The Canadian banks increased involvement in auto lending represents a larger source of loan loss risk, warns Moody’s Investors Service — particularly if the economy slumps.
In a new report, the rating agency notes that the Canadian banks have expanded their auto lending “tremendously” over the last few years; which, it says, raises the risk of losses on these loans if the economy takes a turn for the worse.
“Since 2007, bank auto loans have grown around 20% annually, significantly higher than mortgages, credit cards and personal lines of credit, all of which have grown less than 10% a year,” reports Jason Mercer, assistant vice president at Moody’s.
Moody’s says that auto lending has grown significantly at the banks for a number of reasons, including: low new car prices, a shift in consumer preferences to higher-valued vehicles, consolidation in Canada’s auto lending market, and the
development of loan products to compete with captive auto finance companies and leasing alternatives.
“Not only has auto lending grown faster than other retail lines, but the average loan amount has also increased,” notes Mercer. “Consumers are taking advantage of low interest rates and longer terms to buy higher-priced vehicles, which raises their debt burden.”
Additionally, Moody’s says that several of the Canadian banks have targeted auto lending as a strategic growth sector and have expanded their presence in the market by acquiring captive dealer finance companies and offering increasingly competitive pricing and longer-term loans.
“Average loan terms have lengthened by five months since 2009, but these longer amortization loans, which have ‘lease-like’ terms, create negative equity for borrowers and collateral deficiencies for banks, exacerbating the mismatch between the value of the vehicle and the loan amount, given that depreciation outpaces the loan principal repayment,” Moody’s points out.
“These new terms will result in loans remaining under water much longer, prolonging the borrower’s debt burden and could result in significantly lower recoveries if a borrower defaults,” adds Mercer.
To date, low interest rates have kept debt-servicing requirements manageable, and consumer loan defaults have been very low as a result, Moody’s says. However, it warns that this could change rapidly if the economy slumps, and unemployment rises, and/or interest rates rise.
“Although consumer credit conditions have been pretty benign to date, high debt-to-income levels will leave both borrowers and banks vulnerable if the economy turns,” says Mercer.