NIP in the air. Is winter coming for Asia's bond markets?

Take a cursory look at league table data and Asia’s G3 bond markets appear to have had a very good first quarter.

According to Dealogic figures, issuance volumes are only marginally down on 2017’s record-breaking year. In the first three months of 2018, issuers across Asia (ex-Japan) raised $86.3 billion compared to $94.4 billion from January to March last year (see table 1, below).

But a glance at secondary market performance paints a very different picture. It is hard to find new issues that are trading above their launch price.

As a result, the JP Morgan Asian Credit Index (JACI) returned -1.463% to the end of March for investment grade credit and -1.015% for high yield credit compared to returns of 5.5% and 6.9% for the whole of 2017.

So to coin an old phrase, it appears to have been a tale of two very different quarters for the buy and the sell side of the market.  

Issuers, particularly those which came in January, have been able to lock in the kind of funding levels the market may not see for many years to come if the quantitative easing supertanker is truly turning in the other direction.

On the other hand, many institutional investors are, as one banker puts it, “currently sitting inside their shells” after being blindsided by the volatility, which gripped the market in February.

Where will Asia’s G3 bond markets go from here? FinanceAsia canvassed a group of market participants and their views, much like the data, are mixed.

THE DATA

On the positive side there were some blockbuster trades during the first quarter of 2018 unlike 2017, when the quarter’s largest deal was a $2.5 billion offering for Bocom’s Leasing arm.

ChemChina topped the quarter’s activity, raising $6.435 billion equivalent in early March, plus $5.5 billion from a syndicated loan, to take-out the bridge financing for its acquisition of Swiss pesticide and chemicals manufacturer, Syngenta. Not far behind is Tencent's $5 billion bond, which drew $40 billion of orders in mid-January.

But the region’s two largest trades have had contrasting experiences in the secondary market.

The ChinaChem complex has risen above its issue price. In March, it was made a top pick by a number of fixed income analysts on relative value grounds to other Chinese investment grade credits.

But it is one of only four transactions out of 20 from the four main four categories (China investment grade, China high yield, non-China investment grade and non-China high yield), which are above water.

The other three are:

• The Republic of Indonesia’s $1.75 billion green sukuk from early March, which broke new ground as Asia’s first green sovereign offering and a sukuk to boot.
• Baidu’s $1.5 billion five-and-a-half- and 10-year deal from late March. Who would have thought one of the fabled BAT troika would need to pay a 15bp to 20bp new issue premium (NIP) to clear the market at the short-end, but it proved to be the right call where secondary market trading was concerned.
• SSMS Plantation Holding’s $300 million offering from late January, which offered investors an attractive 50bp pick-up from where the credit had been unsuccessfully marketed in mid-November.

Far more typical is Tencent’s experience. It has underperformed even after taking US Treasury yield movements into account.

It may have generated an enormous order book and be considered one of Asia’s star credits, but its $1 billion 10-year tranche is down about four points and its three-year tranche about five points.

Likewise, Tata Steel’s $1 billion 10-year deal from late January is currently down just over seven points. It is the year’s largest high-yield deal so far.

THE VOLATILITY

One thing everyone agrees on is the dislocating market impact the sudden spike in 10-year US Treasury yields had in February. That month 10-year Treasuries underperformed pretty much every government bond market on the planet, with yields peaking at 2.941% on February 21, up from 2.405% at the end of 2017.

The sudden increase was sparked by US wage data, which revealed the fastest growth rate since 2009. It prompted forecasts that US interest rates would increase quicker than expected, backed up by the more hawkish tone of the new Federal Reserve Governor, Jay Powell.

Then there was the universal unwinding of the short volatility trade via the CBOE Volatility Index (VIX), which shook equity and credit markets alike.

As Clifford Lee, head of Asian fixed income at DBS told FinanceAsia. “The whole market found itself on the back foot, which created a lot of nervousness. Then unfortunately, before anyone could find their footing again, the prospect of a trade war between the US and China erupted.”

Gordon Ip, chief investment officer for fixed income at Hong Kong hedge fund Value Partners, agrees. “I’m a bottom-up investor so it’s not the absolute level of interest rates, which bothers me, but the velocity,” he said.

“The market just can’t cope when the direction suddenly changes and investors simultaneously unwind their positions. It’s like watching 10,000 elephants all trying to charge through one small door at the same time.”

Volatility may, therefore, become the new watchword for 2018. If it is, this year will stand in stark contrast to last year, when issuers enjoyed unprecedented and continuous market access despite any number of potential geopolitical shocks that could have knocked the market sideways.

But while 2017 was a banner year, market participants were well aware of just how expensive valuations had become, even if the only people openly articulating that fact were investors and some fixed income analysts.

Over the past year, investors have increasingly become hyper-vigilant about the possible ending of the three-decade long bond bull market. There is less consensus on whether that moment has actually arrived, or whether conditions will settle down again in the second quarter.

James Arnold, Citi’s head of Asia Pacific debt syndicate articulates the dilemma. “Everyone has been wondering what the unwinding of QE will look like for a very long time,” he said. “How will credit spreads react as liquidity is pulled from the system?”

Bankers say many institutional investors’ knee jerk reaction was to increase cash holdings to the 10% mark in February, anticipating redemptions, which began to materialise for two weeks, then reversed course. Momentum funds have disappeared altogether from the primary market and DBS’ Lee notes that high net worth investors have yet to dip their toes back in the water too.

