Effect of Current Economic Conditions on Consumer Insolvencies
By Grant Bishop, Economist, TD Bank Financial Group

Personal insolvencies have increased sharply during the recession, rising by 37% from August 2008 to August 2009. Higher unemployment has driven the higher rates of bankruptcies and consumer proposals, but heightened levels of personal indebtedness made households more vulnerable to job loss. Put another way: Layoffs were the spark, but a small portion of households’ over-indebtedness was the kindling. Owing to these factors, we anticipate around 150,000 insolvencies during 2009 – equivalent to 5 insolvencies for every 1,000 persons over 15 years of age. While the Canadian economy has turned the corner and positive job growth has emerged, this heightened insolvency rate will only abate gradually and will remain above its pre-2008 level past 2013. In order to avoid higher credit losses, creditors must increasingly hone-in on borrowers’ riskiness and prudently assign credit limits.

Economy-wide, we can examine two ratios to resolve households’ vulnerability to insolvency: household debt to personal disposable income (PDI), and household assets to liabilities. Both showed weakness prior to the recession, but were worsened by the downturn: debt/PDI accelerated during the recession, as incomes fell and credit continued to grow; and assets/liabilities plunged dramatically over the final quarters of 2008, troughing in early 2009. Notably, the latter measure had already started to fall in 2006, as asset growth slowed and households continued to borrow at previous rates.

Higher debt flags households who are more vulnerable to insolvency when faced with job loss, or even stagnating income. And this recession has not been kind. Although interest rates cuts have dramatically reduced the cost of servicing each dollar of present household debt – particularly those debts priced off the prime rate – many households, faced with a weak job market, were still unable to sustain payments at these rates.

Although we must also point out that this is still relatively low on a historical basis, the rate of mortgages in arrears has climbed, doubling from 0.12% of outstanding mortgages in June 2009 to 0.25% in June 2009. Among the types of liabilities for insolvent households, mortgage debt per insolvent consumer has accelerated most markedly, implying that the inability to sustain mortgage payments has contributed to the heightened insolvency rate.

Looking ahead, the Canadian recovery will be fairly gradual, owing to persistently tepid export demand from our major export partner and ongoing restructuring in some of Canada’s core industries. The economic slack in the Canadian economy, reflected in heightened unemployment and idle factories, will not be taken up quickly. Unemployment will ebb only gradually and will not return to the exceptionally low rates seen pre-credit crisis. Nonetheless, the insolvency rate should decrease after peaking in 2010. However, owing to ongoing heightened households debt levels, we project that consumer insolvency will remain above its pre-2008 rate.

Amid the downturn, household borrowing has remained surprisingly robust. Bargain basement interest rates enticed households into new borrowing – particularly for home-buying and renovations. Looking at this aggregate picture of increasing debt, minimizing credit losses requires that the right (rather than the risky) borrowers are receiving this credit.