Canada issues 50 year debt

The government of Canada today issued $1.5 billion in debt with a 50-year maturity. The yield to maturity is 2.96%. For the duration these are amazingly low interest rates. If the Bank of Canada can actually keep the inflation target pinned at 2%, the real rate of interest is less than a percentage point.

Suffice to say, I think this is a prudent move by the government. I wonder when Canadian banks will come up with mortgage products that will let consumers lock in insured 30-year mortgages for 150 basis points above government rates. They do this in the USA, why not here?

I’m also curious to know how much debt the government can issue with these terms before the public market starts to vomit on this much debt. For every seller (the government), somebody out there must want to be long this debt. There is a financial argument about hedging against market volatility (typically bond prices will rise with a reduction in equity prices) and generating some higher semblance of income compared to 1%-yielding cash, but locking yourself in at 2.96% for 50 years? Unreal.

In a very abstract level, the taxpayers of Canada win in this scenario – as long as the pension fund that is buying the debt isn’t the one paying your future defined benefits.

Preparing for a year 2000-type scenario

I am relatively convinced that although the economy appears to be muddling along with a low real growth rate, the markets are pricing in a growth trajectory that is optimistic. We are likely to see increased volatility in the future.

There are some good doomsday type stocks, but perhaps none would be better than Fairfax Financial (TSX: FFH), who have continually prepared for a gloomier future. They have hedged their entire equity portfolio against the S&P 500 and also have purchased CPI-linked derivatives that would profit in the event of a deflation. From Prem Watsa’s annual report, he believes that any credit event in China would cause commodities to collapse (they consume 40-50% of most commodities from iron ore to copper) and it would have an impact on the mining industry. He goes on to state that world iron ore capacity has increased by more than 100% in the last ten years, mainly due to increased Chinese demand.

The excesses in the Chinese real estate market are quite well known and have been reported extensively in the past, but just like what happened in the USA from 2004-2008, it might take some time before any credit events emerge. In addition, the Chinese government has proven to be very adept at managing the situation.

While I don’t profess to if or when such a credit event will happen, if it does occur, it would be very adverse for Canadian investors holding equity and debt in such entities. Fairfax is an interesting bet for a doomsday scenario, but at CAD$470/share they are considerably priced above book value (which is US$339 at the end of 2013 or about CAD$374 at current currency rates). Given the performance of Fairfax’s businesses, one would expect a modest premium over book, but 25% over book seems a bit heavy to swallow. The company also sold 1 million shares at CAD$431 (CAD$417 after expenses) in November, but this was also in relation to their purchase of Blackberry convertible debentures.

OSFI draft guideline on residential mortgage insurance

The OSFI has released draft guidelines (B-21) on residential mortgage insurance companies. There is a comment period up to May 23, 2014. Considering that CMHC and Genworth form substantially the entire market, I do not anticipate much comment.

Despite what the media is reporting (that it would involve a marginal tightening of the mortgage insurance market), upon reading the draft guidelines I do not see this conclusion, which is little change.

Specifically for investors, the only change that will be visible will be a slightly higher amount of disclosure than what is currently provided to the public. This includes (and the bold-print is what I believe will be new):

A breakdown of mortgage loans insured during the previous 12 months as well as the total stock of insured mortgage loans, with further separation by mortgage insurance type (i.e., transactional- vs. portfolio-insured loans), for the following categories:

* Volume: The number and outstanding balance of insured mortgage loans;
* Loan-to-Value: A breakdown according to LTV buckets of 5% increments (both estimated current and LTV at origination);
* Amortization: Amortization period ranges (e.g., 15 – 19.9 years, 20 – 24.9 years, ≥ 25 years, etc.) at origination and remaining amortization;
* Geography: Geographic breakdown by province and territory; and
* Delinquencies: Breakdown of the level of insured mortgage loan delinquencies.

FRMIs should also provide a discussion of the potential impact on insured residential mortgage loans in the event of an economic downturn.

Genworth MI is down less than a percent in today’s trading, which may or may not be caused by the above pronouncement by the OSFI. It continues to be my largest holding despite being trimmed at higher price levels.

Not much to say lately

The market has been going through some corrective headaches, likely on valuation concerns of the well-known high fliers out there (including the biotech sector, which has gone bananas). This all feels like the year 2000 over again.

I still haven’t had anything pop up on the investment radar lately. One opportunity which I did identify last year as a very likely candidate to provide two or three-bagger type gains over the next two to three years has exhibited price depreciation to the point where it is trading below tangible book value. What is even odder is that this company is pretty much top in its business niche and is unlikely to lose the competitive advantage in this niche. It is only trading down because of government regulatory fears. I might write a comprehensive research report on this company, but it is something I would not want to make freely available to the public.