Unwelcome visitor

Asia-based DCM bankers remain upbeat despite the global volatility, thanks to spreads having widened and the outlook for rates and credit remaining positive.

Asia’s offshore G3 markets have seen record issuance volumes in the years since the financial crisis, with each year surpassing the last. Despite recent global financial market volatility and the closure of primary markets as a result, regional DCM bankers remain confident that issuance is set to pick up and another record-breaking year seems unlikely.

Demand for fixed-income paper issued in 144A or Reg S format has remained stubbornly high in the years since the global financial crisis and the region has been a veritable printing press – with deals emanating from across the credit spectrum, from sovereigns, to corporate investment grade, to bank capital and to the very lowest of low grade.

The offshore dollar market for Asian names has appealed versus the competition that presents itself in the form of onshore bond issuance or bank funding in either local currencies or G3 debt.

It is not difficult to see why. The offshore bond markets are deep and liquid, there are fully formed yield curves to use for benchmarking purposes and the opportunity to tap a wide investor base in Asia and Europe (for Reg S deals) with the addition of the US (for 144A deals) is something issuers find hard to resist.

Invariably, for the better rated names there are savings versus the term funding costs in the offshore loan or domestic bond markets and the opportunity to build a fully formed yield curve that reduces all-in funding and pushes the debt service burden out to long tenors.

In the years since the crisis there have been grumbles that Asia’s offshore debt markets have become expensive. This is despite the fact that they offer the infamous “Asia premium” in which issuers in Asian industries offer a yield pickup to their peers in the developed Western markets.

“Asian issuers have got used to an environment in which they can seek razor-thin pricing terms thanks to high liquidity, the global quest for yield in the context of historically low US interest rates and a willingness among global real money investors to diversify. Whether or not the normalisation of US interest rates will change all that is open to debate,” said a Hong Kong-based syndicate head.

Despite a backdrop that has this year for the most part remained auspicious, there have been areas where issuance has stumbled, most notably in the beaten up oil and gas, commodity and China property sectors.

And the backdrop of market volatility in June and July, based on uncertainty surrounding Greece’s membership of the euro together with the recent equity market turbulence in China, has led to widened spreads across much of the offshore Asian bond complex.

“Asian issuers have got used to an environment in which they can seek razor-thin pricing terms thanks to high liquidity, the global quest for yield in the context of historically low US interest rates and a willingness among global real money investors to diversify”

“We feel constructive about primary issuance from Asia-Pacific going into September and October, investment-grade credit, including in Asia, has been one of the most stable asset classes during the general market volatility. Investors have strong cash balances and many issuers have the flexibility to access a range of funding markets,” said Alexi Chan, HSBC’s global co-head of DCM, based in Hong Kong.

The Asia IG index widened by around 20bp after the precipitous collapse in the Shanghai main board at the start of the last week of August, but had begun to grind in as the week progressed as Chinese and global equity markets staged a recovery.

“Asian high-yield has felt the impact of the recent market volatility. But Chinese property issuers have been able to access the onshore renminbi market instead, in good size and at competitive levels, and this has been a game-changer for a number of companies. Nevertheless, I would expect to see China property offshore supply coming back in the months ahead, as the yield gap between onshore and offshore markets narrows,” said Chan.

The ongoing liberalisation of China’s interest rate market, a declining interest rate environment and abundant liquidity among institutional investors – pension funds, mutual funds and life insurers – have allowed Chinese issuers to tap local markets at a lower all-in funding cost than they had got used to in the offshore dollar bond markets.

Modi’s promise

Offshore issuance from India had been expected to take off since newly installed prime minster Narendra Modi promised to kick-start the country’s infrastructure sector, but onshore issuance rates remain competitive in pricing terms to most Indian issuers, who are compelled by regulations to hedge offshore exposure and where the cost of issuing offshore just doesn’t make sense.

“There is demand but not enough supply of Indian names in the offshore market. The technicals remain very good for Indian issuance and when they come to market, as we saw for a recent ICICI dollar deals they can print aggressively,” said Chan.

