IFR Asia Outlook for Asian Credit Roundtable 2020: Part 2

IFR Asia Outlook for Asian Credit Roundtable 2020
25 min read

IFR ASIA: Another audience question for you, Michael. What’s your view on the services sector, things like healthcare and education, are there any fixed income opportunities there that could be useful?

Michael Taylor, Moody’s: I can talk about the credit view, maybe not so much in terms of investment opportunities but, certainly, for many healthcare providers, it has been a positive period in terms of revenues. For some of the private hospitals in the US, however, it has caused some stress because one of their main sources of income is elective surgery, which, in the worst hit areas like New York and California, has been cancelled for the foreseeable future and that does have major implications for the bottom line of those private hospitals.

In the education sector, again, I think there are two things to consider. One is how effectively educational institutions can move to online learning. That’s a process that has been going on for some time. I guess what we’re going to see as a result of the pandemic is that trend – along with the adoption of artificial intelligence and the move towards online shopping – is also going to be accelerated.

It’s the same with online healthcare. There has been a certain reluctance to adopt technologies that would enable you to have a consultation with your doctor remotely using the same kind of video conferencing facilities that we’re using now. Again, I think there is a move towards those kinds of technologies, and we’ll see more of those kinds of technologies being used in both healthcare and education.

From the point of view of educational institutions, there is a downside from the restrictions on travel at the moment and that applies particularly to those universities that are highly dependent on foreign students. In this region, the ones that really stand out are the Australian universities, which have become very heavily dependent on overseas students, especially from China. The restrictions on travel at the moment have major implications in terms of revenues for those universities. Overall, things like travel restrictions are having a major impact but it will also accelerate a shift towards more online provision, whether it’s in education or healthcare.

IFR ASIA: Are you seeing opportunities, Morgan, in these types of sectors? Also we’ve got a question on how you look at financing these investments given potential liquidity crunches.

Morgan Lau, Fidelity: Hi. Yes. On the education sectors, there were a few names that came out from China and we have looked at those names and I think we will continue to do so. The benefit of those particular names, some of them are a bit high-yield, is that their business is based on people wanting to learn something, learning a skill or getting a qualification, which is quite different from, for example, universities in different countries with a lot of foreign students. I think when you are going to some of those educational institutions for qualifications, you actually want to learn a skill whereas if you’re sending students to a foreign country, it’s the whole package of the living experience offshore as well as some of the contacts that you can make that give the value of that particularly university, so they will be affected in different ways. Education as a fixed income investment will probably be still quite okay, and I’m not too worried about the impact of this pandemic.

In terms of raising liquidity, I think it’s a combination of investing in securities with liquidity so you know that, in times of distress, the market makers are still willing to make markets on, obviously. Secondly, our trading desk is very keen on maintaining good relationships with banks so, hopefully, we’ll get better access to liquidity in times of distress.

The first thing is also a result of your foresight. If we are sensing a bit of volatility in the market and, from past experience, if we know liquidity is going to deteriorate, we’ll raise liquidity beforehand. We also use some defensive instruments to maintain liquidity while keeping our investment exposure as well. It’s a whole package of measures that we use to raise our liquidity because we appreciate that fixed income is still an over-the-counter market. That means liquidity is going to be a very big factor in the investment process at times of distress.

IFR ASIA: What does the supply side look like? Will there be any fixed-income issuance from industries that are benefiting from the crisis? They tend to be not so capital intensive.

Alan Roch, Standard Chartered: In general terms, we’ve had US$37bn of issuance, post Covid-19, in Asia and we’ve really been tracking lower than 2019 volumes as far as March and April and even May are concerned. It’s been nowhere comparable to the incredibly supportive primary market we saw in the US, which has seen US$250bn-$270bn of issuance in March and April and a largest month on record.

Now, in Asia, there’s enough evidence from all the transactions that have come to market post Covid-19 to give issuers confidence to proceed with their transactions. I think what we’re going to see and, certainly, that’s what we’re experiencing with our pipeline, is an increase in the number of issuers coming to the market in June and July. Quite frankly, these are issuers that could have come to the market earlier but many of these were waiting for market conditions to stabilise and waiting for other issuers to come, print and demonstrate that that market was open.

