In the low interest rate environment, the Canadian banks have increased their exposure to risky loans, says DBRS Ltd. in a new report.
The rating agency reported that loans to riskier, non-investment-grade borrowers has grown faster than investment-grade loans over the past five years, increasing their share of the Canadian banks’ commercial lending books.
“Non-investment-grade loans now represent 50% of the large Canadian banks’ aggregate loan portfolios versus 43% in 2014,” said Maria-Gabriella Khoury, senior vice president, global financial institutions group at DBRS.
This shift “exposes the Canadian banks to higher risk in the event of a significant downturn,” DBRS said.
The growing exposure to riskier borrowers reflects the banks’ search for yield “in light of low interest rates and the benign credit environment,” it noted.
The riskier loan mix is somewhat mitigated by increased sector diversification, DBRS said.
In particular, it said the banks have reduced their reliance on the traditional cyclical commodity-based sectors, such as energy and mining.
“Although this diversification is a mitigating factor, we believe that the banks’ exposure to non-investment-grade loans could pose a risk in the event of a severe economic downturn as these borrowers could face greater challenges in rolling or paying down their debt versus their investment-grade peers,” DBRS explained in its report.
Ultimately, “the increased exposure to non-investment-grade borrowers is a risk that bears monitoring,” Khoury concluded.