Resiliency was the name of the game as opportunism overcame fear in Canada’s corporate debt capital markets in 2020.
Even as COVID-19 ravaged the globe, many companies, motivated no doubt by the uncertain future, shored up their finances by taking on cheap and accessible debt early.
Statistics compiled by Financial Post Data show that the corporate debt market absorbed $246.6 billion of corporate supply in 2020, the most active year on record and an 18.2 per cent increase over 2019 volumes.
“Last year saw oversubscribed order books, broad distribution, pricing at the tight end of guidance, and good secondary market performance,” said Patrick MacDonald of Toronto, co-head of debt capital markets at RBC Capital Markets, which led FP’s full credit bookrunner corporate debt league tables with 153 mandates worth $37 billion, representing a 15 per cent market share.
Despite COVID-19, 2020’s pattern of activity bore some resemblance to 2019, which featured a then-record first half preceded by a then-slowest second half since the financial crisis.
“Issue activity just about dried up in the first half of March amid the COVID-19-induced uncertainty, but April and May were record-setting, with year-to-date totals up over 70 per cent by the end of May,” MacDonald said.
What appears to have happened, according to RBC, is that well-funded corporate issuers weren’t forced to access the market during the sell-off and instead capitalized on the subsequent rally in late March and early April. As markets stabilized but uncertainty continued, issuers looked to pre-fund borrowing requirements or convert short-term liquidity facilities taken on during the crisis, leading to record activity in April and May. The upshot is that the first half of 2020 saw an all-time high of $160.1 billion in corporate debt supply.
“In 2020, some companies were pre-funding as much as one year before maturity, and some even longer than that,” said Sean St. John, the Toronto-based executive vice president, managing director, and co-head, fixed income, currencies & commodities at National Bank of Canada, which processed 43 corporate debt mandates worth $5.94 billion.
Andrew Parker, the Toronto-based co-head of McCarthy Tétrault LLP capital markets practice, is of similar mind.
“There were a lot of opportunistic deals where people didn’t really need the money,” he said.
Needless to say, it all came as more than a bit of a surprise.
“We spent early March working on contingency planning with our clients, particularly those for whom things weren’t looking so good,” says Tom Zverina, a corporate finance partner in Torys LLP’s Toronto office. “Then things exploded.”
Still, the second half saw only $86.5 billion in corporate debt supply, a 16 per cent decline over the corresponding period in 2019. RBC attributes the second half slowdown to “a technical tailwind that has further underpinned the market.”
Jump-starting the record activity in April and May were several “jumbo” (greater than $1 billion) transactions on attractive terms, offsetting elevated spreads with historically low interest rates. They included offerings from Rogers Communications Inc. ($1.5 billion) and Walt Disney Co. ($1.3 billion) in March, and TC Energy Corp. ($2 billion) and BCE Inc. ($1.5 billion) in May, and Thomson Reuters Corp. ($1.4 billion) in May. Overall, 2020 saw 42 jumbo transactions, a record, beginning with RBC’s $2.25 billion offering in January.
The overall year-over-year increase included a 12.9 per cent increase in supply from financials, to $141.31 billion.
A novel offering structure called Limited Recourse Capital Notes (LRCN) also helped the financial services sector. Pioneered by RBC, LRCNs are structurally efficient Additional Tier 1 (AT1) alternatives to the preferred share market.
“The industry had been trying to develop and secure regulatory approval for this product for years,” says McCarthy’s Parker.
LRCNs were an instant hit, producing $5.7 billion of supply across five issuers (RBC, The National Bank of Canada, Bank of Montreal, The Canadian Imperial Bank of Commerce and Canadian Western Bank) and six transactions in just three months.
Still, the rebound would likely not have occurred without government support.
“The critical piece was when the Feds and then the Bank of Canada made it clear that they would buy back corporate debt,” said National Bank’s St. John.
That, and domestic government debt issuance, which achieved $180.3 billion, up 61.7 per cent from 2019.
Monetary policy also drove lower funding costs, which finished the year 30-150 bps lower. Government of Canada yields fell 50-140 bp, and credit spreads varied only minimally.
All this led to growth more or less across the corporate debt landscape. BBB-category bond issuance increased by 44 per cent more than 2019 to $37.5 billion. Every sector but utilities, health care and communication services grew their offerings. Utilities deals declined 1.7 per cent, health care decreased 9.4 per cent and communication services was down 35 per cent.
“With few exceptions, credit was available to almost everyone,” said Paul Scurfield, the Toronto-based managing director and head of global fixed income at Scotiabank, which shepherded 114 mandates worth $21.24 billion in 2020 to rank third among full credit corporate debt bookrunners in FP’s league tables. “And a lot of companies, having experienced the global financial crisis, took advantage of the opportunity, looking at the available capital as inexpensive insurance policies.”
