The Canadian bond market is going to continue to skew toward corporate issuers this year, as governments continue to successfully retire debt, according to a new report from Standard & Poor’s.

“The major theme for 2004 issuance patterns in the Canadian bond market likely will be a continuation of growing corporate bond supply as governments continue to retire bonds,” it predicts.

As a result, S&P say’s corporate credit risk pricing should get more efficient.

The report estimates the size of the Canadian corporate bond market at almost $450 billion, trumping the $318 billion in outstanding federal bands, and $369 billion in provincial debt. S&P says that the level of corporate debt surpassed government debt a couple of years ago, “so the benefits of growing market liquidity arising from this leadership position have been accruing for a few years.”

This increased liquidity may mean that market players spend more time on credit research, S&P suggests. “We might expect to see a more efficient pricing of credit risk and in the Canadian corporate bond market in particular,” said Standard & Poor’s economist and fixed-income analyst Rob Palombi.

S&P predicts that the major theme for the Canadian bond market in 2004 will likely be continued growing corporate bond supply as governments continue to retire bonds. “Rising leverage in the corporate bond market is not expected to be a major impediment to additional credit spread tightening,” it says.

The rating agency reports that Canadian issuers were more active in the bond market in 2003, raising $140.5 billion; but the level of gross bond issuance was virtually unchanged from a year ago. It expects to see a steady increase corporate bond issuance in 2004 and 2005, “as a sustained expansion in the North American economy produces rising financing needs”.

In 2003, the corporate market was the only growth area, S&P says, as government borrowers continued to retire bonds for a fourth consecutive year and by a record amount in 2003. Issuance in the government market declined by 2.1% to $79.2 billion, down significantly from $88.4 billion at the start of the decade. “In 2004, an above-average pay-down should be expected due to the government’s new debt management strategy aimed at reducing the fixed-rate portion of debt,” it says.

S&P says that 2003 was a win-win year for most corporate borrowers. “Although bond yields experienced considerable volatility, market conditions were highly favorable and investors were very receptive to absorbing new bond supply,” it says. The big rally in the Canadian dollar helped draw foreign investors, too.

About $10.6 billion of the $11.8 billion raised in 2003, was done in Canada in 2003. On a gross basis, domestic market borrowings were the second highest on record at $30.5 billion. Also, average deal size for new bond issues in the domestic market increased to $225 million from $150 million the previous year. In the cross-border market, the average deal size was virtually unchanged in 2003 at about $400 million.

It notes that, a sustained expansion in the North American economy and improving credit quality in 2004, should see risk premiums decline. “Already in 2003, the risk premium declined toward 15%, due mostly to narrowing credit spreads rather than rising bond yields. In 2004, a further decline in the risk premium should come about from a combination of narrowing corporate credit spreads and rising bond yields,” it says.