TORONTO – (Sept. 21, 200) – Standard & Poor’s today said that the near-term repercussions of the Sept. 11, 2001, attacks in New York, N.Y., and Washington, D.C., are likely to impact the business and market conditions for the aviation, leisure, and real estate industries in Canada.
These events will exacerbate the weak outlook that these industries already faced as a result of the global economic slowdown. Looking beyond the direct effects, the implications of the recent events on Canadian economic growth, consumer and business confidence, and the credit cycle will likely aggravate economic and business pressures, already on the rise in Canada and the U.S., in most sectors of the Canadian economy.
“The blow to confidence will depress economic prospects everywhere, potentially lowering GDP growth as businesses become more cautious about investment,” said Joydeep Mukherji, a director in Standard & Poor’s sovereign ratings group. Consumer spending, which has been strong in Canada this year, keeping its economy on a faster pace compared with the U.S., may be hurt as well. Both these trends could worsen economic deceleration in Canada, compounding the negative impact of lower exports to a weakening U.S. market. Although the magnitude is difficult to predict right now, the slowdown will eventually translate into lower revenues at all levels of government, while rising unemployment could place pressure on social spending.
The fruits of economic restructuring during the last decade should sustain the ratings on the Government of Canada (local currency AAA/Stable/A-1+; foreign currency AA+/Stable/A-1+) during this difficult period. Budget surpluses at the federal level, as well as in most provinces, have cut the general government debt burden, lowered the share of interest payments in government spending, and facilitated tax cuts. The improving trends in public finances may be suspended, or even reversed mildly if the economy becomes unexpectedly weak, but the country’s sovereign rating is likely to remain at the double-‘A’-plus rating level, with a stable outlook. “Provided that economic management remains prudent, the rating impact of the recent terrorist attacks may be largely on opportunities foregone rather than any deterioration of creditstanding,” explained Mr. Mukherji.
Canadian banks appear to have weathered any potential operational disruptions. Domestic clearing, payment, and settlement systems were not interrupted, and payment delays by U.S. counterparties proved temporary. “The systems are very resilient,” said Donald Chu, an associate director in Standard & Poor’s financial institutions group. “The principal impact on Canadian banks will be the further economic slowdown.” Loan quality deterioration would accelerate only modestly from any exposures to affected industries such as airlines. In addition, investment banking activities are likely to slow further. The more difficult operating environment will be evaluated as it unfolds, however, and could affect ratings on banks that suffer disproportionately compared with peers.
This event is not expected to result in any rating actions on any of the Canadian domiciled life insurance companies currently followed by Standard & Poor’s. Any significant life reinsurance risk appears to have been limited so far to Clarica Life Insurance Co. (AA/Stable/A-1+) and The Manufacturers Life Insurance Co. (AA+/Stable/A-1+). Clarica announced it expects a one-time provision of less than C$25 million to be included in its third-quarter earnings. Manulife estimated that its net losses would probably not exceed C$100 million. In the property and casualty industry, Fairfax Financial Holdings Ltd. (BBB-/Stable/–) reported that insurance losses from the attacks will cost the company US$100 million-US$125 million, before tax.
The effects of the tragic incidents have created significant risks for Air Canada (BB-/Watch Neg/–), which has stated that the three-day shutdown cost the company C$100 million. “We expect there will continue to be a significant and lingering adverse effect on passenger traffic although the magnitude is difficult to gauge at this point,” said Kenton Freitag, an associate in Standard & Poor’s corporate ratings group. “The combination of the Gulf War and economic recession caused Air Canada’s traffic to fall by 14% in 1991, and the lost traffic was not fully regained until four years later.” Like airlines in the U.S., the impact on Air Canada’s cash position will be serious, although the company is protected in the short term by its C$1.2 billion cash and committed credit line position as of June 30, 2001.