We’re going to move away from a market where issuance has really been focused on the larger sovereigns or quasi-sovereigns and we’re going to see much more corporate supply in June and July and a much wider spread of different sectors and different names.

From a buy-side standpoint, the message we’re getting is that people are ready for this supply to come. I think we’re going to start tracking higher in volumes but our big expectation for the next couple of months is one where perhaps smaller corporates, not quasi-sovereign issuers necessarily, are going to come to the market.

IFR ASIA: Michael, I’ve got a question for you on your outlook for default rates in this part of the world. Do you want to talk us through that?

Michael Taylor, Moody’s: I think the first point to emphasise is that default rates in Asia-Pacific have, over the last few years, been extremely low. Obviously, given the economic background that I outlined earlier, the expectation is that defaults are going to rise in 2020.

We have the credit transition model, which we used to forecast the trailing 12 months high-yield corporate default rate. According to that model, we’re expecting defaults to rise to 6.4% at the end of 2020 under the baseline scenario, which is the scenario where the various downside risks that I talked about earlier don’t materialise. (See Chart on page 10.)

That is a significant revision against our previous estimate, which was done earlier at the beginning of the year, where we had a default rate of 2.4% and, also, compared to the default rate in 2019 of 1.1%. We are looking at a substantial increase in high-yield default rates for corporates.

If we look beyond the region and globally, in February of this year, the speculative-grade default rate was 3.1%. We’ve run a few scenarios and looked at different possible economic outcomes and how things might play out this year. I ought to stress, these are scenarios. These are not hard and fast forecasts. We’ve basically made a few assumptions and said, “What will happen to the default rates globally if that happens?

If the contraction that we’ve had in the first half of the year does turn into a recovery later on in the year, we’re expecting a spec-grade rate default rate globally of about 6.5% to 7% or 6.8% in the next 12 months. If there’s a significant further weakening in economic and financial conditions, similar to what we had during the global financial crisis, that would imply a default rate of 16% in a year.

If things turn out really bad – where we have a resurgence of the virus later on in the year and a repeat of the lockdowns to try to combat it – then we’re looking at a default rate of around 20% or more. It depends very much in terms of what the economic scenario is going to look like for the rest of the year but, certainly, default rates in the spec-grade space are going to rise and they’re going to rise quite substantially.

IFR ASIA: Let’s turn our attention to South-East Asia if we could for a minute. We’ve had a couple of questions on the view on credit markets in places like Indonesia and the Philippines, given significant currency devaluations in a lot of emerging markets.

Michael Taylor, Moody’s: On South-East Asia, again, we’re anticipating that growth rates are going to be lower. Government debt levels are going to be higher as a result of the need to support economies in the face of various kinds of lockdown measures. The impact of that is going to vary quite a lot country by country but, certainly, we’re seeing some impact in terms of the growth outlook.

As far as Indonesia is concerned, yes, we’re seeing in our forecasts growth this year will fall very substantially, but it’s still going to be positive. It’s one of the few major economies that will record positive growth this year. But compared to the 5% or so that we’ve seen across Indonesia’s growth for the last several years, we’re looking at something close to 1% for Indonesia this year. A big impact and that’s coming through various channels. Commodities is, obviously, a big one. As a major commodity producer and exporter, Indonesia is hit by the collapse in commodities prices. Tourism is another, and the fact that tourist islands, like Bali, are suffering quite badly from restrictions on travel. All of that means that Indonesian growth is going to be much lower.

Again, the policy support measures that we’ve seen across the major economies in the region vary quite a lot in terms of size and impact. Indonesia is one of the countries where, so far at least, the policy support that’s been provided, especially the direct fiscal support, has been relatively modest compared to the size of the packages unveiled elsewhere. Again, maybe there is scope for the government to undertake more policy support for the economy. (See Chart.)

