Canadian Provinces Forced to Pay Up as Foreigners Unload Bondsby
Widest yield spreads since financial crisis amid oil rout
`Maple leaves turning,' leaving the question: Who will lend?
Foreign investors are cashing out of the Canadian provincial-bond market just when borrowers need them the most.
Yields of Canadian provincial bonds have widened against their federal benchmarks, with oil-producing regions such as Newfoundland, Saskatchewan and Alberta hit the hardest. Spreads for those provinces have widened at least 35 basis points since the beginning of August, when the first wave of selling began, compared with about a 25-basis point increase for Ontario, Quebec and British Columbia debt, according to Bank of America Merrill Lynch data.
Relative borrowing costs for the provinces have increased as global central banks are cashing out their Canadian reserves in an effort to prop up their own currencies, according to National Bank Financial. Meanwhile, oil-dependent Canadian provinces are looking for more capital as the protracted crude price rout has wiped out revenues.
"That earlier foreign selling pushed provincial-credit spreads to the widest levels that we’ve observed in the post-crisis period," said Warren Lovely, a managing director and head of public-sector research and strategy at National Bank Financial in Toronto. "We digested and observed what really, by recent standards, was some pretty exceptional cheapening of provincial credit versus the underlying Government of Canada bonds."
Global foreign-exchange reserves have declined more than 5 percent over the past year to $11 trillion amid plummeting commodity prices and volatile financial markets. Chinese reserves, representing about a third of the world total, have declined 13 percent to $3.3 trillion as the country seeks to defend its currency amid an economic slowdown.
Foreign investors poured money into Canadian and provincial debt after the 2008 financial crisis, when the country’s strong budget position, AAA credit rating, and secure banks made its currency look like a good bet, said Raymond Humphrey, a portfolio manager at AllianceBernstein Holding LP in New York, who helps manage $400 billion in fixed income.
Since then, the economy has suffered from the global plunge in commodities, with the Canadian dollar declining to its weakest level versus its U.S. counterpart in almost 13 years this month. It traded at C$1.4196 at 8:19 a.m. in Toronto. At the same time, yields on Government of Canada bonds are at almost all-time lows on haven demand.
"All those things kind of helped them weather the storm, but now it seems the maple leaves may be turning a little bit," Humphrey said by phone. "With yields as low as they are, something’s got to go."
Humphrey’s fund is underweight Canadian provincial debt, with a preference toward the more easily traded and stronger credit from Ontario, Quebec and British Columbia. He said he has no immediate plans to buy more provincial debt.
"We’ve gone elsewhere in the global fixed-income markets to find value," Humphrey said. "If those trades work out, we’ll probably come home, and parking in the provinces would probably be a pretty good idea."
International investor retreat from the Canadian provincial-bond market is going to make it harder for issuers to find buyers for the C$70 billion ($50 billion) to C$75 billion they’re going to need to borrow this year, Lovely said. Domestic investors aren’t rushing into the market either because new regulations make it harder to trade, he said.
The average sovereign-wealth fund or central bank has about 2 percent of its reserves in Canadian dollars, and about 10 percent of Canada’s C$540 billion Canadian dollar-denominated provincial-bond market is held by foreigners, Lovely said.
There are still some investors who like provincial bonds, including Pacific Investment Management Co.’s Ed Devlin. He sees a buying opportunity, particularly in Alberta.
"Alberta has cheapened up a lot because of some of the difficulties in the oil patch, so we’ve actually bought some Alberta bonds recently," said Devlin, who manages the Canadian investments of Pimco’s $1.5 trillion in assets. "While Alberta has problems, it has a pristine balance sheet and it’s got a lot of tax capacity.”
Still, Alberta is forecasting a C$6.1 billion deficit in 2015, while Newfoundland expects to be almost C$2 billion over budget. Both provinces recently had their outlook lowered to negative from stable by credit-rating company DBRS Ltd. With a weak global backdrop and competition from other markets, Canadian provincial debtors are still hunting for the right price point for investors, Lovely said.
"We’re just going to need to find a level -- a low enough price, a wide enough spread, a cheap enough currency -- where those investors care to participate," he said.