“India remains a great prospect for the offshore credit markets. Investor demand for Indian paper continues to outstrip supply, leading to a strong technical backdrop for Indian primary issuance and some aggressive prints. A notable dynamic is the interplay between the offshore bond and loan markets, where high levels of bank liquidity has helped drive down pricing in both markets,” said Chan.

According to Thomson Reuters data, offshore issuance from India reached US$17.2bn last year via 30 issues, but has fallen back this year, with just US$7.5bn being printed off 16 issues.

This can be expected to pick up as Modi tries to smooth the way for project finance with streamlining for land acquisition in the pipeline, and as Indian banks seek to meet Basel III requirements via offshore issuance.

There remain concerns among a coterie of market players that a rate rise from the US Federal Reserve will prompt further declines in Asian currencies and capital flight ongoing volatility in global equities, and eventually lead to deteriorating credit quality that will present challenges to issuance.

Already the Malaysian ringgit and Indonesia rupiah have fallen to near 20-year lows against the US dollar and this has stymied issuance from those countries.

“I don’t think the issue of Fed rate normalisation has gone away and I think that the equity volatility we have seen, which is ostensibly all about collapsing Chinese stock markets, might well be to do with the Fed’s ambiguous position with regard to raising rates”

“I don’t think the issue of Fed rate normalisation has gone away and I think that the equity volatility we have seen, which is ostensibly all about collapsing Chinese stock markets, might well be to do with the Fed’s ambiguous position with regard to raising rates,” said a Singapore-based fund manager.

“It seems that given the carnage in Chinese stocks and fears of another global financial crisis developing, the Fed will now stand pat, having been expected to add 25bp to rates in September. But I still think they are likely to raise before year-end.”

It will be interesting to see how new-issue concessions and the pricing discipline emerge, if the bullish view that September will produce a busy new issuance calendar turns out to be the right call.

“The Asia premium is still there in the investment-grade space and has widened by around 10bp–20bp since the recent equity market volatility hit spreads, having compressed by that magnitude in the course of last year. So an Asian single or double A rated oil major will trade 20bp–40bp back of US or European peers. The issue is one of transparency and perhaps the fact that many funds place Asia in the EM silo,” said Herman van den Wall Bake, head of fixed-income capital markets Asia at Deutsche Bank in Singapore.

“It could end up as something of a bait-and-switch situation, with bankers promising tight pricing to issuers who are already shopping around in the very competitive local markets, particularly in China and India”

New-issue premiums in the US market have been rising, and in a few quarters bankers envisage that Asian offshore issuance will be started off cheaply versus comparables and that the iteration from guidance to final pricing will be more modest than we have got used to: perhaps just 15bp at five years for investment grade rather than a full 25bp.

“It could end up as something of a bait-and-switch situation, with bankers promising tight pricing to issuers who are already shopping around in the very competitive local markets, particularly in China and India, and in the offshore loan markets, where pricing is becoming attractive again. It might be that issuers get lured in only to find that investors are demanding more generous terms against what remain a very nervous backdrop,” said the fund manager.

There was a general consensus among DCM bankers that given the volatile market backdrop and the possibility of Fed interest rate normalisation, Asia’s G3 primary market would be unlikely to improve on its 2014 volume tally this year.

“As far as the rest of this year is concerned, I would expect that we are unlikely to see the total US$200m equivalent which printed in offshore G3 for 2014 repeated for 2015. We had around US$137bn equivalent printed at this point last year versus US$120bn right now. I expect to see around another US$30bn to print for a US$150bn total for 2015,” said Bake.

Bake remains bullish on the upper reaches of the credit curve and bearish on high-yield, believing that the recent sell-off offers greater opportunities in secondary which will crimp the buyside base for high-yield Asian offerings.

“Bright spots will probably be investment grade corporates in Singapore and Hong Kong, SOEs and banks in China and from India which has been resilient. High-yield looks pretty much shut on the basis of poor technicals and a prevailing cheap secondary backdrop. Many hedge funds will look to pick up cheap high-yield paper in secondary and take part in restructurings with an eye to a 30%–40% IRR rather than picking up paper in primary, however apparently well priced it might be.”