Analyzing COVID-19’s Impact on Asset-Based Lending in Canada: Current Landscape and Future Outlook

The COVID-19 pandemic (the “Pandemic”) sent shockwaves through the global economy, profoundly impacting various sectors, including the lending industry. In Canada, asset-based lending (“ABL”) has experienced notable changes in demand, credit availability and overall market dynamics. This article explores the impact of the Pandemic on the ABL market in Canada, focusing on shifting trends, challenges faced by lenders and borrowers, and the outlook for the future of this product.

Availability of Credit and Changing Demand for ABL

The onset of the Pandemic prompted a significant shift in the availability and demand for ABL in Canada. While some lenders tightened their credit standards and risk appetites due to heightened economic uncertainty, others recognized the value of ABL in managing risk by using tangible assets as collateral.

In the wake of Pandemic-related lockdowns, companies across various industries, including manufacturing, retail and hospitality sought ABL financing to manage short-term liquidity needs, fund operations and seize growth opportunities. Unsurprisingly, due to the Pandemic’s significant disruptions to cash flow, borrowers in these industries (and others) increasingly failed to meet the financial covenants under their existing cash flow-based credit facilities. As a result, and thanks in part to record-low interest rates, previously reluctant borrowers turned to ABL in response to cash flow and supply chain constraints as a way to endure in a time of great economic uncertainty.

What’s Next?

Looking ahead, the ABL market in Canada is poised for continued evolution in response to the ongoing effects of the Pandemic. Here are a few key considerations for the future:

• Interest Rates: ABL borrowers typically have weaker credit risk profiles and may operate in cyclical or seasonal industries, making cash flow lending an impractical choice. In addition, banks must monitor the value of the underlying assets used to secure ABL loans on an ongoing basis, the costs of which are passed down to borrowers in the form of higher interest rates. Consequently, ABL loans tend to have higher interest rates than traditional cash flow loans. If interest rates continue to rise, ABL may be viewed as a less attractive financing product to certain types of borrowers, especially those with declining asset values. Lenders can combat this effect by emphasizing the flexibility and benefits of ABL to potential borrowers on a case-by-case basis.
• Inflation and Volatile Asset Values: The interest rate dilemma is exacerbated by extremely volatile asset values. Recently, certain categories of goods and services have seen sharp changes in value caused by changes in demand, interest rates, Pandemic-related supply chain issues and general global unrest. Borrowers that have enjoyed greater demand and higher prices for their products may benefit from margining those assets in ABL transactions, despite the possibility of higher interest rates. On the flip side, borrowers who have not seen a proportionate increase in their underlying asset values when compared to increasing interest rates are suffering as a result. Lenders will need to carefully assess risks associated with specific sectors, such as travel and hospitality, while recognizing the potential for growth in sectors like health care and e-commerce. This sector-specific approach will help lenders tailor ABL solutions and manage portfolio risks effectively.
• Supply Chain Management: Recent supply chain issues have forced suppliers and retailers to rethink the popular “just-in-time” inventory management system, not only to help meet increasing consumer demand (which, as we saw in the early days of the Pandemic, was highly unsatisfactory), but also to have a larger pool of eligible inventory to increase the borrowing base in ABL transactions.
• Regulatory Landscape: As the economy gradually recovers, regulatory bodies may consider new measures or amend existing guidelines to address the impacts of the Pandemic on lending practices. Lenders must stay informed and ensure compliance with any changes in regulations to maintain transparency, integrity and risk management practices.
• Recovery and Resilience: Businesses will seek to bounce back after dealing with an incredibly tumultuous period of uncertainty during the Pandemic. ABL will play a vital role in facilitating this recovery by providing flexible financing options based on tangible collateral. Lenders will need to adapt to changing market conditions and support businesses in their post-Pandemic recovery journey.

The Pandemic has significantly influenced the ABL market in Canada. Despite the challenges ahead, the versatility and adaptability of ABL have already helped businesses weather the storm, and will help others to rebuild and strengthen operations. As the economy recovers, the continued evolution of ABL will be crucial in supporting businesses and driving growth in Canada.

If you require assistance with any matter or question related to asset-based lending, please reach out to a member of our Financial Services Group.