June 17, 2020 / 6:41 PM / 19 days ago

Canada's COVID-19 aid risks adding to corporate debt overhang as Ottawa limits handouts

TORONTO (Reuters) - Canada risks slowing the pace of economic recovery as it largely leans on repayable loans to help companies ride out the coronavirus crisis, rather than grant programs that are favored by the United States, economists say.

FILE PHOTO: A Canadian dollar coin, commonly known as the "Loonie", is pictured in this illustration picture taken in Toronto, January 23, 2015. REUTERS/Mark Blinch

Ottawa is rolling out a record amount of fiscal support at more than C$300 billion ($222 billion), about 15% of GDP, which includes C$85 billion of deferred tax payments and C$81 billion of loans to small and medium-sized businesses that will eventually need to be serviced and repaid.

For some companies, servicing the debt could reduce capital to invest or make it unworkable to take a loan in the first place. The debt-to-equity ratio of Canadian private non-financial corporations jumped to 212% in the first quarter, the highest since 2009, and companies rushed to the bond market in the first five months of the year at the heaviest pace in at least a decade.

“Many firms with already high debt loads from prior to the spread of COVID-19 may not seek assistance structured as debt if their debt service costs are already too high,” said Colin Guldimann, an economist at Royal Bank of Canada. “That means those firms may fail rather than bridging the gap with a loan that will ultimately lead them to close.”

Whereas loans under the U.S. Paycheck Protection Program for small businesses turn into grants if certain conditions are met, Canada’s emergency loan program for small businesses, the Canada Emergency Business Account (CEBA), forgives only 25% of the debt.

Canada also offers wage subsidies to businesses but has reduced the budgeted amount of the program.

Businesses see increasing the 25% forgivable portion of CEBA as the highest priority for improving federal relief efforts, a survey by the Canadian Federation of Independent Business showed. Of the C$41 billion estimated for CEBA, credit has been approved for C$26 billion, government data show.

Finance Minister Bill Morneau’s office did not offer an immediate comment.

There are also credit programs for medium-sized enterprises but the debt is fully repayable and interest is charged at market rates. Using market pricing reduces distortions in the economy, such as businesses taking money they don’t need, and the government’s cost, but the debt servicing overhang could weigh on economic growth.

Firms will have taken on more debt coming out of the crisis, so “it’s going to be tough for them to go out and borrow to invest,” said Serge Dupont, a senior adviser at law firm Bennett Jones.

“That debt, it has to be repaid and it’s going to have to be repaid at a time when the economy is still not firing on all cylinders,” Dupont said.

Reporting by Fergal Smith; Editing by Denny Thomas and Steve Orlofsky

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