SINGAPORE (Sept 24): Ten years ago, the US Federal Reserve and other major central banks were slashing interest rates to buoy financial markets and stave off an economic slump. And, when that proved insufficient, they began buying bonds and other securities in the market, in an exercise called quantitative easing. Now, with the global economy on a more stable footing, and the US subprime mortgage crisis an increasingly distant memory, this ultra-loose monetary policy is being normalised. And, there is concern over whether the market is entirely ready for it.
The extent to which central banks have cushioned the global economy is starkly obvious from their now massive balance sheets. According to a recent report by Schroders, the Bank of Japan is holding assets equivalent to 96.3% of its GDP, up from 19.3% in June 2008. The European Central Bank (ECB) is holding assets equivalent to 36.6% of its GDP, up from 14.5% midway through 2008. The Bank of England’s balance sheet accounts for 24.4% of GDP, up from 1.6%. And, the Fed has expanded its balance sheet from 6% of US GDP to 22.3%.
“Following the crisis, central banks had no choice but to step in and increase debt. This is the main explanation for the rise in public debt, given the various plans of intervention by the authorities,” Pascal Blanqué, group chief investment officer at Amundi Asset Management, tells The Edge Singapore in an interview.
Yet, even as central banks kept asset markets liquid, the private sector did not take the opportunity to consolidate its balance sheet. “Regarding household debt, we have seen some deleveraging in developed markets. Apart from those countries, we don’t see deleveraging happening elsewhere. Instead, there is a pickup in credit, stimulated by low interest rates. On the corporate side, low interest rates have been clearly a support to debt growth,” Blanqué adds.
According to a Moody’s report on Sept 10, corporates do currently have relatively high debt loads. “In general, we find that the share of companies with high leverage — where debt is more than four times earnings before interest, taxes, depreciation and amortisation [Ebitda] (or eight times for companies in the property sector) — is large, exceeding 50% of the debt of listed companies for many countries, consistent with the broader trend of rising debt levels,” says Moody’s. Yet, most companies do not currently have a problem supporting these debts, Moody’s adds. “The proportion of companies with weak debt affordability is significantly smaller across most countries and has generally declined, reflecting low interest rates and generally low risk premia in 2013-2017.”
Matthew Dobbs, head of global small caps at Schroders and a veteran fund manager who invested throughout the Asian debt crisis and the global financial crisis of 2008, figures the market has been complacent about this rising leverage in the corporate sector. “Increasing the flow of cheap money put a plaster on the crisis wound but it also facilitated a continued rise in debt. In essence, the can was firmly kicked down the road,” he says. “The costs of servicing debt have been so low that people have not paid enough attention to the amounts they are actually borrowing.”
Things could quickly take a turn for the worse as the Fed continues raising its benchmark interest rate and reducing global liquidity. “We have yet to learn what the long-term effects of quantitative tightening will be. Governments, households and the corporate sector are all more leveraged today than they were -pre-crisis, making the system potentially very sensitive to higher interest rates and thus more fragile,” says Schroders fund manager Robin McDonald.
The risk is compounded by waning global growth momentum, even as US interest rates rise. “Debt is not a problem per se. What is important is sustainability,” says Blanqué, adding that debt has been sustainable so far, as interest rates have stayed low.
Determining the risk of an ugly fallout from excessive leverage is ultimately a bottom-up exercise, as much depends on the specific nature of a company and the manner in which it manages its debts. And, despite relatively high debt loads, there appears to be little risk of things turning sour at most Singapore corporates, according to some analysts.
“So far, companies have shown a strong stomach, avoiding financial indigestion, in spite of their inextinguishable appetite for credit, as seen with a median leverage which is the highest in the region at close to six times. They have managed to refinance high debt loads, owing to supportive banks and local bond markets,” Bertrand Jabouley, director of corporate ratings at S&P Global Ratings, tells The Edge Singapore via email.
“An interesting indicator is Ebitda interest coverage, which remains healthy at close to five times. As far as liquidity is concerned, about $90 billion in short-term debt is coming due across listed companies in Singapore. This amount should be covered by cash in hand and cash flow from operations,” he adds.
Wong Hong Wei, credit analyst at OCBC Bank, agrees. “Debt levels do not appear worrying for Singapore corporates in general,” he tells The Edge Singapore via email. “While debt levels trended higher in the 10 years leading up to 2015, this was supported by corresponding broad earnings growth. Corporate debt levels have also been steady since 2015. Aside from Hyflux, the worst is likely behind us following the restructuring of the troubled offshore and marine [O&M] companies.”
