At the beginning of last year, few people predicted just how radically different a year 2018 would turn out be compared to 2017, which had broken all records in terms of issuance volumes and continuous market access.
Last year was an exceptionally difficult one as the world came to terms with rising US interest rates and trade tensions. Asian credit spreads blew out as the number of dollars contracted and returned home, while the Chinese investor base shrivelled under the withering glare of the country’s de-leveraging campaign.
As market participants return to their desks at the beginning of 2019, most predict a good deal of continuity with 2018. Investors may be starting the New Year with a clean slate, but confidence is pretty thin on the ground and could quickly evaporate under an onslaught of supply.
No one is sure whether spread widening has reached the bottom, or if the problems in the high yield market are simply a leading indicator of what is yet to come in investment grade.
Bankers suggest two New Year’s resolutions for would-be issuers: be ready, and be smart about how you put your syndicate together and distribute your deal.
As Alister Moss, Nomura’s fixed income syndicate head for Asia ex-Japan, said: “Issuance windows are likely to be high in frequency, but short in duration and sentiment driven. They used to be open for weeks, but it’s now a matter of days.”
Gaetano Bassolino, head of Asian capital markets at UBS, also urges issuers to try and strike a better balance between their own interests and that of their investor base. He said that for higher rated investment grade credits, it is generally about 25bp, which makes the difference between an investor being happy or unhappy.
“Investors have got long memories,” he commented. “After their painful experiences in 2018, they’re going to be looking very closely at who performed and who didn’t when they consider which deals to buy in 2019.”
Bankers agree that market-led deals will be the ones that work. One of the main issues that 2017 exposed was the fragile underpinnings of bond syndicates populated by Chinese banks and securities houses, which were there for relationship reasons or to take bonds onto their own books.
Many, although not all Chinese institutions, have scaled back or temporarily pulled out of the market. And even leading Chinese bankers believe that this represents a necessary step for the G3 bond markets as Chinese issuers learn to distribute paper to a more global investor base.
RETURN OF 144A
As Ernst Grabowski, head of Asia Pacific debt syndicate at Morgan Stanley puts it: “The days of a purely Reg S market are numbered. That’s good because a more international investor base means that bonds will be less exposed to micro-trends in the region.”
Grabowski spent much of November meeting investors across Europe and the US. One thing which struck him very strongly was how constructive they have become towards Asia.
“It’s the first time in my career that international investors have been more positive about Asia than regional ones,” he remarked. “The market has sold off sufficiently for them to see value, but they’re not going overweight just yet.”
HSBC’s head of Asian fixed income research, Dilip Shahani, backs this argument up. His team was ahead of the pack in turning bearish in 2018, but has recently adopted a more neutral tone.
In a recent research report, he wrote: “We believe investors in Asian credit are in for a less challenging environment but will still have to navigate in a nimble fashion in the earlier part of 2019. It may even feel like ‘climbing a wall of fear’ from a sentiment perspective.”
Indeed, most bankers believe that investors will adopt a wait-and-see approach to see how 2019 unfolds. There are currently more reasons to fear the year than to embrace it, particularly given most banks’ issuance forecasts.
“We’re predicting a 15% pick-up in US dollar issuance volume to $285 billion in Asia ex-Japan,” said Kang Jae Kim, head of Asian DCM at ANZ.
Most banks estimate that re-financing will account for about $150 billion to $160 billion of the total, up from nearly $100 billion in 2018.
Sean McNelis, HSBC’s co-head of Asia Pacific debt capital markets, flags the large number of call options that fall due in 2019 thanks to a wave of non-call five bonds issued in 2014.
As a result, net new money could be lower than 2019, particularly on the corporate side.
US RATES
What big global trends do investors need to watch out for? One of the big ones remains US interest rates.
“There won’t be a meaningful pick up in Asia until US rates peak and capital moves back to emerging markets again,” said Conan Tam, co-head of Asia Pacific debt solutions at Bank of America Merrill Lynch.
Amit Sheopuri, co-head of Asia Pacific debt capital markets at Citi, suggests investors examine the pace more closely. “Quite a few commentators believe the Fed is becoming more conscious of the global situation and will moderate its tempo,” he stated.
