Asia on track to achieve $150bn bond supply

The region’s debt volumes should reach a record high this year as new sources of demand are uncovered, says Morgan Stanley.

Bond supply volumes in Asia remain on track for another record year in spite of an underperforming market, fund outflows and weak fundamentals.

Morgan Stanley maintains its Asia ex-Japan G3 supply target for the year at $150 billion, a 25% increase from last year’s total of around $120 billion and 36% rise from 2012’s volume of approximately $110 billion as new sources of demand are being uncovered.

The bank also predicts that the market size will reach $1 trillion by 2017, up from 2013’s size of $592 billion. This forecast requires an average annual supply of $150 billion over the next five years — less in the first few years and more in the latter, it said.

 “[Borrowers] have managed to tap into a new demand base, both by geography and by type,” credit analyst Viktor Hjort at Morgan Stanley said. “Of note is the growing share of US demand: allocation to US funds — both investment grade- and emerging market-dedicated — has been as high as a third this year versus one-fifth in the past two years, replacing Asia-based demand, down to 50% versus 60%.”

This is also evident in the increasing proportion of 144A  eligible deals (bonds that include US investors) — more than half this year — although Asian primary markets continue to have a far higher share of Reg S-only issues (debt transactions that exclude US investors) than other emerging markets.

The low proportion of Asian 144A eligible issuance historically has always represented a demand that issuers could tap into if regional demand were to become constrained. This is exactly what is happening now, experts say.

“There will always be global interest for Asian bonds and I think that US managers are structurally underweight Asian credit so there’s a lot of room for them to increase their exposure over the next few years,” said a Hong Kong-based fund manager.

The demand has not only gone overseas, there are subtle changes taking place in demand by investor type as well. In particular, private banking investors, a critical part of demand for Asia high-yield in general and China property in particular in recent years, have retrenched relative to others, now accounting for only 10% of demand, according to Morgan Stanley.

Instead life insurers are accounting for a growing share of demand. That demand is still relatively modest, accounting for 13% of total supply, but since this is one of the most potential sources of future demand for Asia credit the trend is noteworthy, the bank adds.

“What makes lifers natural investors in the asset class is their size, their asset growth and, with the exception of the Taiwanese, their current under-allocation to offshore fixed income,” Hjort said. “Asian insurers have experienced growth of between 10% to 24% annually over the past five years and their foreign investment is typically low.”

Chinese insurers represent the most likely potential source of demand due to both loosening of regulations in 2012 permitting allocations of up to 15% of assets to overseas investments and deregulation of how insurers price products, which may increase competition and consequently risk appetite, bankers say.

The surge in recent supply has caused bond markets to underperform in secondary markets. Year-to-date Asia bond supply reached $70 billion by end-April, annualising $146 billion on Morgan Stanley’s estimates and April itself was the biggest issuance volume month ever at $35 billion.

For example, China Cinda Asset Management’s debut bond sold last Wednesday underperformed in secondary markets shortly after being priced, with its five-year tranche widening by 5bp and its’ 10-year offering hovering at par.

Citi also highlights in a note on Monday that investor concerns about declining property prices, led to a decline in Chinese property bonds — particularly those with non-investment grade ratings. After the Hong Kong holiday last Tuesday, Asian credits opened generally softer in tandem with the lower-than-expected China PMI data and the loss in Hong Kong equities.

Chinese property high-yield credits traded lower with Country Garden's 2021s and 2023s seen at yields of around 9%, while the Evergrande 2018s traded around 88.50/89.50 end-last week, a high yield trader said.

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