International investors in search of Canadian opportunities

For international investors, Canada’s public sector borrowers remain a sought-after but elusive bunch. The appeal is not difficult to spot — a group of highly rated borrowers from a country that, almost alone in the Western world, has had a good financial crisis. But access to Canada’s crown corporation and provincial debt remains a problem for international investors given the way the sector tends to raise bond funding. 

Canada’s provinces — from Aa2/A+/NR (Moody’s/Standard & Poor’s/Fitch) rated Quebec, Nova Scotia, New Brunswick, and Newfoundland and Labrador up to Aaa/AAA/AAA rated British Columbia — are all aiming for a return to fiscal balance. 

That sort of good borrower behaviour and the benefit of the Canadian halo effect that has beamed down from the safe haven sovereign has drawn international investors into the Canadian provincial bond market. “International investors appreciate that long history of the provinces recognising that they need to tackle deficits before demographic pressures come to bear,” says Warren Lovely, head government strategist at CIBC.

The most problematic of these markets for investors to enter has been the domestic market, where the provinces raise the bulk of their funding. New provincial bond issues tend to be bought deals, launched and priced in a very short space of time. With the amount of domestic provincial issuance falling from its 2010 peak of around C$100bn ($96bn) to C$72bn in fiscal year 2012-13 to C$70bn this fiscal year, the problem of getting hold of the bonds in the primary market is growing ever more acute.

For many international buyers the deal windows, which last a couple of minutes rather than hours, are too short and take place in the wrong time zone for them to participate. That has kept investors restricted to the sovereign market where primary access is easier, the sovereign-guaranteed Canada Mortgage Bond (CMB) market and the liquid secondary market for provincial debt.

With a strong domestic bid, the provinces have not needed to court international buyers to participate in their Canadian dollar programmes. Nonetheless, international buyers are keen to enter the market, says Mark Chandler, managing director in global research at RBC Capital Markets. 

“When we go out on the road to see investors, we’re being asked a lot more questions about high grade Canadian provincial and agency products,” he says. “Given the depletion of triple-A rated assets around the globe, some of them view Canada as not just an opportunistic measure for a financial crisis, but a market they’re planning to stay in.”

International investors have found two ways around the problem of gaining access to the primary domestic market for provincial bonds, principally those of British Columbia, Ontario and Quebec — the three biggest provincial borrowers. The first is simply setting up a trading desk in the right time zone, typically one in New York, or using existing US trading desks as a springboard into Canadian markets.

The second has been the use of carve-outs with the Canadian intermediary banks that underwrite Canadian provincial deals. Canadian provinces have tried to capture specific large ticket interest — some of it from overseas — with carve-outs of their domestic issuance since 2011, managing about C$16bn worth since they were begun in 2011.

Carve-outs are, in effect, protected orders, only on bought rather than book-built deals. A province will guarantee a certain amount of bonds to a dealer in the syndicate leaving the rest of the issue to be underwritten in the normal way, allowing the underwriter in question more time to engage the overseas or large domestic buyer. 

The carve-out system has been useful in particular to larger borrowers such as Ontario which are more often engaged with international investors and can use the carve–outs to track their activity.

Ontario and Quebec are the two largest provincial borrowers. Ontario’s borrowing programme has fallen by C$5.7bn to C$33.4bn since it was set in March 2012 for fiscal year 2013-14. By August 28 it had raised C$15.4bn — about 5% ahead of where it anticipated it would be at that point. The province has sold more bonds domestically — about 83% of it programme — than it normally does (around 78%).

Quebec is further advanced, having raised C$9.5bn of its C$11.7bn programme for the fiscal year. With such large programmes, both provinces have led their sector’s efforts to sell debt to international investors.

Quebec has been an international borrower since 1879 when it became, according to the New York Evening Post, the first foreign borrower on Wall Street. It has been borrowing in European currencies since the 1960s, most recently issuing an oversubscribed €1bn 2.25% July 2023 bond earlier in the summer. Ontario’s most recent international sale came six days later on July 16 — a $2.5bn three year deal that attracted a $3.4bn book.

