Reaching for Yield is a Sign of the Times…

Reaching for Yield is a Sign of the Times…

Risk arises as investor behavior alters the market.

Howard Marks

Canada’s bond market is churning out issues backed by increasingly riskier assets -- and yield-starved investors are lapping them up.

Recent deals have included debt backed by a variety of assets including mortgages on Hudson’s Bay Co. stores, a junk-rated retailer; consumer loans charging interest rates of as much as 40 per cent; and home equity lines of credit. Non-bank mortgage lenders may also soon issue debt, market watchers say.

The bonds are hitting the market amid a mixed picture for the Canadian economy. Ten-year government bond yields are trading below the Bank of Canada’s overnight rate. Consumer spending has been tepid and inflation weak, but the economy also recorded its best monthly advance in growth in eight months in January and boasts an unemployment rate at a four-decade low of 5.8 per cent.

“The flattening of the curve, in which you see the ten year bonds inside the overnight rate is prompting investors to hunt for yield,” said Randall Malcolm, senior managing director of fixed income at Sun Life Investment Management.

The new issues included $250 million of securities backed by mortgages on Hudson’s Bay department stores in Montreal and Ottawa, arranged by Royal Bank of Canada. The $207.8 million portion of top-rated bonds were priced to yield 3.64 per cent, or close to 200 basis points over government bonds. A $28.13 million tranche of class B bonds were issued at a yield of 4.36 per cent, data compiled by Bloomberg show.

The borrower of the loans is a joint venture between Hudson’s Bay Co., which is rated six grades below investment grade by Moody’s Investors Service, and RioCan Real Estate Investment Trust, which holds S&P Global’s second-lowest investment rating. Hudson’s Bay has reported losses in at least nine out of 10 quarters, data compiled by Bloomberg show.

The issue is Canada’s first-ever commercial mortgage-backed security pooling loans from a single entity. That gives it “an element of concentration which I haven’t seen in a long time,” said Malcolm.

Fairstone Financial Inc., a lender owned by an investor group including J.C. Flowers & Co., also sold C$322.4 million of bonds backed by a pool of consumer loans with interest rates as high as 39.99 per cent, according to DBRS data. Almost 70 per cent of the loans carried Fico credit scores below 649, which is considered subprime by credit reporting bureau Experian.

The issue, in several tranches, was the first non-prime asset-backed securities deal out of Canada since 2007. Its C$225 million portion has an expected maturity of 2.6 years and holds a 3.94 per cent coupon, Bloomberg data show. That compares with a two-year government bond yield of about 1.59 per cent.

Heloc Issues

The strong interest in the deal was partly driven by “Fairstone’s long history and tenured track record of providing transparent and responsible lending options for a segment of the Canadian market that may experience sudden financial needs, but is not eligible for prime credit,” company spokeswoman Fiona Story said in an e-mail. The biggest portion of the deal holds top credit ratings, she said.

Canada also saw its first issue of Heloc bonds since October 2017 as Fortified Trust, a securitization unit of Bank of Montreal, sold $750 million of notes and $14.8 of subordinated debt at yields of 2.558 per cent and 3.308 per cent respectively.

In Canada, borrowing through Helocs has grown faster than residential mortgages since 2017 and stood at $243 billion in October, or about 11 per  cent of total household debt, according to DBRS Ltd.

Consumer Stress

In addition to those three securitization deals, there’s been five issues backed by credit-card debt and two by auto loans and leases.

Tim O’Neil, managing director and head of Canadian structured finance, at rating company DBRS expects to see more auto and credit-card backed deals and potentially some from non-banking mortgage lenders -which tend to cater to borrowers who can’t qualify at a mainstream bank.

“Credit delinquencies are showing low numbers so it’s good timing to issue,” said Montreal-based Yves Paquette, a portfolio manager at AllianceBernstein Holding LP, which manages $550 billion of assets. His firm is reducing exposure to Canadian credits, however, which can be vulnerable to a cyclical slowdown.

While average charge-offs of Canadian credit cards remain close to record lows, consumers reduced their average monthly payments in February to 38 per cent of outstanding balances, the lowest since 2015, according to Royal Bank of Canada, based on data from securitization programs.

“That deterioration in payment rates may be attributed to some stress on the consumer,” Vivek Selot, a credit analyst at RBC, said in a March 27 note to investors. “Considering that fragile household balance sheets could be a precipitating factor for the credit cycle to turn, any signs of consumer credit quality deterioration seem worthy of attention.”

News Item from BNN Bloomberg,

April 04, 2019

https://www.bnnbloomberg.ca/debt-backed-by-consumers-paying-40-lure-yield-hungry-in-canada-1.1239648