PrefBlog

Change and confusion all ’round! Last Friday, Quebec was upgraded. Today Saskatchewan is downgraded:

• •Weaker commodity prices and elevated capital spending are negatively affecting the Province of Saskatchewan’s budgetary performance and debt burden.
• •As a result, we are lowering our long-term issuer credit and senior unsecured debt ratings on Saskatchewan to ‘AA’ from ‘AA+’ and affirming our ‘A-1+’ global scale and ‘A-1(High)’ Canada scale short-term ratings.
• •The stable outlook reflects our expectation that, in the next two years, as Saskatchewan realizes positive results from its revenue measures and cost efficiencies, its budgetary performance will continue to stabilize, leading to near-balanced operating balances and declining after-capital deficits of less than 10% of total revenues

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The downgrade reflects the province’s weakened budget performance and growing debt burden, which are symptoms of low commodity prices in two of
Saskatchewan’s key economic sectors: oil and gas, and potash. Low commodity prices have prompted the province to implement tax reforms and cost control targets, which are expected to support an improvement in budget outcomes. However, despite these efforts, Saskatchewan’s budget trajectory is now weaker than it was last year, due to slower economic growth and higher near-term capital spending intentions under its Saskatchewan Builds Capital Program. We now expect Saskatchewan’s after-capital balances to remain negative over the next two years. We also expect new borrowing requirements tied to SaskBuilds and government-related entities (GREs) to cause its tax-supported debt burden to approach 150% of consolidated operating revenues, which is high compared with similarly rated international peers’.

We expect Saskatchewan will record, on average, a modest operating deficit of about 2% of operating revenues and an after-capital deficit of 10% of total revenues for fiscal years 2016-2020. We expect that new revenue measures, such as eliminating certain exemptions and increasing the provincial sales tax, will help to mitigate the negative influence of weak commodity prices, leading to a steady improvement in budget outcomes over the next two years. Saskatchewan is forecasting operating revenue growth of 3.7% per year, on average, between fiscal years 2018 and 2020. On the expense side, considering continued spending control and a projected return to more moderate levels of capital spending in the outer years of our forecast, we expect that the province’s after-capital budgetary performance will moderately improve. Saskatchewan is projecting an operating expenditure decline of 1.2% in fiscal 2018, followed by expenditure growth of 1.2% per year, on average, between fiscal years 2019 and 2020.

PerpetualDiscounts now yield 5.08%, equivalent to 6.60% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.60% (maybe a little over) and so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 300bp, a widening from the 290bp reported June 14.

It was quite a day today … I saw a flying pig, a cat with horns, and S&P upgrading Quebec:

• •We expect the Province of Quebec to extend its record of prudent fiscal policies, with strict cost controls and growing tax revenues keeping its budget in surplus and causing its debt ratios to further shrink over the next couple of years.
• •As a result, we are raising our long-term issuer credit and senior unsecured debt ratings on Quebec to ‘AA-‘ from ‘A+’, and affirming our short-term issuer credit rating at ‘A-1+’.
• •The stable outlook reflects our expectation that, in the next two years, Quebec will generate modest after-capital surpluses and reduce its tax-supported debt ratio.

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We expect Quebec to continue benefiting from moderate economic momentum and strict cost controls, enabling it to achieve operating and after-capital surpluses of 8.7% and 1.2%, respectively, from fiscal years 2016-2020. This outlook is better than we foresaw last year, despite the government’s recent decision to hasten the elimination of the health premium tax and boost its program and infrastructure spending before the October 2018 election. While the government’s fiscal framework could change post-election, regardless of the party elected, our base-case assumption is for general continuity in fiscal policies, given the high visibility in undoing some of the fiscal checks, such as the requirement for balanced budgets and the Generations Fund that are enshrined in legislation. The province also has contingencies available within its 2017 budget, should its economic picture moderate or other spending priorities arise.

Positive operating results are allowing Quebec to deposit more than C$2 billion yearly into its Generations Fund, which we treat analytically as a sinking fund. We expect the balance in this fund to reach C$15.9 billion by fiscal 2019, up significantly from C$8.5 billion in fiscal 2016. This, alongside increasing revenues, will lower Quebec’s tax-supported debt to 211% of consolidated operating revenues by fiscal 2019. This is a major reduction from its peak of 235% in fiscal 2015. Nevertheless, even at the lower level, Quebec’s debt burden would remain high by domestic and international standards and, if it doesn’t materially decline below this projected level, would likely remain a barrier to further upgrades. We also anticipate the province’s interest expense to decrease slowly, averaging 9.3% of adjusted operating revenues from fiscal years 2017-2019.

Andrew Willis of the Globe had some very good commentary on the Home Capital settlement:

Part of the solution, announced Wednesday, is a regulatory settlement that sees Home Capital absolve the OSC of any blame for the whole mess. In a news release, Home Capital chair Brenda Eprile said the company “acknowledges that the Commission is not to blame for the events of recent months involving its liquidity position.”

I’m guessing Ms. Eprile grit her teeth while signing off on that line. But her goal is to get Home Capital moving forward, and that meant resolving regulatory issues and potential class-action lawsuits. As part of a settlement that’s going to set back Home Capital – or its insurance company – approximately $30-million, it doesn’t cost Ms. Eprile anything to give the OSC a little political coverage.

I’m also guessing that Ontario’s Premier was thrilled to see that statement, as the provincial Liberals wouldn’t want to be fighting an election next year as the party that nearly vaporized the largest lender to homeowners who can’t borrow from the big banks.
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From the OSC’s point of view, sources say there is an equally strongly-held view that Home Capital and its legal advisers dug in their heels on the terms of the settlement and that led to the public showdown.

This view is bolstered by the fact that many lawyers believe Home Capital and its executives would have been cleared if the OSC allegations had ever been taken to a hearing. Disclosure decisions that Home Capital made back in 2015 were approved by one former OSC chair – lawyer Jim Baillie from law firm Torys, and are now being defended by another former head of OSC, Stikeman Elliott’s Ed Waitzer.

I expect that the next company announcement of a big, well-publicized negotiated settlement will include a phrase along the lines of ‘I am a running-dog lackey of the anti-investor deviationist line! I have been an unwitting dupe of the pro-inadequate disclosure camp!’ Give bureaucrats power that can be countered only by the superior political connections of the Big Banks and Big Insurers and what else do you expect?

What a difference a week makes!

Investors and economists are recalibrating rate forecasts after the central bank’s surprise talk of tightening this week signaled a policy move could come sooner rather than later.

A Bloomberg survey of 17 economists found the majority now project a rate increase this year. Six predict higher rates in October and two suggest a September hike. That’s an about face from a week ago, when only two forecasters were projecting rates would rise in 2017.

Traders are also pricing in a full 25 basis point increase to the central bank’s 0.5 percent benchmark interest rate by the December meeting, according to Bloomberg calculations on overnight index swaps.
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Swaps trading on Thursday showed a 46 percent chance of an increase in July, and a 75 percent chance of one by December. A week ago the odds were 5 percent and 27 percent.

The Canada five-year bounced upwards today, closing at 1.14%.