Business

Saturday March 7, 2009

Bond market facing new challenges

By LAALITHA HUNT


INDEED, it is challenging times for the country’s private debt securities (PDS) market which is the largest source of private sector financing. Although during volatile times, bonds offer more stability than equities, they too are vulnerable to significant changes in the general economic environment.

The number of debt papers issued this year is projected to fall in view of the tough climate. Industry observers say that although there remains strong interest from the corporate sector to tap into the bond market for funds, the actual issuance remains low in 2008 in the wake of the global financial crisis.

CIMB’s Lee Kok Kwan

(Note: Bond prices move inversely proportional to interest rates – when interest rates go up, bond prices go down and when rates are falling as they are right now, bond prices go up.)

Local investors have become more cautious, with further credit rationing for even highly-rated papers, skewing towards the AA-rated category and with ever-widening spreads between the A and AA bands.

RAM Rating Services Bhd chief executive officer Liza Mohd Noor says that while there is still a healthy pipeline of rated-but-not-issued debt papers in RAM Ratings’ portfolio, there is currently a pricing gap between the rates that borrowers are willing to pay against what investors are willing to accept.

“Until this gap can be narrowed to tolerable levels, we expect the issuance of these proposed debt issues to be deferred,” she says.

Widening scope

The domestic bond market has improved remarkably over the past ten years in terms of size, issuance capacity and range of instruments.

As at last December, the size of the outstanding ringgit bond market is almost 80% of gross domestic product and is the largest bond market in Asia, ex-Japan (in terms of GDP percentage).

According to CIMB group deputy chief executive officer and treasurer Lee Kok Kwan, the situation was starkly different during the Asian financial crisis. Then, companies were highly dependent on banks for funding and were reeling on escalating borrowing costs (caused by rising interest rates) largely because there was a mismatch between the tenure of debts and the projects they were funding. That brought to light the relevance of the bond market which has since grown tremendously in terms of depth and scope.

The ratio of bank credit to GDP in Malaysia was high at 149% in 1997.

“As there is only so much capacity in the banking system, Malaysian corporates also borrowed heavily in foreign currency, in both US dollar bonds and syndicated loans, exposing themselves to severe foreign exchange risks,” Lee points out.

Sensing the urgent need for private enterprises to tap the capital market for funding, Bank Negara together with the Securities Commision intervened to develop the local capital market.

MARC’s Wan Murezani

Thanks to its efforts, corporate bond or PDS issuance alone has been growing at an annual average of 17% since 2000.

Total outstanding PDS is estimated at RM230bil as at December last year, up by 36% since 2005.

Meanwhile, Islamic corporate bonds issuances exceeded the conventional issuances since 2005, driven largely by attractive regulatory environment as well as tax incentives given as part of the Government’s plan to promote Malaysia as an international Islamic capital hub.

In terms of instrument types, apart from traditional corporate bonds, investors now have an option to invest in an array of instruments.

For example, structured products such as Collateralised Loan Obligations (CLO) and Cagamas Mortgage Back Securities (MBS) have gained prominence in recent years.

Sliding issuances

In stark contrast, growth in terms of bond issuances fell sharply to 5% in 2008 amid the bearish sentiments.

“Total PDS raised in 2008 stood at RM49.7bil, and of this amount, approximately 60% were raised in the first half of the year when economic conditions were significantly better,” notes Malaysian Rating Corp Bhd head of fixed income Wan Murezani.

Malaysian Investment Banking Association (MIBA) says issuances in the PDS market last year were dominated by AAA-rated and government-guaranteed bonds in the region of 76%.

According to Bank Negara’s latest statistics, the trend of issuance continues into 2009 with the public sector raising net funds of RM5.6bil through the re-opening of the five-year Malaysian Government Securities (MGS) in January.

Meanwhile, funds raised through the issuance of PDS were lower at RM524mil (December 2008: RM3.8bil).

Wan Murezani explains that credit risk has become a big concern among investors and government bonds are considered safe-haven investments.

“Should the economic situation worsen, demand for government bonds may continue to be stronger despite the increasing supply on the basis of flight to safety,” Wan Murezani said.

The impediments

Besides government bonds, industry experts agree that, while corporate issuers along the higher credit spectrums (AAA and AA band) would still be favoured, certain developments in the local financial sector may impede the demand for PDS. For one, the recent implementation of the risk-based capital (RBC) framework in the insurance industry has seen insurance funds increase their demand for low-risk assets such as government guaranteed bonds.

“Some investors also bought into bonds issued by foreign issuers with better yields, adding pressure to Malaysian corporates to match the higher rates,” Lee says.

Another recent development is the increase in the issuance of bank capital instruments such as bank sub debt and tier-1 instruments, which investors perceive to be much safer than investing in lower rated corporate bonds.

Meanwhile, lower interest rate environment is said to bode well for companies.

Lee observes that companies, in particular those that are not so highly rated, were increasingly tapping the floating rate loan markets for financing as Bank Negara has reduced the overnight policy rates (OPR) significantly over the last few months – providing significant cost relief to corporates and small and medium enterprises (SMEs) in funding their working capital requirements.

“As the Malaysian banking system remains highly liquid, there remains significant balance sheet capacity in the system for lending. Nevertheless, there is a need to maintain a balance between the corporate bond market and the loan market as too much disintermediation from the corporate bond market back to the loan market is not ideal because this will result in a systemic concentration of credit risks in the banking system, which was the case going into the 97/98 crisis,” Lee adds.

On the other hand, lower interest rates environment in the capital markets will mean that returns from government bonds and bank deposits are low.

Going forward, domestic liquidity remains healthy and is expected to be sufficient, despite widening credit spreads to meet domestic fund raising requirements in the bond market. Hence, it would be worthwhile for corporates with good credit standing to issue bonds.

However, they would have to match current investors’ expectations and pay for the higher credit risk premiums.

Rising supply

The Government’s pump priming efforts have led to some quarters worrying about a potential oversupply in the bond market.

“The supply concern we have in the MGS market stems from the uncertainty on the quantum of the second stimulus plan. The existing fiscal deficit target of 4.8% implied a RM72bil and RM36bil gross and net MGS issuance respectively. Any additional fiscal stimulus, if entirely funded by MGS, will add directly to MGS supply,” says the Fixed Income Research team of AmResearch, adding that the aggressive cuts in OPR and the rapidly deteriorating economic conditions call for a higher fiscal stimulus.

“Hence, potentially we think the second stimulus package may surprise the market on the upside. The market is widely expecting RM15bil-RM20bil, but we think it is likely to go beyond RM30bil. If entirely funded by MGS, this will mean a doubling of MGS supply,” it continues.

On the other hand, on the demand side, despite the cut in SRR releasing circa RM16.5bil to the market, the research house says the general growth in funds under management is limited. “Taking both supply and demand into consideration we see a high likelihood of an oversupply situation,” it says.

Due to the supply concern, despite the 50 bps cut in OPR, it says the MGS market has not reacted strongly to lower interest rates.

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