Junk Bonds Lure First-Timers as Sales Soar, Yields Plummet: Canada Credit
Sales of Junk bonds in Canada may set another record this year after returns exceeded the rest of the world’s high-yield corporate debt market in 2010 and as companies reduce their reliance on bank borrowings.
Issuance reached an all-time high of C$3.35 billion ($3.36 billion) in 2010 from C$800 million in 2009 as a drop in relative yields led Corus Entertainment Inc., Armtec Holdings Ltd. and six other companies to issue speculative-grade debentures for the first time. That’s up from three companies in 2009, said Robert Follis, Bank of Nova Scotia’s Toronto-based head of corporate bond research.
This year as many as 10 companies may make their debut in the market for junk bonds, selling C$5 billion of the debt, he said. Foreign investors are snapping up Canadian debt, attracted by the nation’s debt-to-output ratio, which is the lowest among Group of Seven countries.
“More companies are realizing they can do high-yield issues in Canada,” Follis said by telephone. “They’re also coming to the market because funds from alternative sources, such as the banks, aren’t as cheap or plentiful as before the credit crisis.”
Canadian high-yield debt returned 22 percent last year after a 32 percent gain in 2009, according to Bank of America Merrill Lynch data. That compares with a 15 percent total return for comparable debt in the U.S. Canadian junk bonds had positive returns every year since 1998, according to Bank of America Merrill Lynch.
‘Rapidly Growing Market’
“Canadian high-yield is a rapidly growing market,” said Craig Wilson, a Toronto-based managing director of junk-bond trading at Canadian Imperial Bank of Commerce. “High-yield portfolio managers continue to have robust fund inflows.”
Elsewhere in credit markets, MetLife Inc., the biggest U.S. life insurer, issued C$300 million of 3.85 percent notes maturing in January 2016.
Statistics Canada is scheduled to release jobless data tomorrow. Employers probably added 20,000 jobs in December, after creating 15,200 positions in November, according to the median forecast of 20 economists in a Bloomberg News survey.
The extra yield investors demand to own the debt of Canadian investment-grade corporations rather than the federal government narrowed to 135 basis points yesterday from 136, according to a Bank of America Merrill Lynch index. The so- called spread was as wide as 154 basis points in June and as tight as 114 in March, based on the index, which tracks 722 bonds with a par value of C$284 billion. Yields increased to 4.04 percent, from 3.96 percent.
In the provincial bond market, relative yields were 52 basis points yesterday, down from 53 basis points a day earlier.
The yield on Canada’s 10-year bond increased 10 basis points to 3.27 percent, as the price of the 3.5 percent security due in June 2020 dropped 78 cents to C$101.86. The bond yields about 19 basis points less than the similar U.S. Treasury, compared with 17 basis points at the end of December.
Canadian two-year bonds yield 106 basis points more than equivalent-maturity Treasuries, down from 116 on Nov. 30.
High-yield, high-risk bonds are rated below Baa3 by Moody’s Investors Service and less than BBB- by Standard & Poor’s.
Issuers are turning to junk bonds instead of bank loans in part because some lenders are becoming “a little more strict” about how much they’ll lend, said Scotiabank’s Follis.
Business loans to Canadian companies by chartered banks fell to a seasonally adjusted C$168.3 billion in November, from C$169.4 billion in January 2010 and C$180.3 billion in January 2009, according to Bank of Canada data.
“Some companies who had bank lines rolling over suddenly couldn’t roll them over,” as a result of the financial crisis, Follis said. “It takes away an element of liquidity risk by terming out some of the short-term bank debt that is cheaper, but the facility has to be continually rolled over.”
Corus, a Calgary-based radio broadcasting company, in February offered C$500 million of 7.25 percent senior unsecured guaranteed notes due Feb. 10, 2017. Armtec Holding, a unit of Armtec Infrastructure Income Fund, floated C$150 million in 8.875 percent senior unsecured notes due Sept. 22, 2017.
Relative yields on the Bank of America Merrill Lynch Canadian High Yield Index dropped to 493 basis points on Dec. 31 from a high of 665 basis points on Jan. 8. A company raising C$500 million would save about C$8.6 million in annual interest fees at the lower spread. Spreads on investment-grade corporate bonds were little changed, ending 2010 at 137 basis points.
The three-month Canadian dealer offered rate, or CDOR, a proxy for the cost of bank funding, tripled to 1.30 percent, the highest since January 2009, from 0.44 percent a year earlier.
Canadian dollar high-yield issuance has the potential to rise this year to as much as C$6 billion, said Wilson at CIBC.
“We could see an increase in merger-and acquisition activity funded through the high-yield market,” he said, adding that refinancing of bank loans and the conversion of some Canadian income trusts to companies may also spur bond sales.
The Bank of America Merrill Lynch Canada High Yield Index had 18 issues and a market value of C$3.38 billion when it began in 1997. At the end of 2010, it had 20 issues values at C$5.17 billion.
Canadian factory raw-materials costs rose at the fastest pace in 10 months in November, Statistics Canada said yesterday. Higher prices for raw materials, which account for about half of Canada’s export revenue, and a currency that’s trading above parity with its U.S. counterpart are also luring international investors.
Foreigners bought C$56.6 billion more federal and provincial bonds than they sold in the first 10 months of 2010, beating full-year records for both categories, Statistics Canada said last month. Foreign buyers purchased a net C$20.1 billion of provincial bonds in the first 10 months of 2010, and C$36.5 billion of federal government debt, Statistics Canada reported on Dec. 16.