What will spark the next financial crisis? Here’s one candidate

Now that everything has been said about the 10th anniversary of the Lehman Brothers bankruptcy, it’s worth asking how close we are to the next crisis. In the market for corporate loans, investors have fulfilled at least one prerequisite: They’re dropping their guard.

The financial cycle has a lot to do with inattention. When something bad happens, people are careful for a while. Then if all is fine for long enough, they forget that bad things can happen. This false sense of security leads to precisely the kind of behaviour that precipitates the next crash.

The corporate debt market has a sort of proxy for inattention: the prevalence of covenants. When lenders are being vigilant, they require that borrowers avoid taking on too much debt or generate ample cash for interest payments. When they loosen up or get desperate for someone to take their money and pay interest, such covenants disappear.

So what’s happening these days? “Covenant-lite” deals are booming among leveraged loans, a sort of subprime debt often employed in corporate acquisitions. So far in 2018, they have constituted an estimated 34 per cent of all issuance by dollar value.  That’s the largest share in at least a couple decades, with the exception of 2017.

The lack of caution has coincided with the ascendance of Donald Trump to the presidency. Back in 2013, regulators issued a warning about the mounting risks and declining vigilance in the leveraged finance market — an unusual move that, judging from the subsequent decline in covenant-lite lending, might have had some effect. But after the Trump administration arrived with its tax cuts and deregulatory agenda, the party resumed.

A false sense of security leads to precisely the kind of behaviour that precipitates a new crash.

It’s not likely to end well. Although leveraged loans — and the structured investments, known as collateralized loan obligations, into which they are often packaged — performed well in the last crisis, Moody’s has warned that next time will probably be worse. Given the weaker protections, default rates will most likely be higher and losses steeper.

None of this means that leveraged lending will precipitate a full-blown crisis. Much depends on where the risk is concentrated. If investors are widely dispersed and defaults cause the market to seize up, the biggest problem could be on Main Street as companies fold because they can neither pay nor refinance their debts. If losses crystallize in institutions central to the financial system, the repercussions could be greater. It’s something to which regulators should definitely be paying attention.

Estimate based on the roughly 80 per cent of all loans for which Bloomberg has covenant data.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Whitehouse writes editorials on global economics and finance for Bloomberg Opinion. He covered economics for the Wall Street Journal and served as deputy bureau chief in London. He was founding managing editor of Vedomosti, a Russian-language business daily.

Philip Gray is an editor for Bloomberg Opinion. He was an assistant news editor at the New York Times, a copy editor on the foreign and national desks at the Washington Post and a copy editor at the Wichita Eagle.


How trade, inflation and debt are influencing the Bank of Canada’s decisions on rate hikes

Purpose Investments CEO Som Seif talks with Larysa Harapyn about the state of the economy in the wake of the Bank of Canada’s decision to hold rates steady.

Toronto miner unearths boulder that contains 9,000 ounces of gold in Australia, worth about $15 million

Rare is the story of a modern mining company that unexpectedly strikes a mother lode of gold.

But Toronto-based junior mining company Royal Nickel Corp. announced Sunday night that its employees in Australia at the Beta Hunt mine — which the company has been trying to sell since April — removed a golden boulder like few others in the world: Within a single cube of earth that measured roughly three meters wide, three meters long, and three meters deep, they found 9,000 ounces of gold including two large lumps — all told worth around $14 or $15 million at current prices. That’s equivalent to roughly 40 per cent of RNC’s $35 million market capitalization as of last week.

“It was a nickel mine for years and years,” said Mark Selby, chief executive of RNC. “But we bought it because there were a bunch of gold deposits sitting beneath it.”

Royal Nickel stock surged 83 per cent to $0.16 on the Toronto Stock Exchange on Monday.

To put the latest find into perspective, the Beta Hunt mine normally produces ore that contains around two to four grams of gold per ton, considered a standard amount. But the latest find contained 2,000 grams of gold per tone, according to Selby.

They broke off one 95-kilogram stone that contained an estimated 2,440 ounces of gold, according to the company. He said it was so pure it did not need to be processed and was sent directly to the Perth Mint.

According to the World Gold Council, the “largest ever true gold nugget” weighed slightly more than 2,300 ounces. RNC’s specimen contains some quartz, however, so it may not count as an apple to apple comparison.

Trevor Turnbull, a mining analyst with Scotia Capital, said that while it’s not a pure gold nugget, its sheer size makes it unique and potentially very valuable.

“They’ll probably sell it as a museum piece and they’ll make a fair bit of money,” said Turnbull.

The company will likely sell the specimen stone to a museum, according to an analyst.

He said the real question, unanswerable without more information, is whether the gold comes from a vein that will quickly “pinch out or whether it stays wide.”

