Photo illustration by The Globe and Mail
The summer of economic recovery is fading away, replaced by a season of growing uncertainty as the weight of tens of billions of dollars in deferred debts bears down on consumers and businesses.
For months, the economy has been pulled along by two lifelines: the unprecedented intervention by Ottawa to prop up households and businesses with income supports and subsidies, and an equally unprecedented move to allow individuals and companies to put off paying their mortgages and taxes. Add to that the uncounted debts amassed by tenants and by businesses that have run up tabs with suppliers.
Lessons for current Liberals on managing debt and remaking government
As a result, employment rebounded faster than many economists had expected. Household debt tumbled, partly because Ottawa’s spending shored up the finances of low-income earners, and partly because debt deferrals – along with limited opportunities to spend – benefited higher income households.
Now, Ottawa is starting to pare back the supports and subsidies, and those tens of billions of deferred debts are coming due, diverting household dollars from being spent to patronize struggling businesses. The banking industry’s rough estimate indicates as much as $6-billion in mortgage payments were deferred over the past six months. By the end of September, $55-billion in individual and business income taxes uncollected since mid-March will need to be paid.
CMHC-insured mortgages
that were deferred
Percentage by province or territory as of July
Alta.
20.99%
Sask.
14.89
Nfld.
14.87
B.C.
11.48
Man.
10.55
Ont.
10.23
N.S.
10.20
N.B.
10.02
Yuk./NWT
9.85
Canadian
average:
12.28%
Que.
9.12
8.41
PEI
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: cmhc
CMHC-insured mortgages that were deferred
Percentage by province or territory as of July
Alta.
20.99%
Sask.
14.89
Nfld.
14.87
B.C.
11.48
Man.
10.55
Ont.
10.23
N.S.
10.20
N.B.
10.02
Yuk./NWT
9.85
Canadian
average:
12.28%
Que.
9.12
8.41
PEI
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: cmhc
CMHC-insured mortgages that were deferred
Percentage by province or territory as of July
Alberta
20.99%
Saskatchewan
14.89
Newfoundland
14.87
11.48
British Columbia
Manitoba
10.55
Ontario
10.23
Nova Scotia
10.20
New Brunswick
10.02
Yukon/NWT
9.85
Canadian
average:
12.28%
9.12
Quebec
PEI
8.41
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: cmhc
Many businesses have built up their own massive debts that, in normal times, would have already forced them to close or into receivership. Those zombie companies, which have not yet conceded that they are all but dead, may stumble through a few more months before finally conceding the inevitable, shutting their doors and laying off their employees.
And that means the relatively sunny economic news of the summer could quickly turn dark, with employment gains stalling or even reversing. It is a dangerous pivot point for the economy, one that economists, the big banks and Canada’s national housing agency are all watching closely. “It’s a temporary reprieve,” says TD Bank economist Ksenia Bushmeneva, who wrote in a research note this week that the “illusion” of falling insolvencies over the summer will dissipate this fall.
At the Canada Mortgage and Housing Corporation, president and chief executive Evan Siddall says he is not worried about the stability of the banking system – it will be fine. His concern is what happens to the economic recovery once Canadians resume paying their mortgages and other debts that have been frozen since the coronavirus pandemic began.
“It’s more about the prospects for the country, which we are very worried about,” Mr. Siddall says. Emergency benefits and other federal spending have cushioned the economy over the past six months. While it is unlikely that the federal government will simply “let the bottom fall out,” he says, it’s also untenable for the intervention to continue indefinitely.
Looking ahead, Mr. Siddall sees a two-fold risk. First, there is growing household debt. The CMHC still believes it will rise to a record high in 2021, and a dip in the second quarter will prove to be temporary. Any economic recovery will fizzle without robust consumer spending, which accounts for three-fifths of gross domestic product.
Then there is the risk of a wider downturn as the full effects of the coronavirus ripple through the economy. One-quarter of the work force is still receiving some kind of income support, Mr. Siddall says. “At some point this ends, and there are some businesses that are going to have to adjust, and there will be unemployment that results.”
Harsh decisions that have been postponed will have to be made, and the hardship will no longer be hypothetical. “It’s an unemployment and people-getting-thrown-out-of-their-home problem,” he says.
Max Rimaldi, President of the Pizzeria Libretto Group, is at the company's Ossington Ave. location on Sept. 15, 2020.Fred Lum/The Globe and Mail
Max Rimaldi is one of tens of thousands of Canadian entrepreneurs struggling to adjust to the grim realities of the coronavirus economy, and straining to avoid laying off employees.
The 47-year-old restaurateur has been battered by each major economic shock over the past two decades. As a day trader, he lost it all in the dot-com boom, and was forced into personal bankruptcy. In late 2008, he had just exited bankruptcy and lined up a loan to start a pizzeria business – only to see that loan evaporate as the financial crisis shut down credit markets.
