Global Spotlight: Canada

Canada’s alternative small business lending market is slowly being saturated with new competition, and the industry has earned a new wave of attention thanks to U.S.-based OnDeck’s plans to go public up north. But a different trend is emerging that sees Canadian players launching operations in the U.S.

New reports in Bloomberg Business published last week highlighted the trend of Canadian money managers entering the U.S. shadow lending industry to do business with local companies — a movement some experts say is likely a response to regulators cutting U.S. companies out of the market through harsher rules.

According to Bloomberg, bank managers have begun to discourage risky lending to U.S. firms, leaving a gap that some Canadian investors are willing to fill.

In the words of Professor of Investment Strategy Alan White at the University of Toronto Rotman School of Management: “Whenever you have regulatory constraints and it closes down a market, it provides opportunities for those who fall outside the regulatory constraints.”

Reports say Canadian players like top private equity firm Onex Corp. and Public Sector Pension Investment Board are strengthening their presence in the U.S. and use alternative investments in pension funds, turning themselves into what’s known as a “shadow” lender (defined by Bloomberg as “firms that act like lenders but don’t have depositors, federal bank regulators or access to the Federal Reserve’s discount window”). Ongoing suppressed interest rates by central banks are also helping to encourage the move, reports added.

Analysts told the publication that Canadian shadow lenders are able to skirt recent U.S. regulation that has led to stricter underwriting standards. Coupled with ongoing suppression of interest rates by central banks, Canadian funds are more encouraged than ever to enter U.S. markets and lend to middle-market business borrowers.

One of the biggest players to enter the U.S. recently is the Canada Pension Plan Investment Board (CPPIB). The CPPIB inked a deal in June to acquire General Electric’s business lending operations, GE Capital, in a $12 billion buyout, beating out other local private equity firms.

Some industry analysts saw the agreement as a signal that Canadian funds are more aggressively sharpening their commercial lending skills. According to Morrison & Foerster LLP’s head of Canada practice and co-chair of its private equity and buyout practice, Jonathan Melmed, in a recent interview with The Wall Street Journal, Canadian private equity funds are “no longer content just being passive investors in private-equity funds.” The publication added that many funds in the nation are more interested in direct lending today as they take advantage of cutting out brokerage fees.

Other high-profile funds are beefing up their U.S. corporate lending strategies, too. Public Sector Pension (PSP) spokesperson Jessica McEachern told Bloomberg that the fund is working in the U.S. to bring that expertise and experience back to Montreal. PSP is launching a new credit office that will include alternative loan originations, she said.

And with the ability to conduct this type of lending — unlike their U.S. counterparts in many instances — the funds stand to gain more than they would have if they stayed at home.

“Do we want pensioners in Canada taking risk? Well, if they leave all their money in bank deposits and Canadian government bonds, they’ll be very safe, but they won’t make very much,” said Canadian economist at Stanford University Darrell Duffie. “The question is how much of these leveraged loans and other risky assets the pension funds will take.”

Back in Canada, the nation’s own shadow lending market is also growing, albeit faced with different regulatory threats than in the U.S.

According to reports in the Financial Post last May, Canadian regulators have limited the growth of the peer-to-peer alternative lending industry because they classified loans as securities, meaning only accredited investors could fund the financing. But reports say that those investors are beginning to take an interest in alternative lenders, meaning the players — like OnDeck or local firm Mongo — aren’t really in the shadows (at least, by Bloomberg’s standards).

The Financial Post said that many of Canada’s emerging alternative lending players are encouraged by the successes seen by startups in the U.S. Plus, reports said, some alt-lenders like Mongo actually finance many of their loans by U.S. private equity firms.

The simultaneous entrance of foreign alt-lending players into Canada, the growth of Canada’s own alternative funding space and the entrance of Canadian funds into U.S. shadow lending territory signals how closely intertwined the two markets are. But the current market climate is also revealing how Canadian players are starting to make a name for themselves in the world’s alternative lending sector.