During 2017, US asset classes outperformed other global fixed income asset classes, but have started to come under pressure. A yield curve inversion at the mid-point of the Treasury curve signals a potential recession on the horizon.
This does not bode well for Asian investment grade spreads. Haitham Ghattas, head of Asia Pacific debt origination at Deutsche Bank, highlights the vulnerabilities it entails.
“Investment grade outperformed high yield during 2018, but we wouldn’t be surprised if there was a narrowing of the IG/HY spread ratio during 2019,” he said.
HSBC’s Shahani points out that investment grade credits have little spread buffer and longer duration than high yield.
“We would be worried about the sector’s performance in the early part of 2019 because of its sensitivity to US investment grade spread performance, its lesser attractiveness when compared with Libor and a still muted China bid for offshore credit products,” he commented.
Nomura’s Moss adds that as quantitative easing is reversed, shrinking central bank balance sheets will leave issuers chasing after few dollars in the system. He also warns about the risk of populism rearing its ugly head again in Europe.
“That factor really affected markets during the first half of 2017 and is already heating up to return in 2019,” he stated.
CHINESE DEFAULTS
And then there is China: increasingly a more important consideration for Asian investors than the US.
“China dwarfs everything in Asia,” said Clifford Lee, head of fixed income at DBS. “There’s no point looking under the bonnet elsewhere if you don’t understand what’s happening in China.”
So what are bankers looking out for in 2019?
Firstly, there is the Sino-US trade war. Raj Malhotra, Soc Gen’s head of Asian debt capital markets, sums up the prevailing view when he says that “issuance will spike and confidence will return if there’s any kind of resolution”.
But underneath that, there are deeper concerns about the structure of the Chinese economy and the central government’s ability to maintain its preferred 6.5% plus growth rate while de-leveraging the economy.
DBS’s Lee suggests that “the market needs to see China act more definitively than it has done to show that it’s on top of credit stress”. He is not alone in forecasting a risk of systemic failure if the country goes into a default cycle.
He believes that the government needs to take a leaf out of the US Federal Reserve’s playbook.
“During the global financial crisis, the Fed understood that it needed to cushion the blow and taper down over time,” he argued. “China needs to do something similar to demonstrate that quality credits are ring-fenced.”
Nevertheless, Chinese bankers argue that good quality credits will continue to be well-received as international investors get to know them better.
Sebastian Ha, head of debt syndicate at Bank of China, also notes changes in the onshore-offshore pricing differential, which may help to bolster the G3 markets in 2019 by reducing the weight of the issuance pipeline.
For higher rated credits, S&P Global Market Intelligence data shows that it is up to 80bp cheaper onshore at the three-year point of the curve and that is before borrowers take the likelihood of further renminbi depreciation into account.
Alwyn Li, vice president of global debt capital markets at ICBCI, agrees. “Costs could be lower in the onshore market particularly on an after swap basis,” he said.
TLAC
This is, however, unlikely to be of much help to a sector, which will not only come to dominate Asian bond issuance in the coming years, but global markets as well.
Towards the end of 2019, Asian investors will have to start familiarizing themselves with two new acronyms: G-SIBs (globally systemically important banks) and D-SIBs (domestically systemically important banks).
Analysts estimate that Chinese G-SIBs will need to raise $400 billion to $500 billion to meet the 2025 regulatory deadline for TLAC (Total Loss Absorbing Capital) buffer requirements.
Factor in their growth over the next six years as well and that means annual issuance of up to $100 billion in a market that has only ever topped $300 billion once in terms of dollar fundraising (2017).
It will be hard for them to raise money onshore since bank investors dominate the market and are not allowed to hold other banks’ TLAC debt.
“This fundraising is going to alter global FIG bond issuance fundamentally, particularly if D-SIBs are required to issue as well,” said ANZ’s Kim. “The banks will have to rely on the entire global investor universe and we could also see a lot less senior debt raised.”
HSBC’s McNelis concurs. “A lot of global investors turned away from Asian bank capital when spreads got extremely tight,” he commented. “That’s changed and money is coming back.”
All eyes remain on the People’s Bank of China, which indicated that it is likely to accelerate TLAC requirements in a report published in early November. Bankers believe that is no bad thing given the huge amount of paper that needs to be raised.
Key now will be how the central bank classifies it.
¬ Haymarket Media Limited. All rights reserved.
