Is rising debt and default a warning sign of an impending economic crisis? – Nationally
Some subprime lenders appear to be facing difficulties as debt levels and borrower defaults begin to rise in Canada and the US, which may leave many wondering if there are early parallels to the 2008 financial crisis.
The concern comes as US tariffs and the Iran war continue to increase pain for consumers, and as that financial damage appears to be emanating from the middle class.
Experts warn that if the crisis accelerates too quickly, it could have negative consequences for the wider economy.
“If more Canadians continue to default, the company is in trouble, and we don’t want to go back to 2008,” said Stacy Yanchuk Oleksy, CEO of Money Mentors, an Alberta-based credit counseling service.
“What we’re going to see is that bankruptcies will increase. Well, nobody’s better off if more Canadians fail, right? Somebody’s got to pay for that.”
As buyers struggle, will lenders follow?
The high cost of living brought on by inflation since the pandemic and rising interest rates have made it challenging for many Canadians to make ends meet.
This is especially true for low-income households that often have low credit scores.
A low credit score means that it is more difficult to get a loan or line of credit compared to a high score. This can include a mortgage, car loan, credit card, bank loan or personal loan.
Those high-risk borrowers — those with low credit scores — are called “subprime,” and those who offer them high-risk loans — often at very high interest rates — are known as “junior lenders.”
Major banks and lending institutions in Canada generally cater to low-risk individuals and businesses, although some may accommodate high-risk profiles with expensive interest rates.
There are options available for those with a perceived higher risk of getting a loan or line of credit, but it often means paying higher interest rates from different or smaller lenders because of the inherent risk that those borrowers may not be able to repay their loan.
For some of these high-risk lenders, that’s exactly what’s happening now.
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Another Canadian financial lender called Goeasy has seen its stock price tank 70 percent in the past month, since going public, and after reporting a large, unexpected increase in loan losses in its latest quarter.
“Goeasey has been in the subprime lending business for a very long time, and in past cycles they’ve proven to be very good at adapting to the credit cycle, and they’ve taken on enough capital to cover the credit losses, and they’ve had a very high return on equity – even in times of conflict,” said Mike Vinokur, senior wealth advisor and portfolio manager at Proper Partners Wealth.
“They either didn’t do due diligence or didn’t have proper controls, and that blows up.”
Vinokur adds that while Goeasy’s struggles appear to be a one-off, even big banks are starting to see small cracks from low-risk profile loans.
“Borrowers with low credit scores who cannot access standard loan programs at one of the six major banks, for example, turn to other lenders who use different judgments to extend credit,” said Vinokur.
“We have seen high-performing loans [loans that default or are close to defaulting] in the big banks, and that is for the big credit, that maybe there is a high level of non-performing loans that are now visible in real time with lenders reaching out to small borrowers.
If borrowers continue to default on their loans, including low-risk households and high-income families, it could have a negative impact on the broader economy if many lenders do not protect themselves against potential losses on bad loans.
“Canadians are under a lot of pressure. They’re pushing to the edge of their map in terms of their budget, and what happens is once you get to the edge, now you’re dependent on credit products,” Yanchuk Oleksy said.
“When they come to us for help because the pressure and debts are too much for them, sometimes they come to the end and the only thing is the lack.”
Are subprime risks spreading?
That said, financial experts who spoke to Global News emphasized that while there are difficulties for subprime lenders and other subprime lenders, the situation appears to be isolated – for now.
But things could change in the wider economy if the crisis accelerates quickly.
“There is a lot of cash on the balance sheets of our financial institutions to be able to withstand any kind of downturn,” Vinokur said.
“We have to monitor the situation to see how much the rate of increase in numbers is because that is always an important question.”
Vinokur uses the COVID-19 pandemic as the latest example of a “major crisis” that can quickly escalate from a small, isolated crisis in the financial system.
“Can banks use their existing leverage to soften the blow over time, wait for that stabilization, and then move into the next economic cycle?” you prune.
What is different now compared to 2008?
Since the financial crisis from 2007 to 2009, lenders such as major banks and other institutions in the US and Canada have had to be more prepared for potential problems.
In 2011, the US Federal Reserve began requiring banks to conduct stress tests to see if they could absorb the effects of potential economic crises and continue lending.
In Canada, banks were required by the Bank of Canada to set aside loan loss provisions starting in 2018 to prepare for a possible economic downturn rather than react after it.
The data was shared in a 2016 research study titled “The Timing of Bank Loans in Times of Crisis.”
“After the global financial crisis, and following the proposal of the Financial Stability Board, the G-20 and the Basel Committee on Banking Supervision started a project to change the model of actual losses to include the model of expected losses,” said the Bank of Canada.
“This has resulted in a change from the realized loss model under IAS 39 to the expected loss model under International Financial Reporting Standards (IFRS) 9, which is scheduled to come into effect in 2018 (eg, Gaston and Song (2014)). Under IFRS 9, banks will have to provide not only for credit losses that have already occurred but also for expected future losses.”
Last month, some of Canada’s biggest banks announced they were increasing their loan loss provisions amid rising economic uncertainty caused by the trade war and US tariffs.
This means that banks are worried that some of the loans they have given to borrowers may not work out and end up taking a profit.
That was also just before the Iran war began, and it sent energy markets reeling from global concerns that it could lead to inflation.
Vinokur says Canada is in a good position with demand and rising revenues for energy resources like oil, and the banking system is in good financial shape despite many consumers struggling to pay their bills.
“It will have to go much, much faster for our banking system to start feeling its difficulties,” he said.
“Right now, dad [the big banks] I think they’ve been rightly aggressive in adding credit losses, loan losses or loan loss provisions, and let’s not forget they’re still earning record amounts of profit.”
