No longer in your debt

The relationship between Asia’s G3 and domestic currency bond markets has been as radically transformed during the past decade as Asia’s relationship with the West.

The first 10 years of FinanceAsia.com have been topped and tailed by two very different financial crises that share a common underlying theme -- misallocation of credit on a grand scale. When Financeasia.com was launched in June 2000, Asia was still grappling with the fallout of a spectacular regional lending boom that had gone bust. It was a crisis magnified by currency mismatches that crippled companies, which had borrowed heavily in US dollars only to find they could no longer repay debts, which spiralled after foreign investors fled and their country's currency pegs collapsed.

Asia's determination not to be caught in the same trap twice had a number of consequences - one unforeseen. Where previously excess liquidity had been funnelled into the pet projects of Asia's crony capitalists, it was now hoarded by central banks and partially recycled back to the West where it fuelled a new and equally unsustainable consumer credit boom. But Asia in 2007 was better prepared to withstand the new global financial crisis which swept across the world, and that was because it had also been channelling domestic savings into building up local currency debt markets.

No country better underlines this trend than the Philippines, which has made huge strides in both the international and domestic debt capital markets over the past decade. In 2000, the country barely had a domestic debt market to speak of. Its government had consequently been forced to become a mainstay of the G3 (dollar, yen and euro) bond markets. But, at that point in time, its eternal quest to plug a budget deficit constantly straining under poorer-than-expected tax receipts, was being undermined by a poor reputation for deal management as well. Hence its major deal of 2000 -- a $1.6 billion cash and exchange offering involving power company Napocor - was badly received.

The deal was mistimed, coming hard on the heels of an escalating corruption scandal involving an associate of then President and former movie actor Joseph Estrada. Investors also said they were tired of the government constantly telling them it had launched its last bond issue of the year, only for another one to miraculously appear the next time spreads tightened.

One decade on, the Philippines still remains in thrall to its colourful politics, with Estrada back contesting a new Presidential election. But the reputation of the country's financing team has entered a completely different league thanks to the hard work and experience they've gained in the markets over the past decade. As Stephen Williams, HSBC's head of Asia-Pacific debt capital markets, puts it: "The Philippines is very disciplined in the way it conducts its bond business these days. It's learnt to choose good market windows and it does deals fast and efficiently, intra-day."

And borrowers now have the option of a domestic bond market as a source of financing as well. In March 2009, for example, the brewer San Miguel opted to make its debut bond deal in the domestic rather than the international bond markets where spreads had ballooned and market access was still difficult. Its Ps38.8 billion ($800 million) deal was four times the size of anything that had gone before it.

Indeed, 2009 was a record year for the domestic Asian currency markets (ex-Japan). Dealogic figures show that $356 billion was raised over the course of the year via 2,176 transactions (excluding asset- and mortgage-backed securities). That was five times the $71 billion raised through the G3 bond markets that year (itself a record) and 15 times the $23 billion raised through local currency markets in 2000 when 370 transactions were priced.

Much of that growth has come from China whose corporate borrowers accounted for about $221 billion during 2009, up from just $3.5 billion at the start of the decade when the government operated an extremely strict quota system. Back then, only large state-owned enterprises (SOEs) were allowed to issue debt and were subject to an approval process that could take up to a year. They also required a bank guarantee before issuance, which effectively killed any credit differentiation between them.

That all changed in the middle of the decade when the government realised it needed a strong domestic bond market to counterbalance the omnipotent banking sector in funding the country's growth. In 2004, for example, the latter accounted for 83% of all financing in China compared to just 1% for corporate bonds.

But the big growth for corporate bonds in China only really came in 2009 when issuance doubled, mirroring a similar jump in bank lending. However, with the exception of UBS, foreign banks haven't been able to take advantage of this issuance bonanza and gaining access to it will be their major challenge of the next decade. The Swiss bank is the only one which has been able to muscle its way up the league tables thanks to its Sino-foreign joint venture, UBS Securities, which it has management control over.

To date, foreign banks have had to limit themselves to a couple of Panda bonds issued by the IFC and ADB in 2005, plus a handful of renminbi-denominated bonds issued in Hong Kong by financial entities incorporated on the mainland.

For the rest of the region, domestic bond markets have provided a valuable complement to Asia's liquid and ultra competitive bank lending markets. And their resilience during the recent global financial crisis has also highlighted that, in some respects, Asia has been able to decouple itself from the rest of the world. During the week in which Lehman fell in September 2008, for instance, global credit markets remained paralysed with fear. But in Malaysia, Maybank was able to raise M$1.1 billion ($344 million) in tier-1 debt to help fund its acquisition of Bank Internasional Indonesia.

The G3 bond markets were to remain closed to Asian issuers from September 2008 until January 2009 and when they re-opened again it was at spreads borrowers hadn't had to stomach since the height of the Asian financial crisis. But it was a short-lived phenomenon, with 2009 characterised by extraordinary spread compression. Take one of Asia's most respected borrowers - the Export-Import Bank of Korea (Kexim). At the beginning of 2009, it had to pay 677.7 basis points over Treasuries to raise $2 billion from a five-year deal with a coupon of 8.125%. Just over a year later, the A1/A rated deal for the quasi-sovereign credit is currently trading around the 141bp level.

