Financial fallout from Covid-19 hard to judge with government supports in place

By James Langton | May 10, 2021 | Last updated on May 10, 2021
3 min read
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Government support measures have been critical to helping Canadian businesses ride out the pandemic, but the uncertain condition of companies once those measures are withdrawn remains a key concern for policymakers.

In a new research note, analysts at the Bank of Canada examined the effect of the Covid-19 pandemic on the bottom lines of Canadian businesses and found evidence of financial weakness that has not yet materialized. A key reason is an array of government supports, including subsidies for small business wages, commercial rents and loans.

“Bold policy measures have helped many businesses manage cash flow pressures despite substantial falls in revenues. Consequently, insolvencies have remained low and default risks appear broadly contained,” the paper found.

The modest default risk is also reflected in banks’ provisions for loan losses, which have largely returned to normal levels after spiking in the initial aftermath of the pandemic, the paper said. And it reported that market-based measures of ‘distance to default’ for large, publicly-traded firms, which also deteriorated when the pandemic first hit, have since recovered too.

“This improvement is visible across all industries, although most have not yet fully recovered to pre-pandemic levels,” it said. “Market-implied default risks appear most pronounced in the oil industry.”

Yet, at the same time, the paper cautioned that the success of extraordinary government support measures make it difficult to predict the financial condition of companies once that support is withdrawn.

“A potential risk in the near term is an unexpectedly large and sudden increase in corporate insolvencies once government support programs run their course,” the paper said.

“The extraordinary financial support provided to some firms over the past year makes it difficult to get an accurate read of the financial health of businesses. In particular, it is not clear whether firms that currently benefit from financial support are financially viable without these programs,” it noted.

The report cautioned: “financial vulnerabilities could grow during the recuperation phase of the recovery.”

Even before Covid-19 hit, corporate debt was already at an all-time high, the paper said.

So, to the extent that companies exit the pandemic with much more debt on their hands, they could prove financially fragile.

“This development can lead to debt overhang and become a broad macroeconomic issue if elevated debt levels discourage firms from taking on profitable investment opportunities,” the paper said.

Another risk, the researchers warned, is an increase in the number of so-called “zombie firms” — companies that are unable to generate enough income to service the interest on their debt for a prolonged period.

“The decline in the number of business insolvency filings despite the large economic downturn may indicate a potential further ‘zombification’ of firms in Canada,” the paper said. “These zombie firms could weigh on economic performance because they are less productive and because their presence reduces investment and employment by more productive firms.”

Moreover, the paper noted that, as the pandemic is not yet over, companies “will continue to face challenges” due to public health restrictions.

“Some firms that managed to stay afloat thus far may see their financial health deteriorate as the pandemic persists,” it said.

Additionally, the paper stressed that the full impact of the pandemic may not yet be known due to the lack of timely data on the financial health of smaller firms.

While certain estimates from Statistics Canada indicate that small companies have been disproportionately affected by the pandemic, “This observation, however, is not yet visible in many of the business sector statistics,” it said.

“At this stage, we cannot conclude with certainty that the financial health of the business sector has been or will remain unscathed by the pandemic,” the paper concluded.

“The pandemic could leave some businesses, especially those in hard-hit industries, in a financially vulnerable position, notably due to high levels of debt. There is also a risk of a large and sudden increase in insolvencies among businesses as government programs run their course.”

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James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.