Air Canada has appealed to the federal government for financial assistance in line with what U.S. carriers are expected to receive from their government. “Because airlines operate in a largely fixed-cost industry in the short run and cannot quickly adjust their cost structures to match the reduced demand, how much the government gives, how fast, and for how long is critical to their near-term outlook,” Mr. Freitag pointed out. He noted that the government may be constrained in its response due to its concern for the precedent it will create for assistance requests from other industries.
Aerospace companies’ prospects are directly linked to the health of the airline industry. With most North American airlines announcing capacity reductions of about 20%, the industry is expected to have a surplus of aircraft, sharply reducing forecast demand for new aircraft. The aerospace division at Bombardier Inc. (A-/Watch Neg/–) will likely see an adverse effect on deliveries and backlog due to its significant reliance on regional aircraft sales to North American carriers. The risk may be partially mitigated by revenue contributions from its mass transit division; however, this segment is not a large contributor to operating profit relative to the aerospace segment.
Canadian airport authorities and Nav Canada will face potential challenges shared by the Canadian aviation industry in the event of a steep and prolonged decline in air travel that may be without precedent, and also the likely increased costs due to higher insurance premiums and heightened security measures. “Considering the precarious financial position of North American airlines, it is quite possible that a majority of any airport authority rate increases will be passed on to consumers through the airport improvement fee, for instance, and the demand elasticity of passengers will be further tested,” said Valerie Blair, a director in Standard & Poor’s public finance ratings group.
In particular, the duress felt by Air Canada, the largest tenant at the Edmonton Regional Airports Authority (A+/Watch Neg/–), Greater Toronto Airports Authority (A/Watch Neg/–), and Vancouver International Airport Authority (AA-/Watch Neg/–) airports, and also the largest customer of Nav Canada (AA+/Watch Neg/–), may make it difficult for these entities to impose higher user fees on the airline. The airline also faces increased security costs, although these may be subsidized by federal sources or industry charges. As a result, the airports’ ability to glean more revenue from Air Canada and other airlines could be limited.
No immediate impact has been felt in the Canadian oil and gas sector. Oil prices remain relatively stable, and Standard & Poor’s expects oil supply to remain fairy constant, thereby stabilizing prices. Nevertheless, a prolonged recession would put downward pressure on oil and gas prices, which is already becoming apparent. Any U.S. military action in the Middle East would likely result in greater demand for Canadian oil and accelerate U.S. interest to reduce its dependency on OPEC.
Canadian telecoms may post third-quarter revenue increases due to boosts in call volume due to current disruptions in North America’s transport system, but these are not expected to offset the economic slowdown currently affecting the sector. Whether a rise in videoconferencing and other related services occurs remains to be seen.
The leisure industry has been adversely affected by the events in the U.S. “Hotels are facing a decline in revenue,” stated Ron Charbon, an associate director in Standard & Poor’s structured finance group. “Business travel cancellations are directly affecting revenues, which has exacerbated already declining revenue per available room.”
For the office sector, the expectation of a softening rental rate market is now an almost certainty as companies pull back in anticipation of economic and security instability after the attacks in the U.S., Mr. Charbon pointed out.
Consumer spending in retail real estate facilities that focus on department store type merchandise is expected to decline as customers reduce their discretionary spending. As business levels decrease, industrial space demand will decline, resulting in downward pressure on rental rates.
Brascan Corp. (A-/Stable/A-2), which holds a 48% interest in Brookfield Properties Corp., is expected to maintain stable quarterly cash flows based on Standard & Poor’s view that the duration of recovery will be timely and the insurance arrangements at Brookfield will be sufficient in connection with its interests in the World Financial Center and One Liberty Plaza. Property insurance is now under the microscope, and income interruption and property replacement are key issues.
The aftermath of Sept. 11 should enhance the credibility of the principal protection found in real estate investing. “So far it appears that insurance on affected World Trade Center properties will protect owners and managers, and debtholders,” Mr. Charbon commented. “This is the ultimate stress scenario.”
