Bondholders Stand to Lose C$7 Billion on Bill: Canada Credit

Canada's Prime Minister Stephen Harper
Since Prime Minister Stephen Harper’s government was re-elected in October 2008, only one of almost 400 private member’s bills survived the Parliamentary process to become law. Photographer: Tomohiro Ohsumi/Bloomberg

Canadian lawmakers begin reviewing a bill today that would give workers’ pensions priority over other debt in a bankruptcy, which analysts say could cost corporate bondholders as much as C$7 billion ($6.93 billion) if enacted.

The legislation, proposed by New Democratic Party lawmaker John Rafferty, was approved in principle by the House of Commons May 26 in a 144-111 vote. It now goes to the Parliamentary industry committee and, if approved there, would face a final Commons vote, likely next year.

The bill “could be potentially very disruptive to the capital markets,” said Jonathan Allen, head of Canadian credit research at Royal Bank of Canada’s RBC Capital Markets unit in Toronto. “What it would lead to is rating downgrades for quite a number of companies.” The changes could lead to losses of between C$3.5 billion and C$7 billion on corporate bonds and bank loans, Allen estimated.

While the bill passed the “second reading” stage, the odds of final passage are long. Since Prime Minister Stephen Harper’s government was re-elected in October 2008, only one of almost 400 private member’s bills survived the Parliamentary process to become law.

Giving “super-priority” to companies’ defined-benefit pension plans is needed to ensure workers don’t lose their life savings in a bankruptcy, Rafferty and other lawmakers say, citing Nortel Networks Corp. and AbitibiBowater Inc.

“There’s just a basic sense of fair-play involved here,” said Jack Layton, leader of the NDP, the smallest of three opposition parties. “The pension that has been set aside as deferred wages and the pensioners shouldn’t be at the back of the pack -- they should be at the front.”

Corporates Underperform

The debate comes as Canadian corporate bonds lag behind the rest of the world. They have had a total return of 2.1 percent since the end of June, compared with 3.54 percent for U.S. investment-grade debt and 3.38 percent for the global corporate bond market, according to Bank of America Merrill Lynch data.

Elsewhere in credit markets, the extra yield investors demand to hold the debt of Canada’s corporations rather than its federal government narrowed to 134 basis points, or 1.34 percentage points, from 135 on Nov. 12, according to Bank of America Merrill Lynch data. It’s the smallest spread since May.

Relative yields on U.S. corporate bonds held at 176 basis points, the same as on Nov. 12, the Merrill data showed. Global corporate spreads were 166 basis points, from 167. Canadian corporate bonds have lost investors 1.2 percent this month, compared with declines of 1.5 percent for U.S. company debt and 1 percent for global corporates.

Provincial Bonds

In provincial bond markets, relative yields were unchanged at 51 basis points, down from 53 basis points the prior week and matching the tightest spreads since April. Spreads have shrunk from as wide as 71 basis points on May 21. Provincial bonds are outperforming U.S. municipal bonds. Provincials have returned 6.2 percent this year, compared with 4.9 percent for municipals.

Canada will auction C$1.4 billion in 30-year bonds tomorrow. The 4 percent bonds mature in June 2041. The previous auction of 30-year bonds, on Sept. 1, drew an average yield of 3.489 percent and a bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered, of 2.29 times.

The benchmark 30-year bond yield fell five basis points today to 3.68 percent. Yesterday, it touched 3.735 percent, the highest level since July 30. The price of the 5 percent security due in June 2037 rose 97 cents to C$122.32.

10-year Spread

Canada’s 10-year bonds yielded 22 basis points more than the equivalent maturity U.S. security. The so-called yield advantage in Canada’s favor has declined from 37 basis points on Oct. 7, which was the most since January 2009, according to Bloomberg data. It has averaged about 12 basis points in Canada’s favor over the past decade.

Canadian government bonds have lost 1.7 percent so far in November, headed for the worst monthly performance since December, the Merrill data show. Treasuries are down 1.4 percent this month, while global sovereigns lost 1 percent.

Canada’s factory sales fell less than economists forecast in September, as automobile demand tumbled while primary metal, petroleum and coal receipts increased. Sales fell 0.6 percent to C$45.1 billion, the third decline in four months, Statistics Canada said today. Economists in a Bloomberg News survey predicted a 0.9 percent drop.

CU Inc., a natural-gas distribution company, sold C$125 million in 4.95 percent bonds maturing in November 2050. The bonds were priced to yield 126 basis points over comparable government debt.

The Parliamentary industry committee will hear testimony from witnesses including the Canadian Council of Chief Executives and former employees of bankrupt Nortel.

Less Attractive

Opponents, including the CCCE, warn the legislation would make the country’s bonds less attractive to foreign purchasers and deter investment in ailing companies. It could also discourage firms from running so-called defined-benefit pension plans, which guarantee a given income amount for retirees, and encourage defined-contribution plans, in which workers’ retirement income depends on how their investments have done.

“Passage of the bill in its current form could have a very dramatic and permanent effect on the Canadian bond market,” Stephen Dafoe, a corporate bond analyst at Bank of Nova Scotia’s Scotia Capital unit in Toronto, wrote in a note to clients. “The impact would be quite material, triggering hundreds of millions or even billions of dollars of losses in market value.”

Dafoe estimated that ratings companies like Standard & Poor’s Ratings Services would likely downgrade firms that have unfunded pension liabilities exceeding 20 percent of their assets, leading to a one-notch credit rating drop for about a fifth of corporate bond issuers.

Cost of Capital

The bill would “increase the cost of capital for businesses,” said Jack Mintz, an economist and public-policy expert at the University of Calgary who studies pension reforms. “It may actually have a bit of a shoot-yourself-in-the-foot type consequence, where a lot of companies would say, if I want to have a lower cost of capital, I just won’t even have a defined-benefit plan in the first place.”

Mintz said there would could be better ways to address the current pension problems, such as requiring defined-benefit plans to keep a reserve the way companies that provide annuities do, or by requiring investment in safer securities.

Lawmakers could address the issue of pension shortfalls without upsetting markets by creating a government-managed insurance plan, as the U.S. has done with its Pension Benefit Guaranty Corp., Royal Bank’s Allen said.

If passed by the committee, the bill would “probably” face a final vote in the House of Commons at the end of February before being sent to the Senate, Karl Belanger, a spokesman for the NDP’s Layton, said in an e-mail.

Money ‘Earned’

Rafferty, a lawmaker from Thunder Bay, a northwestern Ontario city that’s about 375 miles north of Madison, Wisconsin, said thousands of people in his district faced losing up to 40 percent of their retirement income after AbitibiBowater went into bankruptcy protection with a C$1.3 billion shortfall in its pension fund.

“That was not just money that they were given or promised, that was money that they have earned,” Rafferty told lawmakers in April as the House of Commons prepared to vote on the bill. Rafferty was travelling yesterday and could not be reached for comment.

“I’d say forget it,” said Nelson Wiseman, a professor of political science at the University of Toronto. “These things are largely put out by private members to get the kind of attention they’re getting and puff up their chest in their own constituencies.”

Wiseman said that if the government supported the principles of the legislation, it would delay it and present its own law to be able to claim credit for the changes.

Last month, lawmakers defeated in a 140-134 vote a private member’s bill that would have forced the government to probe human-rights and environmental allegations against Canadian mining companies operating overseas.

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