Focus
May 22, 2020 | 13:57
Taking Care of Business
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Taking Care of Business |
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Both U.S. and Canadian policymakers have moved in unprecedented fashion to counter the decline in incomes of households and businesses caused by the pandemic-related lockdowns and shutdowns. The measures have included direct payments to individuals and firms, tax payment deferments, rule changes that lower corporate taxes, government guaranteed loans to businesses, along with central bank purchases of loans and securities to support household and business credit. For businesses, specifically, the policy goal is to minimize the number of firms that suffer insolvency or bankruptcy, as a means to maximize the number of laid-off and furloughed workers that get called back to work. Unlike the liquidity crisis among financial institutions that marked the 2008-09 recession, the 2020 recession is marked by a much larger liquidity crisis among small businesses and non-financial corporations. With many of the government measures involving a loan, in which some or all of it might not be forgiven, and all of the central bank measures involving asset purchases to facilitate the credit creation process, the legacy of this recession is destined to be larger debt burdens among businesses both big and small. At a minimum, increased debt service payments, even assuming interest rates remain very low, should act as a mild constraint on economic recoveries and expansions. However, there is a risk that current liquidity problems remedied by debt accumulation could evolve into future solvency problems, and act as a stronger economic headwind. This risk will reflect the extent to which the government programs involve forgivable loans, along with the degree to which businesses are willing and able to absorb more debt amid the increased access to, and availability of, credit. |
Policymakers are assuming that businesses making it over the COVID-19 hump will be in a much better position than at the start of the pandemic to make good on deferred tax and other government payments due, along with servicing any additional debt burdens. However, for some firms, it’s not going to be business-as-usual for a long while, keeping insolvency risk elevated. It’s also important to note that both U.S. and Canadian non-financial corporations (in aggregate) were flirting with record levels of debt last year (as a % of GDP), which could impinge on the willingness of businesses to meaningfully take on more debt (Chart 1). Furthermore, the perennially higher-running Canadian debt ratio has recently been rising faster than its U.S. counterpart, which could indicate even more caution which it comes to absorbing additional debt. It may also partly explain why Canadian policymakers’ total direct lending and credit support responses have been proportionately smaller than their U.S. counterparts. |
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What’s interesting is that, so far, policymakers appear to be doling out comparable amounts of “free money”. In the U.S., the major forgivable loan programs are topping US$720 billion (or about C$1 trillion). Canada’s forgivable loan programs appear to be running well under C$20 billion, but the Canada Emergency Wage Subsidy—somewhat similar to America’s Paycheck Protection Program in outcome—could top C$100 billion by the end of August (depending on the ultimate up-take). The proverbial 10-to-1 ratio appears intact. While the cross-country comparisons are imperfect, we estimate that the net fiscal costs of the major support measures for businesses (all the items mentioned in the first paragraph) total between 3%-to-4% of pre-COVID GDP in both economies (a bit higher in Canada owing to the added oil sector headwind). Overall, it’s likely too early to conclude that one set of measures is superior to another, especially when Canada’s proposals continue to evolve by the day, and many of the programs on both sides of the border have yet to even start. Below, we list the key business lending and credit support measures by U.S. and Canadian policymakers (denoted in local currency): |
Major U.S. Government MeasuresIn terms of direct lending, the measures total $1.07 trillion, mostly for small businesses ($991 billion). Additionally, Treasury has earmarked $494 billion for the Fed’s various lending facilities. |
Paycheck Protection Program (PPP)Up to $670 billion in small business loans originated by private lenders and guaranteed by the Small Business Administration (SBA). The loans are potentially 100% forgivable, with at least 75% based on proven payroll costs and no more than 25% based on proven mortgage interest, rent and utilities costs. The SBA states: “Forgiveness is based on the employer maintaining or quickly rehiring employees and maintaining salary levels." If a business can’t maintain its payroll, only a portion of the loan has to be repaid. As of May 21, a total of 4.4 million PPP loans have been originated for a total of $512 billion. | Economic Injury Disaster Loan (EIDL) programIncreased funding for up to $300 billion of these not-forgivable loans, originated by the SBA. However, part of the loan amount can be a $10,000 advance that does not have to be paid back. There is also increased funding for up to $21 billion of these grants. Other CARES Act measures
