Article

Financing

Private companies have enjoyed an attractive financing environment for years, supported by historically low interest rates, balance sheets bolstered by increased collateral values, and growing cash flows.

But today’s market brings greater uncertainty, thanks to a weak commodities market, global volatility, and the impact of US federal election. Prudent businesses will look to extend debt maturities, increase headroom on their covenants, fix their interest rates, hedge FX risks, diversify their lending sources and, in general, take fewer risks with their borrowing.

Issues

With oil prices hovering around $40-50 a barrel and mining commodities (other than gold) sitting at historically low levels, banks are facing increased loss provisions as well as losses in their portfolios. This will affect their ability to lend money in any sector and province.

Meanwhile, the interconnectedness of the global economy means Canadian businesses are not immune to uncertainty, wherever it may appear. Brexit, ISIS, economic weaknesses in countries like China, Brazil, and India and political problems in several other countries all influence credit availability here.

Today’s market brings greater uncertainty, thanks to a weak commodities market, global volatility, and the impact the impact of the recent US federal election.

Similarly, the results of the election south of the border and its effect on the US economy is one of the biggest sources of worry in Canadian head offices. Borrowing in Canada is heavily influenced by events in the States, especially as most Canadian banks have US lending operations. Any faltering in US lending will see a corresponding slowdown here. Additionally, Canada’s export-driven economy would feel the effects quickly as we’re so highly dependent on trade with other countries. With the US alone, we exchange roughly $1.8 billion in goods and services every day.

Finally, the high yield debt market in the US is at its weakest point in years, characterized by an outflow of money and increased risk of credit defaults. The first half of 2016 saw high yield volume reach US$119 billion, still down 34 percent from 2015, which tallied US$185.5 billion. This public market, which has also slowed down dramatically in Canada, is seen as a barometer of general market conditions and is often a precursor to what happens in the private debt markets and therefore companies’ ability to borrow.

Opportunities

Fortunately, Canada’s economy continues to benefit from a coordinated effort by developed countries to keep interest rates low. For instance, base rates are 0.5 percent in the UK, the US, and Canada, and 0.0 percent in Germany. For businesses looking for capital, those rates are as favourable as they’ve ever been, with businesses able to borrow at half the rates of just a few years ago.

At the same time, the private debt market continues to grow. Where 65 percent of the financing for leveraged buyouts used to be provided by the banks, that figure is now closer to 25 percent. Private sources like CLOs, hedge funds and private equity-type pools of capital have filled this void; quite significant for a market that didn’t even exist 15 years ago. This translates to a large amount of new capital in the market, which Canadian business can access mostly from US providers.

The biggest concern about this relatively new form of capital is that it’s much less relationship-driven than Canadian companies are used to with the five Schedule I banks. And how these new lenders would react in a downturn is anybody’s guess.

Canadian businesses are also benefiting from a strong US market and a growing economy, which means banks here have a continued interest in lending money.

Meanwhile, commercial real estate values have been increasing, perhaps too quickly for the government’s liking. Some analysts consider real estate to be 20 – 40% over-valued. Although such inflated values have been helpful to companies looking to borrow money, those values can drop quickly as would the underlying borrowing base, which could be

Questions to consider

  • Can you extend the term of your debt facilities?
  • Can you fix your rates of debt?
  • Can you hedge your foreign exchange?
  • Can you match your working capital assets with banks, and longer-term assets with term lenders?
  • Are you prepared to consider adding another lender to your lending mix?
     

Author

Robert Olsen
Partner and National leader
Corporate finance
robolsen@deloitte.ca

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