Canadian banking and lending 2013

By Robert Olsen and Jeannot Blanchet

Broad-based rise in lending

We’ve seen a definite upswing in business lending. Bank of Canada figures for the first four months of 2013 show that total business credit is up 7.7% year-over-year. Bank lending has been a key driver: banks’ short-term business credit increased 12.2% over the same period, while long-term business credit rose by 8.3%. As well, bonds and debentures are up 9.4%.

• Term loans are very popular. Drawn facilities like these allow banks to deploy their capital more efficiently than lines of credit or other non-drawn facilities.
• Asset-backed lending (ABL) is also in high demand. Attractive pricing is luring borrowers away from non-ABL credit — in some cases, ABL advance rates are much more aggressive than those used for traditional working capital credit lines.
• The high-yield market is also seeing tremendous growth, thanks in large part to a much broader investor base: whereas five years ago there were only 20 investors, today there are 100 or more. As well the ongoing drought of M&A activity is prompting many companies to refinance their high-yield issues.

Canada’s banking sector is in very good shape and remains well regarded for its prudent management and risk policies.

Loosening criteria?

We’ve also noted that credit structure is loosening in both the bank and institutional markets, largely due to competitive factors. Covenant-light (“cov-lite”) deals are making a return in the U.S. market, and cov-lite features have showed up in some Canadian deals recently. These deals usually involve non-investment grade credits, where covenants are applied on an incurrence basis, rather than the usual maintenance basis.

Challenges ahead: How will banks respond?

Canada’s banking sector is in very good shape and remains well regarded for its prudent management and risk policies. However, regulatory changes and market shifts are giving rise to new challenges. It remains to be seen how banks will respond in order to preserve returns.

Canadian banks have chosen to get ready to adopt Basel III ahead of the schedule set by the Office of the Superintendent of Financial Institutions Canada (OSFI). The banks are increasing their tier one and total capital ratios to meet both Basel III requirements and the additional capital requirements for national systemically important banks (D-SIBs) recently issued by OSFI. These new capital requirements are expected to push Canadian banks — especially the largest six, now designated as D-SIBs — to work harder to maintain better risk-adjusted returns.

This may be more challenging should consumer lending and mortgage activity fall away. Key real estate markets remain braced for a correction, and consumers show signs of heeding the many warnings over high debt levels. Some analysts believe Canada’s banks are over-exposed to the housing market and over-indebted consumers — Moody’s downgraded six Canadian banks earlier this year over their concerns in this regard. As well, banks with heavy involvement in the mining and energy sectors stand to encounter growth pressures as those sectors falter in current economic conditions.

What’s next for the banks and business lending?

Looking forward, we expect we’ll see corporate borrowers focus on ensuring adequate liquidity and extending maturities on their long-term debt to take advantage of market conditions. As well, we’ll likely see more refinancings, especially in the institutional market, as companies look to capitalize on favourable rates.

As for the banks, we anticipate heavy competition for corporate lending. Price wars are possible, though they’re a race to the bottom for all involved. Lending criteria may be loosened further, though Canadian caution and prudence will likely limit any serious risk. Or we may see banks respond to growth pressures by rethinking their business and operations — tackling the challenges in innovative ways.

Time will tell.

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Robert Olsen is global co-leader of Deloitte’s Capital Advisory practice.

Jeannot Blanchet is national leader of Deloitte's Financial Services practice.