Canadian dollars
Almost a year to the day since the collapse of Lehman Brothers Holdings Inc. froze global markets, deal making is back in a big way.
Revitalized capital markets allowed a sudden burst of major financings this week, on top of continued rallies in equity and debt markets. Canadian companies, led by Barrick Gold and Fairfax Financial, raised nearly $5.9-billion by selling stock - more than in any other week in history, according to Thomson Reuters.
Thanks to a receptive credit market, energy giant EnCana Corp. revived its plan to split into two companies, which requires $5-billion in loans. Citigroup, whose survival was in serious doubt post-Lehman, borrowed $350-million from Canadian investors in the corporate bond market. And long-dead initial public offerings are once again doable, with Montreal-based retailer Dollarama this week filing to go public in a transaction expected to raise $250-million.
It's not only a Canadian phenomenon. Kraft Foods is seeking to acquire British candy maker Cadbury PLC using $8-billion (U.S.) in debt.
Around the world, investors are clamouring to buy bonds and stock offered not only by blue chips such as Barrick, but by the most risky companies. Even complicated derivative structures once thought dead and buried after they played roles in the near-collapse of the financial system, like collateralized debt obligations, are on the rebound.
The optimism is so rampant that investors' appetite for risk is "flirting with euphoria," according to strategists at Credit Suisse, a phrase that has uncomfortable echoes of the boom years.
It's also potentially uncomfortable for regulators, because the rally in markets threatens to sap the momentum behind calls for reform of the financial system, which hasn't yet yielded many concrete changes.
In the meantime, executives know that free-flowing capital markets could quickly go cold, so they're acting fast.
Fairfax Financial's decision to sell $1-billion of stock to help it repurchase a chunk of its Odyssey Re insurance subsidiary was a difficult one for chief executive officer Prem Watsa. Taking back the portion of Odyssey that Fairfax doesn't own has long been a goal, but he was wary of going ahead with a stock sale because he wasn't convinced the market's rebound would last long enough to get it done.
"We were not so sure," he said in an interview, saying the insurance conglomerate didn't want to take any risk that the markets would pull the rug out from under its plans to do the Odyssey deal.
"The ability to finance it was very, very important, and fortunately we were able to do it," Mr. Watsa said. The deal's conclusion will be "a day that we'll remember for a long time."
MARKETS RACE AHEAD
The corporate financing resurgence has a more sober, purposeful tone compared with the capital casino that underpinned the credit bubble.
Energy producer Compton Petroleum yesterday raised $172-million in a share sale that met hot demand, and will use the cash to bring down its heavy debt load. The $4-billion Barrick raised in the biggest share sale in Canadian history will enable the company to unwind gold price hedges that hindered profit growth as bullion rises. For EnCana, getting loans allows the firm to go ahead with a reorganization that had to be shelved when credit disappeared.
And the flurry of deals isn't likely to end soon, said Paul Donnelly, chief executive of the Canadian arm of Macquarie Capital Markets, the giant Australian investment bank.
"I don't think the pipeline is exhausted for a second," Mr. Donnelly said. However, he said, for now stock sales will mostly of a relatively low-risk variety designed to appeal to investors who are still wary after being once burned.
'Diminished grandeur'
The capital thaw brings clear benefits to companies getting back to basics, analysts say. "If a corporation can find access to capital that helps it to, at a minimum, stay in business and employ people, and then beyond that acquire additional efficiencies, become better at what they do, expand their product lines ultimately, those are good things," said Barbara Matthews of Washington-based BCM International Regulatory Analytics and a former U.S. Treasury attaché to the European Union.
But the implications of the wave of financing are not so clear-cut for regulators. As policy makers struggle to implement tougher rules on bank capital, banker pay and financial system oversight aimed at protecting the global economy from another meltdown, the burst of activity is both welcome and worrying.
While healthier capital markets promise to help restart global economic growth, the new-found optimism threatens to undercut momentum on key regulatory reforms designed to keep the world out of another mess like the one that Lehman and other banks created with rampant lending and risk taking. When the sun comes out, the pressure to fix the leaky roof fades.
"They [regulators]haven't laid down the regulations quickly enough," said Charles Geisst, a professor of finance at Manhattan College in New York. "The long and the short of it is that the markets are getting ahead of the regulators. Which they always do, by the way."
Expediency has already led to some proposals being scaled back. "You can already see the diminished grandeur of the reform proposals," agreed Lawrence Mitchell, a George Washington University law professor and author of Speculation Economy: How Finance Triumphed Over Industry . "We're seeing financial re-inflation, rather than reform."
