CB issuance to be underpinned by refinancings

While the Asian bond market kicked off the year with an almost crazy amount of new issuance, the number of convertible bonds has been significantly more modest. So far only five deals have come to market and the largest one raised only $250 million. One reason for the discrepancy is that CB issuers are not as concerned as the issuers of straight bonds about trying to lock in low interest rates ahead of the rate hikes that are expected globally at some point this year; for them a high equity valuation is much more important.

And with stock prices generally down so far this year, the incentive to come to market isn't really there -- yet. Right now, many companies are also coming up towards -- or are already in -- a blackout period ahead of their full-year earnings releases, which prevents them from selling either equity or debt. Consequently, bankers expect that the primary CB market will remain relatively quiet well into March.

Aside from the lagging stock prices though, fundamentals suggest that 2010 should be a busier year in terms of new issuance than 2009 when $12.7 billion worth of convertible or exchangeable bonds were sold in Asia ex-Japan, according to data provider Dealogic.

Because of the many CBs that were sold in 2007 -- a record year in the Asian CB market with $30.1 billion worth of deals -- and the common use of the five-put-three structure, there is also a larger-than-usual amount of CBs maturing or becoming puttable this year. And with many of these bonds trading well below their conversion prices, there will be a need for a certain amount of refinancing (unless the issuer has the cash available to just buy them back).

CB specialists estimate that at least $10 billion of CBs will be put back or redeemed in 2010, accounting for about 79% of the entire equity-linked issuance volume in the region last year, followed by another big redemption year in 2011. Some issuers may choose to sell straight bonds instead as the tightening in credit spreads means fixed-income instruments are starting to look attractive and Taiwan and Indian issuers have the option of also tapping the liquidity in their domestic bank markets, but this theme should support a number of new CBs as well, they say.

Indeed, it is also possible that some of the straight high-yield bonds that are coming up for redemptions this year may be refinanced using convertibles.

"It's too early to say how the year will pan out, but there is a lot of dialogue going on right now," said one banker at one of the major CB houses in Asia. "We are advising issuers not to wait until the last minute to do their refinancing, but to try to tap the market when there is an appropriate window," he added.

And contrary to 2009 when nobody was really thinking about investing, companies are again starting to raise money to support their growth, underpinning what is expected to be the second theme for new issuance this year. Among the CB issuers so far this year, Indonesian Berlian Laju Tanker (BLT) was to use the proceeds from its $100 million deal partly to pay for the acquisition of a Norwegian Shipping company; Jaiprakash Power Ventures will use the $200 million it raised primarily for capital expenditures; Ying Li International Real Estate raised money to pay for two new land sites; and Chinese coal producer Hidili Industry International Development was to use half of the $250 million to repay short-term debt obtained in connection with recent acquisitions and the rest for capital expenditures and future acquisitions.

However, the tentative start to the year has prompted some bankers to tone down their expectations for the year somewhat. One CB banker says he now expects 2010 to turn out about 1.5 to 2 times the volume seen last year, down from an earlier expectation that volumes may increase by 2 to 2.5 times.

One of the deals that could help boost issuance volumes is Hon Hai Precision. The Taiwan manufacturer of computers and consumer electronics in December filed with regulators to issue up to $1 billion of convertible bonds. If realised, this would be one of the largest CBs issued in Asia in recent years.

However, Hon Hai has so far been unable to find any investment banks that are prepared to help it sell the CBs at the terms that were filed with the regulators, including a five-year maturity, no put and a zero coupon, as bankers argue that they are not possible to realise in the current market environment. For the past few weeks it has been very quiet around this issue, but specialists say CB bankers are still lobbying Hon Hai to either re-file with a different structure -- perhaps add a three-year put, or increase the yield -- or boost the fees to the arranging banks so that they can re-offer the bonds below par without losing their entire pay check.

YTL Corp is another company to watch in the next few months. The Malaysian conglomerate, whose core focus is in infrastructure and utilities, has re-filed to sell $400 million worth of CBs. No timing has been announced, and one banker notes that the company has in fact had approval from the regulators for a similar issue for more than a year before it expired, which suggests that even though YTL needs the money, the sale of a CB in the near-term is still somewhat uncertain.

Aside from these two deals, more issuance is likely to come from Chinese companies. One banker also argues that Korean and Malaysian companies are behind in terms of the amount of new issuance they need to do, suggesting they too will hit the market in the next few months.

As far as other features of the CB market this year, most specialists expect the desire for stock borrow to remain a trend when it comes to non-blue-chip credits and issuers operating in more risky industries like gaming and real estate. Contrary to the CB markets in the US and Europe, investors have traditionally been happy to buy Asian convertibles on an outright basis, as a way to play the high-growth equity story and haven't worried too much about being able to hedge the equity option. This changed in connection with the latest financial crisis when credit spreads blew out and banks became unwilling to provide a credit bid for CB issues. Because stock borrow is limited in many Asian names, over the past 18 months controlling shareholders have regularly been making shares available for lending and some bookrunners have also helped create a synthetic borrow for investors by engaging in equity swaps with some issuers.

The increased desire for stock borrow "is an effect of the crisis", one banker said. "Investors are less willing to take stock price risk. If you don't have stock borrow, the terms are either very expensive (for the issuer) or, if it is a tough credit, the deal may just not be doable."

However, top quality issuers will continue to get by without stock borrow and outright investors will remain an important investor group for Asian CBs. As one banker put it: "In Asia, even hedge funds take an outright view on stocks. Stock borrow is good to have, but if it's an attractive name, I don't think that a lack of it is an impediment. It all depends on the issuer and the valuation of the stock."

That said, outright investors also care about stock borrow, because if there is none, it makes it harder to sell the bonds in the secondary market, thus impacting the liquidity in a particular deal.

Of the five deals done this year, Ying Li, Hidili and Hong Kong property and hotel group Far East Consortium saw to it that there was enough stock borrow for those buyers who wished to hedge the equity portion of the CB. In all three cases, shares were made available for lending by a major shareholder. BLT and Jaiprakash offered no stock borrow.

Meanwhile, zero coupon issues as a rule are seen as a thing of the past, with most deals nowadays paying a cash coupon and sometimes also an additional yield if the CB is put back or redeemed. Both this and the demand for stock borrow is a clear indication of the fact that the Asian CB market is currently a buyers' market -- another thing that may make issuers reluctant to come to market right now.

But in any case, the 2009 results need to get out of the way before the CB market can start to see more frequent issuance. Or as one banker said: "Mid-March will be when we really know if this is going to be a good or bad year."