Borrowers in Asia have stepped up the use of rebates to get wealthy individual investors to buy their dollar-denominated bonds, underscoring weakness in the market as returns dwindle to an 18-month low.
At least 24 percent of the deals in the region last quarter provided a monetary incentive for private banks whose clients bought the offerings, more than double the same period of 2011, according to FIL Ltd., a global fund manager known as Fidelity Worldwide Investment that oversees $248.2 billion. While the practice is legal, it’s only common in Asia, lawyers say.
The sweeteners helped push dollar offerings in the region to a record $44.9 billion last quarter, according to data compiled by Bloomberg, even as returns slowed to about 1 percent, the least since the three months ended September 2011 as measured by Bank of America Merrill Lynch indexes. Citigroup Inc. and Barclays Plc predict demand will continue to wane.
“It is not clear that the private bank bid for credit will be as strong as over the last few years,” said Krishna Hegde, the Singapore-based head of Asia credit research at Barclays. “Given the way equity markets and other alternate asset classes have performed and the fact that credit returns have been anemic at best this year, it makes the credit market less attractive.”
Global stocks jumped 7.2 percent in the first quarter, drawing investors away from fixed-income securities. Yield premiums on corporate dollar bonds from Asia rose to 336 basis points more than Treasuries on April 19, from a 20-month low of 303 in January, according to JPMorgan Chase & Co. indexes.
“Spreads have become too tight,” said Debashish Duttagupta, Citigroup’s former Asia-Pacific head of investments, who now runs Citi Private Bank’s global Indian business and who predicts a slowdown in bond investments by private banks. “The whole market is not cheap and we have to be more picky on the deals.”
Billionaire Mukesh Ambani’s Reliance Industries Ltd. sold 53 percent of its $800 million offering to private banks, according to a company statement on Jan. 29. The Mumbai-based issuer offered a 50 cent discount to private banks per $100 of bonds purchased, said a person with knowledge of the matter, who asked not to be identified without authorization to speak publicly.
Singapore-based CapitaLand Ltd. sold $400 million of 10-year bonds in September in part by offering a 25-cent rebate to private banks for every $100 of bonds they bought, said Arthur Lang, the group chief financial officer at Southeast Asia’s biggest property developer.
The rebate “does raise the cost but you can make the argument that because of the momentum it brings down pricing overall,” said Lang, adding that private banks bid for as much as $2.8 billion of the securities. “It has to be done in a yield-hungry environment.”
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. declined for a third day. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreased 1.2 basis points to a mid-price of 80.8 basis points as of 11:35 a.m. in New York, according to prices compiled by Bloomberg.
The index, at the lowest level on an intra-day basis since March 19, typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, decreased 0.5 basis point to 13.25 basis points as of 11:36 a.m. in New York. The gauge narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.
Bonds of Morgan Stanley are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 5.6 percent of the volume of dealer trades of $1 million or more as of 11:37 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The New York-based owner of the world’s largest brokerage sold $3.65 billion of fixed- and floating-rate bonds yesterday in a four-part offering.
Private banks bought 76 percent of Hong Kong-based Agile Property Holdings Ltd.’s $700 million perpetual debt offering in January, according to people familiar with the deal who declined to be identified because they weren’t authorized to speak publicly.
The notes were quoted at 94.2 cents on the dollar on April 19, down from an issue price of par, Bloomberg prices show.
“Private bank rebates that are retained by the bank are an Asian phenomenon and are not common in the U.S. and Europe,” said Matthew Sheridan, the Singapore-based co-head of international corporate finance in Asia at Sidley Austin LLP.
The sweeteners are disclosed to clients most of the time, a change from a year ago, he said.
Recent deals may indicate that demand from private banks and their clients is drying up after Asia’s dollar bonds returned 15 percent last year, the second-highest gains in the past decade, according to the Bank of America Merrill Lynch indexes.
Private banks scooped up just 12 percent of Texhong Textile Group Ltd.’s $200 million offering of 6.5 percent notes on April 11, according to a person familiar with the matter. Borrowers from Asia outside of Japan have $574 billion of dollar securities outstanding, data compiled by Bloomberg show.
Many Asian clients of private banks used leverage including borrowing against their houses to boost purchases to as much as 20 percent of the region’s U.S. currency debt market, according to Barclays. With yields near record lows, they risk having to meet margin calls as borrowing costs rise.
“The leverage aspect does bring back thoughts of what happened in 2007, 2008,” said Bryan Collins, a Hong Kong-based fixed-income portfolio manager at Fidelity. “In particular where we had a lot of leverage participation admittedly from the hedge fund community that unwound and caused a lot of problems.”
The Bank of America Merrill Lynch Asian Dollar Corporate Index slumped 14 percent in 2008, its worst year in data going back to 1997, amid the worst financial crisis since the Great Depression.
Bonds flagged by a Barclays report last month as being more vulnerable to a sell-off include Cosco Pacific Ltd.’s $300 million of 4.375 percent notes due January 2023, the $350 million of 6.375 percent bonds maturing in September 2017 sold by Sun Hung Kai & Co. and Soho China Ltd.’s securities in the U.S. currency.
Private banks are doing their due diligence, and the incentives don’t influence their purchases, said Citigroup’s Duttagupta. Citigroup is the biggest private bank in the Asia-Pacific region by assets, according to a Private Banker International survey in October, with UBS AG ranked second.
“When we seek approval on whether to distribute a new issue our discussions are driven by the ratings and structure of the issue,” Duttagupta said. “Rebates are not even discussed. We always disclose commission and rebates to our clients. We are distributors, not investors.”
Aberdeen Asset Management Plc is being “very selective” with investments in Asian dollar bonds because private bank buyers are overpaying based on past returns rather than future prospects, according to Anthony Michael, head of Asia-Pacific fixed income at the firm, which manages $322 billion globally.
“There’s a lot of rear-vision investment going on,” Michael said in an interview in Sydney this month. “We don’t see a lot of value left in large parts of the high-yield market in Asia.”