Canadian bond issuance rebounded at the start of 2003, ending a decline that lasted six months, says a report by Standard & Poor’s Corp.

S&P says in a report by analyst Robert Palombi that gross borrowing by the federal government, the provinces, municipalities, and corporate issuers totaled $34.2 billion in the first quarter.

“But it has been a rather meager turnaround and below-average issuance volumes are still evident in both the government and corporate bond markets,” it says. “As a result, first-quarter issuance was well below the all-time high of $51.1 billion reached in the second quarter of 2001. Moreover, anemic borrowing patterns also were evident in the pace of net bond issuance, or gross borrowing activity less redemptions. Net bond issuance volumes of only $1.1 billion in the first quarter were significantly below the recent average.”

Despite the weak recovery, S&P says that the turnaround nevertheless marks a significant achievement because the stock of bonds outstanding increased in the Canadian fixed income market.

“In the previous nine-month period, depressed issuance levels caused the stock of bonds to decline by just more than $10 billion. This was not large in terms of size, but it was the lengthiest uninterrupted period of declining issuance in the history of the market,” it says.

In the first quarter, the only source of growth was the corporate bond market. Government issuers continued to retire debt for a fourth-consecutive quarter. In the first quarter, governments retired $5.3 billion of bonds. “Gross and net issuance patterns at the federal level were little changed in the first quarter. It was in the provincial sector where a sharp rise in redemptions was not matched with new issuance, causing net issuance to decline in the government sector overall,” it says.

Corporate bond issuance totaled $6.4 billion in the first quarter. “It was the heaviest net issuance volume reported by the sector in a year, suggesting that corporate borrowing requirements are beginning to normalize. Although capital spending slowed toward the end of 2002, so too, did the growth in corporate profits, possibly triggering an increase in financing needs,” S&P says.

It notes that corporate borrowers faced challenging market conditions in the first quarter amid heightened geopolitical uncertainty and increasing investor risk aversion.

“The combination of these factors caused credit spreads to reach their widest levels in a decade. Yet this did not sideline corporate bond issuance altogether,” it says. “New issue deal flow was by no means heavy, but it was surprisingly resilient against the backdrop of problematic market conditions. It was encouraging to see issuers across the full range of the credit spectrum accessing the debt market.”

Investment-grade issuers experienced the greatest flexibility in tapping the market. “Moreover, due to risk-averse investor attitudes, there was a notable decline in deal flow among investment-grade issuers straddling the speculative-grade threshold of the credit ladder. In the speculative-grade area, the U.S. bond market continued to accommodate Canadian issuers. But relatively few Canadian speculative-grade issuers, and only familiar names, tapped the market,” it notes.

There has been some talk that Canadian firms could turn to U.S. dollar-denominated bond issuance to take advantage of widening Canada-U.S. interest rate differentials and the decline in U.S. borrowing costs relative to Canada. “But this was not borne out by gross issuance patterns in the first quarter,” it says. “Although foreign currency-denominated bond issuance by Canadian companies increased in the first quarter, issuance in foreign markets is still down on a year-over-year basis and also is down relative to the historical average.”

“It is important to keep in mind that widening long-term interest rate spreads between Canada and the U.S. have resulted primarily from downward pressure on U.S. bond yields. Despite the widening of credit spreads, long-term financing costs in the Canadian domestic market remain low relative to historical comparisons and as a result, a flood of issuance by Canadian borrowers in the U.S. market is unlikely,” S&P concludes. “The window for Canadian borrowers to take advantage of relatively lower financing costs in the U.S. could soon close. As geopolitical uncertainties ease and the economic recovery in the U.S. gains traction, wide Canada-U.S. interest rate spreads will be unsustainable.”