To the surprise of many, Canadians have balanced high debt loads and credit quality for over a decade. That era might be over. Transunion Canada data reveals an explosion of subprime borrowers in Q2 2023. Higher living costs and rising rates have combined to produce higher risk borrowers. At the same time, lenders are embracing it—with new loans to risky borrowers significantly outpacing the growth rate of high quality originations.
Subprime Is Canada’s Fastest Growing Borrower Segment
Canada has seen subprime borrowers become the fastest growing credit segment. The number of subprime borrowers jumped 9% over the past year to hit 2.64 million in Q2 2023. High risk borrowers grew at nearly double the rate of near prime and prime borrowers (+5%), and over 4x the rate of high-quality, above prime borrowers (+2%).
“While the number of consumers taking on higher credit balances rose across all risk tiers, subprime consumers – the riskiest segment – experienced an 8.9% YoY growth rate,” warns Matthew Fabian, director of research and industry insights at Transunion Canada.
Canadians Are Filling In The Credit Gap With Credit
Credit demand remains high—and balances are climbing. Credit inquiries climbed 17% higher in Q2 2023, when compared to the same quarter last year. Inquiries are precursors to credit applications, with the growth trend consistent across the risk spectrum, according to Fabian.
Rising credit demand is attributed primarily to a rising cost of living and higher interest costs. We’ve heard this time and time again—when incomes fail to keep up with the cost of living, the difference is made up with credit. That gap accumulates and compounds the longer the issue persists.
For over a half-decade, Canada was warned that high debt loads were a household debt risk. In 2020, the problem began to get worse as cheap money flooded credit markets to stimulate investments and drive mortgage borrowing. Now with the post-Global Financial Crisis (GFC) era of easy money coming to an end, that risk isn’t just being realized. Those risks are now amplified by the excess demand driven by the Bank of Canada (BoC).
Both factors are probably driving the surge in subprime borrowers. It’s the former likely doing most of the heavy lifting though. Two characteristics of subprime accounts are incomes challenged by cost of living, and relatively small credit accounts. A cost of living increase is more likely to be challenging to the budget than a rise in interest on relatively small balances.
Lenders Are Taking On More Technical Risk, But Is It Risky?
Surprisingly, lenders are interested in taking on more risk. An easy to spot trend, since the number of subprime borrowers are rising so sharply. However, the credit bureau found that higher risk, below prime loan originations, climbed 16% in Q2 2023. In contrast, those with prime or better credit scores, drove just a 6% increase in new loans.
Higher interest rates are designed to throttle credit, but TransUnion doesn’t appear to think that’s a good idea. “Lenders have held steady in balancing their risk strategies in the current macroeconomic context, but this environment continues to place some Canadians under stress, as balances grow and minimum payments are higher than before,” explains Fabian.
However, he suggests “…lenders should maintain a growth strategy that allows for financial inclusion, by focusing on resilient consumers and helping those vulnerable to economic shocks.”
Counterintuitive, but throttling credit can lead to consumer demand falling even faster. In the event of a downturn, an even sharper limit on credit can amplify negative shocks. A deeper and longer recession isn’t anyone’s idea of a good time.
Besides, in an economic shock, investors are historically a bigger surprise than subprime borrowers. Despite the myth that subprime borrowers were a major issue during the GFC, more indepth research revealed a smaller shock.
Researchers found that overleveraged investors using subprime lenders are what amplified the downturn. As a wise person once said, subprime borrowers live in a constant recession. Living paycheque-to-paycheque, along with job and shelter insecurity are issues they face everyday. In other words, their whole life is just one big, long recession. A recession tends to provide more shock for overleveraged, amateur investors that are unprepared for changing market conditions.
