It was only a matter of time before
credit losses spread across the US/Canada border, and a new report
from business advisory firm Deloitte is highlighting that the pace
of the downturn is taking many issuers by surprise. It is also
urging them to take pre-emptive action, as Charles Davis reports.
The credit quality contagion has spread
from the United States into Canada, as a new study paints an
increasingly grim portrait of that nation’s card market.
Toronto-based business advisory and
consultancy group Deloitte Canada recently released the report
Uncharted Waters For Credit Card Issuers, based on
interviews with approximately half of all Canadian credit card
The issuers told Deloitte that while they have
only recently begun to feel the affects of increasing delinquencies
and charge-offs, the pace of the downturn is increasing. Issuers
are responding by tightening credit standards and looking deeply at
the health of their portfolios, but the report urges them to do
even more, anticipating heightened economic uncertainty in the
months to come.
Most respondents said they started seeing a 5
percent to 10 percent increase in delinquencies during the fourth
quarter of 2008 compared with the same period a year earlier.
Charge-offs increased 50 to 100 basis points, according to the
Losses set to escalate
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The upper end of the range
represents annualised losses of over C$800 million ($642 million)
to the industry as a whole, where the total value of outstanding
balances is in excess of C$80 billion, according to the report.
Even in a more conservative scenario, losses could be in the C$500
million range in 2009.
Canadian credit card issuers have typically
seen loss rates of less than 4 percent, a rate much lower than that
of the American average of 6 percent. But with Canadian consumers
increasing their debt-to-disposable-income ratios to more than 130
percent – a rate currently higher than that of the credit-crazy US
– Canadian issuers face unprecedented risks. Canadian credit card
balances have increased almost 40 percent since 2004, according to
the country’s central bank, the Bank of Canada. As a result,
Canadian credit card issuers are taking action to avoid the costly
write-downs now common in the United States.
The Deloitte report found that Canadian
issuers have reacted to those risks by tightening credit standards
for new accounts, implementing credit limit decreases and paring
back such acquisition efforts as balance transfer programmes.
The price of aggressive
The report found that although many
of the Canadian credit card issuers that have aggressively grown
their portfolios in the last few years will suffer higher credit
losses in the months ahead, there are measures all credit card
issuers may take to more effectively manage their portfolios,
decrease risk and plan for future growth and profitability. The
report recommended that issuers intervene quickly when accounts
become delinquent, actively review the credit quality of existing
customers, monitor cash advances and credit line usage and stop or
reduce automatic credit limit increases.
It also suggested that issuers adjust
operating costs to reflect current realities and upgrade their
approach to forecasting with scenario planning, or risk runaway
delinquencies as Canadian debt ratios soar.
“Traditional forecasting models based on
historical patterns are proving unreliable predictors of future
risks,” the report said. “You may need a more comprehensive
approach that injects advanced scenario planning into your
decision-making. Since the future is inherently uncertain,
particularly now, scenario planning allows you to examine a number
of possible future outcomes and to develop appropriate
Deloitte said that planning models must take
into account the possibility that the recession deepens before any
improvement is seen, and noted that there are potential regulatory
changes on the horizon. Other areas of uncertainty may include
customer use of other forms of payment such as debit or cash, or
competitors entering or exiting the market.
Stressing precautions that Canadian issuers
already are instituting, the report said that cash advances often
indicate that a cardholder is in financial difficulty. The report
recommended creating a watch-list of accounts with unusually high
cash advance activity – and managing them continually.
“Also, there is a high correlation between the
percentage of the credit line being used and the likelihood of
default,” the report said. “Monitor accounts with high utilisation
as an early warning for troubled cardholders. When you do encounter
accounts that may be in trouble, review the other lending
relationships that the cardholder may have with your institution to
assess your full exposure. Taking a holistic view of the cardholder
and their relationship with your institution is even more important
in these times.”
Risk of high debt levels
The Canadian central bank’s figures
show that consumer credit, on a seasonally adjusted basis, was
C$412.8 billion in November 2008, up 9 percent from the same month
a year ago. The risk of high debt levels was evident in December
2008, when personal and business bankruptcies surged 47 percent
from the same month a year earlier, according to government figures
released in February.
A related report by Moody’s Investors Service
only adds to the worries in Canada, as all five measures Moody’s
uses to determine the performance of the credit card market
deteriorated in the third quarter of 2008.
Customer delinquencies, payment rates, and
credit card company losses resulting from unpaid balances all
worsened compared with the third quarter of 2007. The resulting
losses to credit card companies rose to 3.08 percent in the third
quarter of last year, up from 2.77 percent the year before, Moody’s
Canadian authorities are not as deeply
concerned as US bankers and officials, in large part because a
US-style mortgage crisis is not on the cards thanks to the fact
that most of the home loans issued in Canada are backed by the
government. That guarantee means a sudden crush of foreclosures
wouldn’t force banks to alter their lending habits.
Also in Canadian issuers’ favour are its
tighter lending standards and more stringent credit requirements,
compared with the United States and the UK, Moody’s said.
This means the magnitude of the increase in
credit card payment delinquencies is still likely to remain much
lower in Canada than in the United States, even as the Canadian
recession begins to really sink in.