Why supply is weighing heavily on Asian DCM

After struggling to digest a wave of issuance from Chinese property developers, Asian G3 bond markets await equally strong deal flow from LGFVs that will reverberate around the region.
Crowding out the competition
Crowding out the competition

The supply/demand imbalance in Asia’s G3 bond markets reached a new peak in April as Asian borrowers piled into the market to try and stay ahead of rising US Treasury yields, resulting in spread widening across the board.

Investors’ ability to continue absorbing such strong supply, particularly from Chinese issuers, was tested to its limits, not least because some of them were still trying to unwind long positions in the secondary markets as well.

And while market participants expect supply to ease off in May, the key word is slightly, which means that few bankers or fixed income analysts expect any form of meaningful spread compression over the near-term.

Market participants are also aware that after almost overdosing on a wave of Chinese property developers, they will need to brace themselves for the 30-odd local government financial vehicles (LGFVs) which are currently preparing to offload their bond quotas before they expire.  

“Supply was the key focus for April,” commented Ed Tsui, head of Asia debt syndicate at Deutsche Bank. “At the beginning of the month, market technicals were strong because Easter and two public holidays in Hong Kong gave markets a breather and investors had time to accumulate cash.

“But since then, supply has been heavy and rapid,” he continued. “The market is in the process of digesting all that paper now and while everyone is aware that there’s no lack of new supply waiting in the wings, I do think spreads will start to stabilize with a more moderated pace of new issuance.”

Tsui noted that 33% of the then year-to-date supply spanned just three weeks in April. Dealogic figures also underscore that April 2018 has been the biggest single issuance month for Chinese credits since 2016.

A total of 34 Chinese borrowers raised $25.13 billion, with $15.56 billion hailing from investment grade corporates and $4.65 billion from high yield corporates. Moreover, all of the top 10 Chinese high yield deals by size came from the property sector, led by Sunac’s $1.1 billion issue in mid-April.

On the investment grade side, quasi-sovereign entities dominated issuance, particularly from the energy sector, once they had cleared their first quarter results. State Grid Corp raised $2.7 billion and CNOOC raised $1.45 billion, although chemicals group Syngenta topped the overall rankings after raising $4.75 billion.

One name, which is missing from the league tables, is telecoms equipment manufacturer, Huawei, which was forced to withdraw a dollar and then a euro-denominated transaction in late April after the US government launched an investigation into sanctions violations.

Its demise has provided a clear warning signal that investors need to be more conscious of geopolitical risk. It is one they say they have taken on board.

Jack Siu, senior investment strategist at Credit Suisse’s Asia Pacific CIO office, told FinanceAsia it had been advising clients to be mindful of risks relating to protectionism. “We’ve been focusing on domestic consumption rather than trade sensitive companies since May 2017,” he said.

Both Siu and Tsui agree that one of the key defining moments for global bond markets this year was when 10-year US Treasury yields moved through 3% in April. Siu forecasts that they will stay in this range over the coming three months, rising to about 3.3% over a 12-month period.

Siu believes investors should try to stay short duration. “We remain neutral on investment grade corporate and favour selected short duration names with solid fundamentals, whose values looks attractive after the first quarter correction,” he commented.

He added that valuations have also improved in the high yield market, but expects supply pressures to continue limiting price appreciation. This has been compounded by the fact that a number of Chinese property names remain on offer in the secondary markets, helping to push single-B names, in particular, up to 100bp wider over the course of April.

HIGH YIELD HIT

The repercussions have been felt as far south as Indonesia. The country’s high yield names compete for the same pool of cash and suffered the knock on-effect.

This is one of the reasons why Indonesian high yield corporates ranked as the worst performing sub-sector of the JP Morgan Asia Credit Index (JACI), down 2.8% in the year to the end of April. The other is the downdraft budget deficits nations like Indonesia have been facing as dollar-based investors pull back.

PT Bumi Serpong Damai exposed the sector’s travails when it tried to raise $300 million towards late April just as Indonesia’s financial markets were coming under their worst pressure of the month.

The Ba3/BB- rated credit ended up having to pay close to a 50bp new issue premium to clear its three- non-call two-year deal through the market. It came on a day where all the comps, including its own outstanding bonds, fell about one point, leading to a re-pricing of the entire sector.

But its decision to offer a substantial new issue premium proved to be the right decision. The 7.25% April 2021 offering has remained fairly stable since it was executed, trading about a quarter of a point below issue price as of the beginning of May. This performance also enabled the property developer to return to the market at the very end of April with a $50 million tap, which fulfilled its fundraising needs.

Bumi’s deal was one of only two G3 high yield deals from non-Chinese issuers during April. The other was a $580 million bond for Star Energy Geothermal (Wayang Windu).

If there is one transaction, which investment bankers would like to remember from April it is almost certainly this one. At a time when the region’s infrastructure requirements remain intense, the 6.75% secured project-related bond demonstrated that there is a viable alternative option to traditional bank lending and project finance.

Using the same structure pioneered by PT Paiton Energy last year, the Barclays, DBS, Deutsche and Maybank Kim Eng led offering showed that the same template can also be applied to borrowers slightly further down the credit spectrum.

Star Energy’s deal has a Ba3/BB- rating, although specialists said that one reason why it worked during primary market syndication is because the amortising 15-year deal has a much shorter 9.5-year average life and 6.5-year duration.

But just like Bumi Serpong, the deal came just as Indonesia was struck by volatility and has traded down four-and-a-half points since then.

Where will spreads go from here? Citi, for one, believes they will stabilise.

In a recent credit report, the bank concluded that while it “anticipates marginal widening” for emerging market spreads it also expects them to be anchored by “global growth.”

In a subsequent article, FinanceAsia will examine the impact this volatility is having through the eyes of two recent borrowers.

This article has been updated to correct Jack Siu's name.

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