EXECUTIVE SUMMARY
Consumer Bankruptcy
1997 Bankruptcy Petition Study

June 1997

Copyright © 1997, Visa U.S.A. Inc.

Three debtor profile tables accompany this executive summary.

Personal bankruptcies play a significant role in the level of credit losses experienced by Visa Members. Those losses reached record levels in 1996 and are continuing to rise in 1997. More than one million individuals filed for bankruptcy in 1996, an increase of more than 25 percent over the previous year.

Surging personal bankruptcy filings in conjunction with a strong economy and relatively low unemployment is a worrisome development. In an effort to understand the dynamics of bankruptcy, Visa has periodically analyzed the actual bankruptcy petitions filed by debtors seeking relief. One previous study, published in 1988, focused just on the state of California. In 1996, Visa launched a more extensive study, drawing data from four states: California, Illinois, Massachusetts, and Tennessee. Together with earlier California data, more than 11,000 petitions were analyzed for this report.

The reported data are the actual petitions filed by the debtors. As a rule, these data are unaudited unless the petition is challenged by a creditor or trustee. Chapter 7 filers, may have an incentive to make themselves appear insolvent by overstating expenses and understating income, especially when they are filing a "no asset" case. Chapter 13 filers, on the other hand, have less incentive to appear insolvent because they are planning to repay all or part of their outstanding debt. There is some evidence that petitioners who are homeowners choose Chapter 13 over Chapter 7 bankruptcy because they are trying to save their homes.

Debtor Profiles

The data showed major differences among the the profile of debtors from state to state. The most notable difference is between the profile of a debtor filing Chapter 7 bankruptcy, which discharges all debt, and that of a debtor filing Chapter 13 bankruptcy, which offers a repayment plan over a three to five year period. Complete debtor profiles for Chapter 7 and Chapter 13 petitioners that highlight the most significant findings can be found at the end of this document

Chapter 7 Characteristics

Regardless of the state in which they resided, Chapter 7 petitioners typically shared the following characteristics. They were likely

  • to have had a decline in income in the year they filed their petition
  • to project that their income will be lower than their expenses even after the bankruptcy is discharged
  • to be employed or self-employed
  • to be a bankcard holder

Chapter 13 Characteristics

Chapter 13 petitioners were likely
  • to have had a decline in income in the year they filed (except in California), although the drop was not as much as for Chapter 7 holders
  • to be homeowners, except in Tennessee where only 29.7 percent owned their own homes as compared with 88.6 percent in Massachusetts
  • to file plans in which their monthly income was projected to exceed expenses
  • to have very heavy housing expenses, amounting to about half their monthly expenses (except in Tennessee)
  • to be employed or self-employed
  • to have very little unsecured debt

Chapter 7 vs. Chapter 13

The choice of whether to file under Chapter 7 or Chapter 13 is apparently driven, in most cases, by whether the filer has any large assets, such as a home, to protect. Chapter 13 plans typically allow filers to amortize mortgage arrearages over the life of the plan and are structured to allow current monthly mortgage payments to continue. This was especially true in California and Massachusetts. By comparison, less than 30.0 percent of the Chapter 13 filers in Tennessee were homeowners. Like several other states in the southeast, local practice and custom in Tennessee strongly favors Chapter 13 filings, regardless of the petitioner's asset picture. In fact, approximately 65 percent of filings in Tennessee were for Chapter 13 vs. about 30 percent for the rest of the country.

Income Factors in Bankruptcy

The single most important factor affecting an individual's decision to file for bankruptcy appears to be a decline in income, coupled with an inability to adjust lifestyles sufficiently to accommodate the reduced level of income.

Income Changes

For purposes of analysis, the study divided the petitioners of each Chapter into two groups, those who had an increase in income during the filing year and those who had a decrease. On average about two-thirds of those who filed Chapter 7 bankruptcies reported that their incomes had declined in the year of the filing. The average decline was more than 20.0 percent. By contrast, a third or more of the petitioners actually saw their incomes increase in the year they filed, suggesting that many of these individuals could have filed under Chapter 13.

