Keeping the pace

The threat of US rate hikes hangs over the credit markets in 2015, but strong growth prospects and bank capital constraints mean Asia’s bond markets are in for another busy year.

The long-anticipated end to the US Federal Reserve’s quantitative-easing programme last October did little to stem the heady pace of debt issuance from Asia, and the region’s offshore primary bond markets chalked up another record in 2014.

The outlook in 2015, however, is fraught with uncertainty over the pace of US interest-rate rises, a China slowdown and the risk of funds rebalancing away from emerging markets.

Asia’s primary bond market has broken volume records so regularly over the past few years that new dollar bonds have become something of a commoditised item. The product is likely to be put to the test in 2015, however, with the global outlook arguably more uncertain than it has been at any point since the global financial crisis.

Not only has the full impact of the withdrawal of QE yet to be fully reflected in US Treasury bond prices, but the eventual increase of US interest rates has not yet reached Asian asset prices.

Add to this the likelihood of a sustained slowdown in economic growth in China, falling regional property prices there and elsewhere in the region and rising default risk and you are staring at a less-than-pristine horizon for Asian credit.

In 2015, G3 primary in Asia, excluding Australia and Japan, printed a record-breaking US$210.2bn via 372 deals, according to data from Thomson Reuters. Jake Gearhardt, head of debt syndicate for Asia Pacific at Deutsche Bank in Singapore, reckons that a print around 5%–10% shy of that is a reasonable call for 2015, assuming investment-grade issuers remain enthusiastic borrowers.

“The big question mark in Asia is high-yield, where there’s a sense that the wheels came off, thanks to the well publicised problems in the sector,” said Gearhart.

“Given that the high-yield market in the region is dominated by property and commodities and that the latter is being impacted by US dollar strength, it is not the most auspicious backdrop for that asset class.”

In mid-January, PRC property developer Kaisa missed a US$23m coupon payment on its 2023 bonds, sending shockwaves through Asia’s China-dominated high-yield debt market.

Bonds of Fantasia Holdings and Glorious Property shed 10 and five points, respectively, in follow-through selling after the coupon miss and the market was awash with fears about how a major China offshore bond default would run, given the lack of precedent.

The market has rebounded subsequently on hopes that rival Sunac China Holdings will rescue Kaisa, but, with property prices in the PRC levelling off and the sector already burdened with a raft of offshore debt, it is unlikely that the heady pace of issuance in the China property segment over the past five years will continue.

Regional bankers foresee that reaching a third of last year’s US$13.7bn issuance total from the China property sector will be something of an ask. If that target is hit, it will be thanks to higher-rated issuers with strong name recognition and relatively low gearing.

A case in point was a US$800m seven-year non-call Reg S from Shimao Properties, which ticks those boxes. The notes priced in early February and, though it attracted a healthy book, thanks in part to a 25-cent rebate offered to private banks (which booked 42% of the deal), it was reckoned to have priced around 100bp north of where the developer could have expected to raise seven-year money prior to the Kaisa episode.

Despite the limp backdrop, the possibility of China property issuance on the back of bond calls is there, with an estimated US$1.8bn of high-coupon paper from the likes of Country Garden, Yanlord Land and Powerlong Real Estate ripe to be called and refinanced at much lower rates.

While low-grade China property issuance is likely to stay off the radar, high-yield in Asia is likely to find favour, based on newly emerging attitudes to country risk assessment. With their newly energised outlooks due to changes of leadership, Indonesia and India appear to be the new darlings of the Asian high-yield segment.

Also on a sizzling upward trajectory, the Philippines, which registered Asia’s second strongest growth in 2014 after China, is another at the top of everyone’s buy list, despite the fact that most issuance from the country is unrated.

“There’s ‘top-down’ thinking developing in investors’ attitudes to debt issued from those countries. It might not make a lot of sense when you look at each individual credit, but the market, for the time being, sees high-yield from those countries as a ‘must have’ fashion accessory,” said a regional DCM head at a European bank.

