Some subprime lenders look like facing strain as debt levels and the speed of borrower defaults begin to rise in Canada and the U.S., which can 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 proceed to ramp up the pain on consumers, and as that financial hurt appears to be bleeding out into the center class.
Experts warn that if a crisis rapidly accelerates the issue, there might be ripple effects to the broader economy.
“If increasingly Canadians proceed to default, then the corporate has problems, and we don’t wish to return 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, no one’s higher off if increasingly Canadians are insolvent, right? Someone’s got to pay for that.”
As consumers struggle, are lenders next?
The upper cost of living brought on by a spike in inflation because the pandemic and an increase in rates of interest have made it difficult for a lot of Canadians to make ends meet.
This is very the case for lower-income households that typically have lower credit scores.
Lower credit scores means it’s tougher to get a loan or line of credit compared with the next rating. This may include a mortgage, auto loan, bank card, bank loan or perhaps a personal loan.
Those higher-risk borrowers — those with low credit scores — are known as “subprime,” and those that provide them with higher-risk loans — typically at a much higher rate of interest — are what’s often called “subprime lenders.”
Major banks and lending institutions in Canada typically cater to lower-risk individuals and businesses, although some may tackle higher-risk profiles at costlier rates of interest.
There are alternatives available for those with higher perceived risk to get a loan or line of credit, however it typically means having to pay higher rates of interest from alternative or subprime lenders due to inherent risk that those borrowers may not have the option to pay their loans back.
For a few of these higher-risk lenders, that’s exactly what’s now happening.
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A Canadian alternative financial lender called Goeasy saw its stock price tank 70 per cent up to now month, as of publication, and after it reported a large, unexpected increase in loan losses in its most up-to-date quarter.
“Goeasey has been within the subprime lending business for a really very long time, and in past cycles they proved very adept at adapting to the credit cycle, and taking in enough money to soak up credit losses, and generating a really 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 might 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 look like a one-off situation, even big banks are beginning to see small cracks emerging in lower risk profile loans.
“Borrowers with lower credit scores unable to access typical prime lending arrangements from one in every of the six big banks for instance, turn to alternative lenders that use different adjudication methods with a purpose to extend credit,” Vinokur says.
“We’ve seen higher non-performing loans [loans that default or are close to defaulting] at the massive banks, and that’s with prime credit, that perhaps there’s the next non-performing level of loans now being seen in real time with lenders that stretch to subprime borrowers.”
If borrowers proceed to default on loans, including lower-risk and higher-income households, there might be a ripple effect that impacts the broader economy if more lenders don’t protect themselves to soak up potential losses on bad loans.
“Canadians are increasingly stressed. They’re getting pushed to the perimeters of their map with respect to their budget, after which what happens is that as soon as you hit the sting, you now lean on credit products,” Yanchuk Oleksy says.
“Once they’re coming to us for help since the stress and the debt load has gone above their noses, sometimes they’ve hit the tip and insolvency is the one option.”
Are subprime risks spreading?
That said, financial experts who spoke to Global News emphasized that while there’s strain on subprime borrowers and a few subprime lenders, the situation appears to be generally isolated — for now.
But things could change for the broader economy if the issue quickly accelerates.
“There’s loads of capital on the balance sheets of our financial institutions to have the option to buttress any type of downturn,” Vinokur says.
“Now we have to observe the situation to see what’s the rate of change of escalation because that’s at all times the important thing query.”
Vinokur uses the COVID-19 pandemic as a recent past example of a “big problem” that might rapidly grow from a small, isolated issue within the economic system.
“Can banks use their existing profitability to melt the blow over time, wait for that stability, after which go into the following economic cycle?” he says.
What’s different now vs. in 2008?
For the reason that financial crisis from 2007 to 2009, lenders like large banks and other institutions within 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 soak up the impacts of potential economic shocks and proceed lending out money.
In Canada, banks were required by the Bank of Canada to put aside loan loss provisions starting in 2018 to organize for potential economic downturns slightly than reply to them after the very fact.
The main points were shared in a 2016 research study titled “Timing of Banks’ Loan Loss Provisioning Through the Crisis.”
“After the worldwide 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 switch the incurred loss model with the expected loss model,” the Bank of Canada said.
“This has resulted within the changeover from the incurred loss model under IAS 39 toward the expected loss model under International Financial Reporting Standards (IFRS) 9, scheduled to turn into effective in 2018 (e.g., Gaston and Song (2014)). Under IFRS 9, banks can have to provision not just for credit losses which have already occurred but additionally for losses which can be expected in the longer term.”
Last month, among 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 implies the banks are concerned that among the loans they’ve issued to borrowers may default and they’ll find yourself taking a profit hit.
That was also just before the Iran war began, and sent energy markets surging on global supply concerns that might end in an inflation spike.
Vinokur says Canada is in a comparatively good position considering the demand and revenue increase for energy resources like oil, and the banking system is in a superb financial position despite many consumers struggling to pay for his or her loans.
“It will need to get very extreme, very fast for our banking system to begin to actually feel the brunt of it,” he says.
“Immediately, they [the big banks] I feel 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.”