Even so, he managed to launch the pizzeria, but then the recession took hold. Yet Mr. Rimaldi survived and persevered, and by early 2020, he had built Pizzeria Libretto into a successful chain of four casual dining locations in downtown Toronto. In March, he had just signed leases to expand into two new locations. Then the pandemic and the lockdown hit. “I’ve been through a lot,” he sighs.
Six months later, Mr. Rimaldi is still holding on, largely because of Ottawa’s wage subsidies and the federal rent relief program that reduces leasing costs by 75 per cent for eligible small businesses.
However, his debts are rising. He’s borrowed $40,000 under Ottawa’s small business loan program. The pizzeria owes tens of thousands for much of the 25 per cent of rent not covered by subsidies. Mr. Rimaldi is negotiating with his landlords on how to catch up on those payments. Then there is the $670,000 he owes to suppliers, more than double the amount during normal times.
On the personal front, Mr. Rimaldi has deferred his mortgage and sold his car. His salary is simply the amount of the wage subsidy paid by Ottawa: $847 a week.
And sales are falling, with the pizzeria’s operations limited to some patio seating and delivery service. Revenue is down 70 per cent to the equivalent of $3-million in annual sales.
Repaying those rising debts from depleted sales simply isn’t possible. And if Ottawa fails to continue rent relief and the wage subsidy program, Mr. Rimaldi can’t see how he will continue. “Build the rest of the bridge to get us to the other side,” he urges.
The Canadian Press
The Speech from the Throne in Ottawa on Wednesday will give some clues as to how the federal government intends to buoy the economy. To date, the Liberals look to be headed toward gradually reducing supports, particularly for businesses. Wage subsidies, although extended, are slated to end by January, and the proportion of salary subsidized will tail off through the rest of 2020.
Income supports will last longer, but the proposed Canada Recovery Benefit (CRB) is less generous than its predecessor, the Canada Emergency Response Benefit (CERB). Under the CERB , recipients received $500 a week, while the new benefit pays a minimum of $400 (the same benefits floor will apply to Employment Insurance payments).
Some tax will also be deducted up front from the new benefit. A 10-per-cent withholding tax, for instance, would mean the weekly payment for an unemployed worker transitioning from the CERB to the CRB minimum would drop to $360 – a 28-per-cent decrease.
For many part-time workers and minimum wage earners, that will mean a swing away from a benefit that replaced most of their regular take-home pay – or even exceeded it – to one that is much less generous. Recipients will be allowed to earn significantly more from employment than they could under the CERB before their benefits are eliminated, but those higher earnings will depend on the jobs market continuing to rebound this fall, after showing signs of slowing in August.
At a minimum, lower-income workers face greater uncertainty, and the likelihood of reduced spending power. That has big implications for continued economic recovery, says Jeremy Kronick, assistant director of research at the C.D. Howe Institute. Lower-income consumers tend to spend the vast majority of their income rather than saving. So, the decreased benefits will immediately hurt consumer spending and growth.
Higher income households could make up at least some of that difference. Last week, Statistics Canada reported a sharp drop in household debts, with the household saving rate soaring to 28.2 per cent in the second quarter from 7.6 per cent in the first three months of 2020.
Statistics Canada doesn’t break down its quarterly data by income brackets, although it is considering doing so to give more insight into the effect of the coronavirus on household debt patterns. When the agency released its household debt data last week, it also noted that higher-income households tend to save more.
In recent months, banks have watched money pile up in savings accounts. Some customers have banked relief funds. Others have simply saved more, in part because of fewer opportunities for discretionary spending at restaurants, stores, hotels, gyms, spas and other businesses involved in travel and entertainment.
“They’re sitting on cash, and you’ve seen it in the growth in our deposit balances,” said Dave McKay, the CEO of Royal Bank of Canada, at a conference in early September. He sees flush savings accounts as an embedded stimulus that has yet to be spent.
But Toronto-Dominion Bank CEO Bharat Masrani warns that much of that pent-up spending could be swallowed up by struggling households and businesses trying to pay bills and buy necessities if the pandemic drags on. “The longer it goes, the more difficult it becomes” to unleash those savings in a way that helps revive vulnerable businesses, Mr. Masrani said in an interview in early September.
Another complicating factor: Some of the pent-up demand is for services. It’s unlikely that higher-income consumers will increase their prepandemic frequency of haircuts, for instance, even if they see salons as safe.
There are also gaps in debt data. It doesn’t include several kinds of deferrals, most notably amounts owed to the government. In its July fiscal snapshot, the Department of Finance estimated that deferred income, corporate and sales taxes total $85-billion. And that calculation doesn’t include deferred property taxes and rent deferrals that individuals may have secured from their landlords.
In an email, CMHC deputy chief economist Aled ab Iorwerth warned that elevated savings may simply be a stockpile of cash that will be used to catch up on deferred payments. If he’s right, the stimulus from that national nest egg could be much smaller than hoped.
Hundreds of thousands of payment deferrals on mortgages and other loans are also set to expire in September and October. Some borrowers will default and the loans will turn into losses for lenders – and repossessed houses.
