In late September, Air Canada issued junk bonds. The airline, which sports a rating of double-B-minus from Standard and Poor's, borrowed $200-million for seven years and paid just 4.75-per-cent interest for the privilege.
It's not just Air Canada accessing cheap money. The airline's offering was one of five recent Canadian-dollar-denominated bonds sold by domestic companies without investment-grade ratings. All the bonds are paying interest in the 5-per-cent to 7-per-cent range, and all were well-received by investors.
These rates bring sticker shock for investors who grew up on high-yield bonds that paid double-digit rates of interest. At 4.75-per-cent, is it fair to even call these junk bonds?
Canadian credit markets have opened up to domestic companies with weaker credit ratings, reflecting a massive imbalance between investor demand for income and the supply of debt that pays attractive rates. One likely outcome of this divide: More bonds will be coming from non-investment-grade Canadian companies that used to be forced to tap the U.S. high-yield market for capital.
Air Canada and the other recent domestic high-yield issuers are graded as double-B credits or less by rating agencies. The conventional definition of a high-yield debt, or junk bonds, is anything ranked lower that triple-B-minus by Standard and Poor's or lower than Baa3 by Moody's Investors Service.
While Air Canada is seen as a special case – the airline sold debt as part of a larger refinancing that strengthened its balance sheet and analysts expect its credit rating will soon be upgraded to investment-grade status – the bond offering followed on successful junk-bond issues from a chemical company, a media play and a fuel supplier.
Canadian companies are taking advantage of the "risk-on, risk-off" mentality of investors, which sees everyone from veteran money managers and pension funds to RRSP investors now willing to take on extra risk in pursuit of higher yields, said Jean-François Godin, vice-president and fixed-income analyst at Desjardins Securities.
"Canadian [bond] investors want diversity, they want to own a portfolio of domestic high-yield credits and they've been forced to buy U.S.-dollar debt due to lack of supply," Mr. Godin said. His view, echoed by other credit market experts, is that domestic demand for non-investment-grade debt now vastly exceeds supply.
A sea change in investor thinking began when the Canadian government shut down the income trust market a decade ago, killing a significant source of high-yield securities. Then the financial crisis played out, with low long-term interest rates reflecting a weak outlook for the global economy. That eliminated most government and investment-grade debt as a robust source of income.
The result was a whole new class of income-seeking investors.
TD Securities estimates that there are about 200 Canadian fund managers roaming the markets with mandates to invest approximately $30-billion in high-yield debt. The investment bank pegs the supply of Canadian-dollar debt available to them at $13-billion. The rest of the money gets invested in debt that is denominated in U.S. dollars and other foreign currencies, which introduces additional risks for portfolio managers.
It's worth noting that the Canadian high-yield bond market has been among the top-performing asset classes in the past year, with few defaults and strong performance from new issues once they start trading in the secondary market.
When demand for bonds is twice the available supply, and high-yield debt is turning in strong results, an airline that once filed for creditor protection, and appeared to be in serious trouble again after the global financial crisis, can borrow for 4.75 per cent.
What's striking about the Canadian high-yield market is just how few companies are choosing to take advantage of what appear to be rock-bottom rates. Investment bankers say even non-investment-grade companies are relatively flush with cash, and if they do need to borrow, banks are happy to lend.
Those companies that have tapped the high-yield market are typically funding acquisitions – Parkland Fuel Corp. borrowed $300-million to buy gas stations from Alimentation Couche-Tard Inc., for example – or retiring more expensive debt, as Air Canada is doing. As long as rates stay low and deals keep coming, there's every reason to expect more high-yield offerings from Canadian companies. And when rates do rise, or the economy takes a turn for the worse, we'll find out if we really have left the junk bond era behind.
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CANADIAN JUNK BOND OFFERINGS
There have been five junk bond debt issues in Canada this year and more are coming, as investors snap up high-yield offerings
DHX Media Ltd.
Amount: $50-million
Interest rate: 5.875%
Parkland Fuel Corp.
Amount: $300-million
Interest rate: 5.75%
Iron Mountain Canada
Amount: $250-million
Interest rate: 5.375%
Canexus Corp.
Amount: $110-million
Interest rate: 7.875%
Air Canada
Amount: $200-million
Interest rate: 4.75%
Andrew Willis