Credit Losses Due to Personal Bankruptcy: Some Areas Are More Vulnerable Than Others in the Current Regulatory and Economic Environment
Lauritano, Mark, The RMA Journal
UNTIL RECENTLY, risk managers have reliably anticipated future credit losses by carefully monitoring individual credit and behavior scores. Now, changes to personal bankruptcy laws, the rebound in interest rates, and rising energy prices are adding a new level of uncertainty to projected losses. Many lenders now supplement existing risk models with predictions of personal bankruptcy filings for their major geographic market areas. This article shares Global Insight's views on the future path of personal bankruptcy filings, along with highlights from its state and metro area bankruptcy forecasts.
The Impact of 2005 Bankruptcy Reform Legislation
Since 2004, the outlook for personal bankruptcies has depended more on regulatory changes than on economic changes. In April 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act, a bill in the works for nearly 10 years. With strong backing by the credit industry, the new law's primary objective is to reduce personal bankruptcy filings, which have increased fivefold since the law was last modified in 1978.
Many lenders contend that the upward trend in bankruptcy filings was due to increasing abuse of the system by individuals using the law out of financial convenience rather than as a measure of last resort. The revisions to the bankruptcy law are intended to make bankruptcy much less attractive to those trying to "game" the system while retaining the safety net for those individuals who have fallen on hard times.
Highlights of the numerous new rules and changes to procedures contained in the over-500-page bill are as follows:
* Means Test for Chapter 7 Eligibility
To file under Chapter 7, debtors with incomes above their state's median income must demonstrate that their current monthly income (based on an average of the previous six months), less expected allowed monthly expenses (averaged over the next five years), is less than $100 per month.
* Mandatory Credit Counseling
Debtors must receive credit counseling from an approved credit counseling agency within 180 days prior to filing.
* Time Between Discharges
A debtor cannot receive a Chapter 7 discharge if a prior Chapter 7 discharge was received within eight years (rather than six) of the new filing. For debtors seeking a discharge under Chapter 13, the time between discharges must be at least four years if the previous filing was a Chapter 7 filing and two years if the previous filing was under Chapter 13.
* Dismissal for Missing Documentation
Failure to provide documents, including tax returns, within 45 days after the petition has been filed results in automatic dismissal of the case.
* Tighter Rules for Homestead Exemption
The bill imposes a 730-day waiting period to prevent opportunistic debtors from purchasing a primary home out of state in order to avail themselves of the state's home exemption policy.
* Limiting Scope of What Is Dischargeable
Any debts owed to a single creditor totaling more than $500 for luxury goods incurred within 90 days of filing are presumed non-dischargeable. The previous limits were $1,000 and 60 days prior to filing.
Clearly, the newness of the legislation creates significant uncertainty for lenders, bankruptcy attorneys, and debtors contemplating bankruptcy. While no one knows with certainty how the new rules will play out, a careful review of historical bankruptcy filings data suggests several likely outcomes. It's likely the new law will ultimately have a greater impact on the timing of when individuals decide to file rather than the number of cases in the courts.
The impact of the new law can be broken down into two distinct phases: the six-month period before the legislation goes into effect and the commencement of the new regulations. Until mid-October, individuals were able to file for bankruptcy under the more lenient provisions of the previous bankruptcy law. …