ONE CREDIT, THE Republic of Indonesia’s 30-year bond, aptly sums up the status of Asia’s debt market. It is trading at around 210 basis points over the equivalent US benchmark, so investors are faced with a choice: place funds at three-month Libor or buy 30-year paper from Indonesia and earn an extra 150 basis points for their trouble. It is a simple decision to make, of course, but investors are falling over each other to make the wrong choice.
"You’re getting 1.5% uplift from three-month bank money to 30-year Indonesian risk," says Stephen Williams, co-head of global capital markets, Asia-Pacific, at HSBC. "It’s probably not where it should be."
That’s quite an understatement, but here is another anomaly. In February, the State Bank of India issued tier 1 capital in the form of a $400 million perpetual non-call 10.25-year bond. Paying a coupon of 6.439%, the bonds priced inside the prevailing price for a similar issue by Dresdner Bank.
At a recent global conference on high-yield debt, the head of Asian leveraged finance for a US bulge-bracket bank stood up with trepidation to make his presentation with one slide entitled Why it might be different this time.
"I know it sounds crazy," he says, "but apart from the obvious reasons of unprecedented global liquidity and diversified capital, we’ve been through a nuke in North Korea, a coup in Thailand and bird flu in Indonesia. Plus the CFO of Ocean Grand [a Chinese high-yield issuer] runs off with $250 million. Two years ago, the market would’ve crapped out, now it adjusts and the bid just comes back in."
Much of that bid, of course, is being driven by the growth in global financial liquidity. With fixed-income investors full up with US and European paper, say bankers, there is pent-up demand among investors for Asian credits.
"Over the past three to five years, a lot of managers have expanded their mandates," says Rahul Mookerjee, managing director and co-head Asia, debt capital markets and corporate coverage group, at Deutsche Bank. "They’re getting concerned about the level of exposure to western credits so they want Asian exposure. That factor is not going away for the next 18 to 24 months."
Real fear
The drive to rebalance fixed-income portfolios, fuelled by plentiful and cheap capital, means that even as prices rise for Asian credits, investors are becoming increasingly concerned about being left behind by the market. The frenzy is beginning to feed on itself, reckons Andy Jones, managing director and head of Asia Pacific syndicate at Barclays Capital. "The market’s come a long way but I think it still has room to tighten," he says. "There have been periods during the year when people suspend belief and say: ‘I can’t buy that at that spread.’ But weeks later they’re back and say: ‘I’ve missed this rally, get me into this [credit] now.’"
The fear of being left behind by the market is palpable, say bankers, as investors remain significantly underinvested in the region. According to Deutsche Bank, total G3 bond issuance volumes from non-Japan Asia have grown from nearly $15 billion in 1999 to more than $40 billion in 2006 (see chart).
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Is the party nearly over? |
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Asia ex-Japan G3 bond issuance |
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Source: Bloomberg; Deutsche Bank |
"That’s still nothing," says Mookerjee, "so there’s a virtuous cycle and that’s here to stay. It’s just too expensive to be out of the market for the funds and that drives a lot of the short-term thinking."
With little end in sight to the demand from investors for scarce Asian credits, more marginal issues are being peddled, often aggressively priced with high leverage and light covenant packages.
"Some of these deals we’re seeing now couldn’t have got done 18 months ago," says the Asia head of leveraged finance at a US investment bank, "but you can close them now. Until a few years ago, you could only do a term loan in Asia. Now we have high yield, sub-investment grade, and mezzanine – all in the space of the last two years. And guess what? If you can’t pay the debt, don’t worry, we can throw in a PIK toggle. Every risk today can be priced."
Leap of faith
Although global liquidity is a key reason for Asia’s over-bid credit markets, that is not the full story. There are several other, structural, reasons for the constant pressure on spreads. Despite all of the excitement in Asia’s bond markets, the region remains very much a vanilla banking market. Local banks, restructured, flush with cash and enjoying hugely advantageous costs of funds, are throwing money at Asian companies that most of them do not want. In the Asian financial crisis of 1997-98, wealthy Asian families had control of their conglomerates wrested from them by banks that had over-lent to them in the previous boom. These families are still traumatized by this experience and, with a few exceptions, having successfully restructured their businesses and regained control over their companies, they are loth to borrow again. Most of their operational businesses are throwing off cash, with much of it being hoarded. Those companies that do borrow achieve very advantageous terms from local banks, often in local-currency markets that have become far more liquid than before the financial crisis.
"There are episodes of overindulgent and indiscriminate lending going on," says Ajay Sawhney, managing director, head of Asia leveraged finance origination and co-head of Asia financial sponsors group at Merrill Lynch. "There’s also a complete lack of transparency on how loans and products get priced by the banks, since there’s no secondary trading and the loans are booked and held to maturity. There’s no incentive to reduce their asset base."