Thursday, January 12, 2006

Cheap Credit Could Bite Back, CIBC says

Financial Post, Wojtek Dabrowski, 12 January 2006

The binge on cheap mortgages and loans has the potential to create serious problems for lenders and consumers when the credit cycle takes a turn for the worse, Canadian Imperial Bank of Commerce chief executive Gerry McCaughey warned yesterday.

"When the cycle hits on credit, I think that it's something that we have to think about in terms of best-case [or] worst-case, and when you think about the length of time that has gone on without the cycle playing itself out on the negative side, that could be a harbinger of a more negative cycle than we are anticipating right now," Mr. McCaughey said during the RBC Capital Markets Canadian Bank CEO conference yesterday.

"And if you had large corporate credit and consumer turndown at the same time -- we haven't seen that in recent history, and it could be difficult."

Problems with consumer lending are not new for CIBC. Mr. McCaughey has said the bank's retail division has been experiencing unacceptably high consumer loan losses and has warned the situation is not expected to improve in 2006.

Low interest rates and a strong economy have enticed Canadians to borrow to buy homes or to take out personal lines of credit en masse. The personal savings rate, which is expressed as a percentage of disposable income, has gone from 9.2% in 1995 to 4.7% in 2000. Toronto-Dominion Bank estimates it will decline to negative 0.5% on average for 2005.

If the credit cycle turns in a negative direction and banks impose tighter lending conditions, this could dampen consumer spending.

Last month, the U.S. yield curve inverted, marking what some are calling a powerful sign of trouble for the U.S. economy. The past six recessions have all been foreshadowed by a yield-curve inversion.(An inversion occurs when the yield on short-term government bonds rises above the yield on long-term bonds.)

Canadian economists generally agree the sweet spot of the credit cycle has passed. There is nowhere to go but down, they say, but the question is how quickly and how sharply that descent will occur.

"I think given how surprisingly resilient [the economy has] been for some time, one has to be a little more concerned with the downside, particularly in the banking world," said Craig Wright, chief economist at Royal Bank of Canada.

He said that while such factors as high energy prices have the potential to retard growth, the effect will likely not be dramatic.

"The impact, if we're right, will be moderate and measure over a number of years rather than a number of days," he said.

Toronto-Dominion Bank economist Carl Gomez agrees.

While rising interest rates could crimp the growth in lending by the chartered banks, there is little risk of the housing market collapsing or sharply falling off, "largely because there is no housing bubble or anything like that," Mr. Gomez said.

"We're not going to see a tanking in volumes or anything like that.

"Relatively speaking, yes, we are past the sweet spot, but what we are going to see is not necessarily a huge contraction, but a slowdown or moderation in the credit cycle," he added.

While CIBC has sought to curb consumer loan losses and reduce its exposure, Bank of Nova Scotia has been interested in cautiously expanding its unsecured loan portfolio.

Bob Chisholm, CEO of domestic banking and wealth management at Scotiabank, told the conference the bank recently introduced near-prime mortgage lending, "which generates a much more significant yield ... without commensurate risk on our part."

He said Scotiabank's loan losses are low and added that "some people find that hard to accept that I would prefer some additional loan losses, but I think we can generate more revenue if we take a little bit more risk."