1. Higher Interest Costs and Volatile Forex
For Asia-Pacific borrowers exposed to interest rate movements and the US dollar, the prospects for higher interest costs and volatile foreign exchange rates have increased in the wake of the US election result. The likelihood of investors seeking higher yields and favoring the US dollar rather than emerging market currencies appears to have heightened. How Asia-Pacific issuers adapt to this environment is crucial, especially for those with high exposures to international financial markets, such as those in Indonesia and Malaysia.
To assess the sensitivity of corporates to a spread shock, we stress-tested 390 rated Asia-Pacific corporates for a US dollar credit spread curve similar to the averages prevailing during the 2008-2009 global financial crisis (GFC). This scenario application resulted in yields almost two-thirds more than those prevailing in 2015 for the ‘BBB’ and below rating categories. The test showed that should such stress-level spreads persist over two years (2017 and 2018 in this exercise), about 16% of the rated Asia-Pacific corporate pool could be downgraded. The 16% ratio is plausible given that 10% of our rated Asia-Pacific issuer pool was actually downgraded in 2015, a non-crisis year.
2. China Corporate Debt Overhang
The ever-increasing level of corporate debt in China is intensifying risks because of weakening borrower credit quality. The still-high growth rate of debt could lead to potential losses over the next year or two; however, we believe China’s banks have sufficient financial strength to absorb the potential losses that could arise. In our base case, the rate of credit growth would moderate by a third by the year 2020. Even so, problem credit-to-total credit could double to 10% from our 2015 estimate of 5.6%. (Problem credit here is defined as nonperforming credit plus special mention loans).
In our base case, China’s deposit-taking institutions may choose to top up equity to maintain capital ratios at current levels. With banks generating a 10% return on equity, such capital replenishment, made over several years, should be feasible. However, in a downside scenario where we project the corporate credit growth rate to continue unabated, problem credit could triple to 17%. Fresh capital would then be more critical.
3. Corporate Refinancing Challenge
Although China has a relatively heavier burden to refinance maturing nonfinancial corporate bonds in 2017 than the rest of Asia-Pacific and the US, this is mitigated by the bulk of such bonds being domestically sourced. Our perception is that local Chinese investors retain their appetite for such bonds. About 28% of China’s nonfinancial corporate bonds mature in 2017 compared to 18% for the Asia-Pacific (of which Japan represents a third and 8% for the US).
Interestingly some offshore investors seem more concerned about Chinese borrowers seeking to refinance in 2018 and 2019 when 5-year offshore bonds issued in 2012-2013 and 3-year domestic bonds issued in 2015-2016 come due. The implicit presumption is that global interest rates should have increased by then. Consequently, the refinancing risk for corporates may increase going into 2018-2019. Risk may be mitigated if corporates address such maturing bonds ahead of time in 2017.
4. US Trade Tariff Imposition
There are mixed views on the US presidential elections, given that there has hardly been any information on the new government’s future economic stance. The general anticipation of a more protectionist policy, if it materializes at all, could further weigh on trade and exports in the region. But this might just be an accentuation of existing trends, given that world trade never returned to pre-2007 levels after the GFC.
If future US policy-making follows through with trade restrictions, Asia-Pacific industries with international exposure will be particularly impacted. Trade restrictions would have a highly negative impact on the Asia-Pacific auto industry, and a moderate negative impact on the consumer goods, transport — cyclical, transport–infrastructure and technology sectors.
5. Property Market Adjustment
Property prices in many Asia-Pacific markets have been trending up since the GFC, fuelled by low interest rates, high economic growth and substantial investment appetite. That said, some air has been let out from the balloon to varying degrees through administrative measures. For example, prices have been managed down for a number of years in Singapore, toned down in China and more recently in Hong Kong (only for both to surge again, prompting more cooling measures by the governments), and seems to be finally stabilizing in Australia. Thus far, these corrections have not led to substantial problems in these economies. Good user demand in select cities in China and Hong Kong is providing some support. Nevertheless, there is some risk for further adjustments. In banking, we continue to highlight frothy property prices in some Asia-Pacific markets — including Hong Kong and Australia — as a key risk to bank ratings.
6. Commodity Price Correction
The US election result has put some wind behind commodity prices on the expectation of sustained demand from US growth. Indeed, current trends point to some potential improvement in credit quality among commodity producers going into 2017.
However, the net rating bias for Asia-Pacific metals/mining and oil/gas issuers that we rate is highly negative. The major risk for the metals/mining sector is an unexpected fall in demand for steel and raw materials from China. We expect China’s demand growth for metals and minerals to remain flat over the next six months. The topmost risk for the oil/gas sector is a continuing supply glut, keeping oil prices low. If prices stay below our current assumptions, the stand-alone creditworthiness and, in some cases, ratings, on some companies may worsen in 2017.
|Top Asia-Pacific Risks|
|Risk||Risk level||Risk trend|
|1||Higher interest cost and volatile forex||Elevated||Increasing|
|2||China corporate debt overhang||Elevated||Stable|
|3||Corporate refinancing challenge||Moderate||Increasing|
|4||US trade tariff imposition||Moderate||Increasing|
|5||Property market adjustment||Moderate||Stable|
|6||Commodity price decline||Moderate||Decreasing|
The article is authored by Terry Chan, managing director, at S&P Global Ratings