Asian DCM heads for record year

Euromoney, March 2012

If the first six weeks are anything to go buy, 2012 should be a record year in Asian debt capital markets. G3 issuance up to February 15 was US$21.34 billion, compared to $83.4 billion for the whole of 2011, according to Dealogic.

After a miserable second half of 2011, the bright start has galvanised the region’s DCM bankers. “We ended January with almost $11 billion of issuance. That’s the best we’ve seen, probably, forever,” says Murlidhar Maiya, head of debt capital markets for emerging Asia at JP Morgan. “We just printed our 11^th deal of the year [on February 1], compared to three dozen in all of last year.”

Jon Pratt, head of debt capital markets for Asia Pacific at Barclays Capital, calls it “the busiest start we’ve seen for the G3 bond market in Asia.”

What’s changed? Part of it is a question of pent-up supply: the second half of 2011 was all but a write-off, firstly because of concerns about Chinese governance but mainly because of problems in Europe. So there’s already a build-up of issuance, particularly refinancings, that can’t be postponed indefinitely.

But on top of that, investors can’t stay uninvested indefinitely, and many have seen the new year as an opportunity to put money to work. “Investors are going to have to find yield somewhere to make a return, and that is not going to come from investing in risk-free assets that are maybe not so risk-free anyway,” says Roderick Sykes, head of debt capital markets, Asia Pacific at HSBC. “They will need to look at credit and move further down the credit spectrum.”

It’s a good start. But it’s not that good. “We have come a long way in the last three years but we’re still printing only $65 to 70 billion a year” in Asia ex-Japan G3, says Roland Hinterkoerner, co-head of debt capital markets Asia at RBS. “It’s not much in the global context. It’s three good weeks in the US.”

“I look at it in two ways,” adds Mark Leahy, head of debt origination and syndication, Asia ex-Japan, at Nomura. “Optimistically:  it’s a cracking start to the year, and significantly above where we were this time last year. But at the same time, this run rate will put us at G3 market issuance of about $150 billion. That’s a good number, but it’s not that impressive.” Taking a top down approach, looking at the scale of Asian economies and working out how much G3 issuance should be, gives a quite different perspective, he says. “Taking stock markets as a measure, Asian bond markets in G3 currencies are a tiny portion of what they could potentially be.”

[Subhead]A permanent shift?

But is something more momentous taking place? Some see a major systemic change in Asian funding behaviour. “If you look at the capital structure of Asia as a whole you will see the proportion of equity is significantly larger in Asia than it has been in the US and Europe,” says Julien Begasse de Dhaem, managing director at Morgan Stanley. This is partly a consequence of their recovery from the Asian financial crisis, since when many Asian corporates have maintained large balance sheets – needing no reminder of how important it is to have liquidity and cash – and incurred relatively little debt. Even where there has been debt, the largest proportion of it has been bank financing. “That’s why the bond markets in Asia have historically been thin, because you have this double effect: high equity content, and within debt, high bank content,” Begasse says.

Begasse does not expect the conservatism in Asia to go away – nor should it – but he does see other trends that could change the capital structure, such as an increase in cross-border acquisition, chiefly from China, and diminishing bank liquidity in US dollars in the region. In particular, the European banks – who Begasse estimates have had one quarter of their liquidity in Asia – are pulling back. “That has two multiplying effects: one, they are not lending new money; two, they are selling their portfolios to other Asian banks that have liquidity. That’s a double impact because they are not lending, and the sale of their books is cannibalising the ability to lend.” Basel 3, and the cost of bank financing generally, are only going to exacerbate these trends.

Leahy sees this having an impact already. “Deals done in the loan markets two or three years ago are not going to have the same syndicates as they move into refinancing. Corporates are realising that the availability of cheap bank financing is not to be taken for granted.” And that ought to put bond market issuance up towards the level that these economies should warrant.

[Subhead]High yield returns

Early this year, the biggest deals were all sovereign paper: $3 billion from the ADB, $2.25 billion from Export-Import Bank of Korea, $1.75 billion from the Republic of Indonesia (in a 30-year deal), $1.5 billion from the Philippines, and $2.5 billion from Hutchison Whampoa in two deals within the space of three weeks. These were the sort of names who had been able to find windows when markets largely closed at the end of last year. It was a good start, but bankers wanted to see more. “If you look at the issuers so far this year, there have been three types: sovereigns, quasi-sovereigns and high quality corporates,” said Maiya on February 2. “What you want to see happen is people coming down the credit curve.”

Since then, it’s started to happen. There hadn’t been any high yield deals since India’s Ballarpur Industries in August, and the first that trickled through this year tended to come with a caveat: Shui On Land raised US$400 million of three-year notes at 9.75%, which looked high yield, but was unrated and went chiefly to Asian banking clients; Philippine bank Banco de Oro Unibank raised US$300 million, and at Ba2 was clearly a high yield name, but sold 55% of the deal to Philippine onshore accounts, which didn’t convince some purists.

