Toronto bank towers

The largest seven Canadian banks face elevated risks amid signals of growing consumer debt vulnerability, warns Moody’s Investors Service in a new report.

“A prolonged period of sustained low interest rates has kept Canadian borrowers’ debt-servicing requirements manageable and low unemployment has helped keep consumer loan defaults very low but, high and rising household debt-to-income levels leaves borrowers and lenders vulnerable to an economic downturn,” the credit rating agency says in a news release. And Moody’s foresees growing risks in a number of asset classes.

Specifically, while residential mortgage risk is currently low, this risk is set to increase, Moody’s says. It warns that mortgage-servicing costs are likely to rise, “because nearly half of outstanding mortgages have interest rate renewals within a year and interest rates have recently increased.”

Moody’s points out that the proportion of insured mortgages have dropped from 50% of total mortgage exposures five years ago to 40% today, “as the government shifts the mortgage credit risk burden to the private sector.”

Auto lending represents another growing risk, Moody’s says. “Though credit quality is currently strong, lengthening loan terms signal growing risk,” it says, noting that longer loan terms increase “negative equity” in this area.

Along with these hot spots, the banks are likely to see their first losses from credit cards. “Credit cards lack supporting collateral and have a lower repayment priority than residential mortgages or auto loans; therefore, credit card loan losses tend to occur before, and are more severe, than other forms of consumer lending,” says Jason Mercer, assistant vice president at Moody’s, in a statement.

“The strong credit quality of Canadian consumer loans, thanks largely to record low unemployment in recent years, is under threat on several fronts: debt-servicing costs are increasing because of interest rate hikes, the proportion of riskier uninsured mortgages is on the rise, and longer auto loan terms point to greater borrower vulnerability,” adds Mercer. “As debt-to-income levels continue to edge up, the first bite into bank asset quality will be felt in unsecured credit card portfolios.”