Outlook 2012: Canadian bonds trade off new issue market; lack of supply to help high yield

By Cristal Cody

Prospect News, Dec. 30 - Canadian secondary markets traded mostly off of new issuance over 2011, leaving room for improvement in 2012, market participants said.

"If we get some stability in the first quarter, there's certainly some room to improve here, but investors are going to be reluctant to buy in the secondary market because they don't want to pay the offer when they know there's new issue concessions," an informed bond source said. "It really is a new issue market as far as buying goes."

Corporate bond spreads are not expected to see a huge gap tighter, a source said, but the "more issuers that come, the more attractive secondary spreads get."

Secondary volumes were not robust in the first half of 2011 as issuance rose, a source said.

Bond yields traded lower, too, over the year.

The Markit CDX Series 17 North American investment-grade index widened to a spread of 122 basis points by late December from a spread of 83 bps at the start of 2011.

High-yield bonds returned 4% over the year compared to more than 10% the previous year.

"Underlying interest rates have hit historical lows," a bond source said. "Despite the widening in credit spreads, yields have come in significantly, and that provides very attractive all-in corporate rates for the corporate borrowers."

Investors have a "lot of cash to put to work; it's just a matter of finding a stable platform," the source said.

Spreads likely to tighten

Because of the lack of new supply in the last part of 2011, corporate bond spreads are expected to tighten slightly in the beginning of 2012, sources said.

"If there's a flood of new supply, they'll probably widen out, but that's the expectation going forward," one source said.

Canadian and U.S. government bonds saw record low yields over 2011 in reaction to the financial debt crisis in Europe.

At the start of the year, Canada's 10-year note yield traded at 3.175%. Ending the year, the 10-year note yield was seen at 1.95%.

"We've had fresh lows in the U.S. and Canada all the way through this past year," a bond analyst said.

Canadian sovereign debt yields are expected to rise in 2012 if Europe resolves its financial problems.

"Underlyings were at historical lows and we continue to grind lower in terms of Canada and U.S. Treasury yields," a bond source said. "It's hard to see them getting lower, but we've been saying that for the last couple of months."

New issuance on tap

Steady issuance is expected in 2012 for high-grade and provincial bond markets.

About C$60 billion to C$70 billion of provincial deals are forecast in fiscal 2012, which starts April 1. The largest issuer is expected to be the Province of Ontario, which needs about C$37 billion in borrowing, a source said.

The provinces likely will start issuance fairly quickly in January in Canada and the United States.

"About 80% have completed their borrowing requirements, so we have them needing an extra C$18 to C$19 billion in the next there months," an informed source said.

The corporate market is expected to see about C$70 billion of new issuance in 2012, led by financials, a source said.

"The big five or six Canadian banks will dominate again," the source said. "We'll see healthy issuance from the utilities and the telecom sector."

The new offerings in January should help spreads perform better.

"Things seem to be stabilizing in Europe," a source noted. "As long as that continues, we'll see spreads continue to tighten and probably see underlying Canada yields increase."

High-yield performance

Canada's high-yield market had a good year, but spreads did not perform as well as in 2010.

"This year, the total return was plus 4%, which outperformed the U.S. but certainly wasn't like 2010 where you had low teens returns. It was like 11%," a trader said.

Canadian high-yield bond spreads ended the year trading with a "good bid" and should trade stronger in the upcoming year, the trader said.

"People had too much cash going into the year-end, so I suspect that with the lack of primary supply, people will probably be looking to add product and things will grind higher because dealers don't have inventory."

Junk bond issuance may be flat to down from the 21 deals seen in 2011, though a couple of deals are likely in January and early February, sources said.

"There's probably not going to be any LBOs in Canada," one high-yield source said.

Issuers to watch

In the secondary market, high-yield issuers to watch in 2012 include Connacher Oil & Gas Ltd. (Caa2/BB-), Ford Credit Canada Ltd. (Ba1/BB+/DBRS: BB) and Canadian Satellite Radio Holdings Inc. (not rated), the trader said.

"We're still pretty optimistic and think Ford is getting upgraded to investment-grade," the trader said.

If Ford Credit, the financing arm of Ford Motor Co., is upgraded, the company's three tranches of outstanding Canadian bonds are likely to tighten by 100 bps, the trader said.

Toronto-based Canadian Satellite's 9¾% senior notes due 2018 also are expected to be active since the company is deleveraging after the merger with Sirius Canada Inc. in 2011.

"We expect the bonds to go higher in 2012 - they're a top pick," the trader said.

Connacher Oil & Gas also is on the radar after the company rejected an unsolicited takeover offer in December.

Connacher Oil, a Calgary, Alta.-based crude oil and natural gas company, has 8¾% notes due 2018 outstanding in the Canadian market, which were quoted in late December at 90 bid.

"If they get taken out Q1, their bonds will go up 20 points," the trader said.

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