But then an Indonesian utility, Cikarang Listrindo, launched a $500 million seven year non-call-four Reg S144a deal, attracting eight times that amount in demand. The deal set out with price guidance of 7.5% – not exactly wide, for an emerging market high yield credit at a time when Italy is paying about 7% for its sovereign bonds – but tightened further, twice, before settling at just 6.95%. $4.3 billion of orders came in from more than 250 accounts, with a roughly even split worldwide (38% Asia, 35% US and 27% Europe). Credit Suisse and Barclays led the deal, which is set to be followed by several more; at the time of writing a host of other names, including KKR-owned MMI Holdings (Ba3/B+/B-) and India’s Core Education and Technology (B1/B+), were readying deals.

Granted, Cikarang’s deal was somewhat unusual, since it involved a tender offer and simultaneous new debt offering rather than a truly new issue, but there’s no question that the deal marked a tipping point between people thinking high yield was on the verge of reopening, and concluding that it already has.

[Subhead]Indonesia, market darling

It is little surprise that Indonesia should be at the heart of this revival. The country is the darling of Asian investors right now, having been upgraded to investment grade by two of the three rating agencies with the third expected to follow. It’s not as if this has led to a major change in the way sovereign paper is trading – that happened way in advance of the upgrade – but the knock-on effect to other Indonesian issuers may be considerable, and Cikarang’s reception certainly suggests so. As Hital Desai at Credit Suisse puts it: “Could you get a deal done without the rating uplift? Yes. But does it help? Of course.”

On top of that, a change in rules by the capital markets regulator, Bapepam, should remove a hurdle that has impeded issuance over the last two years.

The upgrade, Sykes says, “is very significant. It lowers the overall risk-free rate people are looking at for the sovereign. Whenever an issuer goes from being non-investment grade to investment grade, it opens up a whole universe of investors who are able to buy the paper.”

An example is Japan. Augusto King, managing director and co-head of debt capital markets Asia at RBS, says his team recently went to Japan to talk to big investors about Indonesia. “Historically, they could not buy Indonesia, but they expect they can start to do so this year,” he says. “The big four insurance companies are all looking at it, simply because the upgrade allows them to.”

Maiya expects “a slew of top rated Indonesian corporates, particularly state-owned, which over time will get pushed into that investment grade line.” The only problem is that Indonesians don’t necessarily need to issue. Traditionally it’s the resource sector who have been the biggest user of international capital markets from Indonesia, which makes sense since they are in a dollar business, but you don’t see a lot of cash-strapped coal miners in Indonesia these days. “These are people who have been making so much money,” says Begasse. “If you are a resources company with enormous free cash flow, with commodity prices where they are, that gives them the opportunity to wait for better market conditions. They have done exactly that.”

[Subhead]The China question

However, for high yield to really come back, Chinese issuers have to come back too, and that’s not as straightforward as it seems. Chinese property issuers are sharply exposed to a slowdown in China – indeed, they’re a large part of the reason for that slowdown – and regulation aimed at easing property prices has not helped them. On top of that, Chinese corporates generally are going to take time to recover from the reputational problems from the accounting scandals of last year.

“In China it is going to be a question of investors getting their confidence back, and that is going to take some time,” says Pratt. Early deals, he says, will be retail driven, as was the case for a deal for Shui On Land in February. “You’re going to see other retail-driven transactions, probably in the real estate sector or other sectors where companies are well known to the retail sector. Deals from new sectors, or new companies in China, are going to have to prove themselves and wait for the right timing.”

Still, there are positive signs already. “Shui On is certainly high yield, and it’s in the Greater China property space, the epicentre of the challenged markets of the second half of 2011,” says Leahy. “I don’t think market practitioners thought that one of the first deals we’d see would be from Greater China property. I doubt this will be a flash in the pan: high yield markets are well overdue a reopening and will come back.”

One flaw with the Asian high yield market is that in the various periods when it has appeared to flourish, it has generally only done so in two areas: Chinese property companies and Indonesian resource stocks. One could argue that last year that expanded to Chinese industrials, but they caught the brunt of last year’s scandals. “With the industrials there are some corporate governance issues to work through, so perhaps they take a little longer to return to market,” says Duncan Phillips, director, Asia debt syndicate at Citi. He’s being polite.

But here, too, bankers are positive. “From the pipeline and conversations with clients, there’s going to be a much broader suite of issuers come to access the market,” says Leahy. “Not just industrials but TMT, consumer, retail, banking; resources is clearly a huge space in terms of capital requirements, and there will still be plenty of demand from better property names.”

Others agree. “I am always a believer that the high yield market will come back, and it doesn’t necessarily have to be credits from China,” says Patrick Tsang at Deutsche Bank. “High yield could be from Singapore, Indonesia or other countries. Investors will be looking for market leaders in respective segments.”

Tsang believes hybrids will also be an increasing focus. “They’re not a new product; since 2010 we’ve seen a range of issuance from Hong Kong and Singapore corporates and higher yielding names from India. But there are new structures out there, more bespoke solutions, and we should expect to see more issuance. I would like to see Asian banks issue new generation hybrid tier one issuance, but they will probably be a second half event, if not 2013.”

