There’s a corporate debt bomb ticking under possible recovery
$2.7T in debt threatens survival of companies and entire sectors
Ashley Taylor is a Bay Street corporate insolvency lawyer who’s never been as inundated as he is right now.
“The last time we were this busy was the financial crisis of 2008,” says the Toronto-based partner at Stikeman Elliott LLP, one of Canada’s leading law firms.
This isn’t surprising, given how COVID-19 has sucker-punched the economy, placing many companies in peril. Indeed, the rate of big-business filings for creditor protection is almost double last year’s rate.
But what’s making matters worse for many Canadian companies is the record level of corporate debt they’re carrying. “The higher your debt levels, the harder it is to service your debt,” says Taylor. “And so a downturn in your business makes you more vulnerable.”
Corporate Canada’s debt (both loans and debt securities) currently totals $2.7 trillion — or the equivalent of 118 per cent of the entire GDP, up from 85 per cent in 2008.
This debt-to-GDP ratio is the third highest among G20 countries — behind only China and France — and the 11th highest in the world. By comparison, corporate debt in the U.S. is at $15.5 trillion (U.S.), amounting to 74 per cent of GDP.
In the U.S., New York University finance professor (emeritus) Edward I. Altman, the creator of the Z-score, a method of predicting business failures, foresees a coming bankruptcy wave among companies with $1 billion or more in debt this year.
Heavily indebted, iconic U.S. companies including Hertz and J. Crew have already bitten the dust.
And then there is the bankruptcy this spring of Dallas-based Neiman Marcus, the storied American department store chain, which was purchased in 2013 for $6 billion by Ares Management and the Canada Pension Plan Investment Board, which makes investments on behalf of Canadian pensioners.
The purchase involved a leveraged buyout approach to the deal, thereby saddling the company with a $5.1-billion debt load. That left the company unable to pay its interest payments before COVID-19 annihilated its retail revenues.
Some of Canada’s most prominent brands are in similar trouble.
In March, after COVID-19 struck, Montreal-based Cirque du Soleil, staggering under a $900-million debt load, laid off 95 per cent of its workforce. This week, it filed for bankruptcy protection and announced the termination of previously furloughed staff. Bombardier, the Montreal-based transportation manufacturer, has more than $9 billion worth of corporate debt. It’s likely to need government handouts to stay afloat.
In fact, entire sectors are at risk, including cannabis, oil and gas, manufacturing, travel, tourism, hospitality and commercial real estate.
When COVID-19 hit, corporate Canada scrambled to shore up its debts. Corporate bond issuance between January and May jumped 22.5 per cent to $78.4 billion, according to Reuters calculations. Meanwhile, the debt-to-equity ratio of private non-financial corporations jumped to 212 per cent in the first quarter, the highest since 2009, according to StatCan data.
These still-escalating corporate debt levels may threaten the entire economy, many economists warn.
Mike Holden, chief economist for the Business Council of Alberta, says a recent survey of 60 Alberta CEO’s revealed deep unease about debt and weak levels of confidence.
“About a quarter of businesses have at least some concern they may not survive,” says Holden. “That’s a troubling finding.”
James Orlando, senior economist at TD Bank, is also watching with growing worry.
“I view it as one of the highest risks in the financial system,” Orlando told the Star regarding corporate debt. His research shows that real estate, manufacturing and oil and gas account for 45 per cent of total nonfinancial corporate debt, with debt levels “well above their respective averages over the current economic cycle.” The longer the pandemic lingers, he adds, the greater the danger that debt will prevent companies from surviving the pandemic.
But it’s not just economists like Orlando and Holden who are alarmed — so is the Bank of Canada. After all, non-financial corporate debt was 315 per cent of income at the end of 2018. Moreover, the share of outstanding debt owed by firms that have poor debt-service capacity and low liquid-asset holdings is higher than normal.
Tiff Macklem, the new Bank of Canada governor, declined to discuss the corporate debt situation for this piece. But Louise Egan, the bank’s chief spokesperson, noted in an email that the bank warns that debt-toincome levels among Canadian corporations are “well above” historical levels and are one of the top vulnerabilities to the country’s financial system.
Egan says the bank is taking decisive steps to intervene. The bank’s balance sheet has grown to more than $500 billion from about $120 billion in early March. Last month, it began a program to buy up to $10 billion of high-quality corporate bonds with help from BlackRock Financial Markets Advisory and CIBC Mellon.
“As we get more data, we will have a better sense of the impact of the containment measures,” Toni Gravelle, deputy governor of the Bank of Canada, said in a speech in Sudbury on June 4. “How many companies will be unable to reopen their doors, and how many job losses will be permanent?” he asked.
So why has corporate debt mushroomed?
Coming out of the 2008-09 credit crisis, central banks around the world dropped interest rates to stimulate the global economy. “The aggressive reductions in interest rates faced by banks and governments has had a strong knockon effect on the borrowing rates faced by large corporations,” says Gary Stevenson, a British economist and former interest trader at Citibank from 2008 to 2014.
Indeed, with interest rates kept low for the past decade, corporations began borrowing heavily with little concern about servicing the debt. One reason they did so is because it’s profitable for shareholders — and that’s because the borrowed money was being funnelled to them. And it was also profitable for corporate bondholders.
