On Canada's Initial Bond Offering in Euros

Includes: CS, DB, EWC, FXC, HSBC, TECK
by: Roger S. Conrad

It’s a well-known North American story by now, Canada’s relative economic strength among developed nations. We’ve been touting the country’s virtues since the middle of the last decade, attracted first by a unique, efficient and investor-friendly legal structure that resulted in low costs of capital for businesses and generous yields for investors.

As we got deeper into the companies we cover, we also developed a better understanding of Canada’s financial system, what makes its economy tick, the way its government works.

What we’ve learned is that an effective regulatory structure on top of deposit-focused banking, the good fortune of abundant resources, and a decade of balanced federal books puts a country in good position to outperform during this unfolding recovery as well as to withstand a second-half 2010 relapse by the US into recession. (And this--a “double-dip” recession--is, as even those guys touted for their dourness acknowledge, less-than-even possibility. Elliott Gue has the history, which suggests more "remote" than "less-than-even.")

Now, Canada is actively pitching its story to the rest of the world, on one hand in a subtle way consistent with its modest reputation, on the other with pointed comments by officials about fiscal sanity.

In a move at least in part intended to draw attention to the many favorable characteristics Canada boasts in the global economic context, the federal government plans to issue a euro benchmark bond of at least EUR1 billion. It’s a ripple in the global scheme of things, but there are important repercussions for the issuer.

According to Bloomberg News, the sale will be managed by a syndicate including France-based BNP Paribas (OTCQX:BNPQY), Switzerland-based Credit Suisse Group (NYSE: CS), Germany-based Deutsche Bank (NYSE: DB) and London-based HSBC Holdings (NYSE: HBC). A banker involved with the deal told Reuters that it will be a 10-year issue; a second banker said it will be priced later this week.

The Department of Finance said the proceeds of the euro bond issue would help “further diversify” the government’s foreign-exchange reserves. Doing so now, while the Canadian dollar is strong relative to the euro, also means its cost of capital will be lower. The value of these new bonds could approach the USD3 billion Canada raised in a September 2009 US dollar denominated offering, which was done to satisfy International Monetary Fund requirements.

This new issue, however, marks the first time Canada is making an initial bond offering in euros. Canada last tapped the European bond market in 1998, issuing deutsche mark bonds and franc-denominated medium-term notes. Both issues were redenominated into euros in 1999.

It’s certainly not an absolute good that Canada is tapping foreign lenders so it can keep up day-to-day government functions. But, after more than a decade of budget surpluses, a sound fiscal position means it can do so cheaply. There are certainly no questions about Canada’s credit quality; Standard & Poor’s gives the country its highest investment-grade ranking, AAA, while Moody’s Investor Service also hands Canada its top mark, Aaa.

At the same time, going abroad to issue debt gets the Canada story in front of new investors. Rising commodity prices and expectations that it will lead economic growth among the G-7 in 2010 are already raising Canada’s profile. This is reflected in the continuing rise of the loonie, which hit its highest point since October 19 Thursday morning at 96.46 US cents.

Were it the intention of Canadian officials to clip the loonie’s wings, the central bank would have simply sold Canadian dollars in exchange for other foreign currencies; it could have intervened to slow the currency’s rise at the same time it diversified its foreign reserves. They chose not to do so, which is loonie-bullish, in the sense that they implicitly rejected intervention.

Currency effects did wonders for Americans owning Canadian assets in 2009; the reasonable case is that the loonie has room on the upside based on what the early evidence suggests will be the nature of the global economic recovery. Canada’s economy and its currency are, now more than ever, resource-based.

The price of oil, based on new demand from emerging economies, has reached a permanently higher range that favors countries, like Canada, with significant exploitable reserves. A new demand profile, altered to account for rising China and India, will help keep the loonie in the greenback’s neighborhood; if all the contributors to that demand profile get back to normal growth in the year ahead we’re looking at parity and beyond.

Finance Minister Jim Flaherty laid a message a little less subtle than a euro-bond offering in highlighting Canada’s attractions relative to its developed-market peers during an interview with Bloomberg News just before Christmas.

Remarking on the possibility that large foreign currency reserve holders will diversify away from the US dollar, he said,

It does not surprise me that China and Russia would take greater positions in the Canadian dollar than they have previously. I would expect countries looking around the world to invest in market currencies that are reliable.

China, in particular, revealed quite an appetite for Canadian assets in 2009, particularly commodities. PetroChina (NYSE:PTR), China’s largest oil company, stepped into the oil sands with a CAD1.9 billion deal for 60 percent of a project run by Athabasca Oil Sands Corp, and China Investment Corp (CIC), the country’s primary sovereign wealth fund, paid CAD1.7 billion for a 17 percent stake in Canada’s biggest base-metals producer, Teck Resources (NYSE: TCK).

In December, Prime Minister Stephen Harper, finally acknowledging the necessity of building ties with what’s emerging as a primary driver of global economic growth, traveled to China to secure the Middle Kingdom as a customer for Canadian oil, natural gas, uranium and other commodities well into the future.

If this Chinese hunger for Canadian assets extends and the country shifts, say, 2 percent of its foreign reserves into Canadian dollars, it would mean about CAD100 billion of currency flows into Canada, according to David Watt, senior currency strategist at RBC Capital Markets. That, too, would keep the loonie flying.

Setting aside the events of Halloween 2006 and the question of his integrity, Flaherty is right that investors will seek reliable vehicles for their capital. More and more are looking to the Great White North.

A Visible Hand

The National Association of Realtors (NAR) reported Thursday that pending home sales fell 16 percent in November, which sounds like horrible news when you read it in an e-mail subject line, for example. Depending on your views on government involvement in the economy, the story below the headline is either catastrophic or hopeful.

“Pending home sales” is a measure of the number of contracts signed to buy previously owned US homes. Another measure, existing home sales, tracks the number of closings that take place in a given month. Closings typically occur a month or two following sales-contract signings. Therefore, pending home sales is often viewed as a leading indicator, the number of contracts being a harbinger of one-month or two-months-ahead real estate sales.

Existing sales actually climbed 7.4 percent in November to an annualized rate of 6.54 million homes, the quickest pace in three years. So what explains this dichotomous news from the NAR? While the government does take a bite, in this case it’s giving, at least to the real estate market: Before President Obama signed into a law a bill extending it on Nov. 6, 2009, the deadline to purchase a home and qualify for the federal government’s first-time homebuyer tax credit--based on closing--was Nov. 30, 2009.

Expect pending sales numbers for December to bounce, thanks to a very visible helping hand. The extension allows closings to occur by the end of June as long as contracts are signed by the end of April.

Quote of the Day

“Maybe 4% isn’t such a puny yield in an economy that is still gripped with serious pockets of deflation.” -- Gluskin Sheff + Associates Chief Strategist David Rosenberg, in his January 5 “Breakfast with Dave” commentary

Disclosure: no positions