Once-hot maple bonds experience big declines

(April 2008) With more investors turning away from risk and investing in government bonds, one debt instrument that has fallen out of favour with investors is the maple bond. In the last six months of 2007, there were only 15 Maple issues worth $4.9 billion; that’s a 53.8% drop over the same period in 2006.

While a decline in maple issuances shouldn’t be that shocking — all non-government bonds have taken a hit recently — it is somewhat jarring how far the mighty maple has fallen.

It was only a few months ago that maples — debt issued by a foreign entity in Canada and denominated in Canadian dollars — were all the rage. In the Investment Industry Association of Canada’s debt issuance report for the first half of 2007, the organization wrote, “Yet a scant two years in existence, maple bonds totalled a full tenth of the U.S. Yankee market.”

The report went on to say that with issuers in other countries such as Australia, France and Germany completing maple deals in 2007, “this trend isn’t abating.”

But it has. In the IIAC’s most recent debt issue report, the association asks, “Has the run-up in maples dried up? Are investors looking to familiar home-grown names in their portfolios and shunning issues from foreign borrowers?”

“Definitely. There’s no question,” says Andy McNair, managing director of debt syndication for TD Bank. “The global overlay of the storm in the credit market has really impacted people’s confidence in what they want to look at and partake in.”

In the first three months of 2007, maples accounted for almost 70% of new issuance in the fixed-income market, says McNair. “This year it’s almost non-existent,” he explains. “Canadian investors seem to have gone back to what they know, what they’re comfortable with on the domestic front.”

A big problem with maples, and one reason why they’ve taken such a hit, is that the bond’s main issuers are financial companies, and the financial sector has seen its fair share of turmoil as of late.

“As an industry, financial companies have been very hard hit,” says Al Kellett, a Morningstar Canada fund analyst. “Because a lot of the credit issues have come from that industry, risks still lie in that sector.”

Jack Rando, the IIAC’s assistant director, says most Maples carry high credit ratings, but most issuers don’t have highly identifiable names. So, because of widening spreads and market uncertainly, people are staying away from less well-known companies, sending the maple market into a tailspin.

If the credit markets had remained stable in 2007, it’s unlikely the love affair with maples would have ended. According to the IIAC’s data, maples were on pace to break records — and in fact, thanks to the strong first two quarters, they still managed to bring in $97.7 billion last year. “Last summer that momentum retreated, as credit markets became subject to extreme pressures,” says Rando. “It impacted both the supply and demand side.”

Can maples bounce back once the markets settle down? Chances are good that interest will be strong again at some point, though we might not see the same frenzy the industry witnessed over the last couple of years. “Most people would argue that they won’t go back to those levels,” says Kellett. “Pricing was pretty high then and there was a lot of optimism. There were very low default rates at the time so that was sort of as good as you can expect.”

McNair is optimistic that maples will return to their glory days. When the markets settle down, investors will be on the prowl for good opportunities and the supply and demand balance will once again tip in favour of maples and other similar instruments.

“What the market did was offer a great amount of diversification for portfolios and very attractive relative returns on investments,” he says. “This is an unusual time we’re in, but we are confident things will return to a period of normalcy.”

One area that could slow down the maple’s comeback is the swap market. Kellett says that usually issuers want to swap out currency exposure so they don’t have to keep dealing in Canadian dollars. That involves trading on the swap market, which is experiencing its own problems right now.

“If there’s a lack of liquidity in the swap market and spreads are wide, it could cost more to swap out currency exposure,” he says. “The swap spreads have widened in sympathy with other issues happening in the market.”

Swap markets involve “counter-party risks,” explains Kellett, because companies enter into a contract with one another. With the collapse of Bear Stearns — a major player on the swap market — many companies are increasingly nervous about swapping currencies. “Now dealers demand a little more spread if you’re going to swap with them,” he says.

Until things settle down in the swap and credit markets, there’s almost no chance that maples will be as strong in the first six months of 2008 as they were in Q1 and Q1 of last year. Rando hopes the latter half of 2008 will be see a bounce, but he’s not making any grand predictions.

What would help maple bonds, though, is if a broader range of issuers entered the market, so investors would be less reliant on the financial sector for new products. Rando is hopeful that will happen as more people look toward Canada as an alternative funding source.

“As the Canadian investor base expands,” says Rando, “and with issuers becoming more aware of Canada as an alternative source of viable funding, that will bode well for the maple bond.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(04/21/08)

Bryan Borzykowski