Maple bonds lose lustre

CAPITAL MARKETS REPORTER

Maple bonds, one of the most popular debt products sold to Canadian investors in 2006 and 2007, have proved to be a disaster for many buyers.

The bonds, sold in Canadian dollars to Canadian investors by foreign companies, were born of a regulatory change in 2005 and were so popular that by early 2007, Canada was the fastest-growing market for international borrowers. Bankers were pulling in millions in fees doing the deals.

In hindsight, investors probably wish they hadn't been so excited about Maples. That's because the first companies to take advantage of the new market were big foreign financial firms, many of the same firms that have made headlines since for failure and distress.

Citigroup, American International Group, Lehman Brothers Holdings and collapsed Icelandic banks Kaupthing Bank and Landsbanki are among the lowlights.

"It's been horrific for anyone who invested in them," said Edward Devlin, who oversees Canadian bond investments for California-based money manager Pacific Investment Management Co. (Pimco).

The odds of losing a significant amount of money in Maples in 2008 were almost one in six, with 17 of the roughly 110 issues in the Maple index finishing the year trading for less than 80 cents on the dollar.

Some bonds have lost almost all their value, including those sold by Lehman and the Iceland banks. Kaupthing's Maple slumped to 5 cents on the dollar, while one of Lehman's issues dropped to about 9 cents.

Even banks that have survived the turmoil of 2008 in some form, such as Citigroup and Royal Bank of Scotland, have had some of their bonds hammered down to about 50 cents on the dollar.

Over all, the Maple index had a return of negative 1.4 per cent in 2008, as better-performing issues offset the big declines in some bonds in the last half of the year. By comparison, the DEX Universe Bond index, the benchmark Canadian bond-market measure, provided a 6.4-per-cent total return.

The Maple market took off after the 2005 repeal of a 34-year-old government rule that limited how much pension funds could invest in foreign securities. Free for the first time to put more than 30 per cent of their holdings in foreign bonds, investors jumped into Maples as a way to diversify their holdings away from just Canadian companies.

The big bond dealers in Canada, led by RBC Dominion Securities, Merrill Lynch and TD Securities, saw an opportunity to create a new product by selling bonds issued by foreign companies in Canadian dollars.

The foreign issuers loved Canada due to the fact they could sell their bonds at better prices in Canada than in other countries because there was a sudden surge in demand. Interest rates were also low.

The first sellers to leap into the market were financial companies, such as banks, because they were among the best-known names to investors. They were also nimble bond sellers who were ready to take advantage of the new entrée into the Canadian bond market. With the credit crunch just around the corner, the timing couldn't have been worse.

"When the Maple market got going, everyone was saying, 'Oh, this is providing diversification to the portfolio,' but, in fact, they weren't, because they were all skewed to financials," said Pimco's Mr. Devlin.

The banks made good money on the product. The average fees disclosed were usually around 0.33 per cent of the total value of the bonds sold. There was about $46-billion worth of Maple bonds sold in 2006 and 2007, meaning that securities dealers reaped as much as $150-million in fees.

That source of income has disappeared as the market for new sales all but vanished in 2008. There were only five sales, amounting to just $600-million, of new bonds last year, and few analysts are predicting a rebound any time soon.

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Maples mauled in 2008

Many Maple bonds sold by banks, popular with investors in 2006 and 2007, were badly beaten up in 2008 as the credit crisis washed over markets.

THE GLOBE AND MAIL // SOURCE: TSX GROUP