Wong says most companies are no longer pushing debt levels higher. “Bond issuances actually fell year-to-date, with [high-yield] issuances seeing a bigger fall in issuance. This is also indicative of a more conservative demand environment for HY bonds. Though the bond markets do not appear to be conducive for HY issuers, the bank loans market is generally still supportive, which helps mitigate refinancing risks.”
According to 12-month trailing data from Bloomberg, there were at least 102 Singapore-listed companies with net gearing ratios of above 100%. Of these, 17 operate in the property management and development industry, while at least 16 are linked to the O&M sector. Several other sectors also stand out, such as construction and engineering, commercial services and supplies, food products, and hotels, restaurants and leisure. Meanwhile, 47 of the 102 companies have interest coverage ratios of 1.5 or lower. The interest coverage ratio, which is Ebitda divided by the interest expense, indicates how heavily a company’s debt burdens the company.
However, there are wide differences in the financial strength of individual companies within each sector. For instance, the largest developers, such as City Developments (CDL) and CapitaLand, have net gearing below 50%, whereas several of the smallest developers, such as Aspial Corp and Chip Eng Seng, have net gearing levels of around two times or higher.
“I believe CDL’s and CapitaLand’s net gearing levels are lower because being large companies, it is difficult for them to find enough opportunities to find land sites for development in Singapore’s residential market, which has been in the doldrums from 2014 to 2017, while the smaller players have to fully utilise their balance sheet just to undertake one-to-two major projects,” Wong says. “Smaller players may also be more nimble — for example, we saw Chip Eng Seng and Oxley Holdings snapping up landbank at the beginning of the en bloc wave, ahead of the larger developers.”
That does not necessarily mean that the smaller developers are at risk. Wong says loans make up two-thirds of the debt composition of some property developers, while one-third represents bonds. “Typically, smaller developers tend to have a high proportion of debt that is secured (which we think helps to lower financing cost relative to unsecured debt) compared with larger developers (we think banks may be comfortable lending to them even without security),” he says.
The small developers have also secured all the debt they are likely to need for the next couple of years. “Most developers have termed out their debt profile sufficiently or are taking steps to do so in order to minimise the risk of refinancing in 2018/19,” Wong says. “However, Singapore developers seldom raise bonds outside of the Singapore dollar market, perhaps due to the cheaper cost of funding enjoyed in the Singapore market, where investors are more familiar with them,” he adds.
Among the property developers that are managing seemingly enormous debt loads is World Class Global (WCG). As at June 30, the company had about $644 million worth of borrowings repayable in one year or less. Of this, a collective sum of $394.5 million is owed to parent company Aspial Corp and a sister company. The debt, which is interest-bearing and unsecured under a revolving credit facility, will mature on Feb 28, 2021. The remaining $249.5 million consists of bank borrowings. The company has long-term borrowings of $159.8 million.
As part of its efforts to reduce property-related debt, WCG is hoping to sell more units from its projects, AVANT and Australia 108. AVANT is a freehold 56-storey residential skyscraper located in the heart of Melbourne’s central business district, while Australia 108 is a freehold 101-storey residential tower that is also in the same area.
According to WCG, buyers have so far made settlements for 401 residential units of AVANT, amounting to A$231 million ($229.7 million) in revenue. The company has already sold 443 units out of a total of 456 units. At Australia 108, buyers have made settlements for 278 residential units amounting to A$152 million in revenue in the last three months. The company has already sold 1,073 units out of a total of 1,103 units. “We are pleased with the progress we have made so far in buyers’ settlements for their purchases of residential units of AVANT and Australia 108. The proceeds from these settlements have enabled us to significantly improve our debt profile and reaffirm our strong company fundamentals,” WCG executive director and CEO David Ng says in a statement.
Accordingly, debts totalling A$135 million and A$60 million have been repaid for AVANT and Australia 108 respectively. WCG says it expects to further reduce debts relating to Australia 108 by another A$20 million before the end of 3Q2018. This will amount to a total debt reduction of A$215 million for both properties. For 1HFY2018 ended June 30, WCG reported revenue of $160.8 million. The company did not book any revenue last year. It booked earnings of $1.6 million versus a loss of $2.9 million a year ago.
Some companies, such as construction company Ryobi Kiso Holdings, have managed to buy time to meet their obligations. Ryobi Kiso has net gearing of 3.1 times and negative interest coverage of 12.8 times. On June 27, the company announced that its subsidiary Ryobi Kiso (S) had been unable to meet its repayment obligations to certain bank lenders and was in breach of banking facilities. This amounted to a collective sum of about $23 million. Some of its creditors also commenced legal proceedings against the company, including winding-up petitions against RKS.
