In a challenging time for risk assets, fixed income has emerged as the bright spot in an otherwise troubled Asian market. More importantly, it is transforming into a mainstream instrument – both for the region’s investors, and its issuers.
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Companies and governments across Asia loaded up on debt in 2012, pushing bond issuance to a record high, reported the Wall Street Journal. Data provided by Dealogic showed that volume out of Asia (ex-Japan) rose to $138.7 billion in 2012, up from $83.4 billion in issuance for all of 2011 and $88 billion in 2010. And then, in January 2013, the markets really hit the accelerator.
According to Matthew Sheridan, a Singapore-based partner at Sidley Austin, a substantial portion of 2012 bond issuance was sovereign, quasi-sovereign and investment grade, as global markets were risk averse during most of 2012. However, the high-yield markets started to gain momentum in late 2012 as risk aversion associated with the U.S. elections and fiscal cliff and eurozone crisis tailed off. “Late in 2012, many seasoned Asian high-yield issuers saw an opportunity to refinance existing, higher interest notes at significantly lower rates,” he says. “These seasoned issuers were well known in the market, had existing disclosure, covenant packages and collateral structures, so they were able to move quickly and opportunistically execute deals on a very short timeframe. This ‘perfect storm’ of factors led to record high-yield issuance in January 2013.”
The fact that Asia’s debt capital markets is in rude health is an encouraging demonstration of confidence in the region. According to the Thomson Reuters publication IFR, global investors now see many Asian securities as defensive investments – and that was certainly not always the case. Bonds have become part of the toolkit in Asia – both for investors and for issuers. While new investors are emerging, so too are Asian companies embracing bonds as a corporate finance instrument, reducing their dependence on the bank market and finding they can benefit from longer maturities and often at lower costs.
Sheridan says that PRC debt issuance, primarily high yield, has dominated the Asian debt markets for the past six years, and within that, PRC real estate developers have dominated. “This is largely due to continued demand for capital by the largest developers at a time when domestic bank liquidity for the real estate sector has been shrinking,” he says. “Compared to bank loans, the high-yield markets enable a borrower to raise larger amounts for a fixed rate and a longer term. As a result, real estate developers have turned to the high-yield markets.”
Historically, Sheridan says Indonesia has also represented a significant share of Asian high-yield issuance. “That market has not been as strong recently due to a combination of factors including relatively low bank rates and high liquidity domestically,” he says. “Nevertheless, seasoned issuers have been able to execute transactions at favourable rates to either refinance or term out their existing debt.”
He adds that the firm is also seeing, more generally, its mid-cap growth clients in a variety of industries including real estate, consumer, energy, mining and heavy equipment growing into large cap companies. “As these companies grow post-IPO, they need to access diverse sources of capital, including banks loans, convertible and high-yield bonds and private equity or joint venture funding,” says Sheridan. “As a result, Asian corporate capital structures have become much more complex over the past five to 10 years.”
Indeed, Asia is leading the way in developing new products, and appetite for risk is flowing over into corporate hybrids and more complex bank capital instruments. “Onshore bank lending for PRC real estate development has declined significantly in the past few years,” says Sheridan. “This has led many of the high-yield real estate issuers to seek innovative sources of funding, including private equity, joint ventures, insurance company and trust financing, both onshore and offshore.” He adds that issuers, underwriters and their counsels have had to develop innovative covenant packages to allow flexibility to access these forms of financing while still offering high-yield noteholders sufficient protection against structural subordination and other risks. “As a result, PRC high-yield covenant packages have many interesting and unique features,” says Sheridan.
According to Dealogic, the volume of debt issued this year will drop somewhat, even if it stays higher than the figures for 2010 and 2011. “While the January 2013 pace has slowed somewhat, and the January transactions were again dominated by PRC real estate developers, we are seeing a strong pipeline of non-real estate, debut issuers getting ready to come to market in 2013,” says Sheridan. It looks like it will take something really unexpected to slow down the momentum that is driving Asia’s debt capital markets.
Yield is king in China’s ‘dim sum’ offshore yuan bond markets
By Saikat Chatterjee
A return to China’s offshore yuan bond markets, or “dim sum” as they are colourfully known in Hong Kong, may be sweet for Gemdale, a mainland property developer. But not all fund managers are smiling. The company raised five-year money at 5.63 percent amounting to two billion yuan. Not bad, considering that last July, it raised a lesser sum for a shorter tenor while coughing up nearly double of what it paid this time around. Add the fact that it did so by keeping to the same weak bond covenant, and Gemdale seems to have pulled off a stunner.
But Gemdale doesn’t seem to be the only one. In recent days, issuers with weak bond covenants have discovered a ready market for their debt and at much cheaper rates. In theory, bond covenants can be divided into two halves: affirmative and negative ones. The former promises to pay bond holders on time, while the latter forbids it from exceeding certain financial ratios such as interest paid/EBITDA, debt to equity and so on. And of course, they are secured by the company’s assets or backed by bank guarantees or letters of credit.
But when theory meets reality (read: offshore hunger for yield meets hungry onshore Chinese issuers), financial “creativity” is the outcome. So mainland companies set up complicated structures to ensure they are able to keep regulators and ratings agencies happy while getting access to cheap capital quickly without having to negotiate labyrinthine approvals processes.
And has that system thrived. Fidelity Investments says Chinese offshore bond issuance is the fastest growing sub-set of the greater Asian dollar and the dim sum bond markets. Offshore issuance by Chinese companies in both the dollar and the offshore RMB markets have boomed over the last two years, and the fund manager says 16 companies amounting to $9 billion have such structures.
Enter keepwell agreements. In Moody’s words, they are used by China-incorporated companies to support offshore subsidiaries issuing debt. Unlike guarantee structures, a keepwell structure requires no onshore regulatory approval. (emphasis added) The agency has rated 19 bonds from 13 Chinese issuers totaling over $9.4 billion using these credit-enhancement structures.
Put simply, as these bonds are issued by offshore subsidiaries, bond holders have no direct recourse to the onshore company. All they can hope for is that the onshore firm will keep in mind the foreign creditors if there is a credit event. Of course, these structures haven’t been tested yet, so investors aren’t sure on how things would unfold in practice.
While rating agencies rate these offerings at a marginally lower level than the onshore companies, that hasn’t stopped fund managers from lining up to vote with their wallets. Gemdale’s offering, for example, saw its order book stretching out to eight billion yuan from 122 investor accounts. Fund and asset managers took 72 percent of the deal, followed by private banks at 16 percent and banks at 9 percent.
While weak covenants may be overlooked by investors as long as the yield is juicy enough in this age of zero interest rates, a credit event is all it may take for dim sum bonds to upset investors’ stomachs.
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