Investors warn Trudeau that his bond reform proposal will backfire

(Bloomberg) — Canadian businesses may face higher interest charges due to the government’s proposal to eliminate the C$260 billion ($195 billion) mortgage bond program, a warned a lobby group of investors.

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Prime Minister Justin Trudeau’s government is considering ending the Canada Mortgage Bonds program in a bid to reduce borrowing costs. CMBs are guaranteed by the federal government’s housing agency, giving them the highest possible credit ratings, as Canada is rated triple A by S&P Global Ratings and Moody’s Investors Service. Despite this, the notes are trading at a higher yield than Government of Canada bonds.

Finance Minister Chrystia Freeland’s proposal to get rid of CMBs would force the government to issue more debt through its regular funding program. The result could be higher yields on federal government bonds – benchmarks widely used to price loonie debt securities – which in turn means higher interest rates for corporations, provincial governments and other bodies that issue bonds, the Canadian Bond Investors’ Association said in a July 5 letter sent to the Department of Finance.

“A change in underlying GC yields will increase funding costs for issuers and reduce valuations of existing securities,” according to the letter signed by Peter Waite, chief executive of the CBIA.

Issuers are likely to be tempted to raise more debt in other currencies, he added. “We have already seen a trend of domestic issuers funding themselves in foreign markets and this change will likely result in more shows being diverted outside of Canada.”

The group represents more than 50 institutional investors in Canada who collectively manage more than C$1.8 trillion in fixed income assets, the organization said.

“This Canada Mortgage Bonds consolidation proposal is intended to reduce borrowing costs and redirect savings to priority affordable housing programs,” a Freeland spokesperson said. “Ongoing consultations are focused on developing an implementation plan that will ensure Canadian mortgage lenders maintain stable access to funding.

The CMB program raises some of its funding through floating rate notes, which are “particularly important” in a rising rate environment, the trade association said in the letter. “The reduction in FRN’s supply will negatively impact an already depleted space since FRN’s issuance has been contested for some time.”

The finance department is consulting with market participants on the future of the CMB program. The deadline for submitting comments is July 14.

–With help from Christopher DeReza.

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