Asian high yield: the only way is up?

Issuance by non-investment grade Asian borrowers has been so strong during the first four months of 2017 that volumes are now very close to topping the region's all-time record-breaking year, 2013.

According to Dealogic's broadest measure of non-investment grade credits, issuers in Asia ex-Japan ex-Australia had raised $29.1 billion by the end of April, compared to $29.9 billion throughout the whole of 2013. 

Much of this strength came from the first quarter of 2017, which broke all records when $23.6 billion was raised from a total of 51 deals, including bonds without standard high yield covenants from the likes of Noble group, Bohai Capital, Hesteel and Beijing Properties.

This issuance level represented a massive 43.67% increase compared to the previous record-breaking quarter in the first three months of 2013 when a total of $16.4 billion was raised through 44 deals.

April 2017 has continued the trend. A total of $5.5 billion was raised over the course of the month according to Dealogic data. This represented 23.3% of the first quarter’s total, which means that issuance levels have slipped somewhat.

However, just this one-month alone is still higher than eight of the previous 14 quarters dating back from the end of 2016 to the third quarter of 2013. For after 2013’s record-breaking first quarter, issuance dropped off sharply to an unlucky $6.66 billion in the second quarter and then $3.1 billion in the third.

Market participants are well aware that issuance and spreads are currently balanced on a knife-edge.

Single-B rated credits are now trading where triple-B rated ones were only a couple of years ago and even triple-C rated credits are discovering they have market access for the first time since Asia Pulp & Paper (APP) came to market in 2000. Older hands will be equally well aware of the disaster, which unfolded shortly after the Indonesian group blew up.

In this two-part series, FinanceAsia examines where the market might go from here and what impact the recent appearance of conflicting signals may have on issuers and investors’ behaviour.

Liquidity in abundance

Few would disagree that the rally is being driven by liquidity. In its most recent EM Client Survey, published on April 21, JP Morgan noted that inflows into emerging markets remain extremely strong.

So far this year, there have been positive inflows in all but one week. The total inflows have already surpassed the level for the whole of 2016.

This has encouraged portfolio managers to put money to work in the primary market, with cash positions falling 0.1 percentage points over the month to 3.8% and down from 4.3% last November according to JP Morgan.

Abundant liquidity has created a virtuous circle, encouraging ever more issuers to tap the market as they see each wave of issuers perform in the primary and secondary market.

Julien Begasse De Dhaem, Morgan Stanley’s head of Asia Pacific fixed income capital markets, told FinanceAsia, “This was one of the main reasons why the first quarter was so special. We also saw a range of issuers from across the region, not just China and a good balance of repeat and first-time issuers.”

But what happens if inflows start to dry up? As JP Morgan’s research team concluded, “Any abating in fund flows could have wide implications for the market given current valuations.”

But debt capital market bankers remain very positive about the future pipeline, although Begasse does say that if the second quarter can match 70% to 80% of first quarter issuance he will be very happy.

Derek Armstrong, head of the Asia debt capital markets group at Credit Suisse, said, “The fact is the market has confounded expectations since 2013 when everyone first thought the fixed income market was on the turn."

Had fund managers scaled back then they would be out of a job by now. This is one reason why HSBC’s fixed income research team “reluctantly” decided to switch from a defensive to neutral stance in their April issue of the “The View”, the bank's monthly review of Asian bond markets.

The team, led by Dilip Shahani, said it is hard to fault market participants for complaining that high yield spreads are expensive on a historical basis.

But they argued that a high level of predictability about Asian GDP growth rates is dampening volatility and permitting “accrual strategies that can be amplified by layering on leverage.”

They added that this will be bolstered by Asia’s pursuit of a more “subdued monetary policy trajectory in the months ahead, while the Federal Reserve moves in a measured manner towards policy normalisation.”

HSBC thinks credit spreads will consolidate around current levels. Begasse and Armstrong agree that default risks remain low and corporate balance sheets strong.

The one thing they believe could disturb the market’s equilibrium will be geopolitical. So far, the centre ground appears to be holding in the French presidential elections and North Korea’s bellicosity has only led to a marginal widening of spreads.

“If the market is de-railed it’ll be something very unexpected which does it,” Begasse stated. “But I really don’t assign a high probability to this happening.”

Fee bonanza

Begasse added that Morgan Stanley began to re-configure its debt capital markets team towards high yield during the third quarter of 2016.

And so far the strategy appears to have paid off, with the bank jumping from 19^th in the league tables for the whole of 2016 to third during the first quarter of 2017 behind Credit Suisse, which has been first or second overall for the past few years (see table 1).

Table 1: Asia ex-Japan, ex-Australia high yield bond bookrunner rankings

Source: Dealogic

High yield remains an important revenue generating area for investment banks, particularly international — in particular, non-Chinese — ones. Bankers calculate that high yield typically accounts for about 10% of overall DCM volumes, but 40% of the fee pool.

And high yield fees have held up (see table 2).

Table 2: Asia ex-Japan, ex-Australia high yield bond fee pool 2010-2017 year-to-end-April

Source: Dealogic revenue analytics employed where fees are not disclosed.

One reason is because fees are concentrated among fewer banks. High yield offerings necessitate smaller syndicates to control an execution process, which is often far from straightforward.

Bankers estimate an average high yield fee of around 1% to 1.5% for a standard high yield offering. While the ‘glory’ days are long gone — a $430 million transaction for triple-C rated APP China generated $14 million for sole lead Morgan Stanley in early 2000 — high yield fees are still a lot higher than other asset classes.

They have held up in part because high yield syndicates have not yet experienced the same level of pressure as equity and investment grade bond syndicates, where a myriad of Chinese banks and securities houses are now jostling among themselves and against the international banks to further their global ambitions.  

At the moment, there is only Chinese institution in the top 10: Haitong Securities. But at the end of the first quarter, it was sitting at the very top of the bookrunner league tables, up from fourth in 2016. 

Its presence is a sign of things to come; a reflection of Chinese borrowers' weighting in the issuance league tables and the increasing firepower of mainland-based investors.  

But international banks believe they still have plenty of strong calling cards. These include getting first-time issuers through the rating process with the global agencies; selectively putting capital to work to support issuers; being able to read global market conditions; structuring covenants and conducting in-depth investor education.

In the second part of this series, FinanceAsia will look at trends in issuance patterns and how recent deals show issuers and investors displaying greater caution.