Euroweek high yield report: the future

Euroweek high yield report, July 2011

What next for high yield in Asia? The standout themes people expect to see are growth and increasing diversity, both in the issuer and the investor base.

“The high yield bond market is clearly an important part of raising money for growth companies: names that have not yet achieved blue chip status,” says Florian Schmidt at ING. “The product came late to Asia but we can see it growing exponentially. We believe in the long-term disintermediation of the borrowing-lending relationship away from bank lending and into the corporate bond market.”

One of the biggest failings of the Asian high yield market to date is that it is so concentrated on specific countries and sectors: Indonesian resources, Chinese real estate, and more recently other Chinese sectors too. “The expansion of issuers is a critical step in the evolution of the market: you can’t just have a market purely dominated by the real estate sector,” says Henrik Raber at Standard Chartered. This is one of the impediments that bankers hope will be corrected in coming years.

“We’re still clearly behind in terms of the quantity of the issuer universe,” says Schmidt. “The only sector to date where you can play relative value is the Chinese real estate sector, and to some extent coal mining in Indonesia. If you look at the US or Europe you will see 20 different sectors.”

But the broadening of the Chinese issuer base is positive, and representative of what we might expect to see elsewhere. “One trend towards the diversification of the issuer universe is specific to China, where you can see the mineral and mining sector developing,” Schmidt says. China Oriental, he argues, was a pivotal deal in this respect: a strong credit, backed by Arcelor Mittal, with state-of-the-art facilities, and strong enough to succeed in pricing straight after the Greek crisis, first with a five year bond and subsequently with a seven-year. With that deal’s success, other similar issues, such as those for coal producers Hidili and Winsway, followed. “A new sector has established itself, and it’s a very good example of how quickly a new sector can evolve.”

Most bankers agree. “You’re going to see the breadth of issuers develop quite a bit,” says Raber. “Within China you’re going to see an increasingly wide range of companies come to market. You’ve got such a breadth of potential issuers them, from manufacturing companies in all sectors to conglomerates, real estate companies, the financial sector, leasing companies – an enormous spectrum. That’s going to be terrific for markets, as more choice and the ability to investor across sectors will be a big step in the development of the Asian high yield market.”

But outside China, where will diversification come from? One sees it from the Philippines in a limited sense, but the market people have been watching most closely is India, where regulatory circumstances – particularly withholding tax – are impeding issuance, as is a clear inflation headwind. “India could be a swing factor: if we see withholding tax reduced, there will be a dramatic increase in corporate issuance,” says Herman van den Wall Bake, head of global risk syndicate for Asia at Deutsche Bank. “That’s a place everyone’s monitoring very closely, because India has huge infrastructure needs and a host of companies at different stages of growth.”

Others are positive. “I think there is a possibility of seeing more corporate high yield deals out of India,” says Augusto King, co-head of debt capital markets at RBS. “My gut sense is Indian companies will make a lot of acquisitions, which historically are funded by bank loans, but I would not be surprised to see some of the bigger acquisitions funded by bonds as well.”

There is, too, some diversification underway among investors in Asian high yield. “You’re seeing a trend of US and European investors setting up offices in Singapore and Hong Kong,” says Terence Chia at Citi. “It makes sense: it puts the managers closer to Asia and enables them to advise head office on what sort of names are appealing.” Recent examples include Bluebay and GSAM.

Will we see greater structural complexity in Asia? Perhaps, but it’s been talked about for a while without gaining traction. “One trend, where everyone has been saying ‘it’s coming this year’ for the last five years, is the LBO,” says one banker. There have been some examples of momentum – KKR in Korea, for example – but it’s still a development for the future. One significant difference between the US LBO market and the potential for one to grow in Asia is that a typical US LBO takes majority control, if not 100%, whereas in Asia frequently a chairman will continue to hold at least half of the company – or at least voting control.

Another development for the future may be payment in kind (PIK) notes. “We’re seeing that in the west. It has the potential for using the high yield market as a mechanism to pay out dividends to owners or sponsors,” says Raber. He also sees the potential for the return of floating rate note high yield instruments, and expects high yield to be used more as a mechanism in leveraged finance; generally he expects liability management to be a greater area of focus for companies looking to take out expensive and shorter term debt and exchange it into longer-term borrowing.

Terence Chia, in Asian debt syndication at Citi, says: “One trend I think will emerge quite strongly is the hybrid. We’ve seen ICTSI, Tata Power and Sino Ocean Land tap this market and we’re going to see more of it.” While Joseph Tse, partner at Allen & Overy, notes the arrival of bridge-to-high yield transactions. “That’s another area where high yield is being used as part of a financing package and there is room for further development.” And Paul Au, head of Asian debt syndicate at UBS, adds: “I think you’re going to see more complicated and exotic structures – currency-linked transactions, secured deals. You will see greater complexity in high yield issuance with a wider range of issuer industries and nationalities.”

Bankers and issuers remain hopeful that the benefits of high yield will be reflected in pricing relative to locally available bank credit – although that is, in places like Indonesia, somewhat elusive at the moment. “There should be an adjustment of pricing in loans versus bonds,” Schmidt says. “But we also see the old story of loan bankers pricing risk way inside where bond bankers or the market would price it. Still, there are an increasing number of examples of bond and loan pricing converging.”

And however long that takes, Asian high yield now appears much more durable than it used to be. “The market is here to stay and it will grow,” says Schmidt. “It’s been hit twice, and hit very hard, but it’s come back on its feet by correcting the mistakes from the past. We have reached a stage where we have a universe of fantastically-run companies in Asia, whose corporate governance and management integrity is by no means inferior to standards set in the US and Europe.”