Also faring well was the sustainable finance sector, which generated $4.9 billion, a 78 per cent increase over 2019. Notable deals included Ontario Power Generation Inc.’s $1.2 billion issue in April and two Brookfield Asset Management Inc. offerings in August totalling $925 million.
“COVID-19 put an exclamation point on large social issues that we need to tackle, so I see the Canadian market for sustainable finance as a very big growth area because of the country’s need to be intelligent about developing its considerable natural resources sustainably and intelligently,” Scurfield said.
The Maple market — Canadian-dollar denominated bonds issued by foreign borrowers in the domestic Canadian fixed-income market — also had a good year in relative terms, generating $8.1 billion in supply, up 81 per cent over 2019, and the third most active year since the financial crisis. Notable inaugural Maple bonds included Verizon Communications Inc.’s $1.3 billion dual-tranche offering, and a $500 million issuance for Athene Global Funding.
There were fewer mergers and acquisitions in the year, compared to previous years.
“M&A, which usually drives 15 to 20 per cent of the bond market, accounted for only five per cent in 2020,” says Ben Hudy, a Calgary partner in Stikeman Elliott LLP’s capital markets and M&A groups.
So, what’s in store for 2021?
“It’s the million-dollar question going forward,” says Rob Brown, the Toronto-based, co-head of debt capital markets at RBC Capital Markets.
On the one hand, he points out, the U.S. election and Brexit are behind us, but COVID-19 remains the big unknown, as does the Democrats’ control of the White House and the House of Representatives and their considerable power in the Senate .
“If things worsen, we’ll see the demise of companies and an increase in insurance-type supply,” Brown said. “But the vaccine rollout will likely boost markets, which means that issuers may shift their focus from survival and liquidity enhancement to fundamental credit metrics, preparing their balance sheets for economic growth.”
Overall, Brown is optimistic, especially if governments keep stimulative policies in place to complement the COVID-19 recovery. But the optimism is cautious, with an eye on the general direction of inflation and interest rates.
“Rates have ticked a bit higher in the first few weeks of this year,” he said. “It may be that the Democratic sweep of Congress is stoking fears of higher inflation.”
Still, those fears could stoke corporate debt market activity seeking to capitalize — once again — on the uncertainties.
National Bank’s St. John is counting on what he calls a “decent maturity calendar in the $84-billion range,” on the back of continued LRCN, green bond and transition-bond momentum, and even some energy infrastructure demand despite U.S. President Joe Biden’s nixing of TC Energy Corp.’s Alberta-to-Nebraska Keystone XL pipeline.
“I think 2021 will be much like 2020,” he said. “Offerings continue to be oversubscribed to start the year, rates are so low that everyone is still looking for some kind of yield, and a lot of industries are doing fine or starting to come back.”
Like Brown, St. John sees inflation as the bugbear.
“What we have to watch most closely going forward are whether, and how much, rates will go higher and what that does to asset values,” he said.
Scotiabank’s Scurfield, for his part, sees a “quieter year” ahead, forecasting 10 to 15 per cent less activity in 2021.
“A lot of it has to do with all the pre-funding and stockpiling in 2020,” he said. “There are also certain industries, like travel and leisure, that won’t be participating because they have maxed out their balance sheets.”
Parker also believes that pre-funding took issuance products off the table for 2021.
“But we thought the same thing last year, so who knows?” Scurfield noted.
Where everyone converges, however, is on the notion that M&A is the wild card.
“The sense we’re getting from clients is that more people will try to realize on growth opportunities, and that could certainly generate more demand for financing,” Parker says. “The fact is we’re already seeing a bit more M&A than we did last year.”
John Emanoilidis, the Toronto-based co-head of Torys’ M&A practice, has high hopes for 2021.
“The vaccine puts the worst of COVID behind us, political uncertainty in the U.S. has been reduced, American buyers continue to see Canada as stable and attractive, debt is cheap for creditworthy clients, there’s lots of liquidity, and a great deal of money competing for opportunities,” he said. “Based on deals in the pipeline and discussion with business leaders, 2021 looks like a very good year for M&A.”
Stikeman’s Hudy believes M&A is poised for a rebound, at least in the energy and resources sector. He points to Cenovus Energy Inc.’s combination with Husky Energy Inc. in an all-stock transaction that closed in early January; Whitecap Resources Inc.’s $900-million purchase of TORC Oil & Gas Ltd., announced in December; and Alacer Gold Corp.’s merger with SSR Mining Inc. in September.
“There’s a ton of pent-up demand on both the buy and sell sides, some really unique opportunities resulting from the pandemic, especially in oil and gas, and a great market for financing that is making many companies realize that they can grow more cheaply by acquisition than by organic means,” he said.
While his focus is on oil and gas, Hudy believes his analysis also holds true in industries that have flourished such as digital delivery, home fitness and home renovation.
“Sellers may be looking to cash out at what they perceive to be near the top of the market,” he said.