Fixed Income Quarterly—Outlook
Page 3
However, issuers could plainly see that investors were pursu- ing corporate bonds of all sorts with seemingly indiscriminate fervour through the opening weeks of 2014. As the demand/ supply imbalance became perceptibly exacerbated, issuers were increasingly incented to hold steadfast on pricing discipline and work new deal spread concessions to lower and lower levels, especially since tangible results were being achieved.
We have seen this dynamic surface a few times in the post-credit crisis environment, when either investors or issuers draw a pro- verbial collective line in the sand to enhance their bargaining position. Given the relatively small domestic corporate bond market, the ability of even small blocks of market participants (issuers or investors), whether purposeful or not, to influence deal outcomes is endemic to the natural to-and-fros of new issuance. While this dialectical posturing between issuers and investors at points has involved covenant structures, it has more often than not revolved around price, and in particular new issue spread concessions.
Numerous iterations of concession battles have occurred over the past several years, with the onset of exogenous risks, or the lack thereof, frequently functioning as the key catalyst for determining who gains the upper hand. When risk emerges, bargaining leverage favours investors. If risk remains placated, issuers claw back their cost of funds.
Ch-Ch-Ch-Ch-Changes
That dynamic changed at the beginning of 2014. The emer- gence of new participants in the Canadian corporate bond market during 2013, such as international investors and short- term bond funds, meaningfully exacerbated the demand/supply imbalance to the point where there has been a perpetual bid for corporate bonds ever since. Admittedly, we experienced points this year when exogenous risk temporarily delayed primary market activity, but investors continued to buy bonds in the secondary market regardless. Moreover, there may have been brief pauses in the narrowing of spreads, but the overall direction in 2014 has been decidedly inward.
Unremitting demand for corporates induced several trans- formations in the functioning of the primary market so far in 2014. For instance, a number of higher-quality non-financial issuers were able to fragment the investor base and piece out deals in increments, securing $20 million here and $40 million there. In aggregate, the issuer ultimately achieved its targeted deal size, but by restricting access to its bonds the desired
Chart 4: Canada Yield Curve
31-Dec-13
31-Mar-14
3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%
3 mo
6 mo
1 yr
2 yr
3 yr
4 yr
5 yr 6 yr
7 yr
8 yr
9 yr 10 yr
15 yr
20 yr 30 yr
Source: BMO Capital Markets, Bloomberg
Chart 5: U.S. Yield Curve
31-Dec-13
31-Mar-14
4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%
3 mo
6 mo
1 yr
2 yr 3 yr
5 yr
7 yr
10 yr 30 yr
Source: BMO Capital Markets, Bloomberg
Chart 6: Canadian Corporate Debt Issuance 1999–YTD 2014
Q1 Q2 Q3 Q4
120.0
100.0
80.0
60.0
40.0
$22.3 20.0
$88.3
$105.6
$20.5
$75.9 $73.9
$75.6 $77.8
$60.8
$61.4
$49.7 $51.3
$54.9
$35.7
$33.3 $27.4
0.0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Note: Includes All Corporates as at March 31, 2014 settlement date Source: BMO Capital Markets
C$ billions