RNC purchased the Beta Hunt mine in 2016 for a mix of cash and its own shares worth around $12.5 million.

Located in Western Australia, about 600 kilometres from Perth, it had been a nickel mine since the 1970s. RNC has been trying to sell it since April so it can focus on raising $1 billion to build its planned Dumont nickel mine in Quebec.

Selby, who lives in Toronto, said he heard the news when he woke up in the middle of the night last Monday to use the bathroom.

“I flip my phone on and find out,” he said. “I didn’t go back to bed. You don’t find 2,000-ounce hunks of gold very often, so it’s good to be lucky.”

The Australian news channel ABC reported that the miners were working underground, at around 500 meters below surface, in the Kambalda district.

Henry Dole, the miner credited with finding the gold, said “Never in my life have I seen anything like this. There were chunks of gold in the face, on the ground, truly unique I reckon,” according to the ABC news report.

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Loblaw spins out its stake in Choice Properties REIT to George Weston

TORONTO — Loblaw Companies Ltd. says it will spin out its real estate investment trust to focus solely on its grocery and pharmacy business.

The company says George Weston Ltd., which has majority ownership of Loblaw, will receive its 61.6 per cent interest in Choice Properties REIT and Loblaw’s minority shareholders will received George Weston shares in exchange.

George Weston already owns 3.8 per cent of the trust and the deal would boost its position to 65.4 per cent.

Weston stock fell 1.74 per cent to $99.87 per share on Tuesday.

The arrangement is conditional on at least two-thirds of Loblaw’s common shareholders and a majority of its minority sharesholders approving the deal in a vote at a meeting expected to take place next month, as well as court and other approvals.

The companies anticipate the transaction will close in the fourth quarter.

Loblaw president Sarah Davis says in a statement that the strategies of Loblaw and Choice Properties diverged over the past few years with the grocer focusing on its core retail business and growing in digital, healthcare and other areas.

The Canadian Press

Tide of investment set to recede from oilpatch amid more pipeline delays

OTTAWA — Observers say fresh obstacles to building the Trans Mountain expansion project raise new alarms over Canada’s seemingly unpredictable regulatory regime, threatening to scare off would-be investors in the U.S. and elsewhere.

The Federal Court of Appeal decision that effectively overruled Cabinet’s approval of the pipeline in 2016. The decision compels the national energy regulator to repeat a portion of its consultation process, halting construction and setting back the timeline for the project.

It follows earlier regulatory delays that have hobbled Trans Mountain and other proposed pipelines in Canada, including Enbridge Inc.’s Northern Gateway pipeline project, straining the patience of foreign investors.

“Investors are beginning to say enough is enough,” said Jeremy McCrae, analyst at Raymond James in Calgary. “The ruling is clearly negative. There was always an overtone of U.S. investors in particular saying Canada’s regulatory regime is hard to work with.”

Christopher Ragan, an economics professor at McGill University and chair of Canada’s Ecofiscal Commission, said investors are “one notch less likely to commit capital toward large-scale investment in Canada” following the decision.

“My general view is that this will be interpreted, rightly or wrongly, as yet another regulatory hurdle that can cause trouble for major projects,” he said.

Most oil-weighted Canadian energy stocks fell on the news. MEG Energy Corp. dropped nearly four per cent to just over $8 per share by market close, while Cenovus Energy Inc. fell nearly two per cent. Integrated oilsands giant Canadian Natural Resources Ltd. saw a 1.2 per cent drop, while rival Suncor Energy Inc. rose 0.6 per cent.

Energy economist Peter Tertzakian said there has been a general falloff in both debt and equity raises by Canadian firms, due partly to the collapse of oil prices in 2014, as well as the layering effect of pipeline constraints and regulatory uncertainty.

“The general trend is that the tide of investment has receded in Canada,” he said.“On equity raises this year the run rate has been almost zero.”

Total debt and equity financing by Canadian oil and gas companies typically average around $3 billion per quarter, according to ARC Energy Research Institute data, but have fallen to nearly zero in recent quarters.

Scotiabank chief economist Jean-Francois Perrault said the decision will “complicate the investment climate” for any potential investors mulling a position in Canadian energy firms.

“Obviously it’s a pretty disappointing result—there’s a fair amount of uncertainty as to how the government proceeds from here,” he said.

However, Perrault also pushed back against claims that foreign direct investment into Canada more generally has suffered as a result of a lack of competitiveness compared to the U.S., or due to an unreliable regulatory regime in Canada.

Direct investment in Canada totalled $11.7 billion in the second quarter, primarily in the form of equity instruments, according to Statistics Canada.

“More than half of the direct investment activity was in the manufacturing sector. As a result, foreign direct investment generated a net outflow of funds from the economy of $10 billion in the second quarter,” the agency said in a report Wednesday.

