All questions

Overview

i General

2021 witnessed a rebound in the corporate lending market as the Canadian economy continued to recover from the fallout of covid-19. The uncertainty that precipitated tightened lending conditions early on in the pandemic gave way to a more competitive landscape for lenders. In particular, pent-up liquidity and heightened demand for new loans generally led to more borrower-friendly conditions for new credit facilities as well as for amendments to existing credit facilities. Many borrowers took advantage of these conditions and negotiated accommodations addressing the impact of covid-19 on their businesses – including acknowledgements that any such impacts previously disclosed to lenders will not constitute a material adverse effect as well as certain add-backs to EBIDTA to account for covid-19-related losses.

At the outset of covid-19, the Canadian federal and provincial governments introduced a number of financing and other credit support programmes to support Canadian businesses negatively affected by the pandemic and to ensure continued liquidity in the credit markets. Demand for these support programmes declined in 2021 in the wake of improved business conditions and the increased availability of traditional financing. Many of these programmes have also expired or are set to expire in the near term. The gradual winding down of government support programmes related to covid-19 has led to some speculation that Canadian insolvency filings will rise in 2022 – particularly among businesses with poor credit that might otherwise encounter difficulty accessing traditional financing.

The trends of historically low (but rising) interest rates and high liquidity have continued into 2022, and, as a result, leveraged loans continue to be attractive to Canadian borrowers. Factors to monitor in 2022 include global inflation and its impact on interest rates, the increase in alternative lending sources (including private credit funds), the growth of sustainable finance, the impact of open banking and the ongoing recovery of the Canadian economy.

ii Standardised terms

In 2004, the Canadian Bankers Association published the Model Credit Agreement Provisions to be used in syndicated loan transactions in Canada. The goal of the Provisions was to standardise selected provisions of loan agreements to more easily facilitate secondary market trading, and include standard provisions relating to assignments and loan trading. They are based on provisions prepared by the Loan Syndication and Trading Association, Inc. Use of the Provisions is not mandatory, but they are commonly used in syndicated loan transactions where the administration agent is a major Canadian bank.

iii Recent Canadian deal activity

Deal volume in the Canadian M&A market in 2021 increased considerably from 2020, with a total of 3,857 deals announced. The aggregate value for announced deals reached C$359 billion – setting a new high-water mark for Canadian M&A activity in a single year.2 Deal volume in 2021 peaked in the first quarter with 1,007 announced transactions, and continued at a robust pace for the following three quarters.3 Mid-market transactions continued to be the driving force behind the high level of activity.4 Sectors that saw significant activity in 2021 were information technology, real estate and mining.5 The trend of Canadian firms continuing to be more active abroad than foreigners acquiring Canadian companies continued, with the majority of all foreign acquisitions made by Canadian firms being in the United States.6

iv Canadian financing sources

Canadian companies continue to finance their operations in a variety of ways. Day-to-day operations and cash management are generally financed with operating loans or lines of credit that are entered into with a company's primary financial institution. Asset-based loans, financed on the security of a company's working capital assets, also continue to be a frequently used source of financing for many Canadian companies, particularly in the manufacturing, distribution and retail sectors. In many cases, a significant portion of the consideration for acquisitions is funded through various types of debt obtained from a variety of sources, including senior secured credit facilities provided by domestic and foreign financial institutions, second lien credit facilities, unsecured credit facilities, streaming arrangements, high-yield notes and mezzanine debt. There has also been an increase in the number of privately financed deals in the Canadian market. Since the onset of covid-19, government funding and credit programmes have become a significant source of funding for businesses adversely affected by the pandemic (though many of these programmes are set to expire in the near term).

Legal and regulatory developments

i Lender-related regulatory requirements

Canadian borrowers regularly obtain financing and leveraged finance products from a broad range of lenders, including domestic and foreign financial institutions, private equity and hedge funds, and through the issuance of public debt, including high-yield debt. Canadian and foreign banks are very active in this area and provide a wide variety of debt products to Canadian borrowers. The key regulatory issue for lenders dealing with Canadian borrowers is whether the lender would be considered a bank for Canadian regulatory purposes. The activities of Canadian banks and foreign lenders affiliated with foreign banks that are carrying on banking business in Canada are subject to regulation under the federal Bank Act. Lenders that are banks or affiliated with foreign banks must obtain the necessary approvals under the Bank Act to establish a presence in Canada, and must comply with certain operational requirements of the Bank Act on an ongoing basis.

Foreign lenders affiliated with foreign banks that do not have a presence in Canada may lend to Canadian borrowers without obtaining regulatory approvals from federal banking regulators, if the lending relationship is established in a way that would not involve the lender being viewed as carrying on business in Canada. Generally, a loan that is made by a lender located outside Canada, and that is approved, negotiated and documented outside Canada with payments being made to an entity outside Canada should satisfy this test.

