Canada

Canadian Banks Are Still Prepared For Record Credit Losses, Despite Low Delinquencies

Since the pandemic began, Canadian households have never been better. They’re saving more, they’re defaulting less, and some have even begun to poop rainbows. At least that’s what the narrative has been.

Non-mortgage loan (A2) filings with the Office of the Superintendent of Financial Institutions (OSFI) shows that may not be the case. Expected credit losses (ECL), potentially unrecoverable debt, barely moved in Q1 2021. Despite many lenders saying the worst is over, they might not believe it. Expected losses are only slightly lower than they were at the beginning of the pandemic. It appears they might just be related.

Expected Credit Losses (ECL)

Expected credit losses (ECL) are potentially unrecoverable debt a lender forecasts. This debt may be written off at any point, and can be a total loss. After 2008, lenders were forced to make realistic assumptions about losses. This involves putting aside more cash, and assessing risk properly. Even if execs say we’re past a default issue, their ECLs will show the truth. It’s an unbiased and quantitative view of risk.

Lenders Still See Bigger Losses Than They Did During The Great Recession

Lenders have seen few delinquencies, but that barely moved the needle on loss expectations. Non-mortgage credit ECLs came in at 1.99% in Q1 2021, down a single basis point (bp) from the previous quarter. The ratio was 59.2% higher than the same quarter a year ago. Prior to 2020, the record peak was in the third quarter of 2009, during the Financial Crisis. Currently, they’re still above that level. 

Canadian Non-Mortgage Expected Credit Losses (ECLs)

The percent of non-mortgage debt reserved for credit losses at Canadian regulated lenders.

Source: OSFI A2 Filings; Statistics Canada; Better Dwelling.

The Expectation of Losses Haven’t Changed Much Since The Start of The Pandemic

One of the most important takeaways in the data is how little these numbers changed. When the pandemic kicked off in Q1 2020, lenders were expecting the worst. Everyone was going to default, and lenders would be bagholders. They saw increased risk, typical of a recessionary environment.

Very few credit defaults have materialized since the beginning of the pandemic. Generous income supports and lender deferrals dropped delinquencies to almost nil. They’re actually better than the best economic environment. Even with few delinquencies, non-mortgage ECLs have only fallen 4 bps. The best delinquency environment compared to expectations of the worst, produced what could have been a rounding error. This is a huge narrative-reality mismatch.

Consumer data in aggregate shows stronger households, and credit delinquencies are nearly non-existent. That might just be a fleeting moment though. The end of government support and payment deferrals may have only delayed the issues, not eliminate them. It won’t be clear until the government takes the training wheels off of the economy whether it can ride on its own.

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15 Comments

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  • Igor 2 months ago

    They’re running inflation hot because they think households can draw on their pandemic savings to make up for reduced buying power. They also expect the extra debt to be used to pay down living expenses. They also see it pushing home sales higher. And pushing consumer consumption higher. And restaurant spending. And tourism. And.. .

    Big expectations for $1,000/person basically.

    • Jarl 2 months ago

      Less than $1k person, because more than half the savings are estimated to be with the top income earners, and half of it has been allocated to other areas not captured as spending.

  • Christopher Barclay 2 months ago

    Inflation should help with this.

    • Andrew 2 months ago

      How does inflation help this? By reducing the inflation-adjusted value of the debt?

      • Trader Jim 2 months ago

        I believe that’s what is known as sarcasm. Inflation above a certain point becomes toxic. There’s a reason we were so laser-focused on 2% inflation and all of a sudden we’re now hyper-focused on increasing it.

      • RainCityRyan 2 months ago

        Correct.
        Inflating away debt … basically boils down to printing enough money to paper over the hole. Issue is that one persons debt is another persons asset (ie savers lend money to debtors) so at a certain point people will stop wanting your paper money (unless it’s to actually fill a pothole).
        The savers will require you pay back the debts in another currency, and that’s when things REALLY get fun.

        • Bob Walter 2 months ago

          Are we also going to inflate the salaries and wages then, because those have been rather stagnant for the past decades.

  • Jason Chau 2 months ago

    People that would have defaulted before the pandemic are receiving a lifeline, but there are too many structural issues to fix it. Shelter costs are one of the biggest factors reducing free cash flow from households, and those costs have become larger.

    Add 5% inflation on food, and god knows what else is spiking in price, and it’s not a mystery why people might crash and burn. The gov is just waiting for everyone to stop paying attention to what’s happening.

  • Frank Daugherty 2 months ago

    Any chance we can get these numbers for mortgage debt in Canada? Thanks and love the blog.

  • PK 2 months ago

    The pandemic has Canadians paying down non-mortgage debt at fastest pace since 1980s.
    https://www.cbc.ca/news/business/statscan-debt-1.6149983

    • Jamie 2 months ago

      Which is not the same as banks needing to put away more money, but I get it’s not easy to understand distribution.

  • Scott 2 months ago

    At least we know why he called an election now….

  • Patient Investor 2 months ago

    Its going to be a bumpy ride from now on with almost any type of investments: stocks, bonds, real estate and so on.
    Alibaba, gold, crypto and so on. A lot of banks are canceling credit lines.

    Some investors are looking at real estate as a safe heaven.Real estate has long been a way to hedge against inflation. In order for the strategy to work, generally the inflationary environment has to be long-lasting. It will be interesting to see whether that environment is short-lived as many analysts predict, or proves to be more protracted.

    Its hard to predict.

  • Strategic 2 months ago

    Well, provisioning are against credit products. If the total outstanding balance of credit products increased provision against them will increase also.

    Dont be so alarmist

    • RWZM 2 months ago

      “If the total outstanding balance of credit products increased provision against them will increase also.”

      Perhaps I’m not understanding you correctly, but the chart is expressed as a percent.

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