Asian corporations issuing US dollar bonds are seeking shorter tenors to lock in favourable pricing targets amid speculation that yields will rise particularly on the longer part of the Treasury yield curve in the second half of this year.
Record-low US Treasury yields spurred Asian issuers to rush to the US dollar market in 2012 to finance dollar debt through longer tenors, helping push debt capital markets issuance to a record US$130 billion. Companies such as state-run Indonesian electric generator Perusahaan Listrik Negara (PLN) and Thai energy company PTT locked in record tight rates through 10-year and 30-year deals in October.
But now the advantage is fading. The spread between the five-year and 10-year US Treasury yield has widened as much as 40 basis points (bp) from 10-20bp in the end of last year, amid concern that rates will rise after Federal Reserve policymakers agreed to review the US$85 billion-a-month bond buying programme in the March 19-20 meeting, according to minutes from the January meeting.
US Treasury yields are used as benchmarks to price US dollar-denominated bonds, and the fact that the spread between the two tenors has widened means that it is more expensive for Asian issuers to finance in US dollars in longer tenors of 10-years and above.
“I think we have seen some issuers leaning to slightly shorter tenors because the credit curve has become reasonably steep,” according to a senior debt syndicate banker. “From that perspective, five-year funding on a relative basis to 10-year funding has become more attractive for some issuers.”
The five-year tenor was the most widely used maturity out of the 60 US dollar-denominated deals printed in Asia year to date tracked by Dealogic. Twenty-two bonds were issued in the five-year tenor, while only 15 were sold in the 10-year tenor.
An added element of increased volatility in the US Treasuries is also a growing concern for the debt capital markets, and bankers are advising issuers to issue US dollar bonds sooner before rates move much higher. The 10-year Treasury yield rose to as high as 2.04% on February 13, and as tight as 1.86% in January 2.
“There’s definitely a pickup in volatility on rates, there’s definitely a risk that rates will go higher and some investors have that expectation. But equally, there are a lot of guys out there who say they expect rates to remain low. So there’s just an increase of uncertainty of where rates are going to in the future, and from that perspective it makes sense for issuers to look at the market sooner than later because they can avoid uncertainty and they are still trading at pretty attractive levels.”
The 10-year Treasury tightened to 1.88% at the time Asiamoney PLUS went to press due to concern that former Italian Prime Minister Silvio Berlusconi was garnering support during the parliamentary elections, but Societé Generalé expects that to rise to 2.5% or higher by the end of this year and eventually erase the support for Asian credit that was supported by lower yields.
“So that factor, which has been a big technical support for the last four years in the credit markets for Asia, should disappear by the end of this year,” according to Guy Stear, head of Asian credit research for the bank.
In addition to weaker technical support due to widening US Treasuries, increased borrowing among Asian companies will also become a factor that will contribute to widening credit spreads in the region.
“The combination of these technical factors and the higher amount of leverage makes us think that spreads will trough in the middle of this year and start to creep higher as more people focus on the leverage situation,” says Stear. “But these issues are not worrying in terms of a sharp widening in spreads because the preconditioning of a sharp widening in spreads is we need to see operating cash flow decline, and we’re still looking at operating cash flow go up this year.”
These factors will weigh down stronger on the longer end of the curve than on the shorter tenors in the second half of the year, according to another credit analyst. The three- to five-year Asian credit spread will remain flat, the two-year spread will become 5% tighter, and the five-10-year spread will widen 15%-20% in terms of spreads, said the analyst, adding that Asian credit spreads will tighten 25bp by June and widen 50bp from June to December.
However, high yields bonds will perform relatively better than their investment grade peers as they are less sensitive to US Treasury yields and are more correlated to the equity markets.
“Generally, one-third of the returns for high yield markets come from underlying yields and two-thirds come from spread, but investment grade markets are the other way around. The high yield markets should continue to do well for longer than the investment grade markets,” said Stear.
But bankers are still optimistic that issuers will utilize the debt markets to raise funding despite the volatility provided by US Treasury yields.
“There would be a negative impact on the overall tone of the market but again if issuers are looking at the market for maturity extension [from bank funding], it’s always there for them and even if interest rates go up, it will still be quite reasonable because historically interest rates have been on the low end for a long time.”