China the lynchpin for Asian DCM volumes

In part two of a discussion on Asian G3 markets, syndicate bankers say South Asia will not be able to pick up the slack as Chinese borrowers head to the onshore market.

Over the Chinese New Year period, FinanceAsia canvassed a selection of Asia's DCM syndicate bankers on their views for the Year of the Monkey.

In part one, they each discussed the impact global volatility is having on primary and secondary markets, concluding that, while regional investors have continued to underpin primary market issuance, many have shied away from the less liquid secondary market. 

Here in part two they take a wider look at issuance patterns across the region in a year when Chinese borrowers are increasingly heading onshore to fulfill their debt financing needs.

With Chinese issuance likely to drop off, they conclude that South East Asia is unlikely to pick up the slack, although interesting new pockets of activity are emerging in green bonds and Masala bonds. 

The bankers who took part are:

Devesh Ashra, head of Asia debt syndicate at Bank of America Merrill Lynch

Duncan Phillips, head of Asia Pacific debt syndicate at Citi

Jacob Gearhart, head of Asia Pacific debt syndicate and origination at Deutsche Bank

Carla Goudge, head of Asia Pacific debt syndicate HSBC

Ashish Malhotra, global head of bond syndicate Standard Chartered

How important is Chinese issuance for Asian DCM these days? What’s your forecast for the rest of this year?

Carla Goudge

Carla Goudge: China has clearly been an important driver not only for Asia but also for global issuance. It’s now the single largest issuing jurisdiction across the whole of the emerging markets.

The drivers for continuously increasing supply may now be taking pause as the Chinese economy re-balances and the Rmb adjusts. However, we have seen highly successful transactions this year from Chinese issuers such as Ping An and China Development Bank. Healthy supply levels will continue to be met by strong demand from investors.

Ashish Malhotra: China is a global power now and it accounts for a huge percentage of Asian DCM. Each year China accounts for proportionally more of the overall pie. In 2013, it was about 30% of the total raised, then 45% in 2014 and 55% in 2015. Even in January China still accounted for half of all issuance.

Jacob Gearhart: Yes China has represented 40% to 50% of annual volumes for the past three years. Lower issuance volumes from China will be the main contributor to lower overall volumes.

M&A financing could change this but I think that will be overwhelmingly done in the loan market. However, Chinese banks are a possible wildcard if they ramp up issuance of TLAC (total loss absorbing capital) instruments.

The big four Chinese banks are now on the list of global systemically important banks, which means they need to raise additional capital requirements on top of what’s required for Basel-III. Last year the Financial Stability Board estimated they will need $400 billion in capital absorbing instruments to meet both standards. However, based on our estimates even below trend asset growth means that could be a meaningful estimation. 

Duncan Phillips

Duncan Phillips: As all the others have said, China is the most important factor in determining overall issuance from the region. This year, the oil and gas sector may have reduced funding needs and Chinese real estate companies have already turned their focus to the domestic bond market.

Slightly more difficult to predict are the inaugural Chinese borrowers including those which have been created for a specific purpose such as development zones or other funding vehicles.

In terms of performance, I think Chinese real estate will continue to do well.  The sector has a huge following and the supply tap has effectively been turned off. More generally, I think in most instances any spread widening will be capped by the ongoing bid from local investors.  

Devesh Ashra

Devesh Ashra: We’ll need to continue monitoring how issuance in the domestic bond market evolves compared to offshore funding options. But I expect to see a broad continuation of a path that emerged in 2015.

As high yield becomes more marginalized in offshore markets, there will be a deeper pool of liquidity for investment grade credits.

Will we see much issuance from South and South East Asia this year?

Phillips: I think the bulk of the volume will come from government and quasi-government issuers from countries including Indonesia, the Philippines and Malaysia. In recent years the Indonesian sovereign has been the biggest issuer from the region. It pre-funded part of its 2016 requirement in December but will have to do more through the year. I would say corporate issuance is harder to predict.

I expect India to be fairly active this year. The public utilities and a few of the corporates are likely to come to market. Some of the bank issuers are also undergoing credit developments that will need to be reviewed closely.

A big topic has obviously been Masala bonds (offshore rupee-denominated bonds) and issuers are very enthusiastic. We’ve done several rounds of investor meetings in Asia and Europe for a variety of issuers, but some more work needs to be done on the demand side of the equation. It’s there, but we need critical mass at the right price point.  

Ashish Malhotra

Malhotra: Issuance from South East Asia has pretty much been an Indonesian story in the past. However, we’re quite optimistic about greater supply from Malaysia this year.

Over the past few years there has been a big push to develop Sukuk financing, but declining oil prices have had a big impact on demand from the Middle East. As this investor source takes a back seat, I think borrowers will start to rely more on conventional investors playing a key role in the Sukuk market as well. 

Gearhart: Deutsche Bank expects issuance from South East Asia to be generally light. Low oil prices and weak FX rates are likely to keep a lid on much capital expenditure funding light.

I think we’re going to be looking at larger and more episodic deals from this part of the world.  

Borrowers have been able to price with a slim to non-existent new issue premium for some years. Is this changing now market conditions are more volatile and if so, are borrowers conscious of it?

