Harry Koza's Weekly Column
March 23, 2007
Delivering the goods 36 Green Meadow Crescent,
08:37 EST Friday, Mar 23, 2007
TORONTO (GlobeinvestorGOLD) - Don't get me started on the new federal budget, that monstrous megillah of tweaks and grease applied to the body politic to lubricate the government's way through the bruited upcoming election.
Still, this budget was a little different. Buried in the boilerplate was a pair of provisions directly aimed at the bond market. How cool is that? Despite the bond market's almost sycophantic dependence on governments ? without whose witless profligacy there wouldn't hardly be a bond market at all ? the bond market, when it comes to the government taking an active interest in its doings, usually displays an attitude similar to that of Jewish shtetl-dwellers in Tsarist Russia. As in: "May the Lord Bless and keep the Government ? far away from us."
So it was with a soup?on of trepidation that mondo bondo regarded the two bond-related measures in this week's new budget.
The first change is the revelation that Ottawa's negotiations (they've been gnawing this bone for around five years now) to amend the Canada-U.S. tax treaty are almost complete. Once the amended treaty is passed by Parliament and ratified by the U.S. Senate, there will be no more withholding tax on interest payments between arm's-length residents of Canada and the United States, including LLC's (Limited Liability Companies, which weren't around when the original treaty was signed, and are thus subject to withholding taxes as high as 25 per cent).
Further, over the next three years, withholding tax will gradually be eliminated on interest payments between non-arm's-length residents of Canada and the U.S. And finally, once the amended treaty with the U.S. kicks in, likely in 2008, Canada will amend its domestic tax laws to eliminate withholding taxes on interest paid by Canadians to arm's-length residents of any other country in the world, unilaterally, without renegotiating any other outstanding international tax treaties. It will apply even to tax havens like the Cayman Islands, where we don't have existing tax treaties.
Yow! One small step for a finance minister, one great leap forward for free markets. This is going to have two big impacts on the bond market. First, it's going to make borrowing money ? through bonds and bank loans ? cheaper for Canadian companies. No longer will there be a 10-per-cent tax on interest paid to foreign lenders on debt of five-year or shorter initial terms, so lenders will require less of a yield premium. Improved access to global capital markets is a good thing for domestic borrowers ? especially lower-rated ones. It will also give Canadian investment banks sharper competition for corporate financings.
Domestic corporate debt issuance in the five-year-and-under term, according to RBC Dominion Securities, amounted to $30-billion in 2006, out of a grand total, in all maturities, of $72-billion. The new rules mean that a good chunk of that will be issued in offshore markets, and not necessarily with domestic dealers running the books, either. Though the domestic dealers already have significant international capabilities, they'll still have to sharpen their pencils and hire a bunch more math geeks at hockey-player salaries (Revenge of the Nerds!). Anyway, it seems inevitable that domestic issuance in the under-five-year term will shrink.
That will tighten yield spreads on the paper. Domestic new issue spreads will narrow both because domestic investors will have to compete with cheaper (sometimes) offshore investors, paying a little more for bonds; and, because there will be less of it, spreads on domestic bonds in the term will tighten from scarcity value alone.
Martin Fingerhut, a securities lawyer at Blake Cassels and Graydon LLP, says there will be more cross-border financings of all kinds ? short-term loans, operating lines of credit, asset-backed commercial paper facilities, credit card and car loan securitizations, commercial and residential mortgage securitizations, maybe even student loan securitizations (there's a large and sophisticated student loan securitization market in the U.S., which helps lower students' borrowing costs, yet there's never been a Canadian securitization of student loan receivables. Pity).
There's no need to start planning a tag day for the domestic dealers, however. The cool thing about eliminating the withholding tax is that it's the flip side of the Maple bond phenomenon. Canadian issuers borrowing in yen or euros or U.S. dollars or zlotys and swapping the proceeds back into loonies will create a swap basis allowing for increased Maple bond issuance. Even better, the budget also added Maple bonds (and most other investment-grade debt) to the list of qualified pension and RRSP investments. You still need to be an accredited investor ($1-million in net worth, not counting your house) to be able to buy Maple bonds for your personal account, but now bond mutual funds can buy them, so individuals can participate that way. More institutional investors will be able to buy Maples, too, which will improve their liquidity, mitigating one of the buy side's most common cavils about them.
The other bond-related provision in the budget involves the consolidation of debt issued by some Crown corporations into the federal borrowing plan. It's not quite the long overdue elimination of some of the bloated Crowns littering the fiscal landscape, but it's a start.
Sr. Market Analyst,
Richmond Hill, Ontario,
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