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Quebec bond yields approach historic parity with Ontario

Quebec on March 30 sold $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.

Mathieu Bélanger/REUTERS

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 one 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 per cent 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 neighbour.

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"Quebec is definitely doing the right thing," Alex Schwiersch, who helps manage about $3-billion in fixed-income assets at Invesco Canada, said by phone. "There is potential for Quebec bonds to trade through Ontario."

Even though both 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.

Balanced books

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 per cent of gross domestic product, from an expected 52.7 per cent at the end of last fiscal year. It plans to borrow $11.3-billion this year, compared with $22.7-billion in the year that ended March 31, in part owing to prefinancing 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 a recent interview. "That does justify our very solid performance by all" our bond issues.

Quebec on March 30 sold $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 $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.

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Better returns

Quebec has also rewarded its bondholders more generously than Ontario this year as its securities have returned 2 per cent, compared with Ontario's 1.8-per-cent gain, according to Bank of America Corp. index data.

Quebec had "a very strong budget" and the spreads of Ontario and Quebec could eventually go even, depending on Ontario's budget, said Hosen Marjaee, who oversees about $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 $1.9-billion deficit, down from $4.3-billion projected initially.

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-plus at S&P Global Ratings and AA-minus at Fitch Ratings.

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