This highlights a weakness in the current system because it suggests that many individuals may be receiving more relief under the bankruptcy code than they actually need. Today, credit decisions are generally made on the basis of income, or, at least, proxies that estimate a borrower's capacity to repay, while decisions pertaining to bankruptcy are made on the basis of asset-to-liability ratios. Unless creditors challenge a filing, the courts rarely ask whether an individual has the ability to pay. They simply look at the petitioner's schedules to determine solvency.

Bankcard Issues

The study tends to refute two of the most prevalent criticisms leveled at the bankcard industry-that the increased use of bank credit cards is largely responsible for the increase in bankruptcies, and that financial institutions are making the situation worse by issuing credit cards to individuals who would not previously have qualified based on income.

If the first charge were true, there should be an increase in bankcard debt relative to other types of debt in the portfolios of bankruptcy petitioners. Time series data from California indicates that the share of bankcard debt relative to total debt remained virtually unchanged between 1988 and 1996 at 14.8 percent.

If the second charge were true, there should be a significant increase in the proportion of individuals with lower incomes filing bankruptcy petitions. The data do not support this either. In fact just the opposite has happened. Between 1988 and 1996, the percentage of bankcard holders filing for bankruptcy who had incomes of $25,000 or less in the year before they filed for bankruptcy declined substantially-from 58.9 percent to 48.0 percent. Meanwhile the percentage of cardholders with incomes above $45,000 increased from 9.0 percent to 23.1 percent.

Expense Issues

The bankruptcy system is designed to provide a fresh start to individuals who are unable to pay their debts. But as noted earlier, there is an incentive for Chapter 7 petitioners to overstate expenses and understate income. Not surprisingly, the average Chapter 7 filer projected that even after the bankruptcy is discharged, his or her monthly expenses would still exceed their income. This is true whether they reported an increase or decrease in income in the year of filing. Clearly, unless they have other sources of income or expectations for additional income, many of these individuals could be back in bankruptcy court in a relatively short time. Alternatively, some individuals may be receiving more relief from bankruptcy than they actually need.

The vast majority-over 90 percent-of Chapter 13 filers projected their post bankruptcy income would be higher than their expenses, some by a comfortable margin. There is a small minority, however, that projected their expenses would exceed their income. It is not at all clear how these individuals planned to complete a Chapter 13 plan.

Misuse of the System

The study makes clear that there is a significant minority of Chapter 7 filers deliberately taking advantage of the bankruptcy system as it is presently constructed. Some misuse stems from individuals trying to "work the system" but much of it comes from the "one-size-fits-all" approach inherent in the code that tends to give debtors relief without regard to the degree of need. Even if such misuse of the system amounts to only 10 percent (and it is probably much higher), basing the bankruptcy system on a petitioner's need for relief could reduce bank credit card losses by more than $1 billion annually. Today, such losses must be borne by all other bank credit card holders who do not declare bankruptcy and pay their bills on time.

There is ample evidence to suggest that a substantial percentage of Chapter 7 filers could pay back all or a major part of their debt over a reasonable period of time, without undue hardship, if the system were based on amount of relief needed.

The Internal Revenue Service has established allowable spending guidelines for various levels of income for individuals who wish to pay their taxes over a period of time. If those same standards were applied to individuals filing for bankruptcy, recovery rates would nearly triple.

Conclusion

Clearly some changes need to be made to eliminate abuses in the system and restore an element of fairness to the process.

In December of 1996, a coalition of credit grantors from all segments of the industry met with the National Bankruptcy Review Commission to present an array of changes to the bankruptcy code that are needed. The bankcard industry presented several specific proposals, including:

  • Debtors should get only the amount of relief they actually need.
  • All consumer debt incurred within 90 days of filing should be nondischargeable.
  • Any debt incurred without reasonable expectation or ability to repay should be nondischargeable.
  • Fraud should be nondischargeable in Chapter 13.
  • All income committed to the plan in Chapter 13 should be distributed to those creditors who do participate.
  • There should be a definition of the circumstances under which a Chapter 7 bankruptcy may be dismissed for abuse.

Any questions or comments regarding this study should be directed to Steve Holiga at (415) 432-1164. For copies of the study please contact Visa Issuer Risk Management at (800) 922-8277.