After nearly seizing up during the pandemic panic in March, the bond market has proven to be a lifeline for Canadian corporations and governments.
Record levels of issuance have been met with unprecedented investor demand for Canadian debt securities, providing an ample source of cheap money to help endure the recession and to finance the national recovery effort.
“At precisely the moment Canadian federal-provincial administrations, government business enterprises and private corporations needed and wanted to access debt capital markets in a big way, they found a receptive international audience,” Warren Lovely, chief rate strategist at National Bank of Canada, wrote in a note.
If anything, there is not enough supply to satisfy the appetite for Canadian bonds.
In April, foreign investors devoured $54-billion in Canadian federal, provincial and corporate debt, dwarfing a $3.7-billion outflow posted in March, according to data released by Statistics Canada on Tuesday.
In addition to international buying, the Bank of Canada’s foray into quantitative easing (QE) has accounted for another huge chunk of total Canadian issuance.
To help restore order to credit markets, the central bank implemented a wide-scale asset purchase program, effectively printing money to buy government and corporate bonds. Over the past three months the Bank of Canada’s balance sheet has more than quadrupled to nearly $500-billion, as of last week.
“After you control for the Bank of Canada’s swelling balance sheet, bond investors have been left to chase a smaller available stock of Government of Canada bonds,” Mr. Lovely wrote.
That’s because most of the domestic supply of federal bonds issued in the second quarter is being swallowed up by the central bank. After accounting for maturing bonds, that will leave a decline in net issuance available to Canadian investors. “That could continue for the foreseeable future,” Mr. Lovely said.
Investors are also scrambling to get their hands on investment-grade Canadian corporate debt.
“You’re seeing deals that are four or five times oversubscribed,” said Crista Caughlin, a fixed-income portfolio manager at Mawer Investment Management.
As the Canadian economy gradually reopens, the potential for a second wave of COVID-19 infections and a reinstatement of lockdown protocols looms large over corporate Canada. “You don’t know how long this is going to go on. And if the demand is there, then you might as well capture that,” Ms. Caughlin said.
The revival of Canadian bonds over the past few months has been every bit as dramatic as the stock market rally.
Back in March, many Canadian issuers were shut out of the market, regardless of credit quality. Canadian bond market liquidity shrunk to just 10 per cent of normal levels, according to a report by Canadian Imperial Bank of Commerce. A full-blown credit crisis was in danger of unfolding if borrowers were unable to refinance their debt.
Investors clambered to unload Canadian debt securities, as the iShares Canadian Corporate Bond Index ETF (XCB) fell by a whopping 23 per cent in just 11 trading days.
Into that breach stepped the world’s central banks, dousing financial markets with trillions of dollars in liquidity, and effectively providing a backstop for corporate borrowers.
The combined effect of interest rate cuts and QE have driven down borrowing costs, as the yield on Government of Canada 10-year bonds has declined by half since late March, to sit at 0.53 per cent.
After the Bank of Canada intervened, investors promptly rediscovered their appetite for Canadian bonds. XCB shares leapt by 25 per cent in the three weeks after bottoming out in late March, and have since returned to within pennies of their prepandemic peak.
Now, the concern has shifted away from a potential wave of defaults and toward excessive public and private debt levels.
The latest corporate borrowing binge has lifted the debt-to-equity ratio of non-financial Canadian companies to 212 per cent – the highest level since 2009.
“Leverage ratios are definitely a concern,” said Benjamin Reitzes, a Canadian rates and macro strategist at Bank of Montreal. “There may be a hangover from all this.”
With a report from Reuters
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