01/11/2012 10:13 EST | Updated 03/12/2012 05:12 EDT

Bankruptcies down in October, government overseer says

TORONTO - The Canadian bankruptcy rate fell in October as the unemployment rate dropped to its lowest level in years, but experts worry a surge in insolvencies could be on the horizon as the jobs picture worsens and debt loads continue to grow.

The Office of the Superintendent of Bankruptcy said Wednesday that the number of insolvencies, including both bankruptcies and proposals to creditors, fell in October to 10,304 compared with 10,712 in September and 11,813 in October 2010.

But debt experts say a low interest rate environment could be masking the reality that a number of people are on the verge of financial collapse if debt repayment becomes more expensive or unemployment continues to rise.

Douglas Hoyes, a bankruptcy trustee with Hoyes, Michalos & Associates Inc., noted that consumer bankruptcies are linked to the unemployment rate, which hit a multi-year low of 7.1 per cent in October, but has since risen to 7.5 per cent.

The increase in unemployment will further put pressure on the finances of Canadians, making it very likely the number of insolvencies will increase this year, he said.

"I don't think we've seen a permanent reduction in the numbers, I think the filings have just been delayed," he said.

"I would assume that if we see unemployment creeping back up, then yes, there is a very good chance that the number of bankruptcies and proposals will creep back up."

Canadian consumer debt has grown to an all-time high, spurred in part by the impact of historically low borrowing costs over several years.

Bank of Canada governor Mark Carney has voiced concern about the ability of borrowers to meet their payments once the central bank starts raising its rate from the current one per cent, although he hasn't said when that might happen.

The average debt level of Canadian households is now equivalent to 151 per cent of disposable income. That means for every dollar of income that Canadians have after paying their income taxes, they owe $1.51 on average, including mortgage debt.

A report from Equifax Canada this week found a 3.4 per cent decline in the average credit card debt with the delinquency rate falling. However, Equifax noted that consumers may be switching to lower interest lines of credit to pay off that their credit cards while overall debt continues to rise.

Nadim Abdo, vice-president of consulting solutions at Equifax Canada, is concerned that their data shows consumers are not taking advantage of low interest rates to pay down debt. Instead they are using it to keep piling on debt to record levels.

"If you look at the U.S., they had reached those levels before and look what happened. The concern is we've never seen debt-to-income as high as it is now," he said.

"If there is a very small shift (in interest rates) it could have a severe impact because people are so overextended in some cases."

In October, total insolvencies fell by 3.8 per cent from September — a seasonally busy month for filings with the federal agency. Bankruptcies decreased by 3.7 per cent and proposals, which offer creditors partial repayment, fell by four per cent.

The total number of insolvencies in October was 12.8 per cent lower than the total in the same month of 2010. Individual bankruptcies were down 12.9 per cent from October 2010, while business insolvencies decreased by 9.4 per cent.

For the 12-month period ended October 31, 2011, the total number of insolvencies decreased by 8.2 per cent compared with the 12-month period ended October 31, 2010.

Hoyes said that while the October numbers were encouraging, he's also worried that the data obscures the reality that many people are only surviving because interest rates are so low.

Hoyes believes three factors are contributing to what could be a bankruptcy "bubble": banks easing up on borrowers, an influx of debt settlement companies and low interest rates.

First, Hoyes believes banks are getting used to the weaker economy and are thus being more lenient with debtors than they would have been a few years ago on missed mortgage payments.

Now, he said, there are simply too many Canadians who are behind on their payments for banks to crack down.

TD Bank CEO Ed Clark said at a banking conference Tuesday that the lender would be reluctant to push someone out of their house if they can no longer afford payments if it was still comfortable with the mortgage.

"We stood by our customers in the 2008 to 2010 period and modified lots of things that would keep them there," he said.

At the same time, Canadians are becoming complacent about increasing levels of indebtedness, Hoyes said.

"High debt levels are the new normal ... We are just used to it now, it's just the way it is and that's kind of eased off some of the pressure."

Consumer debt has come to be seen as something like a dull headache, rather than a life-threatening situation as the low rate environment blunts the pain, he added.

And an influx of debt settlement companies that have cropped up since the recession are also doing their part to prolong bankruptcies, he added.

These companies temporarily remove potential bankruptcy filers from the system as they take monthly payments from debtors to pay creditors back in a lump sum, but if those plans don't work out, individuals end up filing for bankruptcy down the road, Hoyes said.

For Abdo at Equifax Canada, alarm bells that would signal a widespread consumer collapse include an increase in delinquencies and bankruptcies and a move in the unemployment rate back above 7.8 per cent.

If such a downturn were to happen, those with the highest debt-to-income ratios would be left without a buffer or remedy, given that savings levels are also tumbling, said Jeffrey Schwartz, executive director of Consolidated Credit Counseling Services of Canada, Inc.

"If someone starts losing their paycheque how are they going to service all that debt if they don't even have any savings?" he said.

"I'm a little concerned when debt-to-income ratios grow as high as they are and there's so much volatility in the economy without the savings."