Jock Finlayson: "The economic damage done by the pandemic lies in the future, not just the painful recent past."
Almost a year ago, we posted a blog on the impact of COVID-19 and the measures taken to control the virus on business in British Columbia. We speculated that by the end of 2021, the pandemic could lead to a 10% decline in the number of business establishments in the province. At the time, B.C. had roughly 200,000 businesses with paid employees, so this pointed to the possible disappearance of 20,000 firms.
The seemingly endless pandemic is still with us, but as the pace of vaccinations accelerates there is reason to believe better days lie ahead. With the benefit of hindsight, we were perhaps too pessimistic with our crude estimate of “business mortality” during COVID-19. At this point, it does not seem likely that 20,000 B.C. businesses have disappeared since the start of 2020. In January 2021, the Greater Vancouver Board of Trade counted 4,380 fewer “active businesses” in the metro region compared to one year earlier. Some additional business closures will surely occur in 2021. And the Board of Trade’s estimate didn’t capture developments outside of the Vancouver Census Metropolitan Area.
In the meantime, we have had an opportunity to undertake additional research and gain access to data that wasn’t available when we authored the aforementioned blog 11 months ago. This has allowed us to refine our analysis of how COVID-19 has affected business in B.C.
Business insolvencies versus business exits
A surprising aspect of the “COVID shock” is the lack of evidence that more businesses have been rendered insolvent during the crisis. Statistics published by the federal government show no rise in official insolvencies in the last year or so, despite the unprecedented drop in GDP caused by the pandemic. In fact, the Bank of Canada reports that the number of business insolvency filings under the Bankruptcy and Insolvency Act (BIA) fell by almost 25% last year. On the other hand, filings under the less widely used Companies’ Creditors Arrangement Act (CCCA), which facilitates the restructuring of troubled companies and doesn’t typically result in bankruptcy, rose noticeably in 2020.
It is important to understand that the “exit” of businesses from the commercial marketplace doesn’t usually involve a formal filing of insolvency or bankruptcy. Indeed, the vast majority of firms that disappear in any given year quietly shut their doors voluntarily, without invoking either the BIA or the CCCA. This makes sense considering that around 150,000 of the 200,000 or so businesses with paid employees operating in B.C. when the pandemic arrived had fewer than 10 staff, with more than 113,000 being “micro-businesses” with 1-4 employees. So, it follows that looking just at filings under the BIA and the CCCA is not a reliable way to gauge the financial health of the broad business sector.
More shoes to drop
The economic damage done by the pandemic lies in the future, not just the painful recent past. It takes time for a big shock like COVID to play out across the economy. In this case, three factors have helped to slow the adjustment process for the businesses and industries hit hardest by the closures, social distancing requirements, and other operational restrictions mandated by public health authorities struggling to contain the virus.
- First, vast and unprecedented government financial supports for households and businesses have shielded many from the worst effects of the COVID shock. In particular, a large share of the many tens of thousands of B.C. companies that have suffered falling revenues at some point – or on an extended basis – during the crisis have availed themselves of various COVID-related government assistance programs. At the federal level, these include the Canada Emergency Wage Subsidy and the Canada Emergency Business Account, along with the Canada Emergency Commercial Rent Assistance program (cost-shared with the provinces). At the provincial level, the B.C. government allowed employers to defer certain tax payments in the 2020-21 fiscal year, legislated a temporary roll-back of the provincial property tax, froze the carbon tax for one year, and provided modest direct targeted financial aid to a few distressed sectors. These federal and B.C. business assistance programs provided a vital (albeit time-limited) lifeline for many firms across the province.
- Second, businesses grappling with cash flow challenges amid COVID-19 have also gained some extra breathing room thanks to record-low interest rates and borrowing costs engineered – in part – by the Bank of Canada.
- Finally, in some cases B.C. companies experiencing significant financial hardship during the COVID crisis have benefitted from temporary forbearance shown by their financial institutions, landlords, and other suppliers.
All of the federal and provincial financial support programs for business introduced since February 2020 will be dialed back and wound up over the 2021-22 fiscal year. Interest rates and borrowing costs for indebted businesses are expected to increase modestly in the next year or two – and have already risen in the last six months. And the forbearance shown by lenders and other creditors to B.C. firms is necessarily temporary. Additional debts taken on by troubled companies since early 2020 must be repaid in the future (assuming they remain in business).
As this process unfolds, we believe more B.C. companies will disappear over the balance of 2021 and into next year. Most of these won’t entail formal filings under the BIA or restructurings under the CCCA. Rather, they will be “quiet” exits as formerly viable – even if barely – small and mid-sized businesses discover they can no longer continue to manage their debts and/or operate profitably.
In this connection, the previously cited Bank of Canada study finds that more firms in industries hit hard by the COVID shock “are likely to become…financially vulnerable” in the next 6-18 months. A baseline simulation performed by Bank researchers shows the number of “highly leveraged” Canadian businesses increasing to 16.6% of all firms by the end of 2021, up sharply from 12.5% in Q3 of last year (see table below for details). Much of the resulting financial pain is likely to be concentrated in a handful of industry sectors – travel, accommodation and foodservices, leisure and entertainment, community and personal services, and some segments of retail.
Thus, despite the (temporary) decline in formal business insolvency filings in 2020 and the generally healthy financial metrics being reported by most large Canadian companies in the first half of 2021, we continue to expect a rising tide of “business exits” over the next year. Our admittedly crude and now somewhat dated estimate of a 10% decline in the number of active B.C. businesses as a consequence of the COVID shock still strikes us as a reasonable projection, but we now believe the business losses stemming from COVID will materialize over a longer time period than we originally envisaged.
The disappearance of a significant number of businesses due to COVID related disruptions will be partially offset by new business formation. In a typical year, Canada sees the creation of slightly over 96,000 businesses, along with the disappearance of roughly 90,500 existing firms. B.C. generally accounts for 12-14% of these national figures. Business formation has been depressed during the lingering COVID shock. However, we still expect that a few thousand new businesses will be created in B.C. over the course of 2020 and 2021. Thus, the net decline in the stock of operating B.C. companies with paid employees from early 2020 through the end of 2021 should be less than 10%, perhaps in the range of 6-8%
- No, it doesn’t grow on trees. Jock Finlayson last wrote about the industries that drive BC’s revenue streams.
- In November, the BCBC’s Ken Peacock looked at federal data and noticed the enormous number of people that claimed the CERB.
- Roslyn Kunin had a plan for getting us out of the “pink recession.”