Monday, July 14, 2014

Credit Ratings and Bond Yields

(Updated 11 may 2018 before june election)

Quebec is borrowing at lower interest rates than Ontario for the first time in history.

For the first time ever, in June 2017 Standard & Poor's rated Quebec bonds as lower risk than Ontario bonds.  


Rating Agency
Province of Ontario Bonds
Province of Quebec Bonds
Rating
Rank out of 10 Provinces
Rating
Rank out of 10 Provinces
Dominion (DBRS)
AA (low)
4th
A (high)
5th (tied)
Moody’s
Aa2 (negative)
8th (tied)
Aa2 (stable)
4th (tied)
Standard & Poor’s
A+ (stable)
4th (tied)
AA- (stable)
3rd
Sources: Rating agency websites 18 april 2018. I calculated the ranks. 
Note: Fitch also rates Ontario (AA-) and Quebec (AA-) bonds, but does not rate all Canadian provinces.
 
Critics discount the work of bond-rating agencies. And, there is academic evidence that rating agencies follow, rather than lead, the bond market. Bond raters may not be perfect, but their relative assessment of governments is usually accurate.

What counts is the interest rate that governments have to pay when they borrow. And, just as a low score means you are a better golfer, lower is also better for borrowers when it comes to interest rates.

Prior to the oil price collapse, interest rates on long-term bonds confirmed the DBRS and S&P ratings of Ontario and Quebec bonds in the middle of the provincial pack. However, financial markets are now rating both Quebec and Ontario bonds as lower-risk than Alberta and Saskatchewan bonds even though those western oil province bonds have higher ratings from the agencies. Oil-dependent Alberta is now facing slightly higher interest rates even though Quebec and Ontario bonds are rated lower than Alberta bonds by all rating agencies. 

Newfoundland bond rates have moved well above comparable rates for Ontario and Quebec. Oil prices and provincial government oil royalty revenues have recovered a bit recently, but I say "caveat emptor" to all Newfoundland bond owners.


Government Issuing Bond
Maturity Date
Yield
Canada (Federal)
6/1/2029
2.345%
British Columbia (BC)
6/18/2029
    2.92%
Saskatchewan
3/5/2029
3.04%
United States (US$)
8/15/2029
2.97%
Ontario
3/8/2029
 3.01%
Quebec
10/1/2029
2.99%
Newfoundland 
10/17/2029      3.24%
Manitoba
9/5/20293.1%
Ontario
6/2/20373.14%
Quebec
12/1/2038
3.12%
Manitoba
3/5/2041
3.27%
Canada (Federal)
6/1/2041
2.41%
Alberta
12/1/2040
3.2%
BC
6/18/2040
3.07%
Saskatchewan
6/1/2040
3.21%
Ontario
6/2/2041      3.15%
Quebec
12/1/2041
3.12%
Source: TD Waterhouse Ask Yields on 11 May 2018. 
Note: The wide spread between federal and provincial bond yields partly reflects investors’ greater ability to trade federal bonds. The bonds above were issued at varying rates. The yields above indicate what interest rates the governments could borrow at on 5-11-2018 for long-term bonds maturing on the dates above.   


The slightly higher interest rates for Ontario bonds vs. comparable Quebec bonds indicate that bondholders attach a slightly higher risk probability to a worst-case scenario of Ontario having to delay interest payments before bonds mature or being unable to pay off the principal at maturity. To the best of my knowledge, the present period is the first time in history that interest rates have been lower on Quebec bonds than Ontario bonds. 

If you think that the prospect of a provincial government being unable to make interest payments seems unlikely, so did Greek bondholders before the 2008 world financial sector crash. I certainly do not mean to suggest that any Canadian provincial government is heading for a Greek-style bond default. But, there is a chance that some provincial governments will face lower demand for their bonds during the next recession.

Interesting to see that interest rates are higher in May 2018 than in July 2016.


Government Issuing Bond
Maturity Date
Yield
Canada (Federal)
6/1/2029
1.37%
British Columbia (BC)
6/18/2029
    2.22%
Saskatchewan
3/5/2029
2.43%
United States
8/15/2029
1.698%
Ontario
3/8/2029
 2.27%
Quebec
10/1/2029
2.34%
Newfoundland 
10/17/2029      2.87%
Alberta
9/20/2029
2.45%



New Brunswick
9/26/2043
3.10%
Manitoba
3/5/2041
2.90%
Canada (Federal)
6/1/2041
1.74%
Alberta
12/1/2040
2.87%
BC
6/18/2040
2.655%
Saskatchewan
6/1/2040
2.898%
Ontario
6/2/2041      2.71%
Quebec
12/1/2041
2.765%
PEI
6/27/2042
3.06%
Source: TD Waterhouse and CIBC Investors Edge Ask Yields on 15 July 2016. 
Note: The wide spread between federal and provincial bond yields partly reflects investors’ greater ability to trade federal bonds. The bonds above were issued at varying rates. The yields above indicate what interest rates the governments could borrow at on 7-15-2016 for long-term bonds maturing on the dates above.

However, interest rates in May 2018 are still below summer 2014 levels after the 2014 Ontario election.

 Issuing Bond
Maturity Date
Yield
Canada (Federal)
06/01/2029
2.4597%



British Columbia
06/18/2029
3.22%
Saskatchewan
03/05/2029
3.223%
Newfoundland
10/17/2029
3.425%
Ontario
06/01/2031
3.487%






Canada (Federal)
06/01/2041
2.752%
Alberta
12/01/2040
3.487%
BC
06/18/2040
3.512%
Saskatchewan
06/01/2040
3.525%
Manitoba
03/05/2042
3.582%
Ontario
06/02/2041
3.677%
Quebec
12/01/2041
3.745%
Source: TD Waterhouse and CIBC Investor's Edge Ask Yields on 07/14/2014.  

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