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Bond market's summer musings

Andrew Wong, Ezien Hoo and Wong Hong Wei
Andrew Wong, Ezien Hoo and Wong Hong Wei9/2/2021 08:04 PM GMT+08  • 7 min read
Bond market's summer musings
The climate in the region’s bond markets over the past eight weeks has been anything but idyllic.
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Summer in capital markets has historically been associated with slow, idyllic weeks where traders and investors take advantage of the market lull to go on vacation. While this is slowly becoming a thing of the past, given the increased participation of investment pools based in the Asia-Pacific region, the climate in the region’s bond markets over the past eight weeks has been anything but idyllic.

Volatile Asiadollar market

While Internet platform companies have taken the brunt of regulatory and policy action in the past year, it is now clear that China is marching towards an overarching goal of common prosperity. We have seen this in swift clampdowns from the Chinese government on sectors including education, insurance, milk and gaming, aside from the ongoing curbs on property.

On July 23, China shook investors by forcing the private tuition sector to become non-profit, leading to an immediate re-rating of the sector. Apart from astute observers of China’s macroeconomic environment, capital market participants had generally shrugged off earlier reports of impending regulatory and policy development for the sector in the months leading up to the official announcement. The market cap of the two largest listed players have declined by 70% since 22 July 2021, with the sole USD-denominated bond issued by New Oriental Education & Technology Group, the EDU 2.375% ‘25s falling 16 ppt to 80 before retracing to 89 cents to the dollar as at Aug 31.

While the education sector made larger headlines, the larger impact to the Asiadollar high yield market was renewed fears of liquidity stress at property giant China Evergrande Group (EVERRE), which may have implications on the rest of the high-yield market. The EVERRE curve is trading on recovery values with cash bid prices falling below 30, signalling the potential for default. Whilst the Asiadollar market has somewhat stabilised, it remains to be seen how the liquidity issues at EVERRE would be resolved in a more permanent manner.

In stark contrast, the investment-grade market performed well, aided by a proposed capital injection from new investors led by stateowned Citic into the still-investment grade China Huarong Asset Management. The market has looked past the company’s dire profit warning and potentially divergent credit rating outcomes, though the credit rating impact on Citic is less clear at this point given the lack of transaction details.

China’s pursuit of common prosperity may seem anathema to profit-seeking investors, but this is not misaligned with the country’s development path rooted in its political ideology. With China taking action on social equality issues, this points towards further specific actions in sectors that are intricately linked to community well-being. What is significant is the country’s more dovish tone on credit policy and provision of liquidity support to ensure economic stability.

Outside of China, the Asiadollar market was sanguine, with Temasek Holdings’s three tranche bond deal raising $2.5 billion ($3.36 billion) and Mumbai-based HDFC Bank’s $1billion Additional Tier 1 capital well absorbed by the market.

Cooling conditions for rates

While the Singapore dollar market was relatively calmer, in August we saw some interesting developments that tested the SGD bond market for its appetite to take on interest rate risks. The issuance of $600 million Mapletree Investments’ fixed-for-life (FFL) perpetual securities attracted much fanfare, being the first FFL perp priced in the SGD bond market since the redemption of Cheung Kong’s FFL perp in 2016. Never mind that interest rates are expected to rise, demand has held up with prices above par despite 3.7% distribution rates. Temasek Holdings followed suit with the issuance of a $1.5 billion 50Y bond with 2.8% coupon rate, which has similarly traded higher. We think the firm demand is suggestive that investors are buying because the rates are fixed despite obvious interest rate risks.

Today’s investors appear unafraid of higher rates, perhaps because reinvestment risks have been the greater risk. Aside from pockets of volatility in the past decade that saw interest rates spike (e.g. 2013 taper tantrum, end of zero interest rate policy in 2016), investors today have been accustomed to declining rates. Investors in several perpetuals have seen their distribution rates reset down as a result of lower interest rates. This includes the perpetuals of Ascott Residence Trust (reduced to 3.07 % from 4.68 %) and First REIT (reduced to 4.9817 % from 5.68%). Meanwhile, the distribution rates of the perpetuals of Lippo Malls Indonesia Retail Trust and Soilbuild Business Space REIT are expected to fall to around 6.4 % and 4.5% from 7% and 6% respectively as both issuers will not be redeeming the perpetuals on the first call date. More issuers may opt to miss the call to save costs, thereby allowing distribution rates to reset lower, which may further entrench investors to favour bonds or perpetuals offering fixed yields.

Financial institutions continue to weather the storm

One sector that has remained relatively stable is the financial institutions. Their fundamentals continue to remain sound following the release of their 2Q2021 and 1H2021 results in August, from a mix of past actions to improve their balance sheets and earnings quality following the Global Financial Crisis, the critical nature of their services that supports their earnings capacity during dislocated times, and their diversified business models meaning they benefit during both periods of market volatility (through trading) and market stability (growth in loans, fees and commissions). In addition, their systemic importance results in both ongoing and extra-ordinary government support to ensure financial system stability.

That said, systemic importance can be a double-edged sword as it also results in periodic government intervention as seen during the pandemic when global banking regulators halted shareholder returns to ensure financial institutions’ capital strength and capacity to continue lending to the economy.

Nevertheless, recent moves by the Monetary Authority of Singapore, the US Federal Reserve and the UK Prudential Regulation Authority to relax or lift dividend restrictions highlight financial institutions’ solid footing due to a better-than-expected economic outlook, a significant reduction (and sometimes writeback) in expected credit losses, and a sharp bounceback in demand for credit as lockdowns ease. These have translated into solid capital buffers well above minimum capital requirements. Such dynamics have been positive for the sector as it seeks to take advantage of low rates and prepare for the economic recovery — according to Bloomberg, bond issuance by banks in Southeast Asia has risen 29% y-o-y across all currencies since July 1, while Southeast Asian corporate issuance was flat.

Rising temperatures drive growth in sustainable finance

One area of the market that continues to grow is that of sustainable finance. As of Aug 31, green, social, sustainability and sustainability-linked (GSSSL) bond sales from governments and corporates so far this year totals $652 billion already higher than the US$480 billion issued in all of 2020.

This market is likely to continue to grow from both higher demand and higher supply. While climate related concerns will remain dominant following the Intergovernmental Panel on Climate Change’s scalding report assessing the current state of global efforts to tackle climate change and, most recently, Singapore Exchange Regulation’s proposal to make climate-related disclosures for listed companies mandatory for key industries from 2023, we expect social considerations and related financing to also rise in prominence.

This is given higher awareness of social issues (see China’s common prosperity ambition), rising inequality and delayed progress on social goals from the pandemic. Of the total US$612 billion issued up to the end of July, green bond sales totalled about US$292 billion, up 152% on the same time last year, and social bonds totalled US$156 billion, up 214% on last year’s figures. Union Bank of the Philippines recently issued its first social bond under the bank’s sustainable finance framework. Bond proceeds are expected to finance loans to micro, small and medium-sized enterprises that have been impacted by Covid-19 to achieve positive social outcomes.

Andrew Wong, Ezien Hoo and Wong Hong Wei are credit research analysts with OCBC

Photo: Bloomberg

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