Corporate Bonds

by Michаеl Zienchuk

We are continuing our focus on debentures or bonds, as they are securities which may provide less risk for investors. In the previous article we wrote about government debentures which are generally considered the least risky in this asset class. We turn our focus to corporate bonds, which come in a wide range with respect to quality – based on the creditworthiness of the issuer. Here we focus on the most creditworthy corporate bonds and the kinds of investment opportunities they present.

The main gauge, which the market uses to identify creditworthiness of a debenture, is the credit rating of the corporate issuer, with some adjustments for the individual debenture in question. This credit rating is issued by an independent third party credit rating agency. The key factor in determining the credit rating of the issuer of the bond is their ability to make timely coupon payments on the notes, and to repay the principal outstanding of the note. There are four main credit agencies which rate all bonds issued to the market. These include the "Big Three" credit rating agencies – Moody’s, Standard and Poor’s (S&P) and Fitch Ratings, as well as the Canadian credit rating agency, Dominion Bond Rating Service (DBRS).

Bond rating agencies assign corporate issuers and individual bonds with ratings based on letter designations, from triple A (AAA or Aaa) for the highest quality to single D (D) representing an issuer or note that is in default (either unable to make coupon payments or repay the principal outstanding). Credit rating agencies also assign + or – (minus) to a letter level for greater precision. Bonds with a credit rating of BBB- and higher are considered to be investment grade, while those between BB+ and C are considered non-investment grade, or high yield bonds (junk bonds in popular jargon).

Table 1: Bond ratings by Credit Rating Agencies

DBRS	Moody’s	S&P	Grade	Risk
AAA	Aaa	AAA	Investment	Lowest Risk
AA	Aa	AA	Investment	Low Risk
A	A	A	Investment	Low Risk
BBB	Baa	BBB	Investment	Medium Risk
BB, B	Ba, B	BB, B	High Yield	High Risk
CCC/CC/C	Caa/Ca/C	CCC/CC/C	High Yield	Highest Risk
D	C	D	High Yield	In Default

Source: RBC

This system of ratings has been accepted by the bond market, and seems to work quite well. According to Wikipedia, by 2007, the default rate among investment grade bonds (estimated by S&P) was 0.2% for municipal bonds and 4.1% for corporate bonds. For high-yield bonds, the default rates were correspondingly 7.4% and 42.4%.

Although investment grade corporate bonds are generally of higher quality, their risks are considered to be higher than those of first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. In Table 2 below, we list Canadian federal and provincial government bond yields and compare them to corporate bonds with lowest yields. As the table shows, the most reliable corporate bonds offer yield premiums of 30 basis points (0.30%) or more over government bond yields. These higher yields are likely to be attractive to investors, depending on their investment priorities.

Table 2: Canadian government and corporate bond yields

Bond	Maturity	Yield, %
Federal Government
Can. Govt 2 Year	2016-May-01	1.08
Can. Govt 5 Year	2019-Mar-01	1.57
Can. Govt 10 Year	2024-Jun-01	2.31
Can. Govt 20 Year	2037-Jun-01	2.80
Provincial
Alberta	2016-Sep-01	1.20
BC Prov	2019-Jun-17	2.04
Manitoba	2024-Jun-02	3.04
Ontario Prov	2037-Jun-02	3.74
Corporate
Hydro One	2016-Mar-03	1.50
NAV Cda	2019-Apr-17	2.21
Manu LifeIns	2024-Feb-21	2.66
Hydro One Inc.	2037-Mar-13	4.10

Source: CanadianFixedIncome.ca

Michael Zienchuk, MBA, CIM
Investment Advisor, Credential Securities Inc.
Manager, Wealth Strategies Group
Ukrainian Credit Union

416-763-5575 x204

mzienchuk@ukrainiancu.com

www.ukrainiancu.com

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