Pendulum Swings in Favor of Canadian Lenders After Oil Collapse

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The balance of power in Canada’s bond market is shifting back to lenders from borrowers.

After enduring four years of companies stripping more and more restrictions from their riskiest debt, investors are starting to become more discriminating and winning some concessions of their own.

The epicenter is Canada’s oil patch, where the collapse of crude prices reduced cash flow and forced some companies to negotiate with lenders to avoid default. Banks and bondholders won first claim to all Penn West Petroleum Ltd.’s property last week. Connacher Oil & Gas Ltd. bondholders are set to seize the company, while its lenders will get higher interest payments. Outside the oil-patch, Great Canadian Gaming Corp. took the unusual step last week of promising bondholders fatter coupons if they let it push up debt to divert more cash to shareholders.

“The pendulum is going back in the direction of creditors,” said Heather McOuatt, a portfolio manager at Franklin Bissett Investment Management, who helps oversee C$4 billion ($3.3 billion) in fixed income. “There will come a day, I’m not sure when, but it will come again for the energy space where they are back in the driver’s seat.”

Rate Repression

Companies won record-low borrowing costs in recent years as central banks worldwide drove down rates to stimulate recession-wracked economies. Investors piling into ever-riskier securities to generate any type of return accepted fewer safeguards. They also saw the value of existing debt diluted when companies issued more bonds to fund shareholder rewards.

Covenants, or investor protections, worsened further in the second half of 2014 compared with the first half, following a trend that’s accelerated over the last four years, according to an April 30 report by Moody’s Investors Service.

From Enbridge Inc. announcing a dividend increase as it transferred assets to an affiliate and out of bondholders’ reach, to Tim Hortons Inc. issuing bonds to buy back shares, Canadian bondholders have suffered at the hands of shareholders.

The collapse in oil changed the landscape, sparking a sell-off in high-yield debt that peaked at the beginning of the year. That made investors more attuned to the possibility of default, even as borrowing costs plummeted again after the Bank of Canada cut its benchmark interest rate.

Default Spike

“Appetite for risk has decreased,” Marc Goldfried, who oversees C$10 billion in assets as chief investment officer for the Canadian unit of Aegon Capital Management, said by phone from Toronto. “The issuer market, in an effort to get financing done, is doing what they’re supposed to do, offering more protection inside their deals.”

Moody’s forecasts high-yield defaults globally to climb this year. An index measuring the fiscal stress of junk-rated firms climbed in March to the highest level in 12 months, according to an April 1 report from the firm. A separate index showed energy firms were the most strapped for cash they’d been in almost five years.

There hasn’t been a single Canadian high-yield bond issue yet this year as the specter of energy-company defaults kept investors at bay.

Early signs of a shift favoring high-yield lenders have yet to spread to the wider market. With government bond yields still near record lows, competition remains for new investment-grade corporate bonds, Goldfried said.

The yield on the 10-year Canadian government bond touched 1.70 percent Monday, its highest level in about four months. That’s still not far from the record low 1.23 percent touched in February after the Bank of Canada cut interest rates.

In March, long-term business financing including bonds rose 7.9 percent in Canada, the fastest since June 2002, according to a report from Royal Bank of Canada. Among borrowers was investment grade-rated Husky Energy Inc., which managed to sell C$750 million of 10-year bonds March 9, when oil was falling.

“In investment grade, it’s still a food fight,” according to Aegon’s Goldfried. “There is still demand.”