Unprecedented drop in insolvencies likely not a sign of financial stability

Only question among debt professionals is whether we’ll see a rising tide or tsunami of filings in the months ahead.

MNP released its most recent Consumer Debt Index just as the COVID-19 pandemic started gaining a foothold in Canada. The data — which Ipsos collected over the two weeks preceding the indefinite shutdown of non-essential businesses and millions of resulting job losses — revealed households were already feeling more pessimistic about their debts than at any point in the survey’s four-year history.

Even before people understood the full magnitude of what was coming in the following months, it presented easily the gloomiest outlook to date.

Nearly half of survey respondents said they were concerned about their current levels of debt. Three in 10 didn’t believe they could cope financially with a job loss without taking on more debt. A quarter said they couldn’t pay their current bills and debts each month. And an additional 49 percent admitted they were only $200 away from similarly being insolvent.

Add to that the continued trend of rising insolvencies and steadily growing consumer debt across the country — the situation seemed primed for an unprecedented spike in Bankruptcies and Consumer Proposals.

Except that wave never came. In fact, recent data from the Office of the Superintendent of Bankruptcy reveals just the opposite. Across Canada, insolvencies dropped by 39 percent in April and 44 percent over last year.

So, what happened? How can we explain the sharp decline and what does it tell us to expect over the immediate and medium term?

Federal COVID-19 measures did their job

One inference is the Government of Canada’s individual and employer subsidies helped many households avoid crossing that $200 tipping point into insolvency. The Canada Emergency Wage Subsidy (CEWS), enhanced Employment Insurance (EI) benefits, Canada Emergency Response Benefit (CERB), Canada Child Benefit (CCB) top-up, and GST/HST rebate top-up were all announced quickly and with little red tape — providing quick cash flow injections to those most at risk.

And because households were eligible to receive some of these benefits concurrently (e.g. CCB, GST/HST top-up) and others successively (e.g. EI, CERB) with other benefits, the financial stability has been more significant and longer lasting than had everyone in the country received a one-time stimulus cheque.

However, save for EI, almost all these measures have a relatively short shelf life — coming either in the form of one-time payments or lasting only for a handful of months. It remains to be seen how maxing out CERB benefits and the end of CEWS will impact Canadians’ ability to pay their bills. Especially because we don’t know how many employers will survive the pandemic or how many job losses will be permanent.

Lenders stepped up with payment deferrals

On the other side of Canadians’ bank accounts, lenders have been remarkably sensitive to the personal and economic challenges people are facing right now. Many banks, utility companies and other service providers have offered payment relief for those who are feeling the brunt of the pandemic. This has reduced monthly expenses for many heavily indebted households and, in many cases, temporarily halted creditor calls and other collections action.

Ideally, these deferrals will have been interest and penalty free — making consumers no worse off when they resume payments as they were when they applied for payment relief. Unfortunately, it’s more realistic that the pressure on households will be higher when payments resume than they were before the coronavirus shutdown.

As the economy begins to re-open we should expect to see a range of efforts from creditors to catch people up. Whether that takes the form of increased monthly payments or extended loan terms, the net result will likely see most households further behind and deeper in debt.

Drop in consumer spending

COVID-19 also dramatically altered consumer behaviour from March through at least the early part of June. Transportation costs dropped sharply with so many people laid off or forced to work from home. Restaurants, theatres, malls and other bastions of discretionary spending closed to the public. Even with marginal increases in groceries, utilities and online shopping, many households have reported significant savings which have allowed them to keep up with previously unsustainable debt payments — and perhaps helped a lucky few get ahead.

Though we would love to see such fiscal restraint continue, this is unlikely. It’s simply unreasonable to assume people will continue to stay cooped up in their homes as the summer weather moves in, lockdown restrictions relax, and opportunities re-emerge to travel and socialize with friends and family.

Even if spending doesn’t immediately return to pre-pandemic levels, it wouldn’t take much to push many households back into dangerous territory. Even a couple hundred dollars per month (two family dinners out in most cities) may be enough to once again tip the scales toward an insolvency scenario.

Increased credit use

Finally, we come to the great unknown of this whole situation: How much credit have Canadians been using to offset the financial challenges of COVID-19?

We know from our MNP Consumer Debt Index survey data that few households have enough emergency savings to cope with unexpected expenses. In fact, a large cluster (generally between a quarter and a third) often expect to use credit to pay for any unforeseen costs. And though we’ve yet to see any concrete evidence Canadians have significantly increased their debt loads since March, there’s reason to suspect this may be the case.

For one, the Bank of Canada dropped its overnight rate by one and a half percent over March, returning to the historic low levels of the 2008 financial crisis. And low interest rates tend to give consumers a false sense of security that results in increased borrowing. 

Moreover, the three other factors we’ve discussed simply cannot explain such a sharp drop in insolvency filings. Broadly speaking, government subsidies and payment deferrals were only available to those hit hardest by the pandemic. And while these measures may have helped slow or even stall the rise of Bankruptcies and Consumer Proposals, something else must explain their massive decline.

Reduced spending no doubt helps, but it won’t be surprising to find out an uptick in credit has played a prominent role.

A return to normal is as optimistic as it gets

Receding coastal water immediately after an earthquake is a tell-tale sign of an impending tsunami. As the ocean seeks to regain equilibrium, the wave surges inland and engulfs everything in its wake.

Given the already shaky ground Canadians were standing on before the COVID-19 crisis — not to mention the magnitude of the virus, its economic impacts and the government response — it won’t be at all surprising to see a similar pattern in nationwide insolvencies.

At best, we will see the numbers rapidly return to the baseline as federal subsidies and stimulus dollars dry up, creditors begin clawing back deferred payments and consumers return to pre-pandemic spending levels.

More likely, the numbers will shoot past their original 44 percent decline to catch up at least with where the trend was already heading.

But we also can’t ignore a possible worst-case scenario. This projection would need to account for all those households who have lost employment income long-term, are struggling to catch-up with payment deferrals to creditors and / or significantly increased their debt load to make ends meet over the past several months.

It’s difficult to predict how many insolvencies we will see toward the tail end of 2020 and into 2021, but it’s not too much of a leap to say it will likely be as unprecedented as the scope of the pandemic itself.

Life Changing Debt Solutions

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Whether you qualify for a Bankruptcy, a Consumer Proposal or would benefit from any other options to permanently address your debt, an LIT will help you choose the best solution for your unique situation. You don’t have to face your financial troubles alone. We can help you get the relief and peace of mind you need to move forward with confidence.