Quebec Bond Yields Approach Historic Parity With Ontario
Quebec is reaping the rewards of its improved finances in the bond market, lowering its long-term borrowing costs to near parity with Ontario for the first time.
The spread, or difference in yields, between Ontario’s 10-year bond maturing in June 2026 and Quebec’s securities due in September that year has dropped to less than 1 basis point. The spread on the two provinces’ securities due in 2045 was almost equal last month as well, down from as high as 19 basis points in 2014. In U.S. dollar-denominated bonds, the yield on Quebec and Ontario bonds maturing in 2026 was nearly even at 2.74 percent on Wednesday.
Quebec’s pledge to post a third-straight year of surpluses and reduce borrowing in its 2017-18 budget helped lower the yield premium it offers investors, bringing it in line with its richer and more populous neighbor.
“Quebec is definitely doing the right thing,” Alex Schwiersch, who helps manage about C$3 billion ($2.2 billion) in fixed-income assets at Invesco Canada, said by phone. “There is potential for Quebec bonds to trade through Ontario.”
Even though both Canadian provinces enjoy the same credit grade from the three major ratings companies, investors have always demanded a slightly higher yield when lending to Quebec. That generally reflected its higher debt load relative to the size of its economy, and the province’s budget deficits.
The province is now forecasting five more years of balanced budgets, giving it room to set aside more money for debt reduction. Quebec expects to cut its debt to 52 percent of gross domestic product, from an expected 52.7 percent at the end of last fiscal year. It plans to borrow C$11.3 billion this year, compared with C$22.7 billion in the year that ended March 31, in part due to pre-financing in 2016.
“The reality is that we have just tabled not just a balanced budget, but a balanced fiscal framework for the next five years, and not many provinces do that,” Quebec Finance Minister Carlos Leitao said in an interview with Bloomberg TV Canada on March 29. “That does justify our very solid performance by all” our bond issues.
Quebec on March 30 sold C$500 million of bonds due September 2027 at 77 basis points above similar-maturity Canada bonds, the tightest spread since the province first issued the debt. Similarly, for C$500 million of bonds maturing in December 2048 that was sold on March 2, the spread of 87 basis points was the lowest since the province first sold the bond in September 2015.
By comparison, Ontario sold bonds due in June 2027 at 75.5 basis points above federal government securities on March 23 and June 2048 bonds with a premium of 84 basis points on March 6.
Quebec priced $1.25 billion of 10-year notes in U.S. dollars on Wednesday at 53 basis points above midswaps. It sold similar bonds in April 2016 at 90 basis points above midswaps.
“Quebec saw an opportunity in the U.S. dollar market after recently releasing its budget,” said Jamie Hancock, managing director of Canadian debt capital markets at Bank of America Merrill Lynch, which helped manage the sale. “They have had a strong historical following with U.S. investors who like to see regular participants in the market like them.”
Quebec has also rewarded its bondholders more generously than Ontario this year as its securities have returned 2 percent, compared with Ontario’s 1.8 percent gain, according to Bank of America Corp. index data.
Quebec had “a very strong budget” and the spreads of Ontario and Quebec could go even eventually, depending on Ontario’s budget, said Hosen Marjaee, who oversees about C$35 billion in Canadian fixed income at Manulife Asset Management in Toronto.
Ontario will release its 2017-18 budget this spring, Finance Minister Charles Sousa said last week. He reiterated the province’s long-standing pledge to balance the budget for the first time since before the 2008 financial crisis. In the latest update for the fiscal year that ended March 31, Ontario forecast a C$1.9 billion deficit, down from C$4.3 billion projected initially.
Yet even as Quebec makes progress, investors such as James Dutkiewicz from Sentry Investments Inc. in Toronto are concerned about the province’s ability to remain competitive and finance its social programs.
“You’ll see a lot of money probably sell Quebec when it trades through Ontario by anything significant like three to five basis points, but on a short-term basis they could get to zero or slightly through,” said Dutkiewicz, chief strategist and senior portfolio manager at Sentry, which has C$18 billion under management. “But on a multi-year basis, I don’t know if I’d want to own 30-year Quebec bonds three basis points through 30-year Ontario when I have to figure out in five years whether Quebec can maintain its government-funded social infrastructure.”
For now, the province is enjoying its time in the spotlight, which could result in a rating upgrade, according to Warren Lovely, the head of public sector research at National Bank Financial. Both Quebec and Ontario are rated Aa2 at Moody’s Investors Service, A+ at S&P Global Ratings, and AA- at Fitch Ratings.
“Quebec’s success in reining in a high debt burden has been a game changer for the credit, and is something rating agencies can’t ignore,” Lovely said in a note last week.