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TORONTO (GlobeinvestorGOLD) — Welcome to Newfoundland, where the landscape and province's financial situation have often been described as rocky.
Those rocky vistas are a must-see, especially around Gros Morne National Park, but investing in Newfoundland through its bonds has been a trip only for adventurous investors who were interested in the higher-than-usual yields. Now, it's time for re-think on this far-flung province. With its financial outlook improving, Newfoundland is worth considering as a destination for a portion of your fixed-income investments.
Let's be clear — Newfoundland's finances are still the weakest of any province. Dominion Bond Rating Service rates the province's long-term debt at BBB (high), whereas Alberta has the top AAA rating and both British Columbia and Ontario are at AA. Even tiny Prince Edward Island has a slightly higher rating, A (low). A little context is needed here, though.
First, the BBB (high) rating is considered investment grade, which means pension funds could buy Newfoundland bonds if they wanted. Second, DBRS considers the rating to be stable. Third, and most importantly, the general trend in Newfoundland's finances is positive. DBRS itself acknowledged this in May when it bumped the province's long-term debt rating up a notch from BBB. "The rating actions are primarily a result of the notable improvement recorded in the province's fiscal and financial situation in recent years," the rating agency said.
The lower the rating of a province or corporate borrower, the more interest it has to pay bondholders. Newfoundland may be improving on the fiscal front, but it still offers higher yields than other provinces. A recent stroll through the inventory of one on-line broker found a Province of Newfoundland bond due in June 2014 with a yield of 4.21 per cent. Comparable bonds from B.C. and Saskatchewan offered no more than 4.03 per cent. That's not a stunning difference, but every little bit of extra yield helps when interest rates are as low as they are today.
A bond is only as good as the issuer's ability to produce semi-annual interest payments and give you back the face value of your investment at maturity. Newfoundland's reliability in these areas is improving for a couple of reasons, one of them being an agreement with the federal government that lets the province keep 100 per cent of offshore oil revenues without having to worry about clawbacks of equalization payments. With oil prices remaining at high levels, the province's revenue flow is such that this spring's budget was able to deliver increased spending and a lower deficit projection for the current fiscal year.
DBRS still has concerns about Newfoundland, including its high debt level, a declining and aging population and its dependence on federal transfer payments. But with a sound economic outlook and a large and growing offshore oil sector, the province was deemed to be in good enough shape to warrant the rating upgrade.
When looking for individual bonds, investors face a risk spectrum that ranges from high-yield bonds issued by companies with poor credit ratings to the AAA-rated bonds issued by the federal and Alberta governments. With its new BBB (high) rating, Newfoundland's position in this spectrum is better than most. Remember, bonds issued by provinces and other forms of government are generally considered to be less of a risk than corporate bonds because governments have the ability to raise taxes to meet their debt obligations. Moreover, it's difficult to foresee a province like Newfoundland defaulting on its debt without federal government intervention.
Avoid Newfoundland bonds because of the risk? How provincial.
Rob Carrick has been writing about personal finance, business and economics for more than 12 years.