dailynewsnblog
Some subprime lenders appear to be facing strain as debt levels and the rate of borrower defaults start to rise in Canada and the U.S., which may leave many wondering if there are early parallels to the 2008 financial crisis.
The concerns come as U.S. tariffs and the war in Iran continue to ramp up the pain on consumers, and as that financial hurt appears to be bleeding out into the middle class.
Experts warn that if a crisis rapidly accelerates the problem, there could be ripple effects to the broader economy.
“If more and more Canadians continue to default, then the company has problems, and we don’t want to go back to 2008,” says Stacy Yanchuk Oleksy, CEO of Money Mentors, an Alberta-based credit counselling service.
“What we’ll see is insolvencies will go up. Well, nobody’s better off if more and more Canadians are insolvent, right? Someone’s got to pay for that.”
As consumers struggle, are lenders next?
The higher cost of living brought on by a spike in inflation since the pandemic and a rise in interest rates have made it challenging for many Canadians to make ends meet.
This is especially the case for lower-income households that typically have lower credit scores.
Lower credit scores means it’s more difficult to get a loan or line of credit compared with a higher score. This can include a mortgage, auto loan, credit card, bank loan or even a personal loan.
Those higher-risk borrowers — those with low credit scores — are referred to as “subprime,” and those who provide them with higher-risk loans — typically at a much higher rate of interest — are what’s known as “subprime lenders.”
Major banks and lending institutions in Canada typically cater to lower-risk individuals and businesses, although some may take on higher-risk profiles at more expensive interest rates.
There are options available for those with higher perceived risk to get a loan or line of credit, but it typically means having to pay higher interest rates from alternative or subprime lenders because of the inherent risk that those borrowers may not be able to pay their loans back.
For some of these higher-risk lenders, that’s exactly what’s now happening.
Get weekly money news
Get expert insights, Q&A on markets, housing, inflation, and personal finance information delivered to you every Saturday.
A Canadian alternative financial lender called Goeasy saw its stock price tank 70 per cent in the past month, as of publication, and soon after, it reported a massive, unexpected increase in loan losses in its most recent quarter.
“Goeasey has been in the subprime lending business for a very long time, and in past cycles they proved very adept at adapting to the credit cycle, and taking in enough money to absorb credit losses, and generating a very high return on equity — even in times of strife,” says Mike Vinokur, senior wealth advisor and portfolio manager at Propellus Wealth Partners of IA Private Wealth.
“They may not have done proper due diligence or not had proper controls in place, and that’s blowing up.”
Vinokur adds that although the struggles for Goeasy appear to be a one-off situation, even big banks are starting to see small cracks emerging in lower risk profile loans.
“Borrowers with lower credit scores unable to access typical prime lending arrangements from one of the six big banks for example, turn to alternative lenders that use different adjudication methods in order to extend credit,” Vinokur says.
“We’ve seen higher non-performing loans [loans that default or are close to defaulting] at the big banks, and that’s with prime credit, that perhaps there’s a higher non-performing level of loans now being seen in real time with lenders that extend to subprime borrowers.”
If borrowers continue to default on loans, including lower-risk and higher-income households, there could be a ripple effect that impacts the broader economy if more lenders don’t protect themselves to absorb potential losses on bad loans.
“Canadians are more and more stressed. They’re getting pushed to the edges of their map with respect to their budget, and then what happens is that as soon as you hit the edge, you now lean on credit products,” Yanchuk Oleksy says.
“When they’re coming to us for help because the stress and the debt load has gone above their noses, sometimes they’ve hit the end and insolvency is the only option.”
Are subprime risks spreading?
That said, financial experts who spoke to Global News emphasized that while there is strain on subprime borrowers and some subprime lenders, the situation appears to be generally isolated — for now.
But things could change for the broader economy if the problem quickly accelerates.
“There’s a lot of capital on the balance sheets of our financial institutions to be able to buttress any kind of downturn,” Vinokur says.
“We have to monitor the situation to see what is the rate of change of escalation because that’s always the key question.”
Vinokur uses the COVID-19 pandemic as a recent past example of a “big problem” that could rapidly grow from a small, isolated issue in the financial system.
“Can banks use their existing profitability to soften the blow over time, wait for that stability, and then go into the next economic cycle?” he says.
What’s different now vs. in 2008?
Since the financial crisis from 2007 to 2009, lenders like large banks and other institutions in the U.S. and Canada have been required to be more prepared for potential issues.
In 2011, the U.S. Federal Reserve began requiring that banks undergo stress tests to gauge their ability to absorb the impacts of potential economic shocks and continue lending out money.
In Canada, banks were required by the Bank of Canada to set aside loan loss provisions starting in 2018 to prepare for potential economic downturns rather than respond to them after the fact.
The details were shared in a 2016 research study titled “Timing of Banks’ Loan Loss Provisioning During the Crisis.”
“After the global financial crisis, and following the suggestion of the Financial Stability Board, the G-20 and the Basel Committee on Banking Supervision initiated a project to replace the incurred loss model with the expected loss model,” the Bank of Canada said.
“This has resulted in the changeover from the incurred loss model under IAS 39 toward the expected loss model under International Financial Reporting Standards (IFRS) 9, scheduled to become effective in 2018 (e.g., Gaston and Song (2014)). Under IFRS 9, banks will have to provision not only for credit losses that have already occurred but also for losses that are expected in the future.”
Last month, some of the biggest banks in Canada announced they were increasing their loan loss provisions amid rising economic uncertainty brought on by the trade war and U.S. tariffs.
This means the banks are concerned that some of the loans they have issued to borrowers may default and they will end up taking a profit hit.
That was also just before the Iran war began, and sent energy markets surging on global supply concerns that could result in an inflation spike.
Vinokur says Canada is in a relatively good position considering the demand and revenue increase for energy resources like oil, and the banking system is in a good financial position despite many consumers struggling to pay for their loans.
“It would have to get very extreme, very fast for our banking system to start to really feel the brunt of it,” he says.
“Right now, they [the big banks] I think have been reasonably conservative in adding credit loss, loan loss or credit loss provisions, and let’s not forget that they’re still earning record amounts of profit.”
