The Bank of Canada normally uses its annual Financial System Review to provide an update on key financial system vulnerabilities-high household and corporate debt and frothy housing markets have been common themes in recent years-that might amplify the effects of an economic shock. Well, such a shock has arrived in the form of a global pandemic that has significantly curtailed economic activity and pushed oil prices sharply lower-a double whammy for the Canadian economy. So today’s FSR had more of a short-term focus, looking at how COVID-19 has impacted the financial system and the financial health of households and businesses, and how monetary and fiscal support measures are buffering the shock. With the economic outlook remaining highly uncertain, the BoC erred on the side of caution in projecting mortgage arrears and non-performing business loans based on the more severe economic scenario it laid out in April. The pessimistic reading would be that even with policymakers’ extraordinary actions, that scenario would see mortgage and business loan delinquencies eclipse previous peaks-those longstanding vulnerabilities coming home to roost. https://yourloansllc.com/bad-credit-loans-hi/ A more optimistic reading would be that policy support has prevented a significantly worse outcome, and a resilient financial system will be able to absorb losses and leave the foundation in place for an eventual economic recovery. And, as Governor Poloz mentioned, a better economic scenario is still within reach as many provinces are beginning to gradually re-open their economies.
The projections in today’s FSR are based on a scenario in which Canadian GDP is 30% lower in Q2 and recovers slowly thereafter-a significantly more pessimistic forecast than RBC’s base case. In that scenario, mortgage arrears are projected to increase to 0.8% by mid-2021 from 0.25% at the end of 2019, nearly double the peak in arrears seen in 2009. 4% at the end of this year from 1% at the end of last year, significantly higher than past peaks of less than 5% in 2003 and 2010. These outcomes are set against a counterfactual scenario without recent policy interventions-mortgage deferrals and income support for households, and a number of direct support and lending programs for businesses. Without those measures, mortgage arrears and non-performing business loans would be significantly higher (peaks of 2.1% and 16.2% respectively). The upshot is that while we might see a significant increase in mortgage arrears and troubled loans over the next two years in a more pessimistic economic scenario, these outcomes would be much worse without the extraordinary programs that have been put in place to support businesses and households. That has important implications for the banking sector. The BoC’s analysis suggests that, with the policy measures that have been put in place, large bank’s existing capital buffers should be sufficient to absorb losses. Without those interventions, “banks would be faring much worse, with important negative effects on the availability of credit to households and businesses.”
More on the financial health of various sectors of the economy
- Some signs of reduced funding stress: BoC’s bankers’ acceptance program shrinking, drawdown of credit lines has slowed in the past month (some borrowers even repaying) and corporate debt issuance picked up significantly in April after grinding to a halt in March
- But surveys show higher-than-normal rejection rates for SMEs requesting additional funding from financial institutions
- Upcoming corporate debt refinancing needs are in line with historical levels, but many borrowers will face in increased cost of refinancing due to still elevated corporate spreads
- Nearly 3/4 of investment grade corporate bonds are rated BBB (the lowest investment grade rating)-downgrades would double the stock of high-yield debt and significantly increase funding costs for those borrowers
- Firms in the industries most affected by COVID-19 tend to have smaller cash buffers, and a sharp drop in revenues will make it difficult to meet fixed costs including debt payments-what started as a cash flow problem could develop into a solvency issue for some businesses
- The energy sector is facing particular challenges: it has had to rely more on credit lines, has the highest refinancing needs over the next six months and faces the most potential downgrades
- 1 in 5 households don’t have enough cash or liquid assets to cover two months of mortgage payments
- Government support programs (CERB payments and CEWS wage subsidies) will cover a large share of households’ “core” spending (food, shelter, and telecoms)
- Loan payment deferrals (banks have allowed more than 700,000 households to delay mortgage payments) and new borrowing can help offset remaining income losses
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Josh Nye is a senior economist at RBC. His focus is on macroeconomic outlook and monetary policy in Canada and the United States. His comments on economic data and policy developments provide valuable insights to clients and colleagues, and are often featured in the media.
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