This was exemplified at the end of January when India’s Delhi International Airport, or Dial, and the Philippines Rizal Commercial Bank were able to bring successful Reg S deals into a slow market.

Relative value

While it could be argued that the Asian credit story remains appealing, both in terms of the yield premium that the Asian investment-grade sector offers, versus like-rated issuance from the US or EEMEA, recent sell-offs in the lower reaches of the Latin American and EEMEA markets mean there is a better value proposition on offer there.

“There are relative-value issues for Asian credit within the emerging-market debt asset class as a whole. LatAm and EEMEA credits have struggled, with the likes of Brazil’s Petrobras out at Treasuries plus 600bp, from around the 350bp mark in March of last year,” said Gearhart.

“Asia has benefited from a flight to quality, but the question is whether funds will find better value within EM ex-Asia.”

Nevertheless, the consensus among Asian debt bankers is that barring an aggressive rate normalisation from the Fed, the structural bid for credit, a natural consequence of low US interest rates, remains in place.

“The big question mark in Asia is high-yield, where there’s a sense that the wheels came off, thanks to the well publicised problems in the sector.”

“You’ve got Indonesia in the form of Pertamina trading around 300bp through Petrobras and these two roughly share the same ratings zip code. So, Asia looks relatively rich,” said Herman Van den Wall Bake, head of debt capital markets at Deutsche Bank in Singapore.

“But we’re still in the same low interest rate environment so the story holds, that there remains a quest for yield and Asia – particularly at the upper reaches of the credit curve – remains well bid.”

Asian issuers are also likely to be active this year in euros, as outbound M&A gathers pace.

“The euro is going to provide a rich source of issuance in Asia this year. The euro curve is relatively flat and offers cheap funding,” said Alan Roch, head of Asian debt syndicate at Royal Bank of Scotland in Singapore.

“There are European acquisitions by Asian companies that need to be refinanced in euros. In addition the low oil price will encourage further M&A activity in Europe.”

Asian issuers raised US$8.5bn-equivalent in euros in 2013, surging to US$12.2bn last year.

Watching the Fed

While China’s faltering growth poses a threat to Asian credit markets, a large number of Asian DCM bankers believe Fed rate normalisation has the biggest potential to derail issuance.

They point to talk of the withdrawal of QE3 in May 2013, when Asian primary markets shut for almost three months as funds were withdrawn en masse from EM currencies.

Asian banks still need to meet Basel III capital requirements and there remains a debate in the region about how best to structure these products.

Additional Tier 1 and Tier 2 issuance was all the rage last year, with around 58% of issuance in Asia G3 from FIG and, with Basel III compliance yet to be met, there should be more on the way.

The question is: just in what format? A jumbo multi-tranche AT1 bank capital deal that Industrial and Commercial Bank of China placed in December posed more questions than it answered about the standardisation of the product.

A large slug of its euro tranche went to central banks in a bizarre outcome, given the objective of these loss-absorbing securities is to protect national treasuries from financial system risk.

Bank of China lead the way in October with a deal that represented Asia’s largest fixed-income trade and the largest in contingent capital. Both banks raised a stunning US$12.2bn of AT1 debt last year.

“Whether we can see high-beta, high-duration products, such as perpetuals and loss-absorbing bank capital issuance getting successfully sold down in 2015 will be a function of background noise,” said the European bank DCM head.

“If volatility returns, thanks to the Fed, tumbling China growth or a return to crisis in the Eurozone, then such high-risk products will become a major challenge.”

Opinions vary as to how much Basel III-compliant paper needs to come from Asian banks, with rules applied patchily across the region. DBS CEO Piyush Gupta suggested in late 2013 that the shortfall could be as much as US$1trn.

“Most banks in Asia have pretty decent Tier 1 ratios and full Basel III compliance is only required by 2019. So, there’s quite a bit of catch-up time. I would expect more AT1 issuance this year, but on an opportunistic basis. When the issuance window opens, this product will be first to get rolled out,” said the European DCM head.