High issuance of bank debt leading to distortion of bond markets

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Unusually high issuance of Canadian bank debt has dislocated investment grade bond spreads in the Canadian market, said Derek Brown, senior vice president and co-head of fixed income at Beutel Goodman Investment Counsel.

He said rate hikes by the Bank of Canada and strong consumer spending have led banks to issue significantly more debt this year – more than 1.5 times the normal annual amount in mid-summer.

“What’s done is actually dislocated spreads,” he said. “We are now seeing A-rated Canadian banks trading more widely than the vast majority of triple-B bonds in the market.

Speaking on the Soundbites podcast this week, Brown said he and his team had started to overweight investment grade bonds “quite significantly”.

He also thinks there are deals to be found in high yield bonds, particularly in what he calls the “crossover space” of rising stars among double B bonds that are doing particularly well in the current environment. .

Some consumer staples, telecommunications and energy companies are on the verge of moving to investment grade, he said. As an example, he cited the airline industry, which suffered severe losses during Covid.

“When you look at the actual securitized assets on their balance sheets and the increase we’ve seen in travel over the last six months or so, some of them are really well set up over the next 12 to 18 months to return to investment grade.

He said situations like this can cause credit spreads to compress, which can benefit the savvy investor.

“So in high yield, we look for idiosyncratic products [alpha] opportunities, as opposed to overall beta exposure,” he said.

The high-yield sector also includes term loans, which have recently yielded 4% or 5% annually, while fixed income securities in general are down almost 10%.

“Term loans are generally secured loans with variable interest rates. These instruments work very well in a rising rate environment,” he said.

The good news for fixed income investors is that after a difficult start to the year, fixed income securities are starting to generate income.

“We have spent almost a decade at this point where returns on the [FTSE Canada Universe bond] the index was hovering around 2%,” he said. “A few weeks ago we saw the index come back to around 4%, which is much more than what we saw before the financial crisis. With rising yields, investors are actually compensated for much of the duration of their portfolio. »

Brown said rising interest rates may persuade some investors to shift to safer fixed-income products, but there are still some great deals to be found.

“Canadian banks look attractive. Crossover high yield credit looks attractive. Term loans and floating interest rate notes also look attractive,” he said. “Fixed income securities probably haven’t looked so attractive since the pre-Great Financial Crisis.”

Finding opportunities, however, starts with recognizing that some slices of the fixed-income pie are poised to outperform others in the current high-rate environment.

“A lot of investors look at fixed income securities as something of a monolith. That it’s all the same. We view fixed income investing as a matter of sector selection. There are a variety of flavors in fixed income securities. fixed income and it’s really important to use active management to choose which fixed income sectors you’re exposed to,” he said.

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without the contribution of the sponsor.

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