In terms of Indonesian credit, obviously, the collapse in commodities prices will have negative implications for quite a number of Indonesia’s commodities producers. There are also a number of state-owned enterprises that we rate in Indonesia and, again, some of those are commodities producers as well. There’s an impact on some of the state-owned enterprises.

IFR ASIA: Morgan, I wonder if you have anything to add to that? Also, I’d be interested in your view on local currency markets in this part of the world. Have you seen any opportunities there?

Morgan Lau, Fidelity: Thank you. My view on the South-East Asian economy is very similar to Michael’s. I don’t have that much to add. In terms of local currencies, I think people are realising the fact that when the US dollar market is in stress, it does affect global markets given that it is the global reserve currency. After March, will people start to, for example, diversify their currency exposure a little bit into some of the growing and new economies? That’s one of the questions that we need to ask ourselves.

We have also seen that, India and Korea, for example, have come down quite a bit as a percentage of US dollar bond issuance over the years. Obviously, one of the contributing factors is because China has been issuing a lot of US dollars and becoming a much bigger piece of the pie. Another factor is that a lot of those companies have started to look at their own currencies rather than borrowing in foreign currencies. In China, where the corporate bond market is growing really rapidly and is also maturing and is also attracting a lot of foreign interest as well, are we going to see a lower issuance level in the Asia US dollar credit market?

All those things we have to look at as well. At Fidelity, we are looking at opportunities in China and we’re trying to study the viability of making corporate bond investments there as well.

IFR ASIA: Alan, do you have a take on South-East Asia? We’ve also got a question here on the outlook for green bonds, which I know is a topic close to your heart.

Alan Roch, Standard Chartered: For South-East Asia, I was just looking at the numbers now, when you look at credit spreads for Indonesia and the Philippines, which have issued bonds post Covid-19, the average basis point performance in the secondary market is 56bp. There’s been a huge rally in the sovereigns of both the Philippines, Indonesia and the quasi-sovereigns that have issued, particularly in Indonesia.

Definitely, from a market endorsement standpoint, it’s been clear. The Philippines, which was a transaction we were involved in, priced at the lowest yield they’ve ever seen on a US dollar deal in the 10-year and the 25-year tranches, and we’ve seen similar records as far as Indonesia is concerned. The market is definitely one of the success stories of the post Covid-19.

The other thing to note in terms of South-East Asia is the strength of the local currency market has been something that I think a lot of people have paid attention to. The Philippines had an auction on Monday, which was significantly oversubscribed with cover ratios that you rarely see. The local currency market there has been functioning very well. You’ve had similar stories as well in, for example, Thailand where PTT Global Chemical has managed to do a very large Thai baht deal. That, otherwise, is an issuer that could have come to the dollar markets. When the offshore markets were trickier to navigate in March or April, some local currency markets, in the case of Thailand and certainly in the case of China, were much more stable. I think that’s something that has reassured global investors as they look to invest in the likes of Indonesia, Thailand or the Philippines, for example.

As far as green bonds and ESG is concerned, of course that’s a huge theme for issuers as well. When we advise issuers on their roadshow presentations, we spend an enormous amount of time talking about their ESG credentials and how they can ensure that these are well understood by investors. There’s not a single presentation or roadshow or investor call that does not cover that topic in detail – and in a much greater amount of detail today than in the past.

I think it’s a little bit early to really judge the impact of Covid on the differentiation of credits with regards to ESG but the direction of travel is very, very clear and, in my opinion, it will only exaggerate the focus on that topic. It has, historically, been very European-driven but you’re starting to see in Asia as well a much greater awareness among the buy-side, led by global asset managers. That topic is going to be even more at the forefront of everybody’s mind in the market.

Michael Taylor, Moody’s: I think it’s in line with what I said earlier on how we’re likely to see the pandemic accelerate certain trends that were already there. I think we’ll see a greater focus on ESG and that’s certainly part of our expectation.

