Last year saw a rapid increase in the pace of corporate bond issuances as many corporations accelerated planned debt offerings in order to lock in attractive funding costs ahead of potential rises in interest rates. The number of issuances in 2017 is expected to remain flat as yields start to rise. While highly rated companies continue to benefit from favorable terms in the bond market, non-rated issuers and companies with low credit ratings face a challenge if they wish to issue debt, a problem exacerbated by the recent defaults of some bill of exchange (B/E) issuers. The use of short-term debt financing exposes issuers to rollover risk, which can result in much higher funding costs and default risk. We expect the spillover from the recent B/E defaults to have a limited effect in the corporate bond market and just a limited loss of investor confidence. Nevertheless, the continued hunt for yield amid adverse economic conditions and heightening volatility can compound market stresses, and the likelihood of contagion risk will rise dramatically. The rise in the number of unrated short-term debt issuance is expected to slow. Market sentiment has turned more cautious as investors are reassessing the risk of unrated debts.
• No growth in corporate bond issuance in 2017
Corporate bond issuances have continued at a strong pace over the past year. At Bt772,300 million, total debenture issuances in 2016 admittedly came in above our initial expectations. The rise in issuances translates to a 35% year-on-year (y-o-y) rise. The surge in deals was largely the result of many corporations rushing to refinance maturing debts ahead of potential rises in interest rates. Given the higher likelihood of higher interest rates, we believe corporate bond issuance this year will match the level in 2016, with total issuances around Bt750,000-Bt800,000 million. Moreover, we also foresee the possibility of a sharp drop in the issuances. The gloomier scenario reflects the downside risk of more aggressive rate hikes by the U.S. Federal Reserve (Fed) and a sharper drop in market liquidity, leading to much higher asset price volatility and risk aversion. Under such circumstances, corporate bond issuances could decline to Bt450,000-Bt550,000 million. This would match the levels seen in 2012-2015 amid recurring concerns over the Fed’s tapering of its quantitative easing (QE) program, and the potential reduction in liquidity worldwide became an ongoing uncertainty to investors.
Following the growth in issuances over the past few years, the size of the market of outstanding corporate bonds, relative to gross domestic product (GDP), is expected to keep rising (Chart 2). As reflected on Chart 3, large and medium-sized companies increasingly access the bond market to raise money, benefiting from attractive borrowing costs and the diversification of funding sources. Although we believe that banks will remain the center of the Thai financial system for private sector enterprises, the number of corporations tapping the bond market for funding is expected to rise further in 2017. Chart 4 shows the number doubled from 101 to 204 issuers in the past four years ending in 2016.
• Yield movements in late 2016 are increasingly priced into the outlook for 2017
Last year saw many corporate treasurers hurrying to refinance debt, locking in cheap long-term borrowing costs amid rising concerns that the low-rate environment may prove short-lived. In early 2017, yields on government bonds rose by 45-100 basis points (bps) from the low levels reached at the end of March 2016. The rise in yields reflects the expectation that market participants have projected a faster pace of rate hikes in the coming year. Over the same time period, credit spreads have also widened across the corporate bond yield curve. Despite the surges in yields, many corporations still found that bond issuances provide attractive funding costs compared with bank loans. Therefore, the wave of issuances should persist this year. As reflected on Chart 5, the shifts in interest rates charged by banks and yields from bond issuance have not moved in parallel. We believe the funding costs through debt issuances will generally remain more attractive than the cost of funds from bank loans, at least for companies with high credit quality.
That said, the headwinds of rising yields and market volatility, as well as a sharp drop in liquidity from large fund outflows, mean vulnerabilities remain in the corporate bond market. As the US economy continues to strengthen, uncertainty over the stance of the Fed with respect to rate hikes can pose a challenge to financial markets around the world, including Thailand, especially if the economy slows in China. As shown earlier, yields on the Thai government bonds with 3- to 10-year tenors jumped by 20 -55 bps just within the last two months of 2016 even though the country’s policy rate remained unchanged. The jump in yields was because the market had priced in the likelihood that the Fed would decide to lift rates at the December meeting of Federal Open Market Committee (FOMC). The decision was unanimous, and the target range of the Federal Funds’ rate was raised by 25 bps. The minutes of the FOMC also indicated the possibility of a more aggressive stance toward higher rates in the future.
As a consequence, we expect the average interest rates on key benchmarks like the government bonds to increase by 50-75 bps from the levels in 2016. We hold this view based on the assumption that the pace of rate hikes by the Fed will be gradual, and that rate normalization does not lead to rapid increases in capital outflows and excessive market volatility.
Similar to the market conditions in 2016, industries driving corporate bond issuances in 2017 continue to be banks, commerce, agribusiness and food, residential property development, construction materials, and transportation.
• Market rates track rises in the US market
During the last two months of 2016, the local bond market saw spikes in yields, similar to what happened globally. Yields on Thai government bonds in January 2017 rose to the level seen at the beginning of 2016. However, we do not expect yields to follow the same pattern as in 2016 when the Fed delivered only one rate hike. The delays in rate hikes in 2016 supported the bond market and improved market sentiment. For instance, the yield on 10-year Thai government bonds fell by nearly 100bps by the end of March 2016 compared with earlier in the year. The FOMC delayed a planned rate hike in its March meeting, citing the country’s fragile economic recovery at that time (Chart 7).
As expectations of rate hikes were pushed back, yields in the Thai bond market then dropped to very low levels in 2016. We hold the view that such situation is unlikely to repeat in 2017. Fears over the pace and scale of rate hikes in the US have been renewed. This time, the case for rate hikes is stronger given the ongoing improvement in the US economy.
