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Canadian nonfinancial corporate debt has reached new highs, spurred by low interest rates and the desire for firms to hold higher levels of cash. Anthony Okolie speaks with James Orlando, Senior Economist, TD Bank, about the industry’s ability to meet its debt obligations.
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James, you recently published a report on the Canadian corporate debt landscape, which you state has shifted dramatically over the past two years. So what's changed during this period?
Yeah, thanks, Anthony. So we're in a situation in Canada where a lot of debt talk gets centered around households and governments, and rightly so. But Canadian corporate debt, as we even flagged before the pandemic, was one of the biggest risks to the Canadian economy. And one of the reasons why is because most of the debt is actually concentrated in just a handful of different sectors. And whenever you have a concentrated debt, that's always more of a risk in case the next economic downturn is disproportionately hit in those sectors. But Canada got actually a little bit lucky when it came to how the pandemic hit with respect to corporate debt in a sense that some of the most vulnerable sectors actually saw huge demand for their products. And so that really is what caused this shift in the corporate debt market in Canada.
OK, so which industries have the highest concentration of debt?
Yes, most of the debt in Canada is concentrated in areas like real estate. So we know housing is a huge thing in Canada. But also in the construction sector, manufacturing, oil and gas. So those are the type of sectors that it will come to mind when you see the huge amount of debt that's been piling up in Canada.
OK, so which industries worry you the most and why?
Most concerned? The most concerning ones ahead of all of this were things like oil and gas, real estate. Real estate is one that leaps and bounds and has the highest amount of debt. It actually has double the amount of debt than any other sector that is in the Canadian market. Naturally, this is one of those sectors that gets a lot of attention just because we have such a huge amount of housing demand. Canadians love housing. And so the builders are trying to meet that demand. And we know that one of the biggest problems in Canada is the fact that we haven't had supply be able to keep up with that hot demand. And so naturally, there's a natural thing that goes on where a lot of people, a lot of businesses have to spend money before they end up selling properties. And so that is a big debt accumulation that's continued to increase. So that's really the elephant in the room. But it's not just that, there's other areas. So the high touch service sectors, even though they actually have fairly low amounts of debt relative to areas like real estate, they've been hit pretty hard. And so I think those are areas going forward you have to watch out for.
So that's good, important information. Tell us about the sectors that seem to be navigating the change in the economic environment better than others.
Yeah. So I mentioned earlier how the nature of the pandemic has actually been pretty beneficial to a few different sectors. One is energy, so oil and gas. We know that there's been a massive increase in the price of oil, a massive increase in the price of natural gas. And this all comes with the fact that we're reopening. And with the reopening comes mobility, people driving, people jumping on airplanes. And about three quarters of energy demand globally comes from things like mobility. And so what's happened is oil and gas was one of the biggest high risk sectors when it came to the amount of debt they had and their ability to pay the debts that they had already taken out prior to the pandemic. But the increase in price of energy has actually just filled the coffers of these businesses, and they went from one of the highest risk sectors to one of the sectors that actually has some of the strongest balance sheets going forward right now. So that's been a huge shift for them. And another one is actually manufacturing. So manufacturing was a high leverage sector with respect to their ability to pay interest costs. That was definitely becoming strained before the pandemic. But, like all of us, with respect to having to change our behaviors, the demand for goods in Canada, and just like it is around the world, has been huge. Whether it be, having to spend on building your home office or your home gym or just fixing up your home in general. The demand for goods has been huge and Canadian corporations that are manufacturing those goods, I've seen a huge inflow of cash, and as a result their balance sheets have improved tremendously.
What risks do the new Omicron variant pose to these sectors and the current corporate debt levels?
So certainly any flare up of any variant would have an impact on probably the service side of the economy. So we know that in past waves, Canadians have been much more hesitant to go out to restaurants, go out to service oriented type of entertainment. So one area that we flagged is the arts and entertainment sector. This area actually has fairly low levels of debt heading into the pandemic, that they've had to load up on debt recently just because a lot of them just needed to stay afloat during this time period. And so they actually really are in a situation where they need a return to normal to happen so that their profits can catch up to the amount of debt that they've taken on. So this is definitely an area to watch. So if new variants pop up and that makes it such that their profits are either stunted or delayed even further from catching up to that debt, that's definitely a worry. Other factors, such as what happens with energy prices going forward, we mentioned that oil and gas has done really well over the last little while, but we do need those oil and gas prices to stay at fairly elevated levels to maintain those profits. So these are the factors that we're looking out for to see if new variants are going to pose a risk to Canadian corporate debt.
OK, so bottom line, what do these elevated corporate debt levels tell us about the health of our Canadian industries?
Well, so I think the way we're thinking is that even though debt has absolutely increased, we're about two trillion dollars in corporate debt in Canada, and that's about a $200 billion increase before the pandemic even started. This was a big risk for the for the Canadian economy. But there has been an improvement. The fact that we've had house prices increase so much, the fact that oil prices have increased so much, the fact that manufacturing has improved so much means that all the sectors that we've been flagging as huge risks have actually seen some improvement in their profitability, which has actually made it a little bit less of a worry. But those risks have shifted to other kinds of companies. So companies like arts and entertainment is high service types of industries that are very much riding the COVID infections' wave in a sense that if there is a ramp up of new infections, we're going to be in a situation where these corporations are going to have much more delayed profit recovery. And so even though we have high debt in Canada, there's actually been some improving stories that we think we should highlight.
