Asia has managed to weather the storm in Europe’s credit markets in fine fashion, but the pullback of overseas lenders could mean that its resilience is about to be sorely tested.
Source: Reuters
Road signs stand in Mongolia’s South Gobi desert awaiting to be deployed during the development of Oyu Tolgoi copper and gold mine in Mongolia.
In the first working-week window of 2012, three of Asia’s premier sovereign-like issuers – Korea’s export-import policy bank, and the finance ministries of Philippines and Indonesia – succeeded in raising US$5.5bn in the international debt capital markets on the slightest of rallies in investor sentiment.
The once-emerging market boys are back in town, and this time they are staying at the best hotel. Relegated to the cheap seats, meanwhile, are those European nations with high debt and/or budget deficit ratios, who saw their funding costs surge to all-time euro highs as Italian and Spanish yields pushed past 7% and 6%, respectively.
Asia will also have to watch out in the first quarter as sovereign maturities in the eurozone are concentrated in the first half of 2012. Rollover risk will be particularly heavy in the first quarter, with total refinancing requirements reaching around €160bn (US$209bn) for Italy, Spain, Portugal and Ireland.
Clearly, attracting the funding to meet these maturing debt payments in the next few months may well prove challenging, particularly if risk appetite takes a renewed dive with the next step of the panicky and prolonged political process.
Yet, as emerging-market issuers from peripheral Europe have found the door slammed shut in their faces, the clutch of deals at the start of 2012 show that Asia is putting its best foot forward with aplomb.
They reinforce the view that Asia’s governments are going through a “quiet revolution”, in the words of Stephen Williams, head of global capital markets for Asia Pacific at HSBC in Hong Kong. The shifting status of Asia’s fastest-growing economies is, he says, “a movement in the development cycle of our capital markets of significance to our leaders, businesses and the public at large”.
It was, certainly, an impressive week after the epic breadth of issues last year in the sovereign and quasi-sovereign arena in both G3 and domestic currencies – such as ICBC’s Rmb1.5bn Basel III-compliant bonds to Indonesian state oil company Pertamina’s first US dollar global bond, South-East Asia’s first inflation-linked bond from Thailand and a global sukuk from Malaysia – that turned the whole bond world picture on its head.
State-run Export-Import Bank of Korea put out its largest US dollar bond so far, raising US$2.25bn on January 4, before branching out to local currency borrowing later in the month, this time in Malaysian dollars. The Republic of the Philippines claimed its best pricing for a long deal with a US$1.5bn 25-year issue, capping its reputation as the easiest credit on the strip after returning 11% on its paper in 2011 – ahead even of Indonesian bonds at 8.8%, according to HSBC indices. Then, the next Monday, the Republic of Indonesia took advantage of Fitch’s promotion of its sovereign rating to investment grade in blasting its way to a US$1.75bn 30-year fundraising. The RoI issue was the largest-ever long bond out of Asia, came with barely any new-issue premium, and then traded up the following week when Moody’s also raised it to investment-grade status.
Asia still under-represented
Asian governments are taking on debt to help create yield curves for future borrowers, to develop other sources of funding so that they are not reliant on banks, and to guard themselves against the kind of hard currency outflows that wreaked havoc in 1997 as investors cashed in their gains on Asian currency appreciation and panicked themselves into a dash for the ultimate safe haven of US Treasuries. It is all part of Asia staking its claim to its rightful place in the world’s bond markets.
Although that is the idea, the reality is that Asian bonds still occupy an unrepresentatively low place in the global credit universe. One only has to look at the wholly western names of the investment banks without exception that lead managed these Asian bonds – unless you credit HSBC, present on all three deals mentioned and a US$1.5bn issue the next week for Hutchison Whampoa, as part-Asian – to gain an understanding of why this may be so.
Asian banks have not stepped up to the plate, trailing even some European banks that are really not meant to be there. Asian regulators, too, have been slow to grasp the nettle and show leadership at a time when the agenda for global finance is very much open to the floor.
“You have to separate the concept of emerging market being a risky concept with high yields because that picture is changing,” says Cecilia Chan, chief investment officer at HSBC Global Asset Management, which has around US$25bn of assets under management, in Hong Kong. “If you look at the sovereigns that have been upgraded lately – India, China and now Indonesia – with that rating migration, the credit quality has improved, while, at the same time, the credit quality of the developed market has been dropping, it means developed and emerging sovereign ratings have levelled in a permanent shift that is structural rather than temporary.”