Without connection to a bank, foreign and other lenders that are not otherwise regulated as financial institutions in Canada (e.g., insurance companies, trust companies, credit unions and private lenders) do not require any special licences or regulatory approvals to make a loan to a Canadian borrower. These lenders will, however, be subject to laws of general application that apply to the taking and enforcement of security in certain provinces. For example, a lender may require an extra-provincial licence under provincial legislation to hold and enforce a mortgage on real estate in that province. Lenders that lend on the security of real property may also need to obtain a mortgage brokerage licence under provincial legislation if it is not a financial institution exempted from compliance.

Although not a Canadian regulatory issue per se, foreign lenders entering the Canadian market will also need to consider their ability to fund loans in Canadian dollars, as many Canadian borrowers require Canadian dollar borrowings.

ii Borrower-related regulatory requirements

The activities of many Canadian borrowers are subject to some degree of government regulation, and often a particular government licence or approval is a key component of the borrower's business operations. Lenders to such borrowers should ensure that the borrower obtains all necessary governmental consent required to grant security on its assets to secure the proposed financing and to permit the lender to realise on its security. In addition, any transfer of a regulated borrower's assets (including any applicable licences) as part of the realisation process may require further governmental approvals, including approval of the proposed acquirer.

iii Anti-money laundering legislation

The Proceeds of Crime (Money Laundering) and Terrorist Financing Act makes it mandatory for certain entities (including lenders) to ascertain the identity of Canadian borrowers and related parties before accepting them as clients; to report a variety of transactions to the Financial Transactions and Reports Analysis Centre of Canada; and to maintain certain client and transaction records. These requirements are designed to assist in the detection and deterrence of money laundering and the financing of terrorist activity in Canada and around the world. Lenders should ensure that their due diligence requirements include a request for the information necessary to ensure compliance with this legislation.

iv Basel III

Canada's federal banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), recently announced revised capital, leverage, liquidity and disclosure rules that incorporate the final Basel III banking reforms with adjustments specifically tailored for Canadian banks. Most of these rules will come into force in 2023, with certain rules concerning market risk and credit valuation adjustment risk taking effect later in 2024. Canada's banks remain among the best-capitalised in the world in terms of quality and quantity of capital.7

Outlook and conclusions

Despite geopolitical headwinds and inflationary pressures, it is expected that Canadian borrowers will continue to actively seek funding in the Canadian and US debt markets for acquisitions, dividend recapitalisations and other balance sheet restructurings and corporate purposes given historically low interest rates and opportunities arising from Canada's ongoing economic recovery. In addition, Canada will continue to respond to global regulatory changes and market trends – especially those occurring in the US. These trends include the ongoing adoption of alternative reference rates (such as SOFR), the growth of fintech lending, the emergence of sustainability-linked loans and the gradual winding down of government financing and other support programmes related to the covid-19 pandemic.

As US sponsors become more active in Canada and seek financing from Canadian lenders for their Canadian acquisitions, covenant-lite loans are becoming more common in Canada. Covenant-lite loans generally do not include financial maintenance covenants, or include them only on a springing basis based on certain leverage levels. Equity cures of financial covenant breaches are generally permitted. As financial covenant breach is often an early indicator of financial difficulty, the downside for lenders is that they may not be able to trigger a default based on a financial covenant breach and thus initiate restructuring discussions at an early stage when more options are available to address the borrower's financial issues.

Incremental or 'accordion' facilities that permit the borrower to increase the amount of term or revolver facilities available, or to incur additional indebtedness in another form are an increasingly common feature of leveraged loan facilities in Canada, and are often used to finance acquisitions. The terms for these incremental facilities are generally becoming more borrower-friendly. The borrower is usually permitted to incur a fixed amount of additional debt subject to further increases, if certain financial ratios are satisfied. Most favoured nation restrictions with respect to interest rate spreads for additional debt and other protections for existing lenders with respect to the terms of incremental debt are also continuing to weaken.

Unitranche lending has also gained some popularity with Canadian borrowers, particularly those exposed to US lenders through their US affiliates. Unitranche facilities combine senior and junior debt into one credit facility, with the lenders addressing their respective priorities with a first-in, last-out mechanism under an agreement among lenders.

Another trend is the increased activity level of foreign lenders in Canada, particularly those based in the United States. The increasing level and size of cross-border transactions has created new lending opportunities for foreign lenders in Canada. Many foreign lenders are also seeking to expand their relationship with clients in their home jurisdictions to affiliates of those clients located in Canada. A number of foreign lenders have established a local presence in Canada such as a foreign bank branch, and are offering a wide variety of financial products to Canadian clients. Further, there has been an increase in the number of private or alternative lenders in the Canadian market, providing bespoke financing arrangements to address borrowers' unique financing needs and credit challenges. The increased competition in the Canadian financial market resulting from entry of additional foreign lenders and private lenders should be beneficial to Canadian borrowers.