The financial reckoning that Canadians have so far dodged is almost here, as a recession that could start as soon as the second quarter of this year stokes unemployment, mortgage delinquencies and consumer insolvencies, according to new research from Royal Bank of Canada.
Mortgage delinquencies and consumer insolvencies could rise by more than one-third from current levels over the next few years, RBC economist Robert Hogue and research associate Mishael Liu said in research released on May 3. Insolvencies are likely to hit pre-pandemic levels and continue rising from there, and the debt-service ratio will rise to 15.5 per cent, a historic high, in the fourth quarter of 2024.
“The noticeable improvement in Canadians’ finances early in the pandemic wasn’t sustainable,” Hogue and Liu said. “Those gains are now reversing and will likely erode further amid a softening economy and higher interest rates.”
Mortgage delinquencies have yet to rise, the RBC team said, but they noted that homeowners with variable-rate mortgages that reset with Bank of Canada decisions are already bearing the brunt of heftier monthly payments.
However, signs of distress are appearing in the rising rate of consumers who are 90 and more days behind on debt payments for instalment loans used for things such as home renovations, emergencies, debt consolidation, credit cards, auto loans and lines of credit.
“A looming recession and the ongoing effect of higher interest rates will only add stress in the period ahead,” Hogue and Liu said.
RBC is calling for a recession to hit the economy as early as the second quarter with growth falling 0.5 per cent followed by a decline of one per cent in the third quarter. A recession is defined as two consecutive quarters of negative growth.
This “mild” recession will push the unemployment rate up to as high as 6.6 per cent by the first quarter of 2024, from five per cent currently.
“Historically, the loss of a job has been one of the principal factors contributing to loan delinquencies and consumer insolvencies in Canada,” they said.
They estimate that a higher unemployment rate could “reverse” the decline in mortgage delinquencies by half and that the reversal will continue in the medium to long term as elevated borrowing costs for mortgages come knocking at the doors of more homeowners.
Furthermore, rising joblessness coupled with increasing rates and debt loads will push insolvencies upward, even after the labour market recovers and interest rates drop.
Hogue and Liu cited several factors related to the pandemic as the catalyst that set consumers up for the financial trials bearing down on them.
Ultra-low interest rates and generous government support that doled out billions shielded Canadians from the economic fallout of the pandemic. During that time, “net worth increased, and various metrics of debt service, loan delinquencies and consumer insolvencies grew noticeably stronger,” Hogue and Liu said.
People also piled on debt during that time. Consumers owed $1.80 for every dollar of disposable income as of the fourth quarter of 2022, according to the most recent data from Statistics Canada, matching pre-COVID-19 levels. That debt burden has only grown heavier with the meteoric increase in the Bank of Canada’s interest rates to 4.5 per cent from a pandemic low of 0.25 per cent.
Hogue and Liu said they believe Canadians can manage in the short to medium term.
However, “record indebtedness has made Canadians more interest rate-sensitive than ever,” they said. “And the impact of past rate increases will continue to pressure mortgage borrowers for years to come as they renew their mortgage terms at what may be much steeper rates.”