Tight credit starts to bite consumers

TARA PERKINS AND LORI MCLEOD From Saturday's Globe and Mail

January 16, 2009 at 9:10 PM EST

The credit crunch, which has already squeezed corporate borrowers, is now trickling through to consumers, with higher interest rates and tighter lending terms. Some borrowers are being notified that rates on their credit lines and cards are going up, and others are having borrowing limits scaled back.

Home buyers taking out a variable-rate mortgage, meanwhile, will find a premium over the prime rate of 70 to 80 basis points, rather than the discount they might have found just six months ago. (A basis point is 1/100 of a per cent.)

While financial institutions in the United States took similar measures last year and banks in Canada have been charging their corporate customers more, the competitive consumer-banking environment in Canada has made it more difficult for Canadian lenders to pass their higher costs along to individual borrowers.

But signs are mounting that financial institutions are going to raise prices on consumer loans, even as the federal government attempts to tackle the thorny issue of credit in its Jan. 27 budget. Ottawa wants to grease access to credit at reasonable prices to keep the economy churning through the downturn.

The price of bank loans is also likely to hit the spotlight Tuesday, when the Bank of Canada is expected to cut interest rates again.Banks are under pressure to reduce rates and lend more at a time when they are worried that more borrowers will struggle with their debts, a concern reflected in their increased provisions for troubled loans.

Bank of Montreal is sending letters to customers notifying them of a 1 percentage point increase in interest on lines of credit. The prime rate has been declining in recent months while the cost of borrowing has risen dramatically for all banks, the letters say.BMO's increase, which affects customers who obtained credit lines before Oct. 15, does not make its products the most expensive in the industry. “From our survey of the market which was confirmed as recently as today, our personal line of credit offering is competitive and in fact favourable compared to some of our major competitors,” a spokesman for the bank said earlier this week. But the move signifies a new willingness among banks to raise rates.

“I think we'll see the rest of the competitors follow suit in some fashion,” said Edward Jones analyst Craig Fehr. “I think this is going to be the first of many product lines that will get repriced.”The banks, which fund more than half of their loans through deposits, are seeking to loosen the vise grip that lower interest rates have placed on their profits.

“Since the banks depend on deposits for much of their funding, if you reduce prime without being able to reduce deposit rates by the same amount, the margin gets squeezed,” said National Bank analyst Robert Sedran. “Increasing the borrower's spread to prime restores some of that lost profitability. You could see more of that behaviour if interest rates continue to fall.”Canadian Tire is raising the rate on its Options MasterCard credit cards by 2 percentage points, effective in March. A number of competitors have already raised rates, said spokeswoman Lisa Gibson.

“In this case, just given the economy and so on, we made the decision to raise it,” she said. Canadian Tire has also reduced the spending limits on accounts that were inactive in order to reduce risk in the company's portfolio, she added. “We also stopped credit limit increases for riskier customers.”

American Express sent letters to a number of Canadians last month informing them the limit on their card had been cut. The company recently tightened some of its criteria, and has increased scrutiny of customer limits in light of the economic environment, said spokeswoman Lauren Dineen-Duarte.

One cardholder, who says she has never missed a payment and has a good job and credit rating, was surprised to receive a form letter from Amex Dec. 24 scaling back her credit limit by more than $16,000.

“These regular reviews are undertaken to protect card members' interests by helping them avoid taking on additional debt that they may not be able to support,” said the letter, which informed the cardholder her limit had been reduced to $1,000.

Ms. Dineen-Duarte said that although “this is an area that is being given increased scrutiny at this time, we have currently only had to take action like reducing credit limits for less than half-a-per-cent of our total card member base.”

She added that Amex carries out its assessments based on the financial information it has on record, including the card holder's spending and payment patterns, and external information it obtains from credit reference agencies.

As Toronto-Dominion Bank chief executive officer Ed Clark pointed out at an industry conference recently, there is new evidence that more Canadian consumers will have trouble repaying their loans. Personal bankruptcies and unemployment are on the rise, and soured loans are expected to follow.

As a result, financial institutions are stepping up efforts to reduce risk in their lending portfolios, and protect profits.

“Will we be able to start to recover, in the lending markets, our cost of lending?” Mr. Clark mused.

“I think every bank is trying to do that, but this is a highly competitive market.”He later added, “We're going through every line of business and saying, ‘Okay, would you make this loan if you assume we're going to have 8 per cent or 9 per cent unemployment?'”

Discounts on variable-rate mortgages, which had become standard during the housing boom but evaporated late last year, are showing no signs of a revival. Lenders are charging about a percentage point above prime on open, variable-rate mortgages with a five-year term. The best current deal is 60 basis points over prime, according to a mortgage broker.

In October, banks and other lenders stopped offering discounts off the prime rate on variable mortgages, and shortly thereafter began charging their mortgage customers a premium over prime.

While rates are historically low, the difference between receiving a discount and paying a premium above prime can translate into a 20-per-cent difference in the biweekly payment amount on a $300,000 variable-rate mortgage.