Explosive potential

The threat of tapering hangs over credit markets in 2014, but a strong start suggests both Asia’s international and domestic bond markets are in for another busy year.

Event risk is supposed to be heightened in the Year of the Horse, Asia’s Feng Shui masters warn, with the dominant fire and wood elements in the new lunar year predicted to combine and combust.

After a brisk start to the calendar year, issuers and investors may well be wondering what unexpected event lies in store.

One possibility is that the dispute between China and Japan over islands in the South China Sea could escalate into a military conflict, which will certainly present idiosyncratic Asia risk and spark massive capital flight out of the region.

Another is the first real default in China’s domestic capital markets. Such an event was narrowly avoided in January when last-minute funding appeared for the Rmb3bn (US$495m) China Credit Trust, but another, smaller vehicle is heading that way after missing its repayment date in early February.

Other possibilities include the collapse of China property prices or another sovereign defaulting (Puerto Rico and Ukraine are leading contenders). Capital flight from Asia may also follow if the US Federal Reserve tapers its bond buying at a more aggressive pace than the US$10bn increments unveiled at its last two policy meetings.

“Last year’s talk of the big switch from debt into equity was probably overstated and the debt markets still look in good health.”

Even if the Year of the Horse proves less incendiary than the Feng Shui masters predict, few debt market players expect the record US$143bn in primary Asia G3 public debt deals issued in 2013 to be exceeded.

“The theme for G3 primary markets, post tapering, will be normalisation of the spread and rate environment,” said Jimmy Choi, head of Asia debt capital markets at ANZ.

“Last year’s talk of the big switch from debt into equity was probably overstated and the debt markets still look in good health.”

In fact, January started with a bigger bang than anyone expected as US$28.3bn hit the market in January via 36 deals – nearly double the amount anticipated and a record for the region.

Beating the taper

The early onslaught stemmed from the determination of corporate treasurers to capture lower coupon rates available ahead of any rise in US Treasury yields. Yields are expected to rise as US growth normalises and Fed tapering kicks in.

The January issuance blitz, a traditional phenomenon in Asia’s primary G3 debt markets, has not previously been seen in such gargantuan fashion. High-yield featured prominently, with the China property sector alone printing a staggering US$6bn of deals.

However, sentiment quickly changed in late January, as investors began fleeing riskier securities. Attacks on the Turkish lira and Indian rupee prompted rate hikes and widespread fears that an emerging-market currency rout was about to unfold.

The Asia primary market was shut to anything other than high-grade credits. Against one of the most nervous backdrops seen in Asia’s primary markets since the Fed taper rout of last May, it was left to Korea Midland Power last week to reopen the market.

The fact that Korea Midland is a high-grade credit and from South Korea, which has proved resilient to the latest bout of risk-off volatility, was lost on no one. Nor was the fact this was the first Korean deal in 2014 to come in Reg S format, indicating orders from the region without the US bid can anchor Asian G3 bonds.

Korea Midland priced its offering without a new-issue concession and the bonds rallied 7bp in the secondary market, a performance that, no doubt, helped lure Korea Gas into the market the next day. The solid performance of the two deals, perhaps, demonstrated that against a backdrop of rattled equity markets, the issuance window will be available only to seasoned high-grade names.

Local concerns

If global fears, or the Fed’s tapering plans, spark another EM rout, a critical component of this unwind would be the exit of offshore capital from Asia’s local bond markets. Local markets have benefited from hot money inflows in recent years as global investors searched for higher yields, while the Fed began its aggressive low interest rate policy and accelerated with the third round of quantitative easing in 2012.

If Asian currencies suffer sharp downside revaluations, servicing offshore (mainly US dollar) debt would become harder. Issuers may also find it costly to access local markets if rates shoot up due to capital flight. That may, however, be just a worst-case scenario.

A crisis aside, January offered a tantalising glimpse of what the Asia G3 primary bond year may have in store.