The international buyer base offers Canadian provinces a chance to reach a more diverse range of buyers and a bigger pool of liquidity.

But, for all the new portfolios of Canadian dollars that have been built internationally in recent years, there are still swathes of investors, particularly in the US, who have no means or intention of buying Canadian dollar-denominated securities, but have every will to expose themselves to Canadian credit.

“US investors can make up to three quarters of an order book for a dollar deal from a Canadian province,” says Paul Hadlow, managing director and head of US debt capital markets at CIBC. “Central banks and bank treasuries tend to buy the three and five year deals, with asset managers more prevalent in longer dated trades.”

In addition to the traditional Asian central banks and US asset managers, Canadian public sector bankers say they are now seeing increased interest from supranationals and Latin American central banks in Canadian provincial dollar debt.

In turn, Canadian borrowers can use this demand to drive down their borrowing costs or relieve pressure on the domestic borrowing programmes.

The biggest market for Canadian provinces is by far and away the US dollar market, with US buyers the main source of demand. The US remains the first and most frequent port of call on Canadian borrowers’ roadshow schedules. 

But there is also growing interest from outside of Canada’s nearest neighbour and biggest trading partner. Quebec’s euro deal testifies to the interest in Europe for Canadian provinces. Meanwhile, Asian central banks have been long time buyers of Canadian province dollar deals.

And their interest is not restricted to American dollars. In early September Manitoba became the latest Canadian province to tap the Kangaroo market, bringing a A$100m 10 year trade although that remains the only province deal outside of US or Canadian dollar markets, with the exception of Quebec’s euro benchmark, since July 2012 when Manitoba did another 10 year Kangaroo, that time for A$200m.

Manitoba is also a province with a medium term note programme. The borrower, which by early October had raised just over half of its C$4.8bn programme for the fiscal year, uses private placements and floating rate notes to augment its visits to the dollar benchmark market and its domestic funding. The deals offer reverse enquiry buyers a chance to buy Manitoba paper in smaller size on a one-off basis.

Senior Canadian public sector bankers say that MTN programmes have proliferated throughout the market in recent years. “If an investor comes in looking for say, an eight year bond, borrowers will look at that now,” says one Toronto-based head of government finance. “In the past they wouldn’t have been interested but now they realise they can drive some price tension that way. They realise that when an investor comes to them, they have the power.”

Export Development Canada (EDC), bearing the explicit, irrevocable and full faith and credit obligation of Canada, remains the one way to buy Canadian sovereign risk in international markets away from the sovereign’s once-in-a-blue-moon appearances in dollar or euro benchmark markets.

The country’s export financing agency is also a borrower with a programme that is set to grow if forecasts for the Canadian economy bear out. With domestic demand sagging, Canada’s growth is likely to be export-led in the coming years, in particular with exports to its biggest trading partner the US on the increase if the US economy continues to grow. (See interview with Central Bank Governor Stephen Poloz on page 18). 

That will mean a greater demand on EDC’s services. With Canadian banks’ lending conditions still somewhat tighter than the pre-crisis levels, there is even bigger reason to suspect that EDC will need to be in the markets more often or in bigger size in future.

The agency has a borrowing programme for 2013 similar to last year’s which started at US$6.5bn-$7bn and grew to $8bn. It has gone about meeting that target in a range of currencies. So far this year it has issued bonds in Chilean pesos, New Zealand dollars in the Kauri market, Australian dollars, Norwegian kroner, sterling, Turkish lira and made its debut in offshore Chinese renminbi.

The dim sum trade, a CNH100m 2.1% July 2014 bond done in July, was unlike many of EDC’s international offerings.

“Our first dim sum bond was investor specific,” says Chad Buffel, EDC’s senior portfolio manager. “As it is a new market for us, we are assessing our requirements and what we can provide. We don’t want to create expectation and then not deliver.”

That cautious approach is in character with EDC’s approach in general. The agency only tends to enter markets when it knows it can maintain a long term strategic presence. 