Foreign investors also added $917 million of Canadian equities to their holdings, the lowest investment since the third quarter of 2015. Foreign investment in Canadian shares have totalled $6.7 billion since the beginning of 2018, compared with $47.1 billion over the two first quarters of 2017, according to StatsCan.

Politicians and various business associations sounded off on the Federal Court’s ruling Thursday, saying it threatened to leave Canadian taxpayers footing the bill for the long-delayed pipeline. Kinder Morgan Canada Ltd. shareholders voted on Thursday to sell existing Trans Mountain assets to the Canadian government for $4.5 billion. Construction of the pipeline could cost another $6 billion to $8 billion, according to analysts.

“It sends a profoundly negative message to investors both here at home and around the world about Canada’s regulatory system and our ability to get things done,” Canadian Chamber of Commerce CEO Perrin Beatty said in a written statement about the decision.

Conservative leader Andrew Scheer, meanwhile, said the decision represents a “further eroding of confidence” in the Liberal Party’s ability to complete construction of the pipeline.

Thursday’s ruling, laid out by Justice Eleanor Dawson, found that the National Energy Board did not meet its duty to consult with First Nations groups along the pipeline. Cabinet approved the project in November 2016.

Dawson also said the regulator failed to account for the environmental impact of increased tanker traffic in the port of Vancouver, a major point of contention for local communities and activist groups. The NEB has typically not accounted for marine traffic as part of its review process, and made arguments to the court that it was outside of its traditional purview.

Dawson said the NEB “erred by unjustifiably excluding Project-related marine shipping from the Project’s definition” and that its report was in turn “so flawed that it was unreasonable for the Governor in Council to rely upon it” in its approval of the expansion.

The decision will compel the NEB to repeat the third phase of its consultation, which took roughly 10 months to complete between February and November in 2016. The Federal Court said it could repeat the process on an “expedited” basis.


‘This should stop the bleeding in Canada’: Auto stocks soar despite Trump tariff threats

TORONTO — A potential trade deal between the U.S. and Mexico has been greeted with cautious optimism in the Canadian automotive sector despite renewed threats by U.S. President Donald Trump to impose tariffs on the industry.

Trump said Monday the U.S. and Mexico had reached a bilateral “understanding” on a trade agreement that could replace the existing North American trade agreement.

Details from the Office of the U.S. Trade Representative show the preliminary agreements include a wage provision that 40 to 45 per cent of auto content would be made by workers earning at least US$16 per hour, and increase in the auto content required from the NAFTA region to 75 per cent, up from the current 62.5 per cent.

If auto content and wage agreements go forward with Canada on board as well, they could stem the flow of auto sector jobs to lower wage jurisdictions, Unifor president Jerry Dias said.

“I believe this should stop the bleeding in Canada.”

Dias said he was concerned Trump linked potential tariffs on Canada’s auto sector to concessions on the agricultural supply management system, but said it was nothing new.

“It’s a lot of rhetoric, but ultimately he’s doing the rhetoric that he’s been doing since the beginning, that he’ll slap on tariffs if we don’t make some major moves on the importing of their agricultural goods.”

Investors have also welcomed the news, boosting automotive stocks on both sides of the border. Canadian auto parts manufacturer Martinrea International Inc. was up 6.42 per cent, Linamar Corp. was up 6.24 per cent and Magna was up 4.11 per cent in mid-afternoon trading on the Toronto Stock Exchange.

Bill Anderson, director of the University of Windsor’s Cross Border Institute, says he’s concerned about a condensed negotiation window now that key issues between the U.S. and Mexico look to be settled, but that the wage provision would help Canada’s sector.

“Essentially it’s a way of excluding Mexican content, so even though Canada and Mexico have presented a united front, you now have a situation where you could make the argument this will benefit Canada,” said Anderson.

“On that particular issue, what benefits the United States also benefits Canada.”

Anderson said it showed the U.S. had also made concessions during negotiations.

“It’s much better for Canada than earlier in the negotiations when they were saying that there had to be a certain amount of American content.”

The timeline for negotiations could be tight, as a deal would have to be reached by Friday to meet a 90-day notice window for a deal to be signed by outgoing Mexican President Enrique Pena Nieto and for Congress to act before any changes from midterm elections.

Canadian Vehicle Manufacturers’ Association president Mark Nantais said it was time for the Canadian government, which has been excluded from the talks between the U.S. and Mexico in recent weeks, to get back to the table.

“Canada’s got a very small window here in which to step up, and we certainly encourage them to do that.”

A spokesman for Foreign Affairs Minister Chrystia Freeland said the minister will head to Washington on Tuesday to re-join face-to-face negotiations with the U.S. and Mexico on trade.

