Matt Fabian, Director, Research and Consulting at TransUnion Canada, explains how extreme shocks could impact the Canadian credit market — and what this implies for lenders. While there’s no definitive playbook to prepare for all downturn scenarios, there are some general principles that can help buy time, stabilize through the crisis and adapt to the “new normal.”
Canadian market overview: The baseline
Canada is now in the midst of a severe recession. Following the COVID-19 outbreak, real GDP growth once again forecasted down from 1.4% to -1.1%, and there’s a very high likelihood of future significant downgrades1.
The end of 2019 saw credit growth supported by strong underlying economic indicators, but headwinds had emerged. Looking at the market today, we see consumer balances have plateaued, potentially indicating some credit fatigue. Outstanding credit balances are approaching the $2 trillion milestone. Average non-mortgage rates decreased but at a slow rate year-on-year, down just 0.05% to $30,106. Non-mortgage delinquency rates are rising and strong regional variations persist. Consumer-level insolvency rates have been climbing steadily since Q1 2019.
Then, oil prices fell again, exacerbating regional disparity.
The economic impact of oil price slump
The oil price slumps of 2008 and 2015 had severe and long-lasting impacts on delinquencies. The onset of worsened delinquencies lagged the slump by two to three months. In the case of the 2008 oil price crash, delinquency rates began to stabilize 15 to 18 months after the oil price bounced back. In the case of 2015, oil prices didn’t return to historic levels and delinquency rates improved — but not to historic levels and continued to deteriorate due to lower investment in the sector constraining employment and lasting pressures on affected consumers.
The current drop in oil price is comparable to the 2008 and 2015 slumps in terms of speed and severity — which means we could begin to see higher delinquencies by the end of Q2 2020.
Should low oil prices persist, regional economies heavily dependent on oil, such as Alberta, could face significant unemployment and a local recession in the province. In that case, we would expect a similar ramp-up of delinquency rates by up to 40%. Without tighter balance-control measures, the lending industry may be hit with write-downs of up to $900 million.
And this scenario does not yet consider the incremental effects of COVID-19.
COVID-19 — A different kind of downturn
COVID-19 differs from previous downturns in several respects. Unlike the financial crisis or previous oil shocks which were systemic, this is above all a humanitarian crisis with massive social implications. The economic impact is both supply- and demand-driven and may occur in waves over time, causing ongoing volatility. The impacts of the pandemic may be long-term and affect certain industries profoundly.
While we’ll all be impacted, many will be more severely than others. Alberta, Quebec and British Columbia, which have a greater dependence on the retail sector and a large proportion of lending balances, will be more exposed to prolonged closures. Over 364,000 small and medium businesses are at risk due to the oil price and lockdowns. Given that small business survival rates are highest in the first six years, this segment is even more susceptible to downturns.
The table below outlines what we could expect across lending portfolios as the crisis continues:
|Credit card||Credit cards will likely face the dual challenge of falling spend alongside rising delinquencies. The card market has experienced higher risk, and research indicates a delinquency rate of 90 days past due could be 2.5 times that of the trough in a crisis.|
|Real estate||Social distancing measures will slow the real estate markets, but low rates and pent-up demand will support some stability. International experience suggests a non-material impact on prices and a quick recovery.|
|Automotive||The automotive industry faces depressed sales and a saturated prime lending market, driving recent growth toward below prime tiers. Early monitoring shows a large decline in auto inquiry volumes.;|
The government’s economic response plan should soften some of the risk impacts but will create a longer tail. Deferred tax, direct assistance programs, monetary policy and liquidity actions will provide some relief to businesses and consumers. However, the real effect will depend on the length of the shutdown.
Buying time and adapting to the “new normal”
While there’s no definitive playbook to prepare for all scenarios, there are some general principles to follow in preparing for the immediate impact of the pandemic and what will undoubtedly be a “new normal” once it has been contained.
Financial institutions are in a unique position to enhance customer confidence, ease concerns about financial commitments at a time of disruption, and take proactive measures to help the most vulnerable customers. These include:
- Adjusting policies, processes and communications to acknowledge the hardships customers are facing
- Developing contingency and continuity plans to work out payment arrangements or hardship programs
- Proactively identifying which customers are most at risk
- Helping customers buy time by customizing short-term crisis solutions for personal and small business customers
- Supporting and monitoring sectors and regions that will have a much longer recovery
Consumer demand for borrowing and liquidity should remain high, and performance is less likely to deteriorate if lenders continue to provide access to credit. Understanding risk distribution and resiliency throughout your portfolio is therefore critical, and monitoring the at-risk segments in your portfolio should be paramount to your strategy.
TransUnion is committed to supporting our customers with insights and a range of useful tools, including dashboards, webinars and playbooks to help you manage through uncertainty.