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Federal Reserve MeasuresIn terms of support for business credit, the Fed has announced several lending facilities via special purpose vehicles with the capacity to purchase up to $2.7 trillion of loans and securities. As of May 20, purchases have totaled only $51 billion. It has taken time to construct the “term sheets” for the various facilities. However, in testimony this week, Fed Chair Powell said: “We expect all of them to be stood up and ready to go by the end of this month… people are working literally around the clock and have been for weeks.” For example, one wrinkle that had to be ironed out is since the Fed can’t target specific firms (think the airlines), it would want the relevant lending facility to be robust enough so that these firms would all be eligible among others. Note that of the total $494 billion Treasury capital available, $205 billion has already been deployed and $289 billion remains. While it is possible that the Fed and Treasury might opt to increase the loss protection in the lending facilities, the remaining capital could support up to $2.9 trillion of additional credit (assuming an average 10% leverage ratio). |
Primary & Secondary Market Corporate Credit Facility (P/SMCCF)Up to $750 billion of loans in the primary market, and bonds in both the primary and secondary markets, of investment-grade firms and those that fell into junk status after March 22. Only the SMCCF is up and running with its purchase of bond ETFs ($1.8 billion as of May 20). | Main Street Lending ProgramUp to $600 billion of loans to midsize companies with fewer than 15,000 employees or less than $5 billion in annual revenue. There are three tranches in the program covering new loans (MSNLF), priority loans (MSPLF) and expanded loans (MSELF). Not yet running. |
Municipal Liquidity Facility (MLF)Up to $500 billion of securities of investment-grade state and local governments. Not yet running. | Term Asset-Backed Securities Loan Facility (TALF)Up to $100 billion of credit-backed securities including auto loans, student loans, and small business loans. Not yet running. |
Commercial Paper Funding Facility (CPFF)Up to $100 billion of commercial paper issued by investment-grade firms. Up and running ($4.3 billion as of May 20). | Paycheck Protection Program Liquidity Facility (PPPLF)This SPV is not capped because these loans are already government-guaranteed. The Fed could potentially purchase all PPP loans outstanding. Up and running ($45.1 billion as of May 20). |
Major Canadian Government MeasuresWhile details on some programs have yet to be determined and others seem to be modified frequently, the Department of Finance states that its major business lending measures, so far, have a supportive impact of up to $95 billion. |
Canada Emergency Business Account (CEBA)A $25 billion-plus program that provides interest-free loans of up to $40,000 to small businesses and not-for-profits, to help them cover their operating costs. Repaying the balance of the loan on or before December 31, 2022 will result in loan forgiveness of 25% (up to $10,000). | Canada Emergency Wage Subsidy (CEWS)A subsidy worth 75% of pre-crisis wages (and intra-crisis hires), up to $847 per week. Employers can also recover 100% of payroll taxes paid for furloughed employees. Eligible employers include individuals, taxable corporations, and partnerships as well as non-profit institutions and registered charities. Employers will not have to pay employees their full pre-crisis wages to qualify for the wage subsidy. The estimated fiscal cost was $76 billion when the program was running until June. Now extended to August, the estimated cost could push $120 billion, although take-up has been below expectations to date (likely the result of larger-than-expected use of the Canada Emergency Response Benefit). |
Canada Emergency Commercial Rent Assistance (CECRA)The program will provide forgivable loans to qualifying commercial property owners to cover 50% of three monthly rent payments that are payable by eligible small business tenants during April, May, and June. The loans will be forgiven if the mortgaged property owner agrees to reduce the small business tenants’ rent by at least 75%. The small business tenant would cover the remainder, up to 25% of the rent. The cost of the program is being shared with the provinces. Large Employer Emergency Financing Facility (LEEFF)Open to nonfinancial firms with more than $300 million in revenue, seeking financing of $60 million or more, with a significant workforce in Canada. | Business Credit Availability Program (BCAP)Export Development Canada (EDC) and the Business Development Bank of Canada (BDC) will provide not-forgivable loans and loan guarantees for small and medium-sized enterprises, delivered via four channels:
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Bank of Canada MeasuresWith the bulk of credit support coming through EDC and BDC, the Bank of Canada's measures pale in comparison to what the Fed is providing. At current levels of activity for the two money market measures, the total amount of support for business credit is around $21 billion. |
Bankers’ Acceptance Purchase Facility (BAPF)Purchases of bankers’ acceptances (up to 3-month maturities) sufficient to support smooth market functioning. The facility topped out around $39 billion in early April, and outstandings have since slipped to less than $9 billion. | Commercial Paper Purchase Program (CPPP)Purchases of 3-month commercial paper (up to 3-month maturities) in both the primary and secondary markets, sufficient to support smooth functioning. The relatively small program topped out around $3.0 billion at the end of April, and outstandings have since slipped to $1.8 billion. |
Corporate Bond Purchase Program (CBPP)Up to $10 billion of investment-grade corporate bonds in the secondary market, with 5-year and under maturities and included in the FTSE Canada 0+ Year Universe Bond Index. The program will start May 26 and last for a year. |