Longer car loans, mortgage renewals are risks banks need to keep an eye on, Moody's warns

Rising consumer debt loads aren't a problem for Canadian banks yet, but they soon could be, a new report from Moody's says.

Delinquency rates remain low, but that could change in an environment with rising interest rates

Almost half of Canadian mortgages will see their rates increase in the next 12 months, Moody's says. (Bloomberg via Getty Images)

Rising consumer debt loads aren't a problem for Canadian banks yet, but they soon could be, according to a new report from rating agency Moody's.

In a report released Tuesday morning, the agency warns that the credit quality of Canada's biggest lenders is under threat in part due to longer terms on car loans, and the more than half of Canadian mortgages that will see their rates increase this year.

After a series of rules aimed at tightening the market, the majority of Canadian mortgages are now uninsured, which means lenders are on the hook for them if they turn bad and borrowers default.

That wasn't the case five years ago, so the uptick is worth keeping an eye on, Moody's says. And while delinquency rates on mortgages are still at record lows — less than three out of every 1,000 borrowers are currently more than three months behind on their mortgage — the possibility of that number increasing means the banks need to be aware of that risk, Moody's says.

Higher interest rates could be a trigger for that admittedly unlikely event.

The Bank of Canada has hiked its benchmark interest rate three times since the start of 2017, and expectations are for at least two more this year.

"Almost half of outstanding mortgages will have an interest rate reset within the year, which will increase the strain on households' debt-servicing capacity," Moody's analyst Jason Mercer noted. That many Canadian homeowners having to renegotiate their mortgages at rates higher than what they're used to makes their lenders vulnerable, too.

But it's not just mortgages. The Moody's report also raises concern about car loans, which are getting longer and longer. The average new car loan in Canada is currently spread out at almost six years. At that timeline, it's very likely the car will be worth far less than what's owed on it for multiple years on the tail end of the loan.

For now, there's no indication most people aren't managing to stay on top of them — the delinquency rate is a healthy 1.5 per cent — but the report summed up the worst-case scenario succinctly:

"Longer consumer auto loan terms increase negative equity — the amount by which the remaining loan balance exceeds the collateral value — because vehicle values fall faster than the loan is repaid," the report says. 

"This shortfall is often rolled into the initial balance of a new car loan, compounding the negative equity and credit risk."


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