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Fixed Income Quarterly—Infrastructure
New Issuance – We expect issuance in the sector to be modest again this year, which should support spreads. We still expect BC Ferries to refinance its upcoming maturity some time in the near future, while 407 will come to market to finance capex and GTAA may transact opportunistically.
Trading Liquidity – GTAA possesses above-average trading liquidity within the sector and relative to the market. Older vintage 407 bonds have become harder to purchase in size since the covenant change.
Other – Each issuer faces above-average headline risk. Credit Profile
Sector Financials – We expect moderate economic conditions to weigh on financial results again in 2014, but note strong rate-setting capabilities will continue to help offset the impact of any ensuing sluggish traffic and allow sector financials to recover more meaningfully over the medium term.
Sector Fundamentals – We believe traffic growth will remain challenged in the near term due to escalated fuel costs and economic headwinds.
Credit Ratings – Although rating activity in the sector has been decidedly positive the past couple of years, we are cautious about NAV CANADA due to the solvency deficit in its pension plans, as well as the negative outlook currently in place for Leisureworld by S&P. Teranet also possesses a negative outlook from S&P due to challenging conditions for real estate activity in Ontario and was recently downgraded by DBRS.
Viewpoint
Long Bonds Equal Big Gains in Q1/14
The topsy-turvy world of the fixed income market continued into 2014 as the year started with escalating yields on con- cerns the onset of tapering would take rates in a straight line upwards. However, mixed economic numbers across the globe, trepidation about growth in China and the emergence of geopolitical concerns in Eurasia together underpinned a meaningful rally in government bonds and a material bull flat- tening of the curve. This occurrence was consistent with our belief that yields would remain range-bound over the near to medium term and create a long-bottomed u-shape to the future movement of yields, rather than a v-shaped snap back after bouncing off the secular bottom in the first half 2013.
In this range-bound yield environment, we expected that the Infrastructure – Transportation sector would perform more in line with the market since we believed investor would be more inclined to add sectors with greater spread. And, for the most part, this is what transpired during Q1/14. The year-to-date total return of 1.27% for Infrastructure – Transportation in the Short bucket was within a few basis points of the
Chart 1: Infrastructure Sector 10-yr Indicative Spreads
425 400 375 350 325 300 275 250 225 200 175 150 125 100
75 50 25
GTAA
407 Intl.
NAV CANADA BC Ferry Teranet
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Source: BMO Capital Markets
corporate component of the FTSE TMX Canada Universe Bond Index, while its total returns of 3.23% and 5.42% in the Mid and Long buckets, respectively, were about 60 basis points below the index. Similarly, spreads for Infrastructure – Transportation were in line with the market in the Short bucket at a narrowing of 8 basis points. By comparison, sectors spreads underperformed by several basis points in Mids and Longs after tightening by 8 basis points and 6 basis points, respectively, during Q1/14.
On a broad basis, however, Infrastructure – Transportation actually outperformed the corporate component of the index by just over a full percentage point during Q1/14, posting a total return of 4.22%. This outperformance was entirely predicated upon the relatively longer duration of the Infrastructure – Transportation sector, which was more than sufficient to offset its more meagre performance in each segment of the curve. With modest upward pressure expected to persist on long-dated GoC yields now that the U.S. Fed has commenced tapering, the longer duration of the Infrastructure sector relative to the index will likely serve as somewhat of an albatross, even though we do believe yields will be relatively range-bound over the near term.
From a spread perspective, we expect that a paucity of new issue supply from the sector in the coming years will keep spreads reasonably well behaved. Following a decade of considerable primary market activity from the sector, there are relatively few projects currently under construction that require new financing. In addition, there is little in the way of refinancing requirements for 2014 and into 2015, unless some issuers decide to opportunistically take advantage of the market’s historically low rates. Thus, although sector spreads trade tight on an absolute spread basis to provies, we believe there is room for further compression due to this lack of