Governments distracted
Governments around the world are still trying to figure out how to create systemic risk monitors to ensure that a big buildup of hidden problems doesn't occur virtually unnoticed as it did during 2006 and 2007. Rules on banker pay and stricter capital requirements for the global banking sector are still not much more than proposals, with the G20 nations meeting this month in Pittsburgh to keep working on them, even as markets race ahead, investors flock to risk, banks advance bigger loans and cut larger paycheques.
Governments are also getting distracted as new issues come up. The U.S. is embroiled in a debate over health care, while Canada is heading toward a potential election where the issues look more likely to revolve around stimulus packages than for financial sector reform.
"After all we've been through, and with so much anger still directed at financial miscreants, the political indifference toward financial reform is somewhere between maddening and tragic," Alan Blinder, a former adviser to president Bill Clinton and one-time member of the Federal Reserve Board of Governors, wrote in The New York Times last week. One of the main reasons, in his view, is that "People have an amazing capacity to forget."
new regulators
As a result, one major goal that has yet to be accomplished is the creation of overarching financial regulators in key countries. The idea is to find a way to ensure that there are no blind spots between the various regulators that focus on different aspects of the financial system.
In Canada, for example, such a body could have potentially spotted the risks building up in the asset-backed commercial paper market, which existed largely in a netherworld between regulators. In the U.S., such a watchdog would have hopefully caught on to the risks that AIG was taking by selling derivatives rather than just sticking to its traditional business of insurance.
In the U.S., the Obama administration is pushing to have the Federal Reserve take on that role, but it's unclear whether Congress will play along, as some members hold the Fed responsible for allowing the country to get into the economic mess in the first place, while others view the reforms as too little.
The Harper government has said only that it wants to keep ultimate responsibility for watching over the financial system under the purview of the finance minister, but has laid out little else in the way of specifics.
New capital rules, too, which are designed to force banks to hold more cash to make them more stable in downturns, have yet to be finalized.
Those trying to craft the rules appear to realize that the best window for reform may be closing.
"We need to bring greater urgency to the financial reform agenda," U.S. Treasury Secretary Timothy Geithner said after the G20 meeting of finance ministers and central bankers in London earlier this month. "We have broad agreement on a very strong set of principles and objectives for building a more stable global financial system. But we need to move now to put that framework in place."
The key, said former Bank of Canada deputy governor Sheryl Kennedy, is to balance speed with getting it right and ensuring regulation doesn't go too far so that systems such as securitization, which are still necessary, can recover.
"Everyone wants to see financial innovation continue, they just want it to be innovation that is sound, with products that are more transparent, and appropriate due diligence done on the part of investors," said Ms. Kennedy, who's now CEO of Promontory Financial Group Canada LLC, which advises financial firms. "Having learned the lessons, move forward in a better way."
A new credit bubble?
So far, the danger of moving slowly appears confined to the risk that needed regulations will fall by the wayside, rather than an imminent return to the excesses of the boom.
Money, while available again, is nowhere near as easy to find as it was during 2006 and 2007. By almost every measure, capital-raising so far in 2009 is still at levels far below where it was two years ago. Banks are much pickier about who gets a loan, and they are charging more. For example, when a group of investors including the Canada Pension Plan Investment Board agreed two weeks ago to buy Internet phone service Skype from eBay Inc. for $1.9-billion (U.S.), they could only get about $600-million in loans. During the credit bubble, such a purchase could have been almost entirely financed by debt.
Furthermore, while securitization and derivatives such as CDOs are slowly returning, they are nowhere near as prevalent as they were in 2006 and 2007.
"In terms of leverage and liquidity and structuring and complexity and all those things that are getting criticized for getting us into the mess, I don't think very much of that has come back at all," said Doug Guzman, head of global investment banking at the securities division of Royal Bank of Canada, the country's biggest bank.
However, in the longer term, with investors rushing back into credit and equity markets, there's concern pricing will be driven down by competition and standards may follow, just as they did during the credit boom that turned out in fact to be a credit bubble.
Already, the record run this year in corporate debt markets has cut the premium investors demand to take the risk of buying a corporate bond almost to pre-Lehman levels. The average interest rate on a five-year, triple B-rated corporate bond is now about 3.4 percentage points above the rate on a five-year U.S. Treasury bond, just about where it was a year ago. Given that benchmark Treasury interest rates have plunged, overall rates investors are demanding from corporate borrowers, even with an economy struggling to emerge from recession, are often lower than they were prior to the Lehman collapse.
"People's financial memories are not very good," Prof. Geisst said. "With the exception of the Great Depression, and certainly since the 1950s, all of the fiascos which have occurred have been forgotten way too quickly."
With files from reporter Barrie McKenna in Washington