Recent turmoil has made spreads on bank debt quite attractive, particularly subordinated debt known as non-viable contingent capital.Getty Images/iStockphoto
Canada's investment-grade corporate debt has taken a beating this year. Now, it's starting to look like a buying opportunity.
An index of high-grade corporate bonds issued in Canadian dollars has posted a negative return of 0.375 per cent since Dec. 31, on track for the worst first quarter since 2003, according to Merrill Lynch indexes. The extra yield that lenders are demanding over government bonds to hold the debt touched the highest level since the financial crisis last week.
Financial and energy bonds, in particular, are looking affordable after they were swept up in global market concerns about Deutsche Bank AG's ability to pay back its riskiest bonds, the prospect of a U.S. recession and ongoing volatility in China's markets and growth prospects. All this came as a rout in oil, one of Canada's largest exports, passed 20 months.
"The end of the world was priced in, and while things are still uncertain and unknown, the evidence we're seeing hasn't supported an Armageddon scenario yet," Alex Schwiersch, who co-manages $3.35-billion in fixed-income assets for Invesco Canada's Trimark Investments, said by phone from Toronto. "It just doesn't look as bad."
Markets have rallied from mid-February's turmoil as oil has jumped 40 per cent from an almost 13-year low hit in February, China signalled it may pursue monetary stimulus by lowering its reserve requirements for banks and U.S. economic data have reduced deflation worries, he said.
On the home front, investors have been cautious of both energy companies and the banks that may own debt of that sector, said Thomas O'Gorman, director of fixed income at Franklin Bissett Investment Management, which manages $5-billion in fixed income.
But the banks have shown that their exposure is manageable, he said. And recent volatility has made spreads on bank debt quite attractive, particularly subordinated debt known as non-viable contingent capital, or NVCC, which meets Basel III regulatory capital requirements.
"We have been underweight the Canadian banks, just like we were investment-grade energy, forever," Mr. O'Gorman said by phone from Calgary. "But lately, we've been stepping in, especially with some of these NVCC deals, to buy them. I don't lose sleep over Royal Bank of Canada or Toronto-Dominion Bank."
Among the energy companies, Cenovus Energy Inc., recently downgraded to high yield by Moody's, and investment-grade Canadian Natural Resources Ltd.'s debt, which he owns, look cheap, he said. His firm has been gradually adding investment-grade energy bonds over the past 18 months, when before they had none.
Trimark's Mr. Schwiersch said he has a been a little quieter through the volatility, buying utilities and telecoms since the start of the year. The best opportunities are in Triple B-rated debt, the lowest notch of investment grade, because there's more spread per dollar invested, he said.
"There's been a lot of supply into BBB from downgrades," he said. "So that bucket has gotten a lot bigger, and there's limited capacity to take on BBB by the investor base here, and it's cheaper than it would otherwise be."
Investors aren't prepared to declare that the worst is definitely over in the markets, but the outlook is promising. With interest rates so low, nearly three-quarters of the yield on bonds is spread, Mr. O'Gorman said.
For example, Canadian Natural Resources' $500-million (U.S.) of 3.45-per-cent bonds due February, 2021, yielded 5.415 per cent on Tuesday, with a spread over government debt of 407.4 basis points – or 75 per cent of the total yield. "It's almost become the point where you can't underperform very much longer," he said. "Eventually, it just leads to outperformance."