“In previous sell-offs, private banking money bought on the dips,” he said. “This time they’re waiting to see which way the momentum and sentiment heads in.”

Value Partners' Ip concurs that investors are sitting on a lot of cash, but also believes there is a willingness to put it back to work again.

“There’s money sitting on the sidelines and it still outweighs the supply pipeline,” he commented. “Investors also want to continue diversifying their portfolios, but they’re going to become a lot more choosy and will push back on aggressive pricing.

“That’s a good thing for the whole market,” he concluded.

SUPPLY DYNAMICS

One aspect, which is highly unlikely to diminish, is supply. All things being equal, Asia’s rising economic wealth means the region’s bond market growth should easily continue outpacing Europe and the US for years to come. For example, analysts believe the JACI’s market cap will rise from $872 billion to $1 trillion during 2018, a growth rate of 14.6% (compared to 26% in 2017).

Some fixed income analysts argue that supply has been too plentiful, particularly from China where the onshore market is all but closed as the government tries to deleverage the economy and Chinese property companies need to refinance maturing Rmb-denominated debt.

Bankers say their determination to “use rather than lose their quota” before NDRC approval expires means they will continue accessing the market whatever the cost.

This would mark a relatively new development for Asia.

During periods of volatility in the past, the market normally shuts. Investment grade issuers choose to wait for better windows, while high-yield issuers either refuse, or are unable to pay the double-digit yields issuers demand.

What may have changed is the sense spreads are at the beginning of a long widening cycle so sooner is better than later. But the concept of paying an NIP is not one which many Asian issuers are used to.

The region has a lot of borrowers with a much shorter track record than Europe and the US. They are consequently less experienced at managing down-cycles.

This is less an issue for the region’s high-yield borrowers, which are used to having to explain their story and fight their corner. The sector’s lower sensitivity to US rate rises and its shorter duration bonds may also play well with investors in the coming quarters.

But at the moment, the market is just not willing to engage with the lowest rated credits like B3/B- rated Indonesia coal miner, PT Toba Bara Sejahtra, which pulled a debut high-yield bond in mid-March.

Bankers say it is single A-rated borrowers, which are finding it hardest to adjust to what might be the “new normal.”

MIND THE PRICING GAP

Citi’s Arnold argues strong supply is not actually a problem. He stresses that the market can handle it as long as issuers and investors can find better common pricing ground.

“Issuers have held all the pricing power for a very long time,” he explained “Liquidity has been so abundant, that they’ve been able to price flat, or through their secondary market spreads. Yield curves have also been flat.

“We’re now in a period of flux, which may well be marking the transition to a new set of market dynamics," he continued. "That is understandably taking people time to get their heads around. Plenty of investment grade issuers hold mandates to raise funds at x spread over Treasuries and are now having to go back to their boards and explain why it might need to be x + y over Treasuries.”

Bankers estimate that single-A rated issuers and investors are probably about 5bp to 10bp away from a consensus on pricing, although it varies by credit. On the positive side, this pricing gap has narrowed from 10bp to 20bp only a month ago.

Carla Goudge, head of  HSBC’s Asia Pacific debt syndicate, also highlights that Asia’s experience cannot be taken out of a global context.

Here issuance levels are actually down, spreads have been widening, and new issue premiums have also made a come back thanks to the recent uptick in volatility. 

“Everywhere issuers and investors are coming to grips with the current environment," she said. "But fundamentals remain strong in Asia, so we expect a more constructive tone to return sooner rather than later."

RAYS OF LIGHT

Arnold, Goudge and Lee all note a number of bright spots including a more diversified geographical issuance mix. This means that while China will probably still end up accounting for about 70% of total issuance by the end of the year, Southeast Asia might be able to keep up with its annual growth rate for once.

Notable Q1 highlights included Kasikornbank and Ratchaburi Electric from Thailand, plus Petron, Rizal Commercial Bank and International Container Terminal Services (ICTS) from the Philippines.   

All three syndicate bankers point out that there has been no QE-style pump priming in Asia. “The issuer and investor base has grown in tandem with economic growth,” Goudge commented. “There’s structural demand growth here.”

As a result, Asian investors took about 75% of new deals during 2017. Might they provide a bulwark against global volatility at least in their own region during 2018 and onwards?

In the past, rising US Treasury yields have prompted a hasty flight out of emerging markets equity and debt. Some argue the term is no longer the right one to describe Asia’s strong growth and improved fiscal resilience (across much of the region at least).

It is still a market where Asian credits trade wide of US comparables (about 88bp where double-B rated credits are concerned, although the gap has been narrowing since last October). Investors with global mandates expect a premium and bankers do not expect that to change over the near-term, although the differential may continue to narrow.

In the March issue of its monthly bond market report, The View, HSBC also said that investors were underweighting Asian credit in their emerging market portfolios. They noted that, “valuations were deemed expensive because of diminished transparency and weaker stand-alone metrics of entities linked to the central or local Chinese authorities.”

But syndicate bankers counter-argue that Asia might be surprisingly resilient throughout the rest of the year. “If the sell-off continues and the tide is turning, then Asia will be the stable point in a volatile world,” one concluded.