No one can deny that the economic landscape has inextricably changed over the last couple of years. COVID-19 has come and gone (but not without leaving a trace), VC funding is drying up for Fintechs, Canadians are suffering an affordability crisis, interest rates have risen quickly, and debt loads are truly starting to strain Canadians.
At Payson, our clients are starting to ask us, “how should we react?” What will happen to our existing businesses? To losses? Should we be launching the new products we have in the pipeline? Before being able to answer the above, it’s helpful to take the lay of the land.
Inflation:
The Canadian economy, and more broadly, everyday Canadians, have not been immune to global inflationary pressures. The sources of these pressures are varied, but they were largely driven by 3 global phenomena: the COVID-19 pandemic, global turmoils, and changes in employment preferences. These macro-economic factors led to a spike in commodity prices, a surge in global demand for goods and impaired supply chains (Bank of Canada). Businesses started passing on those additional costs to consumers. This led to the highest inflation rates Canadians have seen since the 1970-1980s (World Bank data).
Source: Bank of Canada
Interest Rates:
In reaction to this rising inflation, the Bank of Canada started raising interest rates in March 2022.
Source: Bank of Canada
Although the speed of these increases have not been felt by Canadians in a long time, taking a longer historical viewpoint is telling. The low interest rate environment between 2008 and 2022 was the historical anomaly, not the other way around.
Impact to Fintech Investment:
Along with cheap money came the growth of the fintech space. Canada saw a large increase in fintech investment between 2010 and 2021.
Source: Betakit
As VCs took stock of their current portfolios and focused on profitability instead of growth in 2022-2023, the number of deals in the industry dropped (Reuters). Unit economics replaced user growth as the new buzz word, and fintechs took note.
Impact to Canadians:
The impact of inflation and higher interest rates is being felt by Canadians. The cost of living has increased and so has the burden of servicing debts. A study conducted by Manulife, found that:
71% of Canadians worry about being able to afford essentials like food and housing; 70% worry about making their mortgage payments and 90% are concerned about the affordability of life in Canada. 4 in 5 Canadians are worried about making their debt repayments (an increase of 14 points compared to last year).
The increase in cost of living is pushing the lowest earners to negative debt to income ratios:
Source: Equifax Q3 2023 Consumer Credit Trends and Economic Insights
TransUnion highlights the impact of new debt burdens on delinquency rates. The TransUnion Q3 2023 Credit Industry Insights Report highlights the key impacts:
· Average credit card balance per consumer increased with new economic pressures, correlated with a decrease in consumers paying more than their monthly minimum payments by 311 bps YoY. This will make overall debts harder to manage for certain cohorts of the population.
· Consumer-level delinquencies at 1.55% are up by 12 bps YoY, yet remain below pre-pandemic levels, highlighting Canadians’ current financial resilience.
Source: TransUnion Q3 2023 Credit Industry Insights Report
Inflation is creating affordability challenges, which is leading Canadians to struggle with their existing debt, while higher interest rates will make consolidating those debts and servicing them more difficult. Lenders will also have to contend with less investment (at lower valuations) and higher cost of borrowing; their margins will be squeezed or passed on to consumers.
The impacts are already being felt, with companies like Pillar, a neobank, and Billi, a personal finance app, closing down earlier this year (Betakit). Early indicators of heightened risk will have every risk department looking over their lending policies.
The impacts are also already being felt by consumers. Mortgage holders are worried about renewals, with more and more mortgages falling into negative amortization as payments increase. Higher costs of living is pushing more Canadians to leverage credit cards to make ends meet. Balances are increasing, while payment sizes are decreasing.
And so back to the original questions.
How to react?
If you are currently a lender, you should ensure you have a firm grip and solid understanding of your exposure. Diligently monitor your portfolio, especially your most at-risk segments. You should take time to reassess your credit policy and ensure you have positive unit economics.
If you are looking to launch a new product, make sure you answer the below questions:
1. Is there a need that is currently underserved?
2. Do you have an advantage at servicing that need which competitors lack?
3. Do you understand the risk of the target population?
If you know the answers, you should be able to price your products according to the risk posed, build in resiliency through de-risking tactics and test your way into the market in a responsible way. Remember, though interest rates have increased dramatically, they are reverting back to historical norms. Companies were able to create successful lending businesses through time, so why not now?
As our founder Brent Reynolds once articulated:
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