What to expect from the bond market in 2008

Timing will remain critical in defining the success of a deal for bond issuers this year, says Citi's Aamir Rahim, in an interview with FinanceAsia.
Citi recently held its fifth annual Asia-Pacific fixed-income investor conference in Singapore. As Asian bond issuance grinds to a halt, co-head of Citi's regional fixed-income, currencies and commodities business, Aamir Rahim, talked to FinanceAsia about his outlook for 2008.

Can you tell me what may happen this year in Asia's bond markets?

Asia remains one of the highest growth regions in the world with regional GDP growth still forecast at 7% to 8% for 2008. The fundamental backdrop remains encouraging: Asian companies have some of the strongest balance sheets and local liquidity remains strong. In addition, the global investor base continues to want to capitalise on this story and invest in Asia. External factors though continue to weigh on Asian credit spreads, with G3 liquidity being particularly impacted. Concerns around specific sectors like Chinese property has not helped sentiment and driven the Asian ITRAXX indices to recent highs.

These conflicting forces have created an interesting backdrop for Asia's fixed-income capital markets. High quality credits from Asia have access to international capital markets today. US rates have dropped to levels where several Asian borrowers have accepted higher spreads for the all-in benefit of lower absolute funding costs, and have executed successful transactions. In general, the new issue environment will remain opportunistic and timing will remain critical in defining the success of a deal.

However, many do not want to pay for imported problems while their balance sheets remain strong and their prospects remain stable. In the investment grade space, this will result in continued issuance in local currency markets - this augurs well for Samurai issuance û and issuers will focus on small transactions sourced from alternative pools of liquidity. In the high yield space, we continue to see the market being dominated by private placements.

Finally, a couple of quarters of strong earnings announcements from Asian corporates will begin to differentiate the Asian credit space from its US and European counterparts.

Do you foresee any major trends?

In terms of primary issuance, a couple of well received transactions can help open the market more generally. The growth in the private placement market continues, though at a steady pace.

Liquidity will remain at a premium through 2008. While banks, sovereigns and the alternative investments spaces remain liquid in Asia, investors will be more selective in making investment decisions. The Asian fixed-income capital markets quadrupled in size over the last decade, and the current environment will force us to be more creative if we want to maintain momentum.

The increasing sophistication of the investor base in Asia is beginning to demand this anyway. Fund-linked products, inflation-linked products, multi-asset and local currency derivatives were just some of the sessions that received a lot of interest from investors at our annual fixed-income investor conference.

Asian corporates have begun to develop a global presence. Ten years ago, Asian outbound M&A was under $10 billion. In 2007, there were over 800 transactions valued in excess of $300 billion, including major US and European acquisitions, many of these financed in the Asian capital markets. We expect 2008 to be no different as the age of the Asian "global corporate" is here.

At this conference, you must have gauged sentiment. How are issuers and investors feeling and how are you addressing those concerns?

The sense I got was that issuers and investors are coming to terms with the current environment and are beginning to accept the new realities in the Asian markets. But one thing has not changed: the investor base wants ideas on how to navigate these markets. We are resorting to good old-fashioned creativity in coming up with solutions to help address concerns on both sides.

In these troubled times, what's your strategy for convincing issuers to come to market and how has it changed?

It is not a job of convincing, it is a case of giving the right advice, but for some clients this is not the issue now. For those that have an immediate financing need, credit spreads have largely been negated by the fall in US Treasury yields, so all-in funding costs remain as competitive as ever. But there are options away from the primary G3 loan and bond markets - clearly private placements and local market issuance offer alternatives for some.

A banker once said banks would have to be creative to bridge the gap in pricing expectations between issuer and investor. Do you agree, and if so could you give some examples of such creativity?

The reality is you can't issue at 25bp over Libor when your secondary spreads are at 100bp over Libor, and borrowers know that. In terms of pure new issue management, ensuring the expectations gap is controlled and ultimately bridged is a crucial part of leading a bond to market successfully. You can employ derivative solutions with both the investor and the issuer to help make the cost/return on the deal closer to their respective targets.

In the simplest form, cross-market arbitrage can help achieve both issuer and investor needs. Given the current market dislocation, many such opportunities exist in both the vanilla issuance and the credit derivatives markets today.

Is it possible many won't accept the new levels, and that even if markets stabilise, issuance in Asia will remain relatively low?

If Asia continues to grow at even close to the 7% to 8% rate which is being predicted for 2008, the demand for capital will remain strong. Issuers will migrate to available pools of capital whether in the bond, loan, equity or alternative investment spaces. Domestic relationships will play a stronger role in the success of deals as will relationship lending and local markets. So while this may not manifest itself in the new-issue league tables or in G3 funding volumes, it will get done and likely in similar sizes to last year.
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