Nevertheless, we expect the Bank of Thailand (BOT) to maintain its accommodative monetary policy, keeping the policy rate at 1.5% while the economy gradually gains traction. We foresee moderate GDP growth of 3%-3.5%. Despite expectations for an accommodative monetary policy, we believe the financial system and financial markets will see a gradual rise in interest rates this year.
• Recent B/E defaults will challenge non-rated issuers
The recent failure of some listed companies to redeem their unrated B/Es has rattled the short-term debt market and shaken investor confidence. The market is wary of spillover effects from the defaults and concerned that other non-rated issuers of B/Es might be in a similar position. As a consequence, investors are now more cautious lending to non-rated issuers, making rollovers of maturing debts more challenging for issuers.
The heightened risk aversion appears limited to only non-rated issuers. However, some lower-rated companies are finding it increasingly difficult to roll over existing debts at maturity. These issuers have to offer much higher returns -- on the order of an additional 25-75 bps, which raises their funding costs.
Following the rapid expansion over the past two years in the number of non-rated issuers and companies with lower credit profiles, vulnerabilities in the corporate bond market remain and the threat of deeper market stresses cannot be ruled out. As reflected on Chart 8, the amount of debt instruments issued by non-rated issuers has grown dramatically over the past two years. If the economic recovery is derailed or if market liquidity drops suddenly or severely, higher asset volatilities will make investors even more risk averse. In such cases, funding costs can rise markedly along with default risk, and the rolling over of maturing debt can be extremely difficult, if not impossible, especially for issuers with low credit quality.
Consistently low bank deposit rates and low yields on highly rated debentures have driven investors to hunt for yield, and in some cases, the higher yields have exposed them to excessive risk-taking. The belief that defaults would remain rare in the debt markets, coupled with the attraction of higher yields, has made demand for unrated debt strong among a particular group of investors. As a result, issuances of unrated debt soared during 2015-2016. However, a series of recent defaults on B/Es have shaken this belief and eroded investor confidence.
The market is reassessing the risks of unrated short-term debts. Increased risk aversion and higher market volatility mean many investors are also turning to relatively safer assets. Safer asset now offer yields higher than last year since the yields on key benchmarks have risen lately.
We expect the impact of the recent defaults to be limited given their small size relative to the size of the overall bond market. Liquidity remains ample because of an accommodative monetary policy implemented to help the economy gain momentum. That said, the number of unrated issuances is expected to slow this year as the market grows more cautious. Investors are seeking higher quality assets while uncertainty remains high. It will take time to regain investor confidence.
Some new issuances of unrated short-term debts will be delayed or cut back given the reduced appetite of investors making the cost of financing much higher for many prospective issuers. Under this scenario, we believe banks may play a more active role in supporting the prospective issuers. Banks may offer standby lines of credit and bank loans, which can be less expensive than B/Es if investors are skittish. A shift in funding, from debt issuances to bank loans, could reduce the risk that non-rated issuers will not be able to refinance maturing debts.
• Unrated short-term debts increasingly vulnerable to rollover risk
In the US, commercial papers (CP) are a low-cost, liquid source of funds typically used by large corporations with high creditworthiness. The use of short-term debt financing make issuers vulnerable to cash flow shocks. In other words, the rollover risk of short-term debt does require careful liquidity management on the part of issuers, as well as a high degree of financial flexibility because rollover risk could increase refinancing costs significantly. When their credit ratings deteriorate, low-rated issuers could no longer find investors willing to provide funding, and maturing CP could not be rolled over. The lower-rated issuers had to find an alternative to the issuances of short-term debt instruments.
The B/E market in Thailand remains small relative to the value of outstanding debentures, but the B/E market has grown dramatically in recent years (Chart 9). As Table 1 shows, close to one-fifth of outstanding B/Es were issued either by non-rated issuers or non-investment grade companies as of 12 January 2017.
We believe that what happened to the short-term debt market in early 2017 has served as a great reminder to market participants of how suddenly the appetite for risk can reverse and how a severe disruption in liquidity can heighten the rollover risk. For issuers, the recent B/E defaults have highlighted the necessity of maintaining alternative sources of liquidity so that the maturing short-term debts can be repaid in full at maturity. For investors, the information asymmetries prevalent in the capital markets mean the quality of credit research and analysis remain important for them as they seek to fully understand the risks of their investments.
We expect the spillover from the recent B/E defaults and the loss of investor confidence to be minimal, based on the small size of the short-term debt market and the ample liquidity in the financial markets while the economy continues to recover. We also believe that monitoring by regulators, along with the market mechanism, will help stabilize the debt market, allowing non-rated issuers and entities with low credit ratings to exit the B/E market in an orderly fashion.
Despite this projection, we recognize that market stresses can worsen and the likelihood of contagion risk in the bond market might dramatically increase if investors continue to hunt for yields during the time of a weak economy and heightened volatility.
• Credit spreads for highly rated companies remain favorable
Over the past four years, highly rated issuers have benefited from direct access to funds at very low borrowing costs. As Chart 8 shows, more than two-thirds of the annual debenture issuances were made by issuers rated “A” or higher. Favorable credit conditions and low yields provided the means for them to issue long-dated debt to lock in cheap funding and reduce their exposure to refinancing risk.
Chart 10 illustrates that the average credit spread of five-year debentures issued by “A” rated companies was around 75-150 bps at issuance during 2012-2016. The range widened in the last two years. Since the third quarter of 2016, the credit spread has consistently widened following the huge increase in the supply of corporate bonds. Assuming a gradual series of rate hikes, we expect credit spreads to widen but remain within the range of the past five years.
• Median rating in TRIS Rating’s portfolio is maintained at “A-”
At the end of 2016, a majority of companies rated by TRIS Rating were rated “BBB”and “A”, accounting for 38.15% and 34.10% of the rated companies, respectively (Chart 11)
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