Last year was a watershed year for Asia’s debt markets. For the first time in history, debt accounted for about 40% of investment banking revenues, according to Dealogic. The unprecedented earnings were driven by record volumes, as the total dollar bond issuance from Asia ex-Japan surged to $130 billion.
But competition is also rife. In previous years, the fee pool was spread among a smaller handful of players. These days, every man and his dog wants a piece of the action. Aside from the bulge bracket banks, there are new entrants like ANZ, Mizuho, Mitsubishi UFJ and Bank of China International, which are all vying for business.
Can the fee pool sustain the increased number of banks in the fray? Perhaps. Debt markets are off to a remarkable start this year and high-yield, in particular, has had a good run. For debt bankers, this represents an opportunity to rake in fees as high-yield bonds pay fees in the 1.25% to 2.25% range, and a debut high-yield borrower may pay as much as 2.5%. In contrast, the fees on investment-grade bonds are often whittled down to several basis points, and spread among numerous bookrunners.
Still, the perception that the debt markets are heavily banked is probably true. And while the debt markets are having a great run, the lingering question is, how long will it last? Are we at the top of the cycle?
The record issuance has been underpinned by a number of factors. Rates are at all-time lows, making it attractive for companies to lock in funding. Investors on the other hand, are searching for a yield pick-up to beat low deposit rates.
But rates will not stay low forever, and if the US economy recovers faster than expected and China’s growth picks up, this could lead to a tightening cycle. And rising rates are typically bad news for bonds. There are also concerns that investors could start rotating out of bonds into equity, as stock markets have rallied.
So far, there is no evidence of large-scale switching from bonds to equities, according to a report by private bank Coutts. In the report, Gary Dugan, Coutts’s chief investment officer for Asia and the Middle East, notes that recent money flows show that investors have the same appetite for bonds as they do for equities. US mutual fund flow data through to early February showed net inflows of $23.8 billion into bond funds and $22.4 billion into equity funds.
But on the outside margin, there are signs of a more significant swing out of bonds, Dugan adds, with the five biggest managers of high-yield exchange traded funds (ETFs) seeing outflows equivalent to 7% of total assets during the first two weeks of February.
Anecdotally, there is also talk that Asian private banking accounts – which have become important bond buyers – could be rotating from bonds into stocks.
On the bright side, there are many who believe that Asia’s debt markets will continue to thrive based on the growth in the region and the fact that companies will need to find a way to fund that growth. If markets keep up and there are enough fees to go around, it will be happy days for all.
But with fee compression and increased competition, it will be interesting to see how 2013 pans out – and if the fee pool can sustain the current number of players in the debt market.
