After a record-breaking start to the year, market participants are looking to see what lies ahead in the Asian high-yield market.
Two contrasting themes have characterised Asia’s high-yield bond market in 2019. The year started with recorded breaking issuance from the region’s corporates. But at the same time, there has been a steady flow of defaults as issuers fail to meet their obligations.
How to make sense of these trends was the subject of a panel discussion held during HSBC’s annual Credit Conference. It brought together corporate issuers of high-yield debt with fixed income investors to share their views on the market.
Pent up demand for issuance
The panel started with the high level of issuance seen earlier in the year, which the investors on the panel put down to pent up demand among corporates coming at the same as investors were looking to deploy capital. With the US Federal Reserve changing its stance late in 2018, the investors said it was a good opportunity to add risk to their portfolios.
Valuations were also a factor early in the year, which the investors said were at the most attractive level for years – especially in the Chinese property sector. Many issuers lacked access to the capital markets in the second half of 2018, which meant that when a window of opportunity became available, there was a rush to raise money which led to pricing that was favourable to investors.
From an issuer perspective, they were able to take advantage of growing demand for high-yield debt, which comes from a growing number of fixed maturity bond funds that have to buy high-yield paper. Some issuers were able to take advantage of the strong demand to enjoy lower fund costs, and even make some opportunistic deals to improve the structure of their liabilities – such as pre-financing ahead of their upcoming refinancing needs.
There was general consensus among the panel that high levels of supply in the bond market should not be a cause of concern, as long as there is enough demand to absorb it. That said, the panel did highlight that the appetite for Asian debt leads to some primary issues being priced at stretched valuations. One investor suggested that this kind of situation can be remedied by not participating in the primary issuance and buying the bond in the secondary market after it has repriced.
The outlook for the rest of the year among the panel was for lower issuance, as investors will expect a greater premium due to the market becoming more uncertain. The Chinese property sector is a major part of the region’s high-yield space and there are expectations that it will issue less paper in the near future, as the government is tightening the sector’s use of offshore bonds.
Issuing new debt to raise capital is just one way that a corporate can take advantage of the buoyant market. It also a time for issuers to make positive adjustments to their capital structure. A bond exchange exercise is one such option, but one issuer on the panel said that this kind of procedure often come with a premium. He instead prefers issuing bonds with a call option so that the issuer can buy back the bond if necessary and reissue at a time that is favourable. He did admit however, that this is only really possible for corporates with a strong credit rating.
Being able to call back bonds is a reflection of good cash flows and competent cash management, said one investor. Smaller issuers, with a weaker capital structure, he said, are more vulnerable to market volatility and ratings downgrades, so it is essential for them to conduct liability management exercises as soon as it is possible to avoid facing higher rates when refinancing comes around.
In the worst case scenario, an issuer will not be able to meet its obligations and subsequently default – something that has become a major issue for Asia’s fixed income market. One investor on the panel said that away from outright frauds, most of the region’s defaults have been due to excessive expansion that was driven by leverage, which he put down to being a function of liquidity. He said that we have yet to see credit events caused by private companies having problems in their core business, though he expected that could start to happen in 2020.
The panel finished by pointing to the red flags that investors can look out for in order to spot issuers that might run into problems further down the line. These include a low ratio of cash to short-term debt, as well as long accounts receivable. Poor corporate governance is another problem area, which can be seen when an issuer is unable to adequately explain to investors its acquisition plans or why it has a high cash balance in the bank.