TRIS Rating believes the rise in interest rates will have little impact on the funding costs for debt issuers and the bond market in general over the next 12 months as the pace of any interest rate rises is likely to be slow. We see the prospect of interest rate rises will continue to be the key driver for corporate bond issuances. Issuers aim to lock in the low interest costs attainable in the bond market, as the low rates remain attractive for most prospective issuers. However, the recent default by a corporate bond issuer has dented investor confidence somewhat in the “BBB-” credit rating and below. Based on the market feedback for some recent bond issues, the credit spreads for low-rated issuers have widened significantly, reflecting the higher risk premium demanded by investors. The demand for debt with low ratings has fallen. The lower demand has translated into heightened rollover risk for some weak credits. On the other hand, the demand for highly rated issues is moving in the opposite direction, compressing the credit spreads for some recent issues in the “A” rating category and above. All these market indications suggest a mild flight-to-quality phenomenon. We expect debt issuances in the bond market to slow down in the second half of 2017. However, overall, the volume of bond issuances in 2017 is likely to be around same level as in 2016, within the range of Bt750,000-Bt800,000 million. The major downside risk factor for credit in this year is a rapid hike in interest rates that would stress the credit market.
• Corporate bond issuances expected to slow down in the second half of 2017
In 2016, corporate bond issuances reached a record high of Bt772,300 million. The momentum of new issuances continued in the first seven months of 2017 (see Chart 1). Corporate bond issuances for the first seven months of 2017 totaled Bt454,759 million, growing 18% from the same period of 2016. Thanks to low interest rates environment and the large appetite of investors, the bond market remains an attractive source of long-term, fixed rate funding for most corporations. However, we expect the pace of debt offerings in the bond market to slow down in the second half of 2017. Bond issuances in the second half of 2017 are likely to fall below the level attained in the second half of 2016. Based on this assessment, we forecast total issuances in 2017 will be around the same level as in 2016, within the range of Bt750,000-800,000 million.
We expect the pace of the shift from traditional bank loans to debt offerings in the bond market to slow down in 2017. The impressive growth of debt offerings in the bond market over the past three years was powered by a prolonged period of low interest rates and a strong appetite of investors for bonds. As a result of these two factors, bond market fund raising, as a percentage of total corporate funding, climbed from around 12% in 2013 to nearly 16% in 2016 (see Chart 3). While we expect the long-term trend to continue for many years to come, the slope of the trend line after 2017 may not be as steep as it had been during 2014 – 2016.
• Interest rates remain attractively low for long-term fixed rate borrowings
Thai government bond yields over the last 12 months have moved in the same direction as U.S. Treasury yields. The average yield on 10-year Thai government bonds increased to 2.70% for the first seven months of 2017, compared with an average yield of 2.18% in 2016 (see Chart 4). The yield on short-term bonds has been relatively flat. The average yield on 1-year Thai government bonds rose slightly to 1.51% during the first seven months of 2017 from the average of 1.46% in 2016.
We expect any near-term rise in interest rates to have little impact on corporate issuers. The rise in government bond yields, coupled with a slight increase in the credit spread in 2017 (see Chart 5), have translated into higher borrowing costs for corporate debt issuers in 2017. However, we have not seen a dramatic increase in the average coupon rate. The average coupon of three-year bonds in the “A” rating category increased to 2.67% in the first half of 2017 from 2.30% in 2016. However, the rate remained significantly below the interest rates for bank loans (see chart 6).
• Credit spread gradually widens for “BBB” rated debentures
Generally, the credit spreads for issuers with high credit profiles and low credit profiles move in the same direction, though by different degrees. The credit spreads of debt issues in all credit rating categories have narrowed slightly since March 2017 (see chart 7), except for the “BBB” category. The average credit spread of “BBB” rated bonds expanded slightly to 229 basis points (bps) at the end of August 2017 from 218 bps at the end of March 2017. Based on the feedback from the market for some recent debt issues, we expect that credit spreads for “BBB” rated issuers are likely to widen further in the later part of 2017, though only slightly. The jittery market, caused the recent debt default by a corporate bond issuer, has made investors more selective in subscribing new debt issues, particularly issues in the low credit rating categories. The demand seems to have shifted toward the higher credit rating categories, which may further compress the credit spreads for issues rated in “A” category or above.
