Morningstar DBRS Releases Canadian Structured Finance 2024 Midyear Review

DBRS Limited (Morningstar DBRS) released a presentation that highlights the main trends and developments in the Canadian structured finance market for the year to date (YTD) ended June 30, 2024, as well as the outlook for the remainder of the year.

Summary highlights include the following:
-- As of August 31, 2024, combined new term asset-backed securities (ABS; including private deals), asset-backed commercial paper (ABCP), and covered bond issuance was $64.7 billion.

-- YTD new covered bond issuance has been low at $29.0 billion, compared with the record market issuance levels seen in the last two years. New issuance has been denominated in euros (54%), British pound sterling (17%), U.S. dollars (14%), Canadian dollars (12%), and Swiss francs (4%), with 70% of new issuance brought to market by The Toronto-Dominion Bank (TD). Covered bonds issued by Royal Bank of Canada, The Bank of Nova Scotia, Bank of Montreal, TD, National Bank of Canada, and Laurentian Bank of Canada continue to maintain their AAA credit ratings, while covered bonds issued by Equitable Bank continue to maintain their AA credit ratings.

-- New securitization volume through term ABS (including private deals) and ABCP has been similar to record issuance levels observed in the last two years, reaching $35.7 billion as of August 2024, compared with $35.4 billion in the same period in 2023.

-- New YTD issuance in the Canadian term ABS market reached $6.3 billion, down from $12.0 billion in the same period last year. The market has seen activity from regular issuers, including three auto lease transactions, one auto loan transaction, one auto rental transaction, and one equipment finance transaction. New issuance from credit card issuers, which typically dominate term ABS issuance, have been minimal, totalling $3.6 billion across five new deals, representing about 57% of total new volume. Canadian credit card issuers continue to access the U.S. market, placing 75% of their new volume south of the border.

-- The ABCP market has been growing rapidly since March 2022 when the Bank of Canada began its series of interest rate hikes. The rapid growth can be attributed to the higher yields combined with the top credit quality of the securities, the funding flexibility that ABCP provides to some sellers, and the opportunity for ABCP to fill some of the void left by the discontinuation of the approximately $90 billion market of bankers’ acceptances following the cessation of the Canadian dollar offered rate in June 2024. The total outstanding amount has increased by 46% to $48.9 billion as of June 2024 from March 2022. Auto and equipment financing continued to dominate new ABCP issuance at 54%, followed by residential mortgages at 38%.

-- In the face of higher interest rates, GDP growth in Canada has been weak, and the labour market has been sluggish. The number of quarterly filings for consumer insolvencies has returned to pre-pandemic levels and is likely to rise further as the impact of high borrowing costs and cost of living, along with a weaker labour market, continue to pressure consumers’ finances. Collateral performance in Canadian structured finance transactions has seen some slight deterioration but remains well within expectations across all asset classes.

-- Credit performance in securitized credit card portfolios continues to deteriorate. However, performance metrics are still slightly better than or at similar levels to what was observed before the pandemic. 30+ day delinquencies and net losses have been trending up, while average gross yield seems to have stabilized at around 2.2% above the average gross yield seen in H1 2019, largely attributed to interchange fees resulting from higher card usage. The increase in gross yield has outpaced the increase in net losses, leading to generally higher levels of excess spread available in the transactions.

-- Delinquencies and credit losses in the auto sector have remained low, despite consumers’ financial challenges and used vehicle prices receding from the peak reached in 2023. Credit performance in the securitized portfolios has been supported by the mostly prime nature of obligors included in the transactions and still-high resale vehicle values.

-- Default rates in Canada for prime mortgages have increased slightly to 19 basis points (bps) as of May 2024, driven by households facing increased mortgage payments as their mortgages renew, coupled with increasing unemployment. Although interest rates have started to come down, easing pressure on mortgage costs, a large portion of homeowners will still be renewing their mortgages at higher interest rates over the next two years, which may lead to more defaults. However, credit risk is partially mitigated by the stress test that requires borrowers to be qualified at the greater of the minimum qualifying rate or the contractual mortgage rate plus 2% and household net worth, including the larger homeowner’s equity in the property.

-- The net loss ratio of home equity lines of credit in securitizations rated by Morningstar DBRS continues to be negligible, averaging less than 2 bps as of June 2024, reflecting the prime nature of the borrowers and loan-to-value ratio limit.

-- Average losses for auto-backed floorplan transactions were trending up in 2023, driven by one auto floorplan transaction funded through the ABCP conduits that was fully repaid in December 2023. YTD average losses have been stable at 0.11%. Losses for equipment-backed floorplan transactions continue to be nil.

-- The large-ticket equipment sector continues to perform well with cumulative losses trending far below Morningstar DBRS’ cumulative base-case expectations. Equipment finance transactions with exposure to trucking financing have been experiencing larger delinquency rates because of the softness in the freight market. However, aggregated losses in securitized pools are well within Morningstar DBRS’ expectations.

-- Morningstar DBRS-rated securitized portfolios continue to have robust levels of credit enhancement available that can withstand a deterioration in macroeconomic activity and stress levels that are commensurate with the credit rating assigned.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The report is available at dbrs.morningstar.com.

For more information on this industry, visit dbrs.morningstar.com or contact us at info@dbrs.morningstar.com.

DBRS Limited
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Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577