Outlook 2011: Canadian bond market sales in 2011 expected to surpass 2010 issuance

By Cristal Cody

Prospect News, Dec. 31 - Canadian investment-grade, high-yield and provincial sales rose during 2010, and expectations are on track for issuance to increase in all three markets in 2011.

High-grade sales rose after two years of declines, while the growth of the Canadian high-yield market in 2010 attracted widespread interest.

"One of the predominate trends this year we saw was a lot of Canadian dollar high-yield issuance," a source said. "That was the immaterial change."

The Canadian junk bond market rose from four deals in 2009 to 14 deals totaling C$3.4 billion in 2010. The amount of issuance is expected to stay on track or rise slightly in 2011.

"We don't expect it to slow down," said Michael Wolff, managing director at TD Securities Inc.'s debt capital markets.

The year "was really almost a reopening of the market," he said. "2010 was a significant year."

In November, Newalta Corp., Gateway Casinos & Entertainment Ltd., Livingston International Inc., Cara Operations Ltd. and Paramount Resources Ltd. all sold high-yield deals.

The Nov. 19 sale from Newalta, a Calgary, Alta.-based industrial waste management and environmental services company, was a "blowout deal," an informed source said then of the deal.

Newalta sold C$125 million 7.625% senior notes (B1/BB/) due Nov. 23, 2017 at par, or a spread of 496.9 basis points versus the Government of Canada benchmark bond.

The sale had allocations of 5% to 10%. The bond traded up to 103.5 bid, 104.5 offered.

Quebecor Media Inc. brought the last high-yield deal of the year when it sold an upsized C$325 million 7.375% senior notes (B1/B+/DBRS: BB/) due Jan. 15, 2021 on Dec. 15 at a spread of 395.7 bps over the Canadian government benchmark.

Montreal-based Quebecor Media is a subsidiary of Quebecor Inc., one of Canada's largest communications and media companies.

Steady high-yield pace eyed

One to two high-yield deals a month are likely in 2011, Wolff said.

"We expect it to see the same amount again if not a little bit more," he said.

More buyers are in the country now than two years ago, and foreign interest in Canadian dollar-denominated deals is increasing.

"We have probably more than 100 Canadian-dollar buyers, of which 10% to 20% are U.S.-domiciled buyers buying Canadian-dollar product," Wolff said.

Interest in junk deals is on the rise, in part, because investors are chasing higher yields, but also because of some impact late in the year from income trusts, which lose their tax benefit status on Jan. 1, one source said.

"With investment trusts going away, I think that's created buying, and everybody's going down the capital structure trying to get more income," the source said. "Those two components have been pretty material drivers."

High-grade sales to rise

Investment-grade corporate bond sales hit nearly C$70 billion in 2010, up from about C$50 billion in 2009 after two straight years of declines, and issuance is expected to rise to as much as C$80 billion in 2011, sources said.

The year's deals were led by the financial sector.

Toronto-Dominion Bank sold C$1 billion 10-year medium-term bonds to a good appetite on Oct. 27 at par to yield 3.367%, or a spread of 132 bps over the Canadian benchmark curve. The bonds came slightly tighter than initial price talk of a 135 bps spread.

The bonds are due Nov. 2, 2020 but are structured as a fixed-to-floating rate issue that becomes a floating-rate note after five years.

In December, the Bank of Montreal wrapped a sale of C$1.5 billion 3.49% notes due 2016 and Toronto-based investment management firm CI Investments Inc. sold C$300 million 3.94% debentures due 2016.

"Over the past two weeks, over $8.5 billion in new issues have been priced at a time when leveraged money has been selling and real money, which is overweight credit, has closed its books for the year," strategists with Marret Asset Management Inc. said in a research note.

Government bond yields drop

Government bonds in Canada rallied over the year, sending yields down. On the front end, Canada's bonds could underperform U.S. Treasuries in 2011.

"Canada's 10-year note yield is 50 basis points lower," said Kam Bath, RBC Capital Markets Corp. fixed income strategist. "Canada is outperforming the U.S. toward the end of the year. We think it's a phenomenon that's going to go forward as well."

The Bank of Canada is expected to tighten its schedule in the second quarter, while the Federal Reserve is forecast to stay on hold with the $600 billion quantitative easing program to boost the U.S. economy.

"Two-year bonds could underperform the U.S. because the Bank of Canada is going to restart its tightening cycle in the second quarter and that will cause rates in the front end to rise and will cause a flattening of the two's and 10's curve," Bath said.

Rates in general are expected to rise in 2011.

Over 2010, the Bank of Canada hiked interest rates three times from 0.25% to 1% but is expected to hold the benchmark interest rate unchanged until the second quarter of 2011.

Provincial sales on the rise

Canada's 10 provinces are forecast to sell about C$82 billion of bonds in the fiscal year started April 1, 2010, up from an estimated C$71 billion the previous fiscal year.

"That's all 10 provinces and includes international and domestic total capital markets borrowing," a source said.

Ontario is on track to remain the biggest seller of provincial bonds, while Quebec and British Columbia may not bring as many deals, sources said.

"Ontario is headed for a near record deficit," said Douglas Porter, BMO Capital Markets' deputy chief economist. "They're the biggest borrower so that continues to pump up the provincial level."

While not every province borrows outside of Canadian dollars, "Ontario is quite active outside in the U.S. market," said Andrew Hainsworth, director of debt capital markets at Bank of Montreal.

Statistics Canada reported in December that foreigners have bought C$20.1 billion of provincial bonds through December, beating the previous high annual foreign investment of C$17.5 billion in 1993.

Ontario has sold C$30 billion of bonds since April 1, with about C$18 billion in Canadian dollar-denominated deals and C$12 billion in non-Canadian-dollar markets, he said.

"Their borrowing program is not far off $38.5 billion this fiscal year and they've still got three and a half months," Hainsworth said. "Ontario almost has to go offshore to fund itself to some extent. Ontario and the other provinces are well sought after and have a good following in the U.S."

Quebec has borrowed about C$16 billion in the domestic market.

Provincials a safe-haven

Canada's government and provincial bonds are typically shielded from the fiscal debt concerns in Europe and in the overseas banking systems that shook other markets throughout the year.

"Provincial issuance is generally at a steady rate here in the upcoming year versus this year," Hainsworth said. "Provincial spreads are still quite attractive. You still can pick up about 70 basis points over Government of Canada bonds by buying Ontario's bond."

Provincial bond spreads have remained fairly balanced over the year, he said.

"The five-year Ontario spread versus Canada's were 34, 35 over at the beginning of the calendar and now it's 40 over Canada's," Hainsworth said. "For now the market's able to absorb the issuance and it's been quite popular and well received by investors."

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