Did they get it right? Revisiting Deutsche's 2010 debt outlook

We review the forecasts made by the most active bank in the G3 bond markets this year and find out what it expects for the latter half of 2010.

When FinanceAsia spoke with Deutsche Bank in January the forecast was for another year of robust volumes in Asia's G3 bond markets, with Chinese property developers and high-yield borrowers expected to contribute a greater share of new issuance. Deutsche also predicted activity in Hong and India to increase, alongside the traditionally dominant Korea.

Now, six months down the track, it looks like Deutsche got it right, with its overall predictions barely deviating from what has unfolded so far.

Over the past six months the market has been hit by global events, such as the sovereign debt problems in Europe and the tightening of regulations in the China property sector, which have driven volatility higher. Despite this, Asian issuance is ahead compared with the same period last year, with the only significant fall-out being that borrowers have been forced to take advantage of short windows of opportunity and relative calm, resulting in some very busy periods and short execution times. In the past couple of months, issuance volumes have tapered off.  

Amid the volatility, Deutsche has remained in pole position in Dealogic's Asia ex-Japan G3 bond league tables. As of July 9, the bank had helped raise $4 billion from 23 deals, giving it an 11% market share.

Earlier this month FinanceAsia sat down with Patrick Tsang, head of fixed-income capital markets for Asia, and Herman van den Wall Bake, head of global risk syndicate for Asia, to revisit Deutsche's predictions for 2010 and find out the bank's house view for the rest of the year.

It looks like your forecasts from January were spot on. What's your synopsis of the first half performance in the Asian debt markets?
The volume of new issuance in Asia's G3 bond market remains robust, with a slight increase over the same period last year. The main drivers included the continued sovereign/quasi-sovereign supply, proactive bank capital management, first-time issuance by high-yield and high-grade corporate borrowers, and the return of India.  

The year began on a constructive note, but faded during the second quarter as concerns over the peripheral European economies saw risk aversion return, while global signs of slower economic activitiy and China's efforts to regulate its property market impacted investor demand. This resulted in a significant slowdown in G3 issuance volumes in May and June.

As a result, issuers sought alternative market solutions, tapping into Taiwan's Formosa market as Kexim [Export-Import Bank of Korea] did in June with its 2.65% Formosa bond. We have also seen foreign issuers being active in Swiss francs and Asian currencies such as Hong Kong and Singapore dollars, Thai baht and Malaysian ringgit.

The first couple of weeks in July have seen Asian issuers return to the G3 market. While spreads have widened, the drop in US Treasury yields has resulted in attractive all-in yields.

You mentioned earlier this year the importance of credit differentiation. What did you mean by that?
While liquidity remains a high priority, credit differentiation -- a preference for industry leaders and top-tier names -- has been the key focus. With macro uncertainty on the rise, investors want the comfort that the credits they invest in can withstand the still unlikely scenario of a double-dip recession.

Investors have been demanding new issue premiums to compensate them for market volatility.

However, investors remain largely constructive on Asia given the region's relatively stronger rates of economic growth.

Last year, Korea accounted for 30.5% of deals done in Asia and so far this year it makes up 27.5% of the deals in the G3 markets. What can we expect from Korea in the future?
Korea will remain a very important market for Asian G3 and the leading source of supply this year. The cost of swapping US dollars into Korean won, the Ministry of Finance and Economy's view towards foreign exchange reserves, as well as local Korean won funding levels will continue to determine the timing of the Korean pipeline.

In terms of issuer type, we expect banks and quasi-sovereigns to remain the dominant issuers out of Korea.

The volume of issuance out of India has surpassed that in previous years, as you predicted back in January. What else can be said about the Indian market and Indian borrowers coming to the dollar market?
There are no surprises with regard to the volume of financial institutions supply from India. We had hoped to see more supply from quasi-sovereign and corporate issuers.

We think banks will continue to dominate India's issuance pipeline in the second half of this year. This is because withholding tax considerations have discouraged some Indian corporate borrowers to borrow overseas. Indian banks typically utilise their offshore entities to issue US dollar medium-term notes and do not bring these funds onshore, therefore the proceeds do not incur withholding tax.

As you predicted, China property has been a hot topic this year with nine of the 10 China deals that have priced this year being high-yield property issuers. This led to comments from analysts suggesting that, for a while, deals were being done for the sake of getting deals done. What else can we expect from the Chinese property sector?
We can expect a tough second half for the China property sector as regulatory changes, inflationary concerns, and concentrated over-supply restrict the ability for issuers to access the market. It is important to note, however, that secondary market prices of recent Chinese real estate deals have recovered most of their earlier losses.

While we believe it will be more challenging to get real estate deals done, we do think there will continue to be a market for the leaders in this sector. Smaller players may find the private financing market more receptive in the current market environment.

We recently saw a $350 million high-yield bond from Indonesia's Berau Coal Energy. Will this be enough to kick-start the high-yield markets again?
The right names such as Berau Coal Energy, Melco Crown and Indonesian property company Lippo Karawaci, will continue to have access to the market. Away from real estate, issuers from the resources, mining and retail sectors have been eyeing the market.

Investors continue to prefer structures that offer more protection via guarantees on the operating company, a pledge of assets or other forms of security. Such enhancements have been selectively applied, but remain difficult to implement for China credits due to the existing regulations that forbid operating company guarantees or asset pledges.

Almost a third of all issuance this year has come from the banking sector. How do you explain this heavy presence by the banks? Can we expect this to continue into next year?
We expect the bank capital sector to remain active in the second half of the year. Year-to-date bank capital issuance has been dominated by lower tier-2 offerings and until we get clarity on Basel 3, we are unlikely to see much in the way of hybrid tier-1 supply.

Issuers like Bank of China (Hong Kong), Dah Sing Bank, Citic Bank International and Bank of East Asia have executed new lower tier-2 offerings as part of their proactive capital management, using proceeds to replace, term out, or refinance existing subordinated obligations.

Right now, new issues are few and far between. What are borrowers waiting for?
We expect the market to remain volatile but we will definitely continue to see windows of opportunity for new issuance in the coming months.

Our advice to issuers is to get ready. As and when the market opens up, borrowers need to be decisive and nimble. Chasing after every last basis point doesn't work. A number of issuers are therefore conducting non-deal road shows to position for an expedient execution when the opportunity arises.

Overall, we remain very optimistic. The fact that we've exceeded last year's year-to-date volumes despite the recent volatility is a positive sign. We continue to see liquidity out there, but credit differentiation and relative value are important factors. Investors will continue to be selective in evaluating new deals.

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