State Street Pares Provincials as Deficits Rise: Canada Credit

State Street Global Advisors, which manages about C$2 trillion ($2.01 trillion) in assets, is reducing its holdings of provincial bonds as Canadian local governments wrestle with record deficits.

Provincial debt has gained 3.1 percent since December and is on pace for its worst annual return since investors realized losses on the securities in 1999, according to Bank of America Merrill Lynch index data. Provincial bonds, which returned 11.6 percent last year, trailed both corporate and federal government securities in November.

Ontario and Quebec are seeking to cut deficits as reduced growth forecasts and rising costs jeopardize revenue assumptions amid political turmoil in the nation’s two most populous provinces. The Montreal-based unit of State Street Corp., the third-largest custody bank, is concerned slower-than-expected growth in Europe and the U.S. will make it more difficult to return to balanced budgets while the nation also faces a possible housing-market correction.

“There’s a lot of headwinds coming up in terms of growth,” Claudio Ferri, State Street’s vice president and senior portfolio manager of fixed income, said in a telephone interview Nov 28. “We’ve been underweight provincial bonds for about a month or so.”

Unresolved Leadership

Ontario, Canada’s most populous province, plans to eliminate its C$14.4 billion deficit by the year beginning April 2017. Those plans may be tentative after the province’s premier, Dalton McGuinty, resigned Oct. 15, leaving his party’s leadership unresolved.

“That’s way out there,” said Ferri, who’s in charge of his firm’s provincial strategy. He declined to give specific weightings. “God knows what can happen between now and then.”

Elsewhere in credit markets, the federal housing agency Canada Mortgage and Housing Corp. said yesterday its mortgage insurance balance rose 1.6 percent this year through Sept. 30 to C$576 billion.

Cominar Real Estate Investment Trust sold C$200 million of 4.23 percent notes maturing Dec. 4, 2019. Hydro-Quebec sold C$500 million of 5 percent notes maturing Feb. 15, 2050. The notes yield 119.5 basis points more than federal benchmarks. Paramount Resources Ltd. issued C$300 million of sub-investment grade bonds due in December 2019 yielding 7.625 percent.

The province of British Columbia issued C$500 million of 3.2 percent notes maturing June 18, 2044 yielding 94.5 basis points more than federal benchmarks.

Yield Spreads

The extra yield investors demand to own the debt of Canadian investment-grade corporations rather than the federal government was steady yesterday from a day earlier at 139 basis points, or 1.39 percentage points, according to a Bank of America Merrill Lynch index. The yields were little changed at 2.9 percent.

In the provincial bond market, relative yields were unchanged at 80 basis points yesterday. Yields rose to 2.51 percent, from 2.5 percent on Nov. 28, according to a Bank of America Merrill Lynch index.

Canadian government bonds rose, pushing yields on benchmark 10-year debt down one basis point to 1.69 percent at 9:38 a.m. in Toronto. The price of the 2.75 percent security maturing in June 2022 increased 11 cents to C$109.24 in Toronto.

Canadian corporate bonds have returned 6.4 percent this year, compared with a gain of 2.62 percent by government bonds, Merrill Lynch data show.

Provincial bonds have risen 0.35 percent in November, compared with gains of 0.68 percent by corporate debt and 0.54 percent by government bonds.

Housing Market

Canada’s economy is losing some of the steam from a record housing binge since 2008 as consumers respond to steps by policy makers to tighten mortgage lending. In July, Canadian Finance Minister Jim Flaherty toughened rules on government-insured mortgages for the fourth time in four years, while the Office of the Superintendent of Financial Institutions, the country’s banking regulator also introduced stricter standards.

Existing-home sales were 0.1 percent lower in October than the previous month, according to a report from the Canadian Real Estate Association.

In Ontario, home to the nation’s auto factories, manufacturing is in decline, eroding tax revenue, as a stronger Canadian dollar has made it less competitive globally. The loonie, as the currency is nicknamed for the image of the aquatic bird on the C$1 coin, has appreciated almost 60 percent against its U.S. counterpart in the past decade.

‘Still Struggling’

“It takes provincials a bit longer to get their budgets in order than federal governments following a recession,” said James Price, director of fixed income in Toronto at Macquarie Private Wealth, which oversees about C$15 billion in assets. “We’re in that stage where provincial governments are still struggling to put together balanced budgets, and it’s weighing in the credit markets.” Price holds fewer provincial bonds in his fixed-income portfolios than benchmarks recommend.

Moody’s Investors Service downgraded Ontario’s debt rating to Aa2 from Aa1 in April and remains skeptical it can achieve its budget targets.

“We will have to wait and see whether there are any changes to the province’s fiscal plan,” Jennifer Wong, lead analyst at Moody’s for Ontario, said in an e-mailed response to questions. “We did note when we downgraded the province’s ratings earlier this year that there were risks to the province achieving its medium-term fiscal plan given the subdued growth outlook, extended timeframe back to balance and ambitious expenditure targets. We’ll be keeping an eye on things.”

Quebec Budget

In Quebec, Finance Minister Nicolas Marceau has projected the budget will be returned to balance next year. The budget is the first introduced by the Parti Quebecois government of Premier Pauline Marois since it won a provincial election in September. Because Marois failed to win a majority of seats in the legislature, her government needs opposition support to pass laws.

“The Quebec budget has always been an issue,” State Street’s Ferri said. “Another issue with Quebec is the election. With the separatist party taking power now, a lot of people believe that they may not get many things done, that the economy may flounder from here on in.”

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