The year 2010 has undeniably been a quiet year for the corporate bond market, with modest issuance in the earlier part of the year despite a rebound seen in the global corporate bond market where declining rates saw issuers, particularly at the lower end of the credit curve, tapping the debt market for refinancing purposes. Super-low interest rates in the developed economies, due to monetary easing as governments struggled to return economic growth to a sustainable level, are believed to be the reason for the robust demand seen in the global high yield market.
New ringgit corporate bond issuance, including Cagamas and non-rated tranches, stood at RM35 billion year-to-date as at November 2010 compared to RM42 billion over the corresponding period in 2009. The shift away from bond market funding towards corporate loans could have contributed to the lethargic environment in the primary corporate bond market. We lowered our 2010 corporate bond issuance target to a range of RM35 billion to RM45 billion in July 2010, and at this juncture, we are looking at RM38 billion for the full year. The dry spell in primary market activity appears to have ended judging from pick up in bond issuance in 2HFY10.
We expect corporate bond issuance to hit the RM50 billion mark in 2011 assuming the economy continues on its recovery path, boosting demand for capital. Additionally, the announcement of the Public-Private Partnerships (PPP) programme during the tabling of Budget 2011, involving RM14.5 billion worth of projects to be implemented in 2011, is expected to positively benefit the PDS market as the funding profile of the projects would be better served by bond issuances.
There are also four projects categorised as high-impact strategic development worth RM81 billion that will commence in 2011. Nonetheless, it is worth noting that due to their long expected completion period, fundraising activity for the high-impact developments will likely be staggered over time rather than one-off exercises. This year also witnessed the announcement of Danajamin-wrapped facility programmes amounting to RM885 million in the corporate bond market. We think that the market will likely see more such programmes being announced in 2011 on the basis of Danajamin’s unused underwriting capacity.
Improving corporate fundamentals and credit quality
The Malaysian economy rebounded in 2010 in line with gains seen along other emerging economies. As a result, corporate credit quality which had deteriorated in 2009 amidst difficult operating environment improved in 2010 with the annual corporate default rate falling to 2.6% as at November 2010 from a revised 4.5% recorded at the end of 2009 (the number reported earlier was 5.6%).
A rebound in the economy also saw improving corporate balance sheets, another manifestation of the operating environment returning to pre-crisis conditions.
The revenue of 919 listed corporations on Bursa Malaysia excluding financial institutions rose by 5.2% year-on-year (y-o-y) in 2Q 2010 after hovering in negative territory in the previous three quarters, resulting in operating profit margins widening to an estimated 8.8% over the same period. The build-up of cash among these corporations is also another positive sign where cash balances was estimated to be approximately RM150 billion, resulting in the cash-to-total debt ratio rising to 45.4% in 2Q2010 from 40.1% a year earlier.
The corporate default rate, measured on a trailing 12-month basis, peaked in the middle of 2010 at 5.8% after nine issuers defaulted since the beginning of the recession in early 2009. The peak occurred when the economy was already out of recession due to a lag effect between economic slowdown and the observed deterioration in corporate credit quality.
Nevertheless, a spike in the downgrade-to-upgrade ratio was observed in the month of September solely due to the downgrade of Selangor sector-related issuers. However, it is worth noting that rising credit risk in this case stems solely from Selangor water sector-related issues arising from regulatory risk and is not reflective of a general deterioration in corporate credit quality. Excluding all Selangor water sector-related issuers from our analysis, we find that the downgrade-to-upgrade ratio fell to 1.8:1 as at November 2010 from 2.7:1 in 2009. Going forward into 2011, we expect corporate credit quality to continue to improve with the economy resuming its growth path. If economic growth falters, the expected improvement in corporate credit quality will in all likelihood fail to materialise.
AAA and AA sectors look expensive with spreads narrowing to pre-crisis level
The rally in risky asset classes, including global equities, sent the corporate spreads narrowing globally due to the following factors:
1. Super-low yields in the rates market sent investors searching elsewhere for yield enhancement and corporate bonds offer such yield pickups.
2. Ample supply of corporate bonds, including high yields rated on the international credit rating scale, has come from issuers tapping the bond market for refinancing purposes. Given an improvement in the global economies relative to where they were a little less than two years ago and coupled with the still attractive yield pickup offered by this asset class, demand has remained solid.
The same is observed in the domestic corporate bond market but only in the AA and AAA rating bands. Apart from the improving economy as well as credit fundamentals that we highlighted, the lower corporate bond supply in 2010 could have also contributed to the expensive valuations.
The situation, however, is completely reversed along the A rating band with credit spreads remaining wide, indicating that risk aversion persists along the lower rated investment grade bonds. This means external credit enhancements via bank guarantee or financial guarantee will continue to play on important role in ensuring that the debt capital market remains accessible to this group of issuers.
This is an anomaly in this cycle as even the high yield credit spread in the global credit market witnessed a significant compression post global financial crisis. To put this in perspective, we compared the credit spread for BB industrial credits in the US against A credits in the ringgit market to gauge their recent movements. The assumption that underlies this exercise is that the BB rating band on the international scale roughly maps to the A rating band on our domestic rating scale.
As was the case in the ringgit corporate bond market where the A band spread moves counter to the spreads along AAA and AA rating bands, the same observation was also seen in the international market comparison. The three-year US BB industrial spread which skyrocketed to almost 1,200 bps during the peak of the credit crisis has narrowed to 300 bps, its pre-crisis level. On the other hand, the indicative three-year ringgit A spread which peaked at 440 bps in 1Q2009 narrowed by a far lower magnitude, having been last observed at 380 bps vis-à-vis its pre-crisis average of 250 bps. - report by MARC
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