Canadian businesses rejected by banks are increasingly turning to private lenders for financing, as demand for capital outstrips supply in the traditional debt market.
Business lending conditions have been tightening since late 2021, as banks have set aside more capital for potential losses. At the same time, business demand for loans has soared. Refinitiv data for the three-month period from July through September show debt issuance jumped nearly two-thirds year-over-year.
The circumstances have created a historic opportunity for non-bank lenders – pension funds, credit unions, private debt funds – to swoop in and capture a larger portion of a market traditionally dominated by the country’s largest financial institutions.
“The banks are being very, very conservative,” Shilpa Mishra, the managing director of capital advisory services at accounting firm BDO, said in an interview. “They are being more cautious. We think they are going to continue to stay cautious, and the alternative lenders are scooping up that business.”
While some high-profile bond sales are still happening – Canadian National Railway Co. CNR-T, for example, announced a US$600-million bond sale in late October – most of the recent debt deals have been loans. Brett Saldarelli, an economic analyst at Toronto-Dominion Bank, said loans account for almost 65 per cent of all outstanding Canadian corporate debt, with debt securities such as bonds accounting for the remainder. Less than a decade ago, the proportion was nearly 50/50.
With all that lending going on, Ms. Mishra said, “the best-kept secret” about the Canadian debt market is how much of it is conducted by non-bank lenders. Of some $1.4-trillion in corporate loans issued in Canada year-to-date, she said, 40 per cent came from alternative lenders.
Now, it appears that secret is out.
U.S. bond giant Pacific Investment Management Company (PIMCO) said in a report published Monday that the current lending market may be the best environment for private credit investors since the global financial crisis. “As private credit investors, this is the environment we’ve been waiting for. With demand for capital outstripping supply, investors won’t need to take large risks, in our view, to generate compelling returns.”
From early September through mid-November, Montreal-based Private Debt Partners had already reviewed more than $405-million in potential deals, surpassing its record of $337-million for any previous three-month period.
“And we still have 15 days to go in this quarter,” Jeffrey Deacon, the firm’s managing partner, said in an interview on Nov. 14. “There are more borrowers out there looking at private credit or private debt as an option, and we are seeing it in real time here.
“Businesses struggle to understand what the options are when their bank says no,” Mr. Deacon said. “There is an entire lending universe that exists beyond the traditional commercial lending arms.”
Mr. Deacon formed Private Debt Partners in 2020 alongside his former colleagues from Integrated Asset Management after that firm was acquired by Feira Capital in 2019. Jean-Christophe Greck, one of the new company’s co-founders who serves as its president and chief investment officer, said interest in the company’s services has grown so dramatically that it is already in the process of raising a second fund to issue more loans.
He declined to give specific dollar amounts, but Mr. Greck noted that the second fund will be twice the size of the first and is on track to close within the first three months of next year.
The experience of Private Debt Partners exemplifies a nationwide trend.
“We are in a world now where a lot of businesses are seeking different forms of capital, there is a gap that needs to be filled, and the private lending industry is really stepping up to fill in that gap,” said Bill Wu, leader of the Canadian debt capital markets advisory team for Ernst & Young LLP. “The trend started to increase shortly after the financial crisis and has been accelerating in the past few years.”
Around 2012, private lenders across North America had roughly US$250-million in assets under management, Mr. Wu said. “The forecast for the end of 2023 is to be just shy of US$1-trillion.”
Steve Chen, vice-president of First West Credit Union in Vancouver and head of First West Capital, which offers corporate loans to businesses with annual revenues ranging from $20-million to $200-million, has also noticed “a pullback in the chartered bank lending landscape.”
“We have some tailwinds behind us for the foreseeable future – call it at least six to 12 months,” Mr. Chen said. “There are lots of things working in our favour.”
Usually when businesses start borrowing more money, it is a sign of economic strength, as new debt is typically put toward funding growth. But not this time.
“One thing we have seen a lot less of is growth-oriented financing requests,” Mr. Chen said.
That is in line with the trend Sean Gilbert has observed as global head of debt capital markets for CIBC World Markets. This past September was the busiest in the history of the Canadian debt market, Mr. Gilbert said in an interview, with much of the money being raised used for refinancing.
“It is not relevering the balance sheet,” Mr. Gilbert said. “It is just replacing debt. You’re replacing what is effectively higher cost with lower cost.”
Mr. Deacon of Private Debt Partners said many deals coming into his firm also involve borrowers looking to refinance their existing lender. Banks had been patient with their corporate clients through the peak of the pandemic, he said, “but now that we are in late 2023 I think the gloves are off.”
“We are seeing a lot more situations where banks are just flat out telling clients that they have to be refinancing within a certain period of time.”
Recession fears are also driving some businesses to borrow money as a bulwark against the risk of declining revenue.
“When we look at the amount of cash buildup on non-financial corporate balance sheets, it seems like a lot of businesses are doing it in a precautionary way,” said James Orlando, director of economics at TD Bank. “They are not necessarily spending that money.”
Private lenders tend to charge more interest than the banks, but Mr. Wu of Ernst & Young argues that private debt also offers more flexibility.
“Instead of the traditional three to four bank covenants, you would have maybe one or two,” he said, referring to conditions a borrower must fulfill in order to receive or keep a loan. “Covenants typically restrict growth because it limits what you can and cannot do versus, say, private lending that can come in with a tailored solution.”
Many businesses avoid reaching out to private lenders until after their financing request has been rejected by their bank, which Mr. Deacon argues is a mistake.
“I wish people would call us more when they are still talking with their bank because we can be a good option to help them evaluate,” he said. “The value of the structure that we can put in place versus what the bank will give the borrower can be worth the premium that you are paying on the interest rate.”
Editor’s note: This article has been updated to clarify that $1.4-trillion in corporate loans have been issued in Canada year-to-date, through to Q3.