As a result, the total non-financial corporate debt globally totals a staggering $74.4 trillion (U.S.). In March, the Institute of International Finance issued a warning that the “speed of the decline in market confidence is also a reflection of massive financial imbalances — notably high and rising corporate debt.”
The debt has led to an explosion in the corporate bond market, too. Corporate debt is traded on the open market in several ways, most commonly with bonds issued directly by companies. This market alone totalled $13.5 trillion (U.S.) at the end of 2019 — twice the amount in 2008. Now much of this debt is deteriorating in quality, with 51per cent of global bonds being rated BBB — just a notch above junk bond status.
There is also a threat from one other quarter. In a speech last year, Carolyn Wilkins, senior deputy governor of the Bank of Canada, highlighted the greatly increased role of the so-called “shadow banking ” sector, which includes hedge and private equity funds and other non-bank lenders.
A C.D. Howe Institute report co-authored by Wendy Wu, an economist at Wilfrid Laurier University, probed this issue more closely. “It’s very difficult to get data on what debts belong to whom,” says Wu regarding loans from non-bank sources that she estimates now total $1.5 trillion, or about 10 per cent of total financial assets and 34 per cent of total assets of all Canadian deposit-taking institutions.
“There can be a contagion effect,” Wu warns, referring not to COVID-19, but to potentially default-prone shadow banking loans that could engender chain reactions of the sort that shattered U.S. and international financial markets in 2008.
Like their counterparts at the Bank of Canada, Federal Department of Finance officials are scrambling to ensure they
can shore up the corporate sector. But so far, Ottawa’s finance wizards are saying almost nothing about how bailing out corporate debts — a very political hot potato — could fit into all their behind-thescenes planning.
Although they declined to speak to the Star about their efforts, on June 11 the department published a list of business supports — some potential and some already disbursed — totalling around $700 billion.
In an email message, Anna Arneson, a spokesperson for the federal finance department, confirmed Ottawa has already given almost $27.4 billion in loans at thousands of companies, but the government cannot name who is getting help as it “does not have prior consent” to disclose recipients’ “business name or other sensitive financial information disclosed in confidence as part of the application process.”
Additionally, a set of unnamed banks has received $10.7 billion in loans, and $260 billion to support “interbank funding,” and “functioning of key finding markets.”
Even before the $700-billion figure was tabled, the Parliamentary Budget Office warned that when new federal spending is combined with lower tax revenues, the current federal deficit could exceed $250 billion and total debt could hit $1 trillion.
Economists across the spectrum are alarmed about Ottawa’s epic spending, and epic secrecy. Mainstream academic economists, including Michael Veall at McMaster University, Stephen Gordon at Laval University and Randall Morck at the University of Alberta, are also disconcerted by the corporate debt levels stemming from Ottawa’s easy money policies, and they’re watching federal support measures with deep concern about the level of public debt they may entail.
“I’m worried about how we get back to some semblance of normal again,” says Stephen Williamson, who holds the Stephen A. Jarislowsky Chair in Central Banking and is a Bank of Canada Fellow at Western University.
Former federal finance mandarins are starting to speak up as well. Gordon Thiessen, Bank of Canada governor from 1994 to 2001, has long warned that Canada’s system of “macroprudential policy tools” to manage serious financial risks lacks any formal assignment of responsibility, and also lacks a clear framework for direct action.
William White, a former Bank of Canada deputy governor who went on to serve as head of the monetary and economic department at the Bank for International Settlements in Basel, says the corporate debt hangover is a global phenomenon in which Canada is now unfortunately the prime exhibit.
In fairness, White emphasizes, Canada and most other small and middle-sized nations are largely slave to monetary policies set by the U.S. Federal Reserve Board and its “easy money” policies fuelled by low interest rates and loose regulation of lenders, even after the crisis of 2008. “We responded to the Fed’s easy money policies by easing ours too,” he says wistfully.
Philip Cross, until 2012 one of the government’s top economists in his role as chief economic analyst at Statistics Canada, is livid that the “financialization” of the economy has brought us to this impasse. The lessons of 2008 were little heeded by Canada’s financial overlords, both in government and in the private banks and corporations.
“Nobody seems to be taking responsibility — even the Bank of Canada — for the overall levels of debt,” Cross fumes. “But it’s clear the private banks and financial institutions have gained far too much influence.”
David Dodge, who was governor of the Bank of Canada from 2001 until 2008, agrees corporate Canadian financial policymakers largely ignored the lessons of 2008. As a result, taxpayers may now be on the hook for a sizable share of corporate Canada’s bad debts, says Dodge. Which may mean “we’re heading back to the same federal debt to GDP ratio we faced in 1992,” when the federal government was forced to drastically cut spending on public programs across the board to service and pay down the federal debt.
“There were lots of lessons that we should have learned,” says Dodge, “as governments, as banks, as households and, in particular, as private corporations, by reducing our reliance on debt finance, right across the economy.”
“I’m worried about how we get back to some semblance of normal again.”
STEPHEN WILLIAMSON BANK OF CANADA FELLOW AT WESTERN UNIVERSITY