Debt capital markets poised to disintermediate bank lending in Asia
Tighter bank lending conditions – and an inevitable decline in regional savings – ensures that this year's boom in international bond issuance from Asian corporates will continue to gather pace, say analysts.
Asia watchers have predicted a sustainable surge in international bond market issuance for years but these predictions might finally be ringing true as bank lending conditions continue to tighten, triggering a supply of new bonds, and bolstered by ever-strengthening global demand. Bank deposits in Asia have grown thin during the past three years, brought on as a result of slowing economic growth and shrinking current accounts across the region. As a consequence, loan-to-deposit ratios in Asia are at all-time highs. In response, banks there are tightening credit standards, raising the costs of loans and issuing fewer bonds.
The allure of Asian capital markets has grown as investors look for diversification. Low interest rates in the west are pushing investors east, where the macroeconomic outlook is more promising. Meanwhile, the eurozone crisis has forced some investors to look further afield as well, in a bid to find a safe haven amid the chaos back home, suggesting Asian sovereign bonds are on their way to becoming "safe" assets for global financial intermediaries.
Moreover, corporates in Asia are more likely to assume more debt to boost return on equity. While Asian corporates’ cost of debt is at a 20-year low, at around 3.3%, the implied cost of equity remains high at 14%.
So while bank lending conditions remain tight, debt capital market conditions are strong. In search of yield, investors in Asia are turning away from bank lending to pursue the bond market, initiating disintermediation in bank lending.
|Source: Morgan Stanley|
And while local currency and bond markets will provide some liquidity, the sharp rise in Asian banks’ foreign currency loan-to-deposit ratios – many exceeding 100% to 200% – suggest there is a strong need to tap the offshore bond market in the medium term, says Desmond Lee, fixed-income research analyst at Morgan Stanley. According to Dealogic, Asian borrowers had issued $106 billion-worth of hard currency bonds year-to-end-September.
There is also a profound macroeconomic driver for the surge in Asian bond issuance – the progressive decline in regional savings intermediated by the banking system. “Asia’s current account surplus is shrinking and deposit growth across banking systems is slowing, [which] means Asian banks are no longer the bastions of liquidity they once were,” says Viktor Hjort, head of Asia fixed-income research and head of global corporate credit strategy at Morgan Stanley.
|Source: Morgan Stanley|
“This means that debt capital markets will now begin to play a more prominent role for Asia’s corporates and we expect corporate bond issuance volumes to run far above the historical norm.”
At present, Asian markets scarcely rely on the bond market for funding. Excluding the most mature markets in Asia, bank loans in Asian markets often exceed 100% of GDP, whereas the bond market equates to only 30% of GDP. Starting from such a low point, the Asian bond market has great potential to grow.
China, India and Korea will be the largest issuers of bond supply in absolute dollar terms, given the size of their economies and corporate sectors, says Lee.
Developing the bond market is necessary to maintain a healthy economy and create greater stability, says Rajeev De Mello, head of Asian fixed income at Schroders. “Policymakers are interested in developing the bond market because they are also worried about the clogging up of the banking system which is affecting Europe now and affected Asia in the late 1990s” he says.
“Since then, China and the rest of Asia have understood the need to develop bond markets so that companies can go straight to investors in case the banks have a problem.”
Year-to-date, US dollar bond issuance by Asia ex-Japan banks have almost doubled to $30 billion, says Lee. Moreover, a much broader universe of banks, including those in frontier markets, have chosen to enter the offshore dollar bond market.
Mongolia’s Trade and Development Bank, a state-owned policy bank, successfully issued five-year $580 million sovereign-guaranteed notes to international investors in March.
In May, VietinBank, Vietnam’s largest private lender, raised $250 million in its first overseas bond issuance of the year.
However, not all bond issues have been successful. In October, Mongolia's XacBank withdrew its dollar bond debut after speculation that there would not be enough interest amid a deteriorating market environment.
Nevertheless, the surge in offshore liabilities inevitably represents a source of anxiety for some policymakers.
“Although, generally, this is viewed well, Asians are reluctant to see foreign ownership of local bond markets go up too fast," says De Mello at Schroders.
“So on one hand, policymakers in Asia want the bond market to develop, but on the other hand they worry about hot money inflows and outflows, on whether this could destabilize the currency and hurt exporters. This is particularly the case in China and one of the main reasons they maintain capital controls even though they are gradually reducing them.”