It includes everything right down to the lifestyle, she suggests, in the sense that Shanghai’s residents are learning to be effortlessly sophisticated with the arrival of luxury goods and the trappings of success after decades of being cut off from the world.
While this is good news, Chan regrets that it means Asian sovereign debt – most of it investment grade – is increasingly slipping out of her range. As portfolio manager of the HSBC Asian Bond Fund, which, she boldly announced in December, was 40% invested in Asian high yield at the expense of being underweight investment grade and preferred corporates to governments, it is symptomatic of the region’s market development.
Asia, as an exporting continent with a legacy of European colonialism, cannot escape the eurozone fallout – whatever its people may think. Foreign investors drove Asian bonds in 2011 with cheap dollars before selling as the US tightened its monetary policy and Europe descended into further chaos.
“Emerging Asia is susceptible to ebbing foreign capital because it still relies on external credit, particularly for short-term working capital and trade finance,” says Uman Manzoor, credit strategist at Citigroup. Roughly three-fifths of offshore lending in South-East Asia comes from European banks, he adds. “The biggest risk to Asian bonds, therefore, is that more of this capital drains as eurozone banks pull back.”
Clear and present danger
Cash-starved foreign banks are already beginning to exert pressure on Asian credit markets. So-called ’axe sheets’ of loan assets are getting longer. As a result, Swire Pacific, one of Hong Kong’s most powerful blue-chips, is on the block for 95 cents on the dollar, if you fancy a slice of its last syndicated loan, a HK$9bn (US$1.2bn) five-year facility signed only last June. Nine banks committed HK$1bn apiece to the Swire loan and the market will be watching carefully for the impact of the discounted sales on the cost of the company’s next financing.
“It is clear global risks have increased and it is going to be a more challenging operating environment, even for the Asia-Pacific region,” said Ian Thompson, senior managing director and chief credit officer at S&P. “A dislocation in global funding markets also has the potential to damage credit in Asia-Pacific. If export demand continues to wane and global credit markets deteriorate further, then sovereigns, corporations and banks in Asia could feel the strain.”
Several corporate issuers, long dependent on cheap bank funding, have already felt the impact of tighter credit. Hong Kong infrastructure group NWS had to pull a dollar bond in January. Hong Kong’s IFC Development had to cut the size of its three-year loan to HK$5bn and sweeten pricing, but, even then, after initially sounding out the market last July for a HK$17bn refinancing, it is still struggling in syndication.
Their troubles highlight the dependence of Asia’s credit markets on investors based many thousands of miles away in Europe or the US. That leaves Asian borrowers – and, indeed, the region as a whole – sorely exposed to the threat of a wholesale capital flight.
“The main systemic risk to Asia-region economic stability and growth prospects comes largely from a slowing in global growth rates more generally and, particularly, the broader macroeconomic volatility that may stem from the European sovereign debt crisis and flight-to-quality capital flows that negatively impact Asian markets and economies, and underscore the distance that still needs to be traversed to attain ‘safe-haven’ status,” said Neeraj Seth, head of Asian credit at BlackRock, the giant US fund manager.
As tighter bank lending pushes more Asian companies to submit to the scrutiny of the capital markets, there is a risk that more dirty secrets will come out in the wash. Sino-Forest, the Hong Kong-listed Chinese forestry company, confirmed its descent into bond market ignominy late last year with its failure to publish financial statements, serving a timely reminder that Asian success stories are sometimes just too good to be true.
Investors remain extremely wary of riskier high-yield credits, putting more pressure on governments and local state-backed lenders to fill the funding gap. As those local agencies raise their own funding to take up that slack, that will only add to Asia’s exposure to international capital flows.
Some, however, see opportunities amid the uncertainty.
“Despite the sell-off in recent months, it is worth noting that, over the past 12 months, not a single Asian high-yield bond has defaulted to date,” says Bryan Collins, portfolio manager at Fidelity in Hong Kong. “Overall, the dislocation in financial markets has pushed a disproportionate number of Asian high-yield bonds to distressed levels that are simply not justified in terms of company fundamentals and, therefore, present attractive opportunities for seasoned investors.”
