Corporate Yields at Record Lows on Foreign Cash: Canada Credit

Yields on Canadian corporate debt are at the lowest levels in at least two decades as international investors purchase record amounts of the nation’s bonds and as the government plans to balance its books by 2015.

The yield-to-maturity on a broad index of investment-grade corporate debt, comprising 705 bonds with a par value of C$278 billion ($277 billion), fell to 3.566 percent on Oct. 11, the lowest since June 1992, when Bank of America Merrill Lynch data begins. Yields reached 6.18 percent in October 2008, the highest in more than six years, amid a worldwide credit crunch.

Foreign investors purchased record amounts of government bonds through July, government data show, and Canada’s economy is matching Germany’s as the strongest among its developed peers after the recession. Finance Minister Jim Flaherty said two days ago that Canada will be the first Group of Seven country to balance its budget by 2015. Two-year yields in Canada are the second highest in the G7 after Italy, adding to the attraction for international bond buyers.

“The dominant factor remains the search for yield that comes as government bond yields are driven so low,” Mark Chandler, head of Canadian fixed income and currency strategy at Royal Bank of Canada in Toronto, wrote in an e-mail. “Weak price pressures and disappointing growth” are also driving yields lower, as well as the prospect of another round of quantitative easing by the Federal Reserve, Chandler wrote.

Extra Yield

Elsewhere in credit markets, the extra yield investors demand to hold the debt of corporate rather than federal debt widened yesterday to 145 basis points, from 144 basis points the day before. Spreads were as wide this year as 154 basis points in June. Relative corporate yields in the U.S. stood at 180 basis points, and at 168 basis points for a broad index of global corporate bonds, the Merrill Lynch data as of Oct. 12 showed.

Corporate bonds in Canada have made investors 0.2 percent this month, according to the Merrill Lynch data, compared with 0.6 percent gains each for U.S. and global corporate bonds. U.S. corporate yields stood at 3.579 percent on Oct. 12, compared with 3.36 percent for global corporates.

Weaker employment and housing data helped push bond prices higher. Canada’s five-year bond yield touched 1.85 percent two days ago, the least since April 2009. The 10-year bond yield fell to 2.68 percent the same day, the lowest since March 2009.

Employment gains averaged 6,600 during the past three months, down from the 75,530 average in the previous quarter, according to Statistics Canada. Housing starts fell 1.5 percent to a seasonally adjusted annual pace of 186,400 in September, Canada Mortgage and Housing Corp. said last week.

Among Group of Seven countries, Canadian government two-year debt yields this week stood at 1.37 percent, compared with 1.67 percent in Italy and 0.36 percent in the U.S.

Global Buying

Foreigners are buying Canadian federal, provincial and mortgage bonds, driving benchmark yields lower and dragging down corporate returns at the same time, Chandler said. Toronto-Dominion Bank’s 5.141 percent bonds due in November 2012 yield 1.84 percent, according to the Merrill data. Hydro One Inc.’s 5.77 percent bonds maturing the same month yield 1.943 percent.

International investors bought C$56 billion of Canadian bonds more than they sold through July, the most since Statistics Canada data begins in June 1988. Net sales were C$47.2 billion last year, and have averaged about C$19 billion during the past decade, according to Bloomberg calculations.

Foreigners purchased C$9.6 billion more Canadian corporate bonds than they sold through July, about half the C$17.2 billion during the same period last year, according to Statistics Canada data. Spreads tightened from as wide as 401 basis points in January 2009 to 114 basis points in March.

Spreads Tighten

Spreads “have been tightening steadily over the past 18 months and this, in addition to the low government bond yields, has helped to drive yields lower,” Robert Follis, managing director of corporate bond research at Bank of Nova Scotia’s Scotia Capital unit, wrote in an e-mail. Low yields are “mostly due to the continuing strong demand for all fixed-income products, but also due to the low interest-rate environment, which puts downward pressure on government yields.”

Statistics Canada is scheduled to report international securities transactions for August on Oct. 18.

Two-decade low yields mean companies can borrow more cheaply, giving them scope to shore up balance sheets by refinancing higher-cost debt and improve earnings. A company raising C$100 million would save about C$2.6 million in interest costs a year if it borrowed money now, compared with going to market in October 2008. Rogers Communications Inc., Enbridge Inc. and Hydro One were among companies that sold debt last month, making it the busiest September for corporate issuance since 2007.

Provincial Bonds

Canada’s provincial bond market, with about C$458 billion outstanding, is up 0.2 percent this month, compared with the 0.1 percent advance in Merrill’s index of Canadian government bonds. Yields on the provincial index reached 2.911 percent on Oct. 11, also the lowest since the data begins in 1992. The Standard & Poor’s TSX Composite, the nation’s primary stock gauge, is up 2.5 percent in October.

Corporate yields may remain low through the end of the year because another round of quantitative easing by the Fed could drive funds into stocks and, for those accounts that don’t have the flexibility to buy equities, into corporate bonds, according to RBC’s Chandler.

Traders are speculating the Fed will announce plans to stimulate economic growth after its Nov. 2-3 meeting.

Disappointment Risk

“There’s some risk of disappointment if the Federal Open Market Committee fails to deliver on QE promises,” Chandler wrote. “However, I’m sure they’re cognizant of this risk and if the statement underscores that they will do ‘whatever is necessary,’ it’s possible the benign backdrop for corporate bonds will hold through to the end of the year.”

Bank of Canada Governor Mark Carney became the first G7 central banker to raise borrowing costs since July 2008 when he lifted the overnight rate by a quarter percentage point to 0.5 percent in June, from a record low 0.25 percent. Successive increases in July and September brought the overnight rate to 1 percent. Policy makers next meet on Oct. 19 to set rates. The central bank releases its quarterly monetary policy report a day later.

The two-year interest-rate swap, a gauge of the average short-term rates during the next two years, rose to 1.54 percent yesterday, the highest since Sept. 30. The rate reached a six-month low 1.30 percent on Aug. 24.

Canada’s deficit will be 1.6 percent of output next year, compared with 6.1 percent in the U.S., 5.5 percent in the euro zone and 8.2 percent in Japan, according to median estimates compiled by Bloomberg.

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