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The global financial crisis created a backlog of issuers, which meant that 2009 ended up being a record year for G3 issuance. This enabled the region to finally buck a trend of declining issuance on a net basis. Indeed, the past decade has been characterised by two distinct waves -- the first of which lasted until the middle of the decade and saw rising issuance volumes matched by a steady compression in banks' fee income. After peaking around the $50 billion mark in 2005, the second wave saw issuance volumes decline on net basis to a negative balance of $14 billion in 2008 after redemptions and coupon payments were taken into account.

However, the onset of the financial crisis did mean that banks started making money from deals again. "Issuers really appreciated that they needed banks' support to ensure their deals traded well in the secondary market," said Carsten Stoehr, head of Asia-Pacific fixed income at Credit Suisse. "Korean quasi-sovereign borrowers were back paying 45 cents again, levels last seen at the beginning of the decade."

Typically, fees for Korean issuers during the middle half of the decade were less than half this amount and for any of the highly prized Asian sovereign deals, fees sub-10bp were the norm.

In many respects, it feels as if the Asian repeat issuance pool has changed little since 2000. Korea has accounted for about one third of all issuance pretty much every year for the whole decade and the same names -- Hutchison Whampoa, KDB/Kexim, Petronas, Republic of the Philippines -- predominate.

But there have been two developments, which underline the way the G3 market has matured and developed. The first is the broadening of the Asia bid. "It's been an important structural shift," explained Stephen Roberts, head of Asia-Pacific fixed income at Salomon Smith Barney during the early part of the decade. 

The volatility generated by the Asian financial crisis spurred many in the region away from trading equity markets to making longer-term investments through pension and insurance funds. This led to the growth of domestic pension fund giants such as Hong Kong's Mandatory Provident Fund and Malaysia's Employees Provident Fund, plus the emergence of sovereign wealth funds (SWFs) such as China Investment Corporation (CIC) in China. 

"Asian central banks amassed huge reserves as a result of their trade surpluses, particularly with the US," said Michael Dee, former head of Asian debt capital markets at Morgan Stanley. "Those excess reserves beyond what was needed to defend their currencies became the basis for the establishment of the SWFs."

And indeed, today Dee is a senior managing director at the oldest Asian sovereign wealth fund of them all -- Temasek. This year, the Singaporean investment holding company has launched a new investment company, Seatown Holdings, with a remit to diversify the Singaporean group's investments further into equities and bonds.

Allied to a deepening of the local Asian investor base has been the arrival of global funds, which have set up in Asia. Together, they've created an investor pool, which now accounts for about 40% to 60% of demand on a typical deal. Global investors also now look to Asia to take the lead on pricing.

The second major change has been a deepening of the yield curve and broadening of the credit spectrum. "It did use to feel as if there was a bifurcated market in Asia," said Carlos Cordeiro, former vice chairman and head of Asian DCM at Goldman Sachs. "In the mid-1990s, there was a lively high-yield market in Indonesia at one end of the spectrum and a fledgling corporate bond market for top-tier credits like Hutchison Whampoa at the other end. Now there are many more credits in the middle as well, while benchmark borrowers like Hutch have issued debt across the whole yield curve."

Early on in the decade it looked as if that broadening might be stymied by the problems of the one company which overshadowed the entire market -- Asia Pulp and Paper (APP). Its appetite for debt-fuelled expansion created a $13.4 billion monster, whose implosion represented the biggest corporate default in emerging markets history and led to haircuts of 50% for many bondholders.  Defaulters like APP and other Indonesian entities such as Polysindo, or Polyswindle as disgruntled bondholders called it, made a pariah of the Asian high-yield market for a number of years. 

When the market tentatively re-opened in 2002 it was only to companies like PT Telkomsel and Indofood  -- strong established brand names and in the case of Telkomsel, one that had the backing of its much higher-rated majority shareholder, SingTel.

Come 2010 and the Asian high-yield bond market is still dominated by Indonesia, but there are now a roster of Chinese names to add to the list as well. In particular, Chinese property companies such as Country Garden and Renhe have rode the wave of China's latest property bubble.

One issue that Asia doesn't seem to be able to shake off, however, is the Asian premium. This means that Asian deals typically need a 10bp premium over comparable European or US credits to be successful. A decade ago, this was attributed to a lack of familiarity on the part of the US investors who formed the bedrock of most deals. Now it is attributed to the lack of large liquid benchmarks for Asia's growing fund management community to buy.

Bigger deals top the wish list of both the investment banking and investor community. The former also say that Asia needs to do more to term out debt that still averages about five years, compared to eight years in Europe and 10 years in the US. Domestic capital markets are still not as open as many foreign bankers would like, capital does not flow freely around the region and clearing and settlement systems remain under-developed. But the Asian debt markets remain a potent symbol of Asia's emergence on the world stage over the past decade. "Gone are the days when Asia needed a bailout," concluded Credit Suisse's Stoehr. "The purchasing power lies in Asia now. This region has gone from being a receiver of global liquidity to a provider of liquidity. This is what will power it through the next decade."

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