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Junk Bonds Rally on Dearth of High-Yield Sales: Canada Credit

The yield premium investors demand to own junk bonds in Canada is near the lowest level in more than two years relative to those for investment grade securities amid a shortage of new debt sales.

The gap narrowed to as little as 3.31 percentage points on Jan. 14, the slimmest margin since Oct. 23, 2008, according to Bank of America Merrill Lynch indexes. The spread widened 0.06 percentage point, or six basis points, through yesterday to 3.37 percentage points.

A four-week pause in issuance has increased demand for Canadian-dollar denominated bonds sold by Air Canada, Cara Operations Ltd. and other companies in 2010, a record year for high-yield debt sales in Canada.

“Existing product is definitely trading more expensive than a month ago,” said Mark Wisniewski, a fund manager who runs about C$500 million ($504 million) of Canadian high-yield debt at Gluskin Sheff + Associates Inc. in Toronto.

Canadian high-yield bonds returned 0.85 percent this month though yesterday, compared with a decline of 0.18 percent for investment-grade debt, according to Bank of America Merrill Lynch index data.

“The Canadian-dollar high-yield market is well bid,” Craig Wilson, a Toronto-based managing director of high-yield trading at Canadian Imperial Bank of Commerce said in a telephone interview. “Fund managers are getting strong inflows.”

Returns this month for Canadian junk bonds trail the 1.5 percent return on U.S. high-yield debt and 1.6 percent on global junk bonds, according to Bank of America Merrill Lynch data.

Record Sales

Canadian Imperial, the country’s fifth-largest bank, expects C$5 billion to $6 billion of Canadian-dollar high-yield debt to be sold this year, Wilson said. Last year companies issued about C$3.35 billion, up from about C$800 million a year earlier, according to Bloomberg data.

New issuance was also slow at the start of 2010, with just C$100 million of high-yield debt sold in January, and C$1.1 billion in the first three months, Bloomberg data show.

Elsewhere in credit markets, Hydro-Quebec sold an additional C$500 million of 5 percent bonds maturing in 2050 at 87.5 basis points more than comparable government of Canada debt.

The province of Ontario sold an extra C$600 million of 4.65 percent 40-year bonds at 84.5 basis points more than Canadian benchmark bonds.

Corporates Fall

Total Energy Services Inc., a provider of rental equipment for the oil and gas industry, sold C$60 million of 5.75 percent convertible bonds maturing in March 2016, according to Bloomberg data.

Cadillac Fairview Corp., the real estate unit of the Ontario Teachers’ Pension Plan, sold C$2 billion of notes in a two-part transaction, according to a person familiar with the offering.

The extra yield investors demand to own the debt of Canadian companies rather than the federal government narrowed by one basis point yesterday to 132 basis points, or 1.32 percentage points.

The difference in yields between Canadian government 30-year bonds and two-year notes widened to 200 basis points from 184.8 basis points on Dec. 31 and the widest since Dec. 15. The so-called yield curve is the flattest among Group of Seven countries, reflecting growing demand for Canada’s long-term bonds.

The Bank of Canada yesterday predicted a “modest” economic recovery hampered by a strong currency that restricts exports, and said a “gradual” reduction of monetary stimulus through 2012 will keep inflation under control.

Economic Rebound

Output will grow at a 2.5 percent annualized pace in the first quarter of this year following a 2.3 percent expansion from October to December, Canada’s central bank said. Policy makers yesterday raised their forecasts for the last three quarters of 2011, with the expansion reaching a peak of 3 percent in the third and fourth quarters.

“The Canadian economy is now in a period of more modest growth,” according to the Monetary Policy Report released in Ottawa. “With ongoing productivity challenges and the persistent strength of the Canadian dollar, the anticipated recovery in net exports may not fully materialize.”

Bank of Canada Governor Mark Carney kept his key borrowing rate at 1 percent Jan. 18 and yesterday’s report reiterated that any future increases would be “carefully considered.”

The Canadian dollar weakened for a second day following the report, after reaching the highest since May 2008 earlier this week.

High-Yield Rally

The yield premium on Air Canada’s C$300 million of five-year notes over comparable government of Canada debt is near its narrowest since the bonds began trading in August, according to Bloomberg data.

Canadian high-yield debt returned 22 percent last year after a 32 percent gain in 2009, according to Bank of America Merrill Lynch data. That compares with a 15 percent total return for comparable debt in the U.S. Canadian junk bonds had positive returns every year since 1998, according to Bank of America Merrill Lynch.

“There’s no reason to think issuance will fall off this year,” Ed Sustar, a Toronto-based credit analyst at Moody’s Investor Services, said in a telephone interview. “Investment bankers are out there pitching deals like crazy.”

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