“We have needs in all currencies but our bond deals aren’t linked to specific projects,” says Buffel. “They are strategic markets for us. We want to be in the market when the investors are there. It might be more costly but we’d rather have investor demand so that the product performs.”

EDC aims to be adaptable to market conditions. But that does not just apply to non-dollar markets. The borrower was happy to issue short-dated dollar floating rate notes this year because investors clamoured for them. 

It avoided big deals in the format as most of the trades done had a two year maturity whereas EDC looks for three or five year deals, typically. But it was still quick to tap demand when it arose.

“That’s the point of investor relations work,” says EDC’s vice president and treasurer, Susan Love. “It is not just to tell them about your credit but to find out what investors need and to be open to their ideas.”

EDC says it has seen greater interest from the US as government sponsored enterprise issuance has declined.

Another new market that EDC is monitoring is the socially responsible investment (SRI) market through themed bonds. With a lending portfolio as diverse as EDC’s it must review its own portfolio to see if a green bond would suit the sort of assets it has.

“Our lending side promotes on the clean technology sector and anything environmentally or socially responsible,” says Love. “So it makes sense that treasury looks at ways to support those sorts of efforts.”

The other large presence in the Canadian public sector debt market is that of the Canada Mortgage and Housing Corporation (CMHC). It issues Canada Mortgage Bonds (CMBs) through a special purpose trust, the Canada Housing Trust (CHT). The bonds are guaranteed by CMHC and backed by the Canadian sovereign.

CHT pools mortgages packaged into National Housing Act Mortgage-Backed Securities (NHAMBS) from a list of approved mortgage sellers, which it then repackages into CMBs — bullet maturity bonds paying fixed semi-annual interest in either five or 10 year maturities, and floating rate notes.

CMHC issues and guarantees around C$40bn of CMBs every year through the CHT — a volume it does not expect to change anytime soon. Around 25% of the programme is sold internationally.

But there is growing interest in the market. “There is a strong international following for CMBs,” says CIBC’s Lovely. “We continue to educate new investors in the programme.”

Analysts predict that with yields and supply falling in the government bond market, the CMB market could be set to become a government bond proxy as investors search in new places for yield.

That is reckoned to be a far more important factor for the CMB market than either the prospects of a housing bubble in Canada, which Canadian bankers and CMHC say are overdone, or the recent cap on the amount of guarantees CMHC can provide on NHAMBS products.

“The amount guaranteed under the CMB programme is separate and distinct from the National Housing Act Mortgage-Backed Securities guarantees,” says Mark Chamie, CMHC’s treasurer. “The market for NHAMBS has an C$85bn volume limit for 2013 and that limit has no impact on our ability or willingness to provide guarantees on CMB issues.” 

Away from the big issuers, the hunt for credit quality combined with yield continues. Senior Canadian public sector bankers say that international investors are drilling down beyond the provincial and crown corporation level to find every last source of Canadian public sector credit.

“We’re seeing international investors coming in for triple-A rated municipalities,” says one senior Toronto-based SSA banker. “We have not seen them there before and they show up wanting to take C$25m tickets. That’s a big ticket in those markets.”

Bankers say that is a direct result of growing international Canadian dollar investment portfolios. Once overseas investors have grown accustomed to the government bond market and as its yield levels fall, they are sacrificing a degree of liquidity by looking into smaller markets such as municipal bonds.

“We used to go to Asia and it was strictly corporate bond chatter,” says one senior Canadian public sector banker. “Now we take along our corporate analyst and talk about lots of other products that are available to them now they have a dedicated portfolio in Canada. These portfolios appear to be sticky.”

Whether those pools of cash remain in Canadian dollars and continue to find new havens ever deeper in the Canadian public sector remains to be seen.

A great deal is riding upon Canada’s economic growth, which is expected to be export-led in the years to come with the domestic trend set to be sluggish. But the Canadian public sector is wedded to the idea of fiscal balance which will keep bond supply suppressed and an already rare group of credits in international markets rarer still.