Swollen with cash from the resources boom, Canada’s capital markets are being tapped by foreign companies eager to borrow at rates lower than they can get on their home turf or in the biggest capital markets of all, the U.S.

Citigroup Inc., the biggest financial services company in the world, Royal Bank of Scotland Group PLC and even Wall Street powerhouse Goldman Sachs Group Inc. have come to Canada to sell loonie-denominated bonds. Foreign borrowers get to borrow cheaply and Canadian bond buyers get access to the top tiers of world-class credit without taking on the currency risk of holding bonds denominated in pounds, euros or greenbacks.

“Maple bonds,” the moniker of the new debt instruments, are pouring out of offshore issuers in record amounts. For the year-to-date as of May 31, there were 24 issues of Maples sold in Canada, vs just 11 issues in the same period a year earlier, according to Standard & Poor’s Corp.

Maples are a win-win product for both issuer and investor. They offer Canadian investors significantly higher interest than equally rated bonds from familiar domestic issuers, provide geographical and even sector diversification, add to the available stock of AAA-rated debt and give issuers access to fresh capital at lower rates than in other markets, says Brad Bondy, director of research for Genus
Capital Management Inc. in Vancouver. “Familiarity breeds investment,” he quips.

Indeed, familiarity is the key to understanding the way Maples work. Maples have been developing as a distinct part of Canadian debt markets since 2003. And the 2005 federal budget’s elimination of foreign-content limits on pension funds and retirement portfolios has created a vast new market for the bonds. Then, Canadian interest rates began dipping below those prevailing in the U.S., where a great deal of European debt had previously been sold.

Maples offered big yield boosts when the category was new. In early 2004, AAA-rated corporate bonds carried 15 to 20 basis points of yield premium over Ontario long bonds, says Chris Kresic, senior vice president for investments at
Mackenzie Financial Corp. in Toronto. But even though the spreads are down to five or six bps, this hasn’t reduced the appeal of Maples for either the buy or the sell side, he says: “The success of the Maples is a testament to Canadian investors’ demand for yield in a low interest rate market.”

In the beginning, unfamiliarity was the force that kept Maples paying significantly higher yields than Canadian bonds with similar ratings, terms and coupons. But money managers are becoming comfortable with AAA-rated names such as Rabobank Group, a Netherlands-based banking giant. Kresic figures Maples will remain desirable assets even if the yield premium over Canadian names goes negative: “The Maples market provides diversification and a quantity of AAA-rated issues that buyers want.”

Maples, which so far have been issued for the institutional market, should eventually become accessible to retail buyers, says Rob Palombi, director of fixed-income research at S&P in Toronto. The interest rate spreads on Maples have shrivelled; a few bps of extra yield on a Maple bond is hardly enough to get the attention of any retail bond buyer, whose main challenge is to buy bonds on terms close to what pension funds and life insurers get. Typically, bond desks boost prices to small retail investors with less than a few million dollars to spend on a deal. The retail investor winds up losing 25 to 50 bps of yield this way.

More yield per dollar put into Maples should be coming, Palombi reasons. As the Maples market matures, it will expand to include industrial companies and names rated at the lower end of the investment-grade range, he explains. By moving down the ladder of credit ratings into the lower end of investment-grade bonds, Maple investors should get substantial boosts in their returns. Wider spreads should attract retail buyers and managed bond portfolios marketed to individual investors, he adds.

Maples will probably grow in volume and visibility, as well, Palombi says. There is less AAA-rated debt on the market because the federal government has been running surpluses and has cut issuance, he notes. The relative scarcity of AAA-rated bonds continues to drive buyers to names such as Germany’s AAA-rated bank, Kreditanstalt für Wiederaufbau, which was established in 1948 to help with post-war reconstruction and is now abbreviated to KfW Bankengruppe.

@page_break@Despite these positives, investors and advisors will have to be careful not to fall into the dead zone in which unfamiliar or infrequently traded bonds get parked. Randy LeClair, vice president and portfolio manager at AIC Investment Services Inc. in Burlington, Ont., warns that Maple bond owners may find it hard to get liquidity in secondary markets. If there is not a lot of trading, it is difficult to generate a yield curve for issues, he adds. That, in turn, discourages analysts and professional investors. But, as the volume of Maples sold grows, the secondary market should gain liquidity, he says.

Maples are going to be a growing presence in the market, says Walter Schroder, president of Dominion Bond Rating Service Ltd. in Toronto: “We have a big budget surplus. The U.S. is running a deficit of US$2 billion a day. That is 5% of annual gross domestic product, and it is accumulating abroad. That is pushing up interest rates in the U.S. Canada, with its federal budget surplus, has lower interest rates. As long as that condition prevails, foreign borrowers will have an incentive to borrow in Canada.”

Mutual funds are already buying Maples for their Canadian bond portfolios. “The Maples market is still under development,” says Steve Locke, senior fixed-income portfolio manager at Howson Tattersall Investment Counsel Ltd. in Toronto. His firm, which runs Saxon funds, has bought Maples for their yield boosts. He says there’s not yet enough reason for stand-alone Maple bond funds.

But expect growing familiarity with Maples to generate investor demand. Mutual fund marketers will have the opportunity to sell portfolios of Maples on their merits — higher yield without foreign currency risk, top-notch credits and diversification.

Advisors, too, are getting to know Maples. Derek Moran, a fee-only financial planner who heads the Kelowna office of Vancouver-based Macdonald Shymko & Co., appreciates the idea of getting good yields on corporate debt that often has higher ratings than domestic issues: “Would I recommend a Maple? If the bond fits the client, then the quality would be a boost for the yield, and the yield would be a boost for the rating. It doesn’t get any better than that.” IE