James, thank you very much for joining us.
Thank you.
Yeah, thanks, Anthony. So we're in a situation in Canada where a lot of debt talk gets centered around households and governments, and rightly so. But Canadian corporate debt, as we even flagged before the pandemic, was one of the biggest risks to the Canadian economy. And one of the reasons why is because most of the debt is actually concentrated in just a handful of different sectors. And whenever you have a concentrated debt, that's always more of a risk in case the next economic downturn is disproportionately hit in those sectors. But Canada got actually a little bit lucky when it came to how the pandemic hit with respect to corporate debt in a sense that some of the most vulnerable sectors actually saw huge demand for their products. And so that really is what caused this shift in the corporate debt market in Canada.
OK, so which industries have the highest concentration of debt?
Yes, most of the debt in Canada is concentrated in areas like real estate. So we know housing is a huge thing in Canada. But also in the construction sector, manufacturing, oil and gas. So those are the type of sectors that it will come to mind when you see the huge amount of debt that's been piling up in Canada.
OK, so which industries worry you the most and why?
Most concerned? The most concerning ones ahead of all of this were things like oil and gas, real estate. Real estate is one that leaps and bounds and has the highest amount of debt. It actually has double the amount of debt than any other sector that is in the Canadian market. Naturally, this is one of those sectors that gets a lot of attention just because we have such a huge amount of housing demand. Canadians love housing. And so the builders are trying to meet that demand. And we know that one of the biggest problems in Canada is the fact that we haven't had supply be able to keep up with that hot demand. And so naturally, there's a natural thing that goes on where a lot of people, a lot of businesses have to spend money before they end up selling properties. And so that is a big debt accumulation that's continued to increase. So that's really the elephant in the room. But it's not just that, there's other areas. So the high touch service sectors, even though they actually have fairly low amounts of debt relative to areas like real estate, they've been hit pretty hard. And so I think those are areas going forward you have to watch out for.
So that's good, important information. Tell us about the sectors that seem to be navigating the change in the economic environment better than others.
Yeah. So I mentioned earlier how the nature of the pandemic has actually been pretty beneficial to a few different sectors. One is energy, so oil and gas. We know that there's been a massive increase in the price of oil, a massive increase in the price of natural gas. And this all comes with the fact that we're reopening. And with the reopening comes mobility, people driving, people jumping on airplanes. And about three quarters of energy demand globally comes from things like mobility. And so what's happened is oil and gas was one of the biggest high risk sectors when it came to the amount of debt they had and their ability to pay the debts that they had already taken out prior to the pandemic. But the increase in price of energy has actually just filled the coffers of these businesses, and they went from one of the highest risk sectors to one of the sectors that actually has some of the strongest balance sheets going forward right now. So that's been a huge shift for them. And another one is actually manufacturing. So manufacturing was a high leverage sector with respect to their ability to pay interest costs. That was definitely becoming strained before the pandemic. But, like all of us, with respect to having to change our behaviors, the demand for goods in Canada, and just like it is around the world, has been huge. Whether it be, having to spend on building your home office or your home gym or just fixing up your home in general. The demand for goods has been huge and Canadian corporations that are manufacturing those goods, I've seen a huge inflow of cash, and as a result their balance sheets have improved tremendously.
What risks do the new Omicron variant pose to these sectors and the current corporate debt levels?
So certainly any flare up of any variant would have an impact on probably the service side of the economy. So we know that in past waves, Canadians have been much more hesitant to go out to restaurants, go out to service oriented type of entertainment. So one area that we flagged is the arts and entertainment sector. This area actually has fairly low levels of debt heading into the pandemic, that they've had to load up on debt recently just because a lot of them just needed to stay afloat during this time period. And so they actually really are in a situation where they need a return to normal to happen so that their profits can catch up to the amount of debt that they've taken on. So this is definitely an area to watch. So if new variants pop up and that makes it such that their profits are either stunted or delayed even further from catching up to that debt, that's definitely a worry. Other factors, such as what happens with energy prices going forward, we mentioned that oil and gas has done really well over the last little while, but we do need those oil and gas prices to stay at fairly elevated levels to maintain those profits. So these are the factors that we're looking out for to see if new variants are going to pose a risk to Canadian corporate debt.
OK, so bottom line, what do these elevated corporate debt levels tell us about the health of our Canadian industries?
Well, so I think the way we're thinking is that even though debt has absolutely increased, we're about two trillion dollars in corporate debt in Canada, and that's about a $200 billion increase before the pandemic even started. This was a big risk for the for the Canadian economy. But there has been an improvement. The fact that we've had house prices increase so much, the fact that oil prices have increased so much, the fact that manufacturing has improved so much means that all the sectors that we've been flagging as huge risks have actually seen some improvement in their profitability, which has actually made it a little bit less of a worry. But those risks have shifted to other kinds of companies. So companies like arts and entertainment is high service types of industries that are very much riding the COVID infections' wave in a sense that if there is a ramp up of new infections, we're going to be in a situation where these corporations are going to have much more delayed profit recovery. And so even though we have high debt in Canada, there's actually been some improving stories that we think we should highlight.
James, thank you very much for joining us.
Thank you.