The most heart-warming event from a DCM banker’s point of view was the market’s embrace of Basel III-compliant bank paper. Hong Kong’s Dah Sing Bank priced in mid-January a Basel III bond. That appeared to comfort investors after a shaky response to these securities since ICBC (Asia) issued the region’s first international Basel III-compliant bond last October.

The market noise was so loud after ICBC’s offering that many wondered if the paper could clear at anything other than the thinnest of spreads versus banks’ outstanding senior secondary curves. One problem with ICBC’s bonds was the involvement of two sets of regulators.

Dah Sing’s terms limit regulatory involvement to the Hong Kong Monetary Authority, and they included both full and partial write-down features, unlike ICBC Asia’s full-write option.

The availability of secondary comparables in ICBC and Citic Bank, as well as the hefty sponsorship from institutional buyers, instead of private banks (which bought most of ICBC’s bonds), undoubtedly, helped in the deal’s execution.

Dah Sing’s deal may represent the true birth of the Basel III asset class in Asia, paving the way for many more Asian lenders to supplement their regulatory capital.

Indian banks also look set to embrace the format, with help from the likelihood that the Reserve Bank of India will allow any write-downs of capital in the event of non-viability to be reversible for bond holders. A test of this thinking could come soon as United Bank of India teeters above the 9% minimum capital ratio required of Basel III-compliant bonds.

Nonetheless, capital pressures suggest India’s banks will be busy issuers of Basel III-compliant bonds when the market opportunity arises.

Likewise, China’s banks will be looking overseas to boost capital, particularly against a backdrop of tightening domestic liquidity. China Construction Bank did a roadshow on a subordinated deal back in November and is likely to get the ball rolling on PRC bank issuance in 2014.

Hybrid surprises

The perpetual bond market opened earlier than anyone had expected, with deals pricing in early January for Greentown China and Hong Kong’s Towngas, although whether or not this represented the early year euphoria where high-beta deals could step through with ease among the welter of issuance is a moot question.

While it seems likely that any perpetual offerings this year will come only from high-grade issuers with name recognition, the market seems to have decided on its two favoured structures.

Investors prefer either the “cliff” structure, where 50% equity treatment from the ratings agencies is available and replacement capital is not required should the paper be called; or a step-up, which is sufficiently high to convince them that the first call option will be exercised.

After last year’s perp meltdown, in which a number of high-profile deals tanked in the secondary market and the product quickly acquired a toxic reputation, it now seems likely that the perp market will re-emerge when risk-on windows appear – particularly given that the spread of Asian hybrid capital versus senior in secondary trading has narrowed to about the 170bp–190bp area, an all-time low.

The high-grade market is likely to resemble last year. Korea’s policy banks and generating and operating companies are likely to be big issuers as will China’s state-owned enterprises. China’s oil majors, for example, remain on an acquisition binge.

Two interesting trends emerged late last year – issuance in floating-rate note format and issuance in euros, where a benign basis swap allowed issuers to undercut dollar funding rates.

The perception that US interest rates are heading north this year allowed Kookmin Bank to print a three-year FRN last month, and to achieve pricing through its implied fixed curve. China Development Bank and Bharti Airtel, meanwhile, were quick off the blocks in capturing the euro arbitrage opportunity. More euro issuance from Asia is to be expected, while that swap opportunity remains in place.

Despite prolonged fears that China’s property market is in bubble territory, issuance from PRC developers is likely to continue apace in 2014, particularly given that around US$4bn of calls and puts on paper issued prior to 2011 fall due this year.

Asia’s sovereigns are expected to surpass the US$6.5bn of issuance they produced in 2013, with calls for up to US$12bn of sovereign paper to be brought to market –thanks to redemptions and deficit financing. Indonesia sold a US$4bn two-part bond in January, its biggest deal on record, while the Philippines and Sri Lanka also got off to an early start.

Vietnam, Thailand and more exotic credits, such as Papua New Guinea, are also tipped to add to the Asian sovereign tally in 2014. Their ability to do so, of course, will depend on whatever explosive events the Year of the Horse may bring.

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