• Refinancing risk remains a concern for some issuers
Low interest rates and easy credit touched off a search for yield among bond buyers. As a result, issuers with low credit profiles tried to tap the debt market in order to get a low-cost source of funds. Some of the low-rated issuers have limited sources of reliable funding with which to replace bond issues that were not being rolled over. A low-rated borrower is naturally faces greater headwinds when refinancing existing debts. Refinancing risk will remain a concern as long as investor confidence has not recovered. As we forecast a gradual recovery of the Thai economy, slow rise in interest rates, and ample liquidity in the financial system, we expect those lowly rated issuers who fail to attract interest in the debt market for their refinancing debt issues will gradually exit the debt market in an orderly fashion. But the risk of shocks should not be disregarded. We believe that debt market will continue to face uncertain situations that could lead to volatile market conditions. Financing conditions can deteriorate rapidly for issuers with lower credit profiles. Funding costs would spike sharply or at worst, the issuers will not be able to get new funding source to repay un-rolled issues.
The turbulence in the Bill of Exchange (B/E) market has highlighted the importance of having in place back-up credit facilities from financial institutions for those corporations that want to take advantage of the low funding costs offered by the B/E market. This is not the first time that issuers of B/Es were caught off guard by an abrupt change in investor sentiment. As a means of prudent liquidity management, B/E issuers should always have back-up sources of liquidity to weather adverse changes in market conditions. There are also questions raised about the risky behavior, practiced by some issuers, of borrowing short term in the B/E market and using the proceeds to fund fixed assets or other long-term investments. This behavior by the borrowers clearly indicates an under-estimation of the rollover risk.
• Portion of non-rated issuers declined
The appetite for non-rated issuers has been weak this year. Investors have become more selective. Bond issuances by non-rated issuers declined sharply to 3.24% of total issuances during the first seven months of 2017, from 7.08% in 2016 and 4.61% in 2015. We believe the market has passed a turning point, ending a three-year rise in issuance by non-rated issuers. The recent events in the B/E market has spotlighted the default risk of non-rated debt issuers.
The credit spread for the “BBB” rated category tightened during early of 2017. The tightening enticed more issuances in this segment in the first half of 2017. Issuances in the “BBB” category reached Bt107,102 million in the first seven months of 2017, compared with Bt133,480 million for all of 2016. However, we expect the trend to reverse in the last part of 2017. Investor demand will drop and credit spreads will widen for “BBB” rated issues in the later part of 2017, the result of a spillover of market jitters from the B/E market to the bond market. The largest group of issuers remains the “A” rated category, accounting for around half of total issuances (see Chart 8).
When viewed by industry sector, the top-5 sectors of issuers during the first seven months of 2017 were similar to those of 2016. Notably, issuances in the telecommunication sector in the first seven months of 2017 exceeded issuance for all of 2016 (see Chart 9).
• Bond issuances with tenors in the two- to three-year bracket were in high demand
Recently, investor demand for corporate bonds skewed toward the shorter end of the duration spectrum. Investors are reluctant to lock their yields when interest rates are at historical lows. Bonds with a tenor of less than three years accounted for 41% of issuances in 2016 and 50% of issuances in the first seven months of 2017 (see Chart 10).
As of 17 August 2017, the aggregate principal amount of maturing corporate bonds will rise to Bt425,207 million in 2018, and peak at Bt484,918 million in 2019 (see Chart 11). Higher interest rates will affect the credit profiles of issuers and the issuances of corporate debentures. We believe that the impact of rises in rates in 2017 will be limited as rates will rise at a slow pace. The effect of interest rate hikes depends on the credit profiles of the issuers, whether the bonds carry a long or short tenor, and a fixed or floating rate. Almost all (99.87%, as of 17 August 2017) outstanding corporate debentures in Thailand carry a fixed rate. However, issuers which have high creditworthiness have benefited more than weaker issuers. Issuers with high ratings locked in cheap, long-term funds during 2015-2017 (see Table 1, Table 2, and Table 3). Rising rate will hurt issuers with weaker credit profiles more. Issuers with low ratings will have to refinance maturing debt at higher costs as most issuers have been able to issue only short maturity debentures (maturities up to three years).