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Canadians rush to restructure debts - and stave off bankruptcy - but cost can be ghastly

Briefing highlights

  • Canadians rush to restructure debts
  • Overseas stocks suffer after Fed comments
  • Markets at a glance
  • National Bank, Laurentian post higher profits
  • Dick’s stores end assault-style weapon
  • Valeant misses revenue forecast

Canadians restructure debts

Many Canadians are scrambling to restructure their debts, staving off outright bankruptcy, as interest rates rise.

But there's a lot more going on here than meets the eye, and it can be a costly process.

The number of insolvencies among consumers is actually down, according to statistics released today by the Office of the Superintendent of Bankruptcy Canada, falling 2.9 per cent last year, though marginally in December alone.

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Insolvencies break down into two parts, bankruptcies and proposals. We all know what bankruptcy is, of course. A proposal is a restructuring of debt under new terms, but is still done under the Bankruptcy and Insolvency Act.

And as this chart shows, bankruptcies are on the decline, down 8.1 per cent in the fourth quarter, and 8.5 per cent for all of 2017. Proposals, though, rose 7.5 per cent in the quarter, and 2.8 per cent through the year.

Here's another interesting statistic: The proportion of proposals to total consumer insolvencies rose last year to 52.6 per cent from 49.7 per cent from a year earlier.

"Since the heavily indebted household sector has obviously become accustomed to extraordinary low debt-servicing costs, we are starting to wonder if some households are already beginning to struggle with recent interest rate increases," said David Madani, senior Canada economist at Capital Economics in Toronto, referring to November, rather than the latest, numbers.

"Thankfully, there hasn't been any upswing in consumer bankruptcies yet, but it does appear that debt restructuring has risen significantly."

The Bank of Canada recently raised its benchmark overnight rate, and is expected to follow that increase with more, though economists differ as to how many times and how fast.

Carlos Capistran, for one, the Canada and Mexico economist at Bank of America Merrill Lynch, expects Governor Stephen Poloz, senior deputy Carolyn Wilkins and their colleagues to boost the overnight rate three more times this year, bringing it to 2 per cent by the close of 2018.

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"After the BoC hiked 25 basis points in January, we expect it to hike again in April, July and October," Mr. Capistran said in his latest outlook.

"This timing could change, and the hikes may be more spread out in the year (i.e., April, September and December)."

Obviously, there are two sides to a consumer debt story, including that of the lender.

"The average revenue and profit generated from a consumer proposal is higher than the revenue and profit generated from a typical consumer bankruptcy," said Scott Hannah, president of the Credit Counselling Society.

"This may be one of the reasons contributing to this trend," he added, referring to a shift to proposals over the last several years.

There are actually four sides to this story when you factor in insolvency trustees and third parties known as debt consultants. And it can be a source of concern.

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"While I believe Canadians should resolve their financial difficulties to the best of their ability, and a [consumer proposal] will typically provide a higher return to creditors than an assignment into bankruptcy, a consumer's financial circumstances ultimately should dictate which option they should pursue," Mr. Hanna said.

"I wonder if this is not as clear as it once was in light of the emphasis some trustees place on [consumer proposals] versus a [bankruptcy]."

Indeed, the Office of the Superintendent of Bankruptcy Canada, or OSB, recently studied the "potential risks associated with the integrity of some aspects of the consumer insolvency process," notably relationships between licensed insolvency trustees, or LITs, and debt consultants, the "fee charging third parties."

The results of that study, released last year, illustrated just what's going on in many cases: If you're struggling with your debts, you're going to pay for that consultation, possibly dearly.

"Debtors served by LITs who had ongoing relationships with debt consultants usually ended up paying thousands of dollars more for the administration of their insolvency than debtors who were not sourced through a debt consultant," said the OSB, which is dealing with the issue.

"Typically, debt consultants required a consumer debtor to sign a fee agreement for consulting services prior to being introduced to a 'selected LIT.' Debtors typically understood the role of the LIT as being limited to meeting with the debtor to 'file' the proposal developed by the debt consultant."

In the cases studied by the government agency, the consulting fee averaged about $2,400, and ran as high as $4,200. And for "lower value proposals," it tended to be between 20 to almost 40 per cent of the value of the proposal, the OSB said.

"Typically, $250 or $500 was charged to the debtor's bank account upon signing the fee agreement, with the balance of the fee structured as an obligation for future payments to the debt consultant to be drawn directly from the debtor's bank account in instalments after approval of the proposal," the OSB said

There's so much more, including the sale of "supplemental services" through a debt consultant, or loans by the consultant to the folks they're consulting, and other stuff you don't want to think about.

The OSB cited a practice involving "proposal insurance," something built as a loan "with ongoing payments to promote 'credit repair.' "

"In one case, a debtor with a $31,900 proposal was sold proposal insurance, structured as a loan, for over $6,300," the OSB said.

"With the booking fee, the monthly administration fee and a 15-per-cent rate of interest, in total the insurance cost $9,150. Added to the debt consultant's advisory services fee of more than $2,300, the total amount paid by the debtor in respect of this proposal was $43,350."

The OSB stressed that such practices are not common across the industry, whose members number about 1,000 and who "consistently" follow high standards.

But it also noted that it found "that administrative practices of LITs who enter into relationships with debt consultants can place the integrity of the insolvency process at risk and can negatively impact the financial interests of both creditors and debtors in an insolvency filing."

This troubles Mr. Hannah, obviously.

"There is a lot of confusion in the marketplace, and my concern is that the average consumer may not fully understand all of their options to resolve their financial difficulties and is directed more heavily towards one solution," that being a proposal, Mr. Hannah said.

"I am sure that all trustees will state this is not accurate, but looking at the facts that came out in the superintendent's report, and the ongoing upward trend in [consumer proposals], there is certainly a cause for concern based upon the facts."

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Markets at a glance

With the U.S. dollar perking up, the loonie is struggling, sitting at about 78.3 US cents.

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National Bank, Laurentian see higher profits

National Bank of Canada posted a stronger first-quarter profit, its chief executive officer lauding "excellent performance in each business segment."

Profit rose to $550-million, or $1.46 a share, diluted, from $497-million or $1.34 a year earlier.

Separately, Laurentian Bank of Canada profit rose to $59.7-million, or $1.41 a share, from $48-million or $1.30.

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