds a worrying economic picture at the heart of these moves.

BMO’s filings show that the jump in credit loss provisions for last quarter “reflected a deteriorating economic outlook,” though it noted continuing improvements in the business environment after the peak of the pandemic offset some of these concerns.

The Montreal-based lender also pointed to a rapid rise in interest rates — the Bank of Canada hiked rates by a cumulative 425 basis points over the past year, with its next decision coming on Wednesday — as putting strain on its customers.

“The high-rate environment could have a direct impact on our customers through higher borrowing (e.g., mortgage rates) and debt servicing costs,” BMO wrote in filings Tuesday.

But just because the banks are preparing for higher credit losses doesn’t mean they’ll come to pass, says Angelo Melino, economics professor at the University of Toronto.

When the banks raised their provisions in 2020 because they were expecting major losses during the pandemic, a healthy dose of government aid offset the rate of defaults for businesses and consumers, Melino tells Global News.

But some of those fears from three years ago are being realized today.

In January, total insolvency filings across businesses and consumers were up 13.5 per cent from the previous month and 33.7 per cent higher than a year earlier, according to the Office of the Superintendent of Bankruptcy. Business insolvencies were up 55.4 per cent year over year, the data shows.

Melino says banks are noticing the uptick in bankruptcies as pandemic-era stimulus dries up and businesses are forced to reckon with the new operating environment.

“A lot of companies that have been hanging in there no longer can,” Melino says. “So, in addition to everything else going on in the economy, there’s an overhang of stuff that’s been going on from the pandemic.”

Melino says the banks’ hikes to their credit loss provisions essentially confirms the dour economic outlooks that have led to recession calls from forecasters on and off Bay Street.

Source: globalnews