Canada’s biggest banks set aside $2.5 billion to cover an expected wave of loan defaults

Canada’s largest banks have set aside almost $2.5 billion to prepare for a wave of credit and loan losses as economic conditions worsen.

The Big Six banks, which reported fiscal first-quarter earnings over the past week, all posted significant increases in such reserves — called provisions for credit losses (PCLs) — compared to a year earlier, when they totalled just $373 million.

It’s the biggest buffer for credit losses since the first year of the pandemic, when the financial giants also built up provisions before it became clear that government financial supports and a stockpile of consumer savings would help stave off a wave of loan delinquencies.

But Canadians are now grappling with sharply higher borrowing costs, after a year of aggressive interest-rate hikes by the central bank, and facing still-persistently high prices for food and other necessities.

Bank executives said this week they don’t expect a dramatic spike in defaults, particularly as employment remains high, but they anticipate what they call a “normalization” of credit loss trends.

They said the risks of delinquencies and losses on credit cards, lines of credit and auto loans are more likely than mortgage defaults, and such delinquencies have already started to increase in recent quarters.

“We expect write offs and delinquencies to revert towards pre-pandemic levels,” said CIBC’s Chief Risk Officer Frank Guse, while executives from the other banks shared similar comments.

“As anticipated, key credit metrics continued to rise from cyclically low levels experienced last year,” said Ajai Bambawale, chief risk officer at TD, “with this trend most evident in the consumer lending portfolios.”

Royal Bank CEO Dave McKay said Wednesday that his bank’s financial results were hit by higher PCLs in the quarter, noting, “we expect them to continue increasing from cyclical lows.”

The country’s biggest bank set aside $532 million in PCLs for the three months ended Jan. 31, up from $105 million in the same period last year, and McKay added that the growing cost of debt will play a role in the broader economic picture.

“We do forecast a softer landing, characterized by a modest recession, largely underpinned by the impact of rising debt service costs on the consumer,” McKay said.

Scotiabank Chief Risk Officer Phil Thomas said consumers are already spending less on travel and dining out, though the savings have been partially offset by higher grocery expenses.

“We know that our customers are responding to a higher cost of living by making trade-offs to manage their spending habits.”

Still, Scotia’s Thomas said, “the low level of unemployment across most of our core geographies is a driving factor for the stability of household incomes despite inflationary pressures.”

The banks said strong employment numbers, wage growth and savings mean many of their mortgage clients are well positioned to avoid defaults and noted that mortgage delinquency rates remain low.

Yet, the outlook for some Canadian homeowners could be significantly worse than the picture the major lenders have painted.

The banks generally do not work with clients with low credit scores, leaving those borrowers to turn to private lenders that offer much higher interest rates.

A new report from Ontario’s financial regulator this week said that 10.6 per cent of all mortgages brokered in the province in 2021 were private mortgages (not through the big banks). The Financial Services Regulatory Authority of Ontario said it believes that number went up in 2022 and is likely to increase again this year.

“For many people private mortgages should be a short-term stop gap, not a long-term solution,” FRSA said in a statement on Monday, urging consumers to educate themselves before locking into financial products that typically come with higher fees, shorter terms and unfavourable conditions such as interest-only payments.

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