Focus

August 02, 2024 | 14:47

Has the Wave of Canadian Business Failures Crested?

Economist

Senior Economist and Vice President
Economics

Erik conducts research on financial product market trends, emerging risks and macroeconomic trends for the Bank.... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Econom... (Read more)

Michael Gregory , CFA

Deputy Chief Economist and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Scott Anderson , Ph.D.

Chief U.S. Economist and Managing Director
Economics

Scott Anderson is BMO’s Chief U.S. Economist and Managing Director. He analyzes and forecasts U.S. national and ... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been wi... (Read more)

Sarah Howcroft , CFA

Senior Economist and Director
Economics

Sarah Howcroft conducts risk analysis across a range of countries and industries in which BMO has strategic inte... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal nearly two decades. He is re-sponsible for the Canadian macro-econom... (Read more)

Shelly Kaushik

Economist
Economics

Shelly joined BMO Economics in 2020 and conducts research on the Canadian and regional economies. She also provi... (Read more)

Erik Johnson

Senior Economist and Vice President
Economics

Erik conducts research on financial product market trends, emerging risks and macroeconomic trends for the Bank.... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Econom... (Read more)

Michael Gregory , CFA

Deputy Chief Economist and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Scott Anderson , Ph.D.

Chief U.S. Economist and Managing Director
Economics

Scott Anderson is BMO’s Chief U.S. Economist and Managing Director. He analyzes and forecasts U.S. national and ... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been wi... (Read more)

Sarah Howcroft , CFA

Senior Economist and Director
Economics

Sarah Howcroft conducts risk analysis across a range of countries and industries in which BMO has strategic inte... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal nearly two decades. He is re-sponsible for the Canadian macro-econom... (Read more)

Shelly Kaushik

Economist
Economics

Shelly joined BMO Economics in 2020 and conducts research on the Canadian and regional economies. She also provi... (Read more)

Feature

Has the Wave of Canadian Business Failures Crested?

Business insolvencies should remain elevated into 2025, but we’ve likely passed the peak barring a weaker economy.

The Bank of Canada has cut rates at back-to-back meetings, bringing some relief to businesses carrying higher debt loads. Rate cuts are also a welcome relief to their customers who are under pressure from the ongoing cashflow shock brought on by higher mortgage and rent payments (for more on that topic see the July 26^th issue of Focus). Governor Macklem indicated that more cuts are coming, but will it be enough to stem the tide of business insolvencies that have surged over the past 19 months?

Canadian business insolvencies likely reached their zenith (759) back in January, aligning with the CEBA loan repayment deadline (Chart 1). The CEBA program lent nearly $50 billion to over 570,000 businesses. While it represented around 5% of non-mortgage loans to businesses, even those marginal debt loads are looming larger in this restrictive interest rate environment. Just under 30% of firms paid back their CEBA loans prior to the initial deadline of year-end 2023, and another two-thirds or so anticipate paying back the loan prior to the final deadline at the end of 2026. That leaves one-quarter of the initial recipient pool at elevated risk of insolvency over the next two years. This is one of the reasons that business failures have ramped up.

The good news is that insolvencies have eased somewhat through June (460), though they remain well above their pre-pandemic monthly trend of just over 300. Looking back over the past 12 months, total insolvencies neared 6,200, or more than 65% above their 2016-to-2019 average. Including both employer and non-employer businesses, that translates to an insolvency rate of 1.3 per thousand businesses, or roughly where it stood in the recovery from the Great Recession in the mid-2010s. However, it is still a long way from the double-digit highs seen in the late 1990s.

Across regions, the rise in business insolvencies is playing out very differently (Chart 2). Ontario and Quebec have seen insolvencies more than double from their pre-pandemic averages. Those two provinces maintained longer in-person activity restrictions during the pandemic, and Ontario is also likely feeling more of the effects of the mortgage refinancing shock given elevated home prices in key markets. Provinces in Western Canada have also seen insolvencies rise above trend, though they appear to have peaked below the stress seen in central Canada. On the other end of the spectrum is Atlantic Canada, where insolvencies are still below pre-pandemic norms. Parts of those two regions (Alberta, Nova Scotia) are benefiting from the affordability-driven reshuffling of Canada’s population.

From January 2020 to October 2022, total insolvencies were more than 2,400 lower than would have been anticipated, as government support and forbearance programs buffeted spending. However, cumulative insolvencies have since more than made up for that shortfall, rising almost 2,800 above their pre-pandemic trend through May. This story is playing out across industries, with most of the 2-digit NAICS sectors seeing more bankruptcies since November 2022 than the corresponding reduction during COVID (Chart 3). Sectors lying above the 45-degree line either had to take on additional debt to survive during the pandemic (in-person services) or are challenged by the rotation back to service spending (retail trade, transportation and warehousing). The BoC’s July MPR highlighted weak discretionary spending as another driver of differences across sectors. The construction sector (not shown on chart) will be one to watch as it has seen over 500 fewer bankruptcies than expected since January 2020, despite elevated interest rates.

The 2024Q2 Canadian Survey on Business Conditions points to costs being the biggest drag on business performance. With producer prices moderating, input costs will likely prove less challenging later this year. Policy rates are also expected to decline another 150 bps by mid-2025, which will provide businesses with additional relief on borrowing costs. That resonates with sentiment measures improving in Q2, but the picture looks different by firm size (Chart 4). Smaller firms are struggling more than larger ones, as they don’t have access to longer term debt financing to cushion the blow of rising rates.

With interest rates expected to remain restrictive for a while longer, insolvencies should stay elevated and above pre-pandemic levels into 2025, though we are likely past the peak barring a downside economic surprise. The upshot for banks is that commercial loan losses could also start to ebb in Canada if the U.S. experience during the financial crisis is a guide (Chart 5). Lower borrowing costs and a firmer economy would help.