[Subhead]What investors think

Good as the news is in Asian DCM, one can’t escape the fickle nature of the international investment community. Money floods here in good times, but at the first sign of volatility in the west, it flies home as a risk-off defensive bet. As one banker ruefully observes: “China is AA- rated, but as far as people 12,000 miles away think, it’s still an emerging market.”

“It’s crazy, isn’t it?” says Hinterkoerner. “We still live under the old mantra where risk-off means you sell Asia, whereas it should be buy Asia because you want to buy the surplus countries.” Change comes slowly. “The safe havens are still the dollar and the Treasury market, and Europe will fuel that. In the course of the year I don’t see that changing.”

Still, the long term trend is improving. “The overall trend is for a greater weighting in global funds to Asia,” says Stephen Williams, head of global capital markets, Asia Pacific, at HSBC. “There is always a knee-jerk reaction in a crisis where investors would rather be playing closer to home than in investments they don’t see very often.” Also, he says, in volatile times Asian credits have tended to hold up well in price, but that only means that when a fund manager needs to make redemptions, they pick Asia since it will have lost less money. Additionally, as Asian deals get bigger, they come become easier to short. “So for technical reasons rather than sentiment reasons, Asia can’t help but be caught up globally.”

There are some other technical shifts taking place. Another is that Asia’s investor base is becoming a more powerful bloc in its own right. “Three years ago, if you were doing a dollar deal from Asia, you had less than 50% sold into Asia in most cases,” says Begasse. “Last year we’ve had deals with 75% sold into Asia.”

In particular, Asia is an increasingly important home for private banking money, most notably from Singapore. A February deal from New World Services had half of its book from private banking. “The private bank investor base is great for Asia: it has a strength of distribution that many other jurisdictions don’t have,” says Hital Desai, a vice president in debt capital markets syndicate at Credit Suisse. “Certain Indonesian and China property bonds have a strong following from the private banking community.”

And, while capital flight can be frustrating, things can change quickly. “Four or five years ago nobody believed a single number coming out of Indonesia, and now it’s the darling of the world,” says one banker. “Three years ago if you went to investors globally and said what do you mean by EM assets, they meant sovereigns and quasi-sovereigns. Their view of an emerging market asset was Korea Eximbank. For that asset class to have evolved from there into what we have today, where people really look at emerging markets as a properly distinguished asset class in its own right, that’s a huge sea change.”

[Box]The local story

In Asian bonds, G3 is not the whole point. If anything, it’s less of the whole point with every passing year. Ever since the Asian financial crisis, Asia’s local currency bond markets have been growing steadily, not just in scale but in depth and sophistication, to the point that today they make up far greater volumes for Asian issuers than G3 ever will. According to Dealogic, while last year’s ex-Japan Asia G3 total of $83.42 billion was considered a good year, local currency issuance came to $491.2 billion; there was more than three times as much raised in yuan alone last year, from three times as many deals, as in G3 issuance combined. Also according to Dealogic, China logged $164.5 billion in corporate investment grade issuance in 2011, up 39% on the previous year, and ranking second worldwide – meaning there was more corporate high-grade issuance out of China than out of the Eurozone last year.

“The developing asset class in this comparison is actually the G3 market,” says one banker. “The local currency markets have been developing for decades.”

Markets vary, but even in the less celebrated cases there are signs of growing resilience. One frequently cited example is San Miguel borrowing Ps40 billion (about $800 million at the time) in local currency funding in the Philippine peso market at the depths of the crisis in 2008. Elsewhere, maturities continue to lengthen in Hong Kong and Singapore. Singapore in particular has become a hub for perpetuals from foreign names like Henderson Land and Cheung Kong, and has started to take high yield, including Shui On. Thailand stood out last year for a major inflation-linked bond (see deals of the year, Feb 2012). It has since announced a second series, with HSBC mandated, while other sovereigns are believed to be looking at inflation-linked product as well. Thailand is also now approving non-Thai issuers three times a year provided they meet certain criteria – money used onshore, strong credit profile and a bearable impact on the swap market, for example. As is often the case, Korean banks have been trailblazers in this area, with Hana Bank launching a Bt 10 billion (US$324 million) two-part issue in February.

There’s no question capacity has increased beyond measure since the Asian financial crisis. “I remember doing a deal for BNI in the 90s, a five-year deal,” says King. “At the time it was a big scoop for them to do a five-year deal; until then the pension fund was having to invest in one year deposits. Times have changed a lot and you can do good tenor in a lot of these markets for good names – though they still don’t cater for SME credits.”

Still, they’re only good to a point. “These markets are not going to provide you with big size if you really need it,” says Begasse. “If you want a billion dollars, you have to go the US dollar market and knock on US investors’ door. These are marginally important markets, and will remain so.”

For developments in the dim sum market, see the news section.