Credit Ratings and Bond Yields

(Updated 7 July 2017)
What am I looking for in this blog post? 

Is Ontario maintaining its longstanding fiscal strength relative to Quebec as measured by bond ratings and interest rates? 

When recession next strikes in central Canada, will we see Quebec borrowing at lower interest rates than Ontario for possibly 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 (stable)	4th (tied)	Aa2 (stable)	4th (tied)
Standard & Poor’s	A+ (stable)	5th (tied)	AA- (stable)	3rd (tied)

Sources: Rating agency websites 7 July 2017. 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 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 than Ontario even though 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. If oil prices and provincial government oil royalty revenues stay low, Newfoundland may be the first Canadian province to face severe fiscal difficulties. Caveat emptor, Newfoundland bond owners.

The recent deterioration in oil province bond yields relative to Ontario bonds may reflect concerns that oil and other natural resource prices may stay low for a long period and that resource-dependent provinces may have political problems persuading residents of the need to diversify their provincial government revenue structures away from resource royalties toward income and sales taxes.

Government Issuing Bond	Maturity Date	Yield
Canada (Federal)	6/1/2029	1.98%
British Columbia (BC)	6/18/2029	2.75%
Saskatchewan	3/5/2029	2.92%
United States	8/15/2029	2.55%
Ontario	3/8/2029	2.804%
Quebec	10/1/2029	2.857%
Newfoundland	4/17/2028	3.2%
Alberta	12/1/2033	3.215%
PEI	1/29/2032	3.35%
New Brunswick	9/26/2043	3.54%
Manitoba	3/5/2041	3.43%
Canada (Federal)	6/1/2041	2.39%
Alberta	12/1/2040	3.34%
BC	6/18/2040	3.19%
Saskatchewan	6/1/2040	3.39%
Ontario	6/2/2041	3.27%
Quebec	12/1/2041	3.31%

Source: TD Waterhouse and CIBC Investors Edge Ask Yields on 20 January 2017. 
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 1-20-2017 for long-term bonds maturing on the dates above.   

The slightly lower interest rates for Ontario vs. comparable Quebec bonds indicate that bondholders attach a slightly higher risk probability to a worst-case scenario of Quebec having to delay interest payments before bonds mature or being unable to pay off the principal at maturity. (I should say that the lower long-term interest rates on Government of Canada bonds vs. comparable US Treasury bonds indicates that market investors view Canada as lower-risk than the US government. This gap has been in place for the past few years.)

(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.)

Ontario, Quebec and other governments have no problem borrowing now. And, borrowing interest rates remain near all-time lows. But, let's see how Ontario compares to Quebec and other provinces at regular intervals over the next few years and particularly when voters return to the polls in 2018. Let's see if Ontario can continue to boast lower rates than Quebec.


If I can make the time, I would like to check the historical record to see whether Quebec has ever had a better bond rating than Ontario with lower interest rates on Quebec bonds than Ontario bonds. That has not happened yet. But, is that day coming? Quebec is projecting a balanced budget this year. Has it ever been the case that Quebec has run a provincial government surplus at the same time that Ontario and Alberta, the post-war powerhouses of Canada's economy, ran deficits? 

Interesting to see how much higher interest rates are on Trump Day in January 2017 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 as Trump takes office in January 2017  are still below summer 2014 levels.

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%
Nova Scotia	12/01/2031	3.52%
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.