Experts and regulators had feared a possible “cliff” of defaults as deferrals run out, but bank executives are optimistic that the vast majority of borrowers will resume making payments. Problematic loans to the hardest hit households and businesses will cause real pain to borrowers, but banks are betting those loans can be unwound gently without posing a broader risk to the banking system.
The bulk of outstanding loan deferrals, totalling about $267-billion as of July 31, are for residential mortgages. A large share of those home loans are insured – ranging from 31 per cent at RBC to 40 per cent at Bank of Nova Scotia and Canadian Imperial Bank of Commerce – which protects the lenders against losses.
The CMHC competes with two private mortgage insurance providers, and as of July, the national housing agency says payments were deferred on 12.2 per cent of the mortgages it insures, down from a peak of about 17 per cent in June. The agency says it is currently impossible to predict how many mortgagees will move from deferral to default.
Under its worst case scenario – which Mr. Siddall says is “wildly pessimistic” – 2 per cent of mortgages would be in default. That might not sound like much, but that worst case would be four times higher than during the 2008-09 financial crisis, when 0.475 per cent of CMHC-insured mortgages went into default.
Among uninsured mortgages on deferral, many borrowers have built up substantial equity in their home, which gives bankers breathing room to pursue refinancing options, or acts as a cushion against losses if a client is forced to sell a home.
Credit card debt and personal loans are unsecured, and some may not be repaid at all. But the balances at risk are comparatively small, with just $23-billion still under deferral. Banks point out that total credit card balances have fallen during the crisis, and some customers who were granted deferrals chose to make payments anyway. Also, record-low interest rates will help for loans with variable rates.
Small businesses are often much more troublesome for lenders and the economy than households. At the end of July, 76,000 loans to small and medium-sized businesses were still on deferral, worth a total of about $62-billion. (Most of those loans are to Canadian companies, but at least $17-billion are to borrowers in the United States, Latin America and the Caribbean.)
Pat Cronin, the chief risk officer at Bank of Montreal, has estimated that 1 per cent to 5 per cent of deferred commercial loans may turn delinquent after the bank’s deferral program expires, but that doesn’t mean they’ll all be written off. Many borrowers will go back to making payments, and experts say it could take until 2021 or 2022 before the full extent of delinquencies becomes clear, as some commercial clients keep fighting to stay afloat with fewer customers and lower revenue than they had before the pandemic.
That optimism is understandable, but there are already clear early signs of trouble ahead for the economy. Consumer insolvencies, though down sharply from this time last year, ticked up between May and June, and again in July.
Insolvencies filed by consumers
in Canada
Monthly 2020, total number and percentage change
from previous month
Bankruptcies
Proposals
12,000
+2%
-2.7%
Since June, insolvencies
have been trending
back upward
10,000
8,000
-38.8%
+3.7%
+3.9%
-8.8%
6,000
4,000
2,000
0
Jan.
Feb.
March
April
May
June
July
Note: In bankruptcy, assets are surrendered to pay creditors. A
consumer proposal is a legal settlement agreement that allows a
repayment plan without forfeiting assets
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: gov’t of canada; mnp ltd.
Insolvencies filed by consumers in Canada
Monthly 2020, total number and percentage change
over previous month
Bankruptcies
Proposals
12,000
+2%
-2.7%
Since June, insolvencies
have been trending
back upward
10,000
8,000
-38.8%
+3.7%
+3.9%
-8.8%
6,000
4,000
2,000
0
Jan.
Feb.
March
April
May
June
July
Note: In bankruptcy, assets are surrendered to pay creditors. A consumer
proposal is a legal settlement agreement that allows a repayment plan
without forfeiting assets
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: gov’t of canada; mnp ltd.
Insolvencies filed by consumers in Canada
Monthly 2020, total number and percentage change from previous month
Bankruptcies
Proposals
12,000
+2%
-2.7%
Since June, insolvencies
have been trending
back upward
10,000
8,000
-38.8%
+3.7%
+3.9%
-8.8%
6,000
4,000
2,000
0
Jan.
Feb.
March
April
May
June
July
Note: In bankruptcy, assets are surrendered to pay creditors. A consumer proposal is a legal settlement
agreement that allows a repayment plan without forfeiting assets
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: gov’t of canada; mnp ltd.
Business insolvencies are still on the decline, but that, too, may prove to be both temporary and misleading. Insolvency consulting company MNP Ltd. says three factors have pushed down insolvency filings during the pandemic: the massive amount of government income support, the sharp reduction in consumer spending and the resulting spike in savings, and the reluctance of lenders to pursue aggressive collection action.
All three are now coming to an end, says MNP president Grant Bazian, who warns of a false sense of security from a summer of relatively balmy economic news. That warm glow is going to fade – and soon – he says. “People’s problems aren’t going away. They’re just deferring them.”
Dan Kelly, president and CEO of the Canadian Federation of Independent Business, says he is “absolutely” certain that small-business bankruptcies will surge when the fiscal cushion provided by deferrals and subsidies disappears. In many cases, the arithmetic is already clear. “The business owner knows they’re dead, they just haven’t had the funeral yet."
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Patrick Brethour
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