Ryobi Kiso says its troubles were due to “intense competition” from fellow industry players. This resulted in thin margins for piling and ground engineering projects, which put pressure on the company’s cash flow. It did not help that there were delays by main contractors in certifying claims, protracted negotiations over variation orders for work done, and the need to make prompt payments to suppliers and subcontractors to ensure that projects continued to run smoothly.
The company posted a mixed performance in FY2018 ended June 30. Despite higher revenue of US$146.9 million, the company sank into a loss of US$56.9 million versus earnings of US$801,000 a year ago.
To address the situation, Ryobi Kiso commenced a court supervised reorganisation process. On Aug 27, the High Court of Singapore granted a moratorium protecting the company from legal proceedings and enforcement actions for a period of six months. This gives the company “breathing space” to work with creditors to develop a scheme of arrangement for the reorganisation of its liabilities and business.
Mencast Holdings, the maintenance, repair and overhaul solutions provider for oil and gas companies, was able to renegotiate with the banks. On May 8, the company says it received a letter from one of its principal banks, waiving a “non-compliance in financial covenants”. Mencast says the bank accommodated the “breach” on a “one-off basis”. This allowed the company to reclassify about $139.1 million of its borrowings from current to non-current liabilities.
Mencast has been hit by the slump in the O&M industry in recent years. But a slow recovery in the industry could reverse its fortunes. For 1HFY2018 ended June 30, the company posted a y-o-y revenue growth of 11% to $30.5 million. Net loss almost halved to $4.8 million. “The group reported increase in revenue for two consecutive quarters for the period ended June 30, 2018. Market sentiment had improved amid signs of an increase in customer’s enquiries,” the company says in the notes accompanying its financial statements.
According to Mencast, the company had outstanding orders amounting to about $50.8 million as at June 30, up from $15.5 million as at Dec 31, 2017. This includes orders from the recent joint venture with KSE Marine Works. The deliveries for these orders are expected to be spread within the next 24 months, the company says.
Trade war, rate hike risks
While Singapore-listed companies may be able to manage their debts currently, there are risks ahead. “The same ingredients lead to the same indigestible dish: deceleration in earnings in a given industry, the consequent loss of lenders’ confidence in this industry’s near-term fortune, and the withdrawal of liquidity,” says S&P’s Jabouley.
This situation could be triggered by the escalating trade war between the US and China, which could dampen global trade and affect global growth. On Sept 18, US President Donald Trump announced a new round of 10% tariffs imposed on US$200 billion worth of Chinese imports that will become effective on Sept 24. The tariff rate will be raised to 25% on Jan 1 next year. China retaliated by slapping tariffs of 5% to 10% on US imports worth US$60 billion, which will take effect on Sept 24 too. This covers items such as wheat and textile, but excluding soybean — a key agricultural product that is linked to Trump’s election base.
“Trump sees trade as a zero-sum game and is concerned with bilateral trade deficits. Both notions are incorrect. Trade is not a zero-sum game — both parties are better off with trade, as successive rounds of globalisation and trade liberalisation have demonstrated,” says Pushan Dutt, professor of economics and political science at INSEAD. “Triggering trade wars is an abdication of responsibility by the US government and can break up the current global trading system, of which the US has been the primary beneficiary.”
Marie Owens Thomsen, chief economist at Indosuez Wealth Management, says the first impact from a worsening trade war will be on GDP. “Obviously, if we have a marked drop in GDP, that will affect everyone’s debt servicing capacity. I think it’s hard to [overemphasise] how important trade is for everyone’s welfare,” she tells The Edge Singapore in an interview.
Thomsen recalls how trade has transformed China into an economic powerhouse after the world’s second-largest economy was admitted into the World Trade Organization in 2001. “Once China joined the WTO, it was just like fireworks. A very large portion of China’s success is attributed to its ascension to the WTO and the increase trade,” she says.
If global trade is dampened, this could lead to damaging consequences. “Once these measures start biting, it is entirely possible that we start to see drops in trade volumes, and if that happens, very quickly afterwards we will start to expect a recession. Protectionism today could definitely cause another crisis of the size of the 2008 crisis,” Thomsen says.
Another big risk is the pace at which global liquidity is tightened. With easing momentum in global growth, some market watchers are hoping that the Fed will moderate the pace of its rate hikes. For instance, Thomsen thinks the Fed will go ahead with just one more hike this year — on Sept 26. The way she sees it, the US dollar has appreciated about 8% this year, after accounting for trade weightage and inflation. And, by her calculations, a 10% appreciation of the US dollar is equivalent to a 50 basis point rate hike.
She also says the ECB has said it will not tighten monetary policy until September 2019. “Keep rates low for longer. Everyone has an interest in keeping rates low for longer because everyone has more debt,” she stresses.
The Fed has indicated that it will hike rates two more times this year.