Phillips: I think it may have to change. I can think of two or three deals we worked on this year where demand was sluggish because the relative value discussions were more challenging.

Global concessions have risen with the market volatility and we may find Asian investors are more inclined to demand the concessions being paid elsewhere.

Ashra: For the most part, we’ve seen Asian investment grade issuers pay new issue premiums at or inside other regions. Secondary market spreads make a good starting point for determining where it should be. But scarcity and quality are the fine-tuning measures for investment grade concessions in Asia.

Jacob Gearhart

Gearhart: Low new issue premiums have been a function of local demand rather than broad global participation in deals.  The strong Asian bid has helped regional issuers to pay less of a premium in the past.

It will be telling to see how long regional and local investors are able to effectively support Asian issuance given the lack of global participation in deals. If Asian currencies continue to weaken I can’t see how they are going to be able to continue support G3 deals.

Malhotra: In the past Asian borrowers have generally paid a slim to non-existent new issue premium. I think they’re now being more pragmatic and can see that even in the US, borrowers are offering a concession. Most borrowers do realize they need to pay one, and for them the key question then becomes whether it needs to be 5bp, 10bp, or 15bp etc etc.

Some borrowers are opting not to tap the G3 bond markets. They might have access to the loan markets, or just think conditions are too volatile. But those who come to the bond market are receptive to paying a new issue premium.

Goudge: This question gets back to an earlier point I made. We are seeing choppy markets, but even in the midst of this volatility there are some strong windows for execution. By carefully navigating the market and coming on the right days, issuers can avoid paying unnecessarily large new issue premiums. To do this, we’ve seen the most successful issuers partner with their bookrunners to time their deals carefully.

These issuers have also partnered with banks to form strong relationships with investors so although markets may be difficult investors feel fundamentally comfortable with the credits they are being asked to buy, which can also lower the required new issue premium.

Do secondary market levels reflect true value, or is liquidity still too thin? How does this impact the pricing of primary market deals?

Malhotra: Secondary market liquidity really varies across countries and sectors. It’s certainly true that it’s non-existent in certain pockets of the market right now. For example, trading in the CNH or dim sum market has completely dried up. I expect it to recover when the dollar-renminbi FX rate stabilizes though.

It’s also true that secondary market trading levels don’t always reflect the real depth of investor appetite for a particular credit. This can make deal pricing far trickier. That’s why it’s very important for issuers to go on a roadshow and gauge investor appetite. 

Phillips: Credit secondary market illiquidity isn’t a new topic, but its relationship with primary pricing has been debated more recently. The argument, in a nutshell, is that it’s inappropriate to base pricing on a new $1 billion issue on a secondary market quote relating to flows of say $1 million.

It’s a fair point, but market volatility aside, some might argue that new issues should price tighter than secondary levels, not just wider. I think the real solution comes down to a better quality pricing dialogue with investors. In Asia, it’s a combination of more deal roadshows and less non-deal roadshows as well as really encouraging investors to set spread limits, which they stick to.

Gearhart: I think the primary market is probably the best barometer of price in so far as there is one single trade of meaningful volumes going through.

Are there too many banks on deals these days and how is that affecting your ability to execute and take responsibility for primary and secondary market performance?

Phillips: Large syndicates have been common in Asia for some years now but I do think it’s less of a problem these days for two reasons. First, there’s a better sense of hierarchy among the bank group, often due to clearer local protocols.

Secondly, I think the work of the ICMA (International Capital Markets Association) has helped raise industry standards across the street. I’m a big supporter and chair their Asia Debt Syndicate Forum.

Malhotra: Yes there are a large number of banks on deals these days. When that’s the case it’s very important that each bank’s role is well defined. When it’s clear which banks are global co-ordinators and which banks are there for relationship reasons then it makes it much easier to co-ordinate.

What other interesting trends do you see this year?

Gearhart: Nothing has gone as anyone expected this year. So expect the unexpected would be the theme. Investors are maintaining higher cash balances and issuance volumes are lower.

For the time being the loan market remains robust and were are encouraging clients to take advantage of that be it for re-financing, liability management or acquisitions. In the bond markets the more defensive EM assets will continue to find buyers as there is a flight to simplicity with a focus on sovereign and quasi-sovereign names at the expense of corporates.

Malhotra: I think we’ll see a lot more liability management this year. This could either be due to balance sheet stress, or because an issuer sees an opportunity to buy back debt at depressed prices or a transaction that either extends maturity or allows them to lock in low rates.

Right now most of the activity we see is with crossover type credits. There’ve been quite a few deals in the Singapore dollar-denominated market where credits have been altering their maintenance covenants.  I think we’ll see a lot more deals like this particularly in the local currency markets across Asia.

Phillips: I also think we’ll see a continued expansion of Euro-denominated issuance and greater use of liability management tools by Asian borrowers. But I fear that the more notable trends of the year might be those that are associated with more challenging new issue market conditions.

Ashra: We’ve been at the forefront of green bond issuance both globally and in Asia. In recent Asian deals we’ve seen substantial growth in the amount of bonds placed into green-dedicated bond portfolios. In these volatile markets, that investor diversification has even more merit from an issuer’s viewpoint.

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