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Thursday, 20 June 2019

Secular or cyclical?

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Asia’s newfound love affair with bonds is transforming the region’s capital markets. Equities have lost much of their traditional appeal as investors struggle to cope with volatility, and even risk-hungry private-banking clients have turned to fixed income. Will Asia ever return to habit?

The last 12 months have reversed the traditional mix in Asia. The current year has been an outstanding one for Asia’s debt capital markets, just as equity issuance has faded. Is this a function of rates and markets, or is there a more significant shift taking place?

The increase in debt-capital-market volumes has been momentous. Total Asian debt issuance in G3 was US$115bn up to early November in 2012, compared with US$73bn for the whole of last year.

“You’re talking about a 48% increase year to date and the year hasn’t ended yet,” said Paul Au, head of DCM syndicate at UBS in Hong Kong. Moreover, it has been a fairly broad-based improvement. “The issuance has been across the region, from many different countries, with a good mix of corporate and sovereign issuance and a pick up in high yield issuance.”

One interpretation is that the increase, and the decline in ECM volumes, is a function of temporary circumstances.

“It’s part of a global phenomenon of record low interest rates and credit spreads that have been tightening through the year,” said David Ratliff, head of investor sales and relationship management, Asia Pacific, at Citigroup. “You’ve got US Treasuries at all-time lows, and in a lot of local currency markets you’ve also seen rates come down to dramatically low levels. Issuers are taking advantage of that.”

At the same time, equity issuance has been problematic in such difficult markets. “It’s been challenging for ECM,” said Herman van den Wall Bake, head of fixed-income capital markets for Asia at Deutsche Bank. “The reduced growth prospects in the region, and the fact that margins have come under pressure, have impacted valuations and investor appetite. Many companies have opted not to dilute themselves at these levels and have looked at the debt market instead.”

However, there are broader shifts at work, too. If this was just a case of people ignoring equities for all forms of debt, there would have also been a rise in loan volumes, but that has not been the case. “It’s not a function of leverage all of a sudden going up,” said van den Wall Bake. “The syndicated loan market is down 20% year on year. Instead, what you’ve seen is a trend away from bank financing and towards bond financing.”

People have been expecting this to happen for some years, but the exceptionally high liquidity among Asian lenders has stopped it from taking place. Earlier this year, however, banks globally began to be squeezed and the term and quantum of lending began to change.

“Hong Kong blue chips, instead of getting five- or seven-year loans, were only getting three-year loans,” van den Wall Bake said. With margins on those loans increasing, too, as banks passed on borrowing costs, bonds started to look much more attractive.

“The minute bond markets reopened in January, there was a stampede of corporates trying to lock in term funding,” said van den Wall Bake. “As the year progressed and we saw base rates rally and credit spreads tighten, the appeal of terming out debt was compounded.”

This has become increasingly clear through the current year as rates from the perspective of issuers have got better and better. Take Hutchison Whampoa, for example. It launched five- and 10-year bonds in January, raising US$1.5bn at 3.5% and 4.625%, respectively. It returned in November for the same volume and tenors, this timing paying 2% and 3.25%, respectively.

“Basically, they’ve saved themselves 150bp in the same year, with just 10 months in between,” said van den Wall Bake.

On top of that, there is a continuing change in the nature of the Asian investor base. This manifests itself in a number of ways, from the growth in the number and scale of sovereign wealth funds, to the steady development of pension funds, and the increasing appetite for debt securities among private-banking clients.

“The Asian investor base has become a lot more independent, which means issuers from the region are able to depend a lot more on Asian investors alone for their issuance, rather than needing global or 144a transactions,” said Au.

Ratliff agreed. “Over the last few years, you’ve seen the local institutional and private-banking client base grow in terms of its importance to getting credit deals done,” he said. “Going back several years, there was a lot of demand for Asian debt deals – first from Europe, second from the US and, then, the local Asian institutional client base. Since then, you’ve seen Europe shrink a bit, and a big rise in Asian appetite for new issuance.”

Correspondingly, issuers can raise money with confidence in the local bid without having to worry about the state of the US market at any given time. Au points to a US$750m deal UBS joint led for Citic Pacific, raising the money in Reg S format. “Two or three years ago, if someone had asked me, should I go to the states and do a 144a, my answer would have been: if you want US$750m, then absolutely you have to go to the US. Now, the answer is no.”

Van den Wall Bake agreed. “In the past, you would have thought a Reg S deal was good for US$500m, or at a stretch US$750m. Now, it’s a billion, and there are many examples of order books in excess of US$10bn. We’ve never seen this.”

It is not just the scale of the Asian bid that is changing; it has many different components, all growing in sophistication. One is private wealth. “There is a notable increase in appetite from private-bank clients and family offices,” said Ratliff. “Especially in Hong Kong, you’ve seen an increase in the number and size of family offices, some of which operate almost like hedge funds and get involved in the new issues in both debt and equity.”

Au, too, said the PB bid had “probably increased. It’s a reflection of liquidity among individual and high-end investors. A lot of them are putting more money into fixed income and that has created a deep liquidity pool for Asian credit”.

Au also notes an important shift in the way international investors are moving their Asia analysts into the region – which sounds obvious, but has not always been the case. “The big US and European accounts are setting up offices in the region, so that they can trade Asian credits in Asian time zones,” he said. “In the past, for some of these accounts, you had to pay a visit to them in London or the states. Now, you can see them in Singapore and Hong Kong.”

Additionally, the growing scale of Asian central banks is helping to drive the curve out to longer tenors, with longer-term deals becoming commonplace. Where Asia was once known for shorter-dated paper, it is no longer the case.

“Five to 10 years is the sweet spot and we’ve seen some very good interest in 30-year deals for strong credits,” said Ratliff. Citigroup has been on 30-year deals for Temasek, PTT and PLN this year and, most recently, a 30-year Reg S transaction for China Overseas Land & Investment, the first of its kind for a PRC real-estate company.

“You’ve even seen some longer-tenor deals getting priced inside the spreads of shorter-tenor ones,” Ratliff said. “That’s a sign of robust appetite. It’s a brilliant environment for issuers to be tapping debt markets.”

In terms of the type of issuance that has characterised the year, van den Wall Bake highlights investment-grade corporates as the main driver. “Investment grade has been open all year, as investors are more comfortable owning strong corporates with steady cash flows,” he said.

Another banker said: “Right now, would you rather own a government bond or a bond from Coca-Cola? Which is the safer credit? Most investors would rather own Coke and the same applies in Asia. If you want peace of mind, you want a strong corporate with steady cash flows.”

So, where to go from here? Few see any significant change in the global rate environment over the next year and, therefore, no obvious reason to expect a major reversal in issuance trends.

“Next year, unless you see a big backup in rates or credit spreads, the new issuance environment is going to remain pretty robust,” said Ratliff. “There’s insatiable appetite from institutional investors for debt and duration.”

Van den Wall Bake takes the view that Asia has been playing catch-up and is only now representing the proportion of global or emerging market flows it long should have done. “I do think you can replicate it. It was not a one-off.”

The bigger question will arise when the rates environment does change, and equity capital markets become an option again. Will the renewed importance of Asian DCM continue to stand up when that happens? If it does, then this year will be seen as the moment a substantive change in Asian funding took place, and not just a function of wild markets.

To see the digital version of this report, please click here.

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