Behind closed doors, it is a scenario that bankers on Bay Street have feared for months, even years.
With the euro zone on the rocks and the U.S. economy struggling to regain top speed, the world's two largest economic blocs are sputtering. What if China stumbled, too? Canada's resource sector, with its reliance on rising world demand for oil, coal and metals, would look awfully precarious. That, in turn, would cause major fallout in the Canadian financial industry, which has itself become ever-more dependent on the activity that mining and energy firms generate.
This scene is now unfolding like a slow-motion train wreck. Mining, a business that has fed the Street with deal after deal for nearly a decade, suddenly accounts for barely a blip of total deal volumes. Few investors will go near junior oil and gas companies. The TSX Venture Exchange, the home of hundreds of burgeoning small-capitalization resource names, is down almost 50 per cent since peaking near the height of the commodity supercycle last March. Even big, global companies such as Teck Resources Inc. have been battered.
The downturn has been devastating for Canada's resource-focused independent investment banks, a group of dealers that includes GMP Capital and Canaccord Financial Inc. Both firms posted $5-million losses last fall; since then, GMP has halved its dividend and Canaccord slipped back into the red. GMP, once a $28 stock, closed this week at $5.45, and is not that far above the lows it hit during the 2008 financial crisis. Their smaller peers, boutique investment banks, are said to be in worse shape, and even the resource groups of the big bank-owned investment dealers are reeling.
As one banker put it: "No one's having any fun."
What has transpired over the past year is a reversal from Bay Street's boom in the decade prior. The ever-expanding commodity cycle fundamentally changed Canada's financial industry, forcing firms in Toronto, Calgary and Vancouver to hire armies of resource-focused bankers, lawyers and analysts. The many deals these firms shepherded even gave a modest boost to Canada's influence in global finance.
Now, not only have deal volumes plummeted, but firms are actually losing money. About 40 per cent of institutional investment banks were in the red in 2011, according to the Investment Industry Association of Canada, and the group said early indications this year suggest the situation may now be even worse.
"You could make the argument that this period we've been in for the independent brokers is worse than 2008," said Sumit Malhotra, an analyst with Macquarie Securities. "As terrible and sharp as 2008 was, it really only consisted of two cataclysmic quarters. We've now had more than a full year of slow bleed when it comes to the profitability of these companies, especially in mining and, to a lesser extent, energy."
To understand just how slow it has been, of the 30 biggest equity financings this year, only three have been for mining companies, despite this sector comprising about 20 per cent of the S&P/TSX composite index.
On a recent quarterly conference call, GMP chief executive officer Harris Fricker admitted that he doesn't see an end to the current slump in mining activity. "If you look at the performance in precious and non-precious metals on the indices, obviously that has been extraordinarily weak. And currently we don't see abatement in those trends," he said.
That doesn't bode well for the perennial mining powerhouse. Over the past four quarters, GMP's mining investment banking revenue slumped to just $71-million, less than half of the $144-million earned in the previous four quarters.
GMP and Canaccord both declined to comment for this story.
The pain isn't confined to investment dealers. Law firms are affected because they aren't being asked for their legal opinions, and asset managers are getting pummelled too. Sprott Inc., in particular, has been in the spotlight. Last year, the resource-focused firm reported annual drops of 24 and 30 per cent in its flagship funds. In January, the firm announced a shift in strategy, introducing more income and balanced funds.
Sprott wasn't forced to act simply because it had bad returns. Investors are now demanding something different. "Investors have lost so much money in the last year-and-a-half, that there are now feelings of apathy, surrender and 'Get me out,'" chief executive officer Peter Grosskopf said in an interview.
Their frustrations, and their impatience, have made it hard for asset managers like Sprott to stay invested in junior resource plays. If a miner even suggests a weaker-than-expected resource estimate, it is immediately hammered by the bearish market. In mid-May, Canaco Resources Inc., a Vancouver-based mineral exploration company, saw it shares lose 60 per cent of their value after a preliminary economic assessment on its Tanzanian project fell far below what investors were hoping for.
The one thing everyone on Bay Street now wants to know is how this slump will affect bonuses. At Canaccord, total compensation across the firm fell 22 per cent last year – the company's fiscal year-end just passed on March 31 – putting the drop pretty much in line with its total drop in revenue. But, at most firms, compensation has yet to take a big hit. That's because no one knows how long the drought will last. Cut bonuses too early, and you may lose bankers to your rivals just as the deals come back.
Still, there have been some restructurings. Canaccord recently let people go on its trading desk, and other firms, such as BMO Nesbitt Burns and Macquarie have trimmed their ranks.
What could turn this around? As always, there is the suggestion that mergers and acquisitions could pick up because some mining companies are being priced too cheaply – in some cases, they're practically being valued for little more than their cash in the bank. And if the market turmoil can settle for even a few weeks, bankers may also be able to drum up enough investor confidence to bring more companies to market. BMO Nesbitt Burns' mining team said it knows of 10 companies that want to launch initial public offerings.
That's the optimistic view. Mr. Grosskopf believes the volatility is here to stay. "There's just too many global events going on," he says.
With such a rough outlook, some firms are doing everything they can to diversify. GMP bought a New York-based fixed-income dealer; Canaccord recently acquired London-based brokerage Collins Stewart Hawkpoint.
Still, it's hard for an investment bank to transform its business overnight, and such fundamental changes may ultimately be luxuries that only the largest players can afford. There are rumours of small firms needing capital injections or being on the verge of going under – though the Investment Industry Regulatory Association of Canada said it is not aware of any imminent issues – and deal volumes are likely to slow as summertime approaches.
"If the underwriting cycle doesn't recover soon, a lot of the smaller firms are probably going to have to think long and hard about whether they can make a go of it on their own," Mr. Malhotra says.
With files from reporter Boyd Erman
Editor's Note: GMP has cut its dividend in half. Incorrect information appeared in a previous version of this article.