Nantais said he’s encouraged to see progress on NAFTA negotiations, but that it will be critical to understand the terms that have actually been agreed to so far.

Trump threatened to impose 25 per cent tariffs on Canada if a deal isn’t reached, but Nantais said it still seemed to be a negotiating tactic.

“We have to realize he’s still in a negotiation, so while he may have made progress on a bilateral relation with Mexico, there’s Canada yet to go.”

BMO chief economist Douglas Porter said in a note that the deal “raises more questions than answers for Canada” and leaves the country in a difficult situation.

“Canada now appears to be in a near-take-it-or-leave-it situation with respect to spinning the U.S.-Mexico deal into a broader agreement on a revamped NAFTA.”

Still, he noted investors have welcomed the news and likely helped push the Canadian dollar up half a per cent on the headlines.

“Perhaps the clearest indicator that the market is viewing the U.S.-Mexico deal as a positive for Canada is the strengthening of the Canadian dollar.”

© The Canadian Press

Loonie’s gains set to fizzle as focus turns from NAFTA to Bank of Canada

The next few weeks are looking bad for the Canadian dollar, even amid expectations that Canada could rejoin NAFTA talks, according to Toronto-Dominion Bank.

The Canadian dollar gained about 0.4 per cent after the U.S. and Mexico reached a bilateral deal to revamp the North American Free Trade Agreement, boosting prospects that Canada will come off the sidelines.

But in the view of TD, the loonie’s gains will probably fizzle as traders shift their focus back to comments over the weekend by Bank of Canada Governor Stephen Poloz downplaying the prospect of aggressive rate increases. He spoke in Wyoming at a symposium of central bankers.

The loonie could “start fading later in the week,” because positive developments in NAFTA talks and a potential October rate hike are already priced in, said Mark McCormick, TD’s North American head of FX strategy. “Poloz’s speech at Jackson Hole poured some cold water on the notion the bank may shift this tightening cycle into overdrive,” he wrote separately in a note.

2018 Struggle

The Canadian currency has weakened about 3.1 per cent this year versus the greenback as tensions escalated between the U.S. and some of its biggest trading partners. Last month, hedge funds and speculators amassed the biggest net short position in the loonie in more than a year. Those bearish bets have since been trimmed.

TD recommends buying the U.S. dollar against its Canadian counterpart when the pair dips toward $1.2950. The loonie was at $1.2978 per U.S. dollar as of about 11:45 a.m. in New York. It’s also trading near the $1.29 year-end median forecast of analysts surveyed by Bloomberg.

Greg Anderson, head of FX strategy at Bank of Montreal, sees stability ahead for the Canadian currency despite the shifting interest-rate outlook and trade developments.

“I don’t think we’re going too far from $1.30,” Anderson said. Poloz isn’t going to want to tighten at a more aggressive pace than the Federal Reserve, “because he doesn’t want the Canadian dollar to run away.”


Canada should be afraid of this indicator now flashing red, Goldman says

One under-appreciated indicator is flashing red for some developed markets, Goldman Sachs analysts say.

The private-sector financial balance — an economy’s total income minus the spending of all households and businesses — has proven more powerful in predicting crises than the current-account balance, Goldman analysts led by Jan Hatzius, the bank’s global head of economics, wrote in an Aug. 23 research note.

“The good news is that the biggest DM economies — the U.S., the Euro area, and Japan — are all running healthy private sector surpluses,” they wrote. “The not-so-good news is that some of the smaller DM economies — especially Canada and the U.K. — are running sizable deficits and appear vulnerable to higher interest rates and weaker asset markets.”

The finding is another warning sign for the global economy at a time of sporadic turbulence arising from monetary tightening, U.S.-China trade battles, and stress in some emerging markets.

A private-sector deficit means households and firms can’t finance their current spending with current income and rely on net borrowing or asset sales, the Goldman analysts wrote. That makes growth and financial stability more vulnerable in an environment of rising rates or market declines, they said.

A private-sector deficit means households and firms can’t finance their current spending with current income and rely on net borrowing or asset sales.

Canada and the United Kingdom appear to be the most exposed, particularly given an overheated Canadian housing market and the threat of Brexit negotiations slamming income expectations and private spending, they said.

A private-sector surplus, on the other hand, is a strong predictor of growth. Tallying 17 developed economies from the mid-1980s to the present, the analysts show that when the private sector balance is 1 percent of GDP higher, the GDP relative to potential rises about 0.4 percentage point faster in the ensuing three years — an impact that they judge “economically large.”

A large private-sector deficit is a more reliable indicator than either debt growth or asset prices, the Goldman analysts said. This gauge is also seen as outperforming the current account balance as a crisis predictor because focusing on the private sector better measures the risk of “bouts of speculative mania.”