The investor focus on ESG considerations, which we were already beginning to see pre-pandemic, is going to increase and that will be very much part of our suite of offerings going forward. We’re incorporating ESG factors into our credit ratings, and more broadly within Moody’s, outside of the credit rating agency, we also have a suite of offerings around ESG topics, which we’re in the process of developing further. ESG is definitely going to be on the agenda post-pandemic.

IFR ASIA: Let’s try to finish with a couple of predictions. Alan, do you think we are going to smash records this year in terms of new issue volumes?

Alan Roch, Standard Chartered: I don’t think this year will beat the records, because some of the deals that should have happened are just not going to happen. They’ve gone to the loan market or they’ve gone to the local currency market and, fundamentally, CapEx requirements, particularly in some sectors, are going to be lower. I don’t think we’ll see a US story here in Asia where volumes are going to beat last year.

I do think more mid-sized corporates in investment grade or in high-yield are going to come to the international market. There’s no reason for them not to come. The pricing differential between dollars and local currency has narrowed as well so I think that will be a trigger for many. I am expecting June, July and Q3, in particular, to see many more transactions but I don’t think it will make up the shortfall in volumes and beat 2019. Hey, I would love to be proven wrong!

IFR ASIA: Kenny, do you continue to see the international markets as a major source of liquidity for yourself and for other Chinese property developers in the future?

Kenny Chan, Zhenro: Right now, the overall trend for sales in our industry is picking up and the momentum is also picking up. We see more home buyers are looking, and more developers are listing projects. I think the China property sector is a relatively safe haven for investors, but we also see market consolidation. We expect, maybe, 20% or 30% of our peers may be squeezed out in the coming two to three years. We’re happy to see these market consolidations, and overall it is a good investment.

From the developer’s perspective, I think the bond market is still important to us. I agree with Alan that we will also go back to the loan market, and there may be more equity transactions through share placements this year because, right now, the P/E multiples are actually at a very good level.

IFR ASIA: Morgan, do you think there’s still further to run in terms of credit spreads here?

Morgan Lau, Fidelity: It’s a question that we have to divide to into time horizon and regions. If we just focus on the Asia-Pacific region, let’s say in the medium to long-term, I think we definitely see more contraction in terms of credit spread. We’re still, actually, quite a bit above the floor so we still have more to go.

In the short-term, if we look at all the major selloffs and financial crisis in the past, we should still be expecting some periods of volatility and some pullbacks. In the short-term, we still have a very cautious positioning but, in the medium to long-term, we think credit spread can go a bit tighter.

IFR ASIA: Michael, I’ll give you the last word for today’s session. Are we looking at a sharp recovery in this part of the world or are you expecting more pain and suffering in the months ahead?

Michael Taylor, Moody’s: Well, I don’t know how much pain and suffering but I’m certainly not expecting to see a very rapid rebound this year. This episode, I think, is going to hit the region much harder than we saw during the global financial crisis. Although people talk about a global financial crisis, it was really more of a North Atlantic crisis. We didn’t really see the impact in this region so much. You have to go back to the Asian financial crisis to see something similar in terms of impact around the region.

We will see slower growth. For some of the countries in the region, the reconfiguration of supply chains that we were talking about near the beginning is going to have a big impact too. We started to see the shift of supply chains moving from China to some of the countries in South East Asia last year as a result of the US-China trade dispute. That’s a trend that might accelerate but, at the same time, I think if North America and Europe are looking to bring some of their supply chains back onshore then that’s going to affect all countries in the region. There won’t be too many winners from that one.

As I’m very fond of saying, coronavirus is not a typhoon, it’s an earthquake. With a typhoon, you can hunker down and batten down the hatches, you wait for the typhoon to pass and then you do a bit of repairs and life goes back to normal. With an earthquake, especially if it’s a severe one, that doesn’t happen. If you rebuild, you have to have a different plan. You have to use different building codes and you have to make the buildings more robust. Sometimes you can’t even rebuild certain parts at all because the ground’s just become too unstable. I think coronavirus is more of an earthquake than a typhoon and it’s going to change things pretty fundamentally going forward.

IFR ASIA: Ladies and gentlemen, thank you all very much for your attention.

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