Investors are clamouring for Canadian corporate debt even as offerings slow down.Getty Images/iStockphoto
Canadian bond investors desperate to get their hands on more corporate debt are caught in a dilemma. This year, there isn't enough to go around.
For the past four years, investment banks have warned that corporate debt issuance was likely to slow since it was almost impossible for bond yields to fall any further. Because Canadian companies had already taken advantage of what were likely to be the lowest rates they could dream of, they were expected to curtail their borrowing when rates rose.
Yet, yields kept falling, and in turn, debt issuance kept soaring. Since 2011, Canadian corporate debt offerings have totalled close to, if not more than, $100-billion a year.
Following this record run, the slowdown is finally here. Halfway into 2016, total issuance is 17 per cent lower than it was at the same point in 2015. CIBC World Markets currently projects a total of $83-billion for the full year, compared with $95-billion last year.
Although a cooling was bound to materialize, it is a bit perplexing because the slowdown isn't for a lack of buyers. "It's not driven by demand," Toronto-Dominion Bank managing director Patrick Scace noted. "Demand for [corporate] credit remains very strong."
That's true for debt of nearly all types in the developed world. The total of $12-trillion (U.S.) worth of sovereign debt issued by developed countries now carries negative yields because buyers are showing such heavy demand. (Both prices and yields move in opposite directions.)
But it is especially true for Canadian companies such as telcos, which have slightly lower debt ratings than the banks, yet remain investment grade. BCE Inc.'s latest issue of 10-year debt, for instance, currently yields 2.77 per cent, while Royal Bank of Canada's equivalent bond yields 2.25 per cent. "There's certainly an increased appetite for Triple-B credit," RBC Dominion Securities managing director Patrick MacDonald said.
The demand exists despite the global turmoil caused by Britain's vote to leave the European Union as well as weaker expectations for global economic growth. Amid the uncertainty, corporate credit continues to trade extremely well.
Credit-default swaps serve as a form of insurance on corporate bonds and their prices reflect the perceived risk of default on a given bond. The higher the risk, the more expensive the swaps are. CIBC World Markets global head of macro strategy Joanna Zapior creates her own pricing estimates for a basket of Canadian investment-grade debt with five-year terms and found the yield spread above benchmark government bonds is roughly 1.85 percentage points at the moment, down from 2.50 points in February.
To put that in context, the same basket of credit-default swaps saw the average yield spike to more than four percentage points during the global financial crisis in 2007 and '08. Before the crisis started, the spread was below one point.
Demand for corporate debt also remains extremely heavy in the United States. On Monday, the iShares iBoxx Investment-Grade Corporate Bond ETF, which is the world's second-largest exchange-traded bond fund, added $1.1-billion of new investor money – a new record for daily inflows, according to Bloomberg. Such an appetite has been met with what is expected to be record new issuance this year.
In Canada, however, the offerings are slowing for multiple reasons. Because rates have already been so low, companies got ahead of the problem and refinanced existing debt during the past few years, and because economic growth is so low, many of them aren't looking to spend heavily on capital expenditures, which are often funded with debt. They're sitting on their hands for now.
Mergers and acquisitions activity is also having an effect. A good chunk of deals involving Canadian companies are for foreign assets, and in those cases, the Canadian buyer is more likely to finance the deal using foreign debt. Emera raised most of its debt for the $10.4-billion acquisition of Teco Energy in the United States.
Should something about the current environment change, though, Canadian companies can rest reasonably assured they'll be able to borrow whatever they need. The fear of central bank changes to rates, which have big effects on the bond market, is all but forgotten. "Every time there's talk of rate hikes," TD's Mr. Scace explained, "they don't happen."