Bond investors grow uneasy amid Ontario Hydro sale
Ontario’s plan to sell a majority stake in the province’s electrical utility is being celebrated by just about everyone in Canada’s financial community except for holders of the debt.
As the province proposes cutting ownership in Ontario Hydro to 40 per cent, bond investors are growing wary about the $9 billion lent to the utility when they assumed it would have100-per-cent government backing. Hydro One bonds have lagged a rally in Ontario’s debt over the past month amid concern the underlying financial guarantee that supported Hydro One’s credit ratings will erode.
“As the Province of Ontario reduces its ownership, the perception of that implied support diminishes as well,” David Frei, who manages $2.5 billion in bonds for Fiera Capital Corp., including those from Hydro One. “All else being equal, it’d be negative for bond values; credit spreads would go up, the value of the bonds would go down.”
Ontario, saddled with a projected $11-billion budget deficit, said Thursday it will start by selling a 15-percent stake in Hydro One in an initial public offering to raise as much as $2.25 billion. Its ownership will be reduced in stages over the next four to five years. With Hydro One estimated to be worth about $15 billion, it would be one of the biggest asset sales in Canadian history.
By the end of the process, the province forecasts it will realize $9 billion in proceeds to be used to pay down debt and invest in a $130 billion, 10year transit, transportation and infrastructure plan.
Yields on Hydro One debt started decoupling from those on Ontario’s securities as preliminary details of the proposal began appearing in the Canadian press.
Ontario has sought to quell the concern about eroding support for the utility. Under the IPO, the province would remain the largest shareholder by barring any other investor from holding more than 10 per cent. Ontario would continue to exert control though its regulatory powers, according to a statement on Thursday.
“What’s good for ratepayers is good for bondholders,” Matt Kolodzie, a credit analyst with Royal Bank of Canada, wrote in a note. “It has been our long-standing view that the credit quality of Hydro One is not depen- dent on ownership, rather it is the strength of the regulatory framework that supports the credit.”
The country’s largest pension plans, including Canada Pension Plan Investment Board, are seen by analysts as a potential bidder for the Hydro One stake.
Canadian provincial bonds have outperformed both federal and corporate debt this year and Ontario has been among the best performers. Investors have been betting the weaker Canadian dollar will benefit Ontario’s manufacturing-intensive economy and aid its deficit fight.
Based on Ontario’s ownership, Moody’s Investors Service has assigned an A1 rating to Hydro One, three levels higher than the Baa1 it would receive on a stand-alone basis, according to Mark Laing, a credit analyst at BMO Capital Markets in Toronto. Ontario’s decision to reduce its ownership stake may lead the credit-rating companies to reevaluate their rankings, Laing said.