Taiwan Is Sole Loser in Asian Bonds as Insurers Buy Foreign Debt

Taiwan’s bonds are showing little prospect of recovery after being the only government securities in emerging Asia to hand investors a loss in the third quarter.

Yields on Taiwan’s 10-year notes will climb eight basis points to 1.80 percent by year-end, according to Stone Chang, who manages the territory’s sole domestic bond fund, while Taipei Fubon Commercial Bank Co. predicts 1.86 percent. Taiwan’s sovereign debt lost 1.1 percent last quarter as local insurance companies took advantage of rule changes to buy higher-yielding foreign-currency bonds, while securities in South Korea, Thailand and India delivered returns of more than 2 percent, Bloomberg indexes show.

“The chips in Taiwan’s bond market are in a mess,” Chang, who oversees the NT$3.4 billion ($112 million) Prudential Financial Return Fund, said in a Sept. 23 phone interview in Taipei. “Insurers now have no reason to hold a position returning about 1.7 percent.”

The island’s rates are the world’s lowest outside of Europe and Japan and a rebound may help revive demand for local debt after 89 of 90 domestic bond funds either shut shop or shifted their attention overseas in the past decade. Taiwan’s insurance companies, which had NT$17.5 trillion of assets at the end of June, didn’t buy any government securities sold at an auction last week.

Higher Yields

The government in May excluded foreign-currency bonds sold locally from insurance companies’ overseas investment quotas, spurring a record $10.9 billion of issuance of the securities in the last three months by firms including Goldman Sachs Group Inc. and Morgan Stanley.

There were 14 sales of 30-year callable dollar notes last quarter and these were sold at an average yield of 4.72 percent, 242 basis points more than Taiwan’s government paid at its last sale of similar-maturity debt in July. Overseas assets made up

44.6 percent of insurers’ portfolios in May, according to data from the Taiwan Insurance Institute, near the 45 percent limit they face on such investments.

“I don’t think the bond yields are done reflecting international bond sales,” Chang said. “As issuers diversify, Taiwan’s government bond yields will rise even further.”

Less ‘Desperate’

Losses for Taiwan’s bonds last quarter compared with a 2.7 percent return in South Korea, emerging Asia’s best performer, according to Bloomberg indexes. Gains were 2.6 percent in Thailand, 2.3 percent for India, and 0.5 percent for U.S. Treasuries. Geopolitical risks in Ukraine and the Middle East boosted demand for sovereign assets, while Europe’s new stimulus measures also pushed down borrowing costs.

In Taiwan, weaker insurer demand is starting to show in sovereign debt auctions. The finance ministry sold 10-year bonds last week at the highest yield in a year, with insurers buying none of the securities, compared with the average 8.3 percent they purchased at auctions in the past five years.

Taiwan’s insurance companies held 32 percent of outstanding government bonds as of Aug. 31, while banks owned 64 percent, based on holdings registered with the central bank. In the face of restrictions on overseas investments, the local financial industry had been compelled to pour funds into the domestic market, reducing borrowing costs.

“Insurers are not as desperate as before to buy Taiwan’s government bonds as there have been many international bond sales offering higher rates,” Jeffrey Huang, a Taipei-based fixed-income trader at KGI Securities Co., said in a Sept. 26 phone interview. “As yields rose, banks’ mark-to-market losses on their old bonds have also made them more cautious about buying new ones.”

Funding Conditions

Others are more doubtful whether foreign debt issuance will reduce insurers’ demand for local notes. The lack of diversity among issuers as well as inactive secondary trading is a concern to insurers, Standard Chartered Plc strategists Lawrence Lai and Shankar Narayanaswamy wrote in a Sept. 17 note.

Verizon Communications Inc., the biggest U.S. wireless carrier, was the only non-financial firm to sell dollar bonds in Taiwan last quarter, while only 12 of the 36 outstanding notes were traded in the secondary market in August, according to GreTai Securities data.

Demand from local banks may also increase as funding conditions remain flush, Lai and Narayanaswamy said. The central bank held its benchmark rate at 1.875 percent for a record 13th straight quarter last week, while adding that monetary policy had shifted to neutral from “adequately loose.”

Rate Increases

Taiwan has also taken other steps to bridge its ample cash supply. The government last week allowed insurers to buy real estate abroad without the financial regulator’s approval. A yuan clearing agreement signed with China in 2012 paved the way for firms to sell Chinese-currency notes in Taiwan, while the regulator has also eased rules to encourage domestic financial companies to invest in their overseas counterparts.

“Low interest rates in Taiwan have led to a very difficult operating environment for insurers,” Prudential’s Chang said. “The central bank also doesn’t mind outflows, since it wants the Taiwan dollar to fall.”

Taiwan’s dollar depreciated 1.7 percent last quarter to NT$30.436 against the greenback, Taipei Forex Inc. prices show. A weaker currency boosts the island’s exports, which account for about three-quarters of its economy.

The territory’s central bank may raise its key rate at least once by the first quarter of next year, according to seven of 14 economists surveyed by Bloomberg. The Federal Reserve last month raised its end-2015 median estimate for the fed funds rate by 25 basis points to 1.375 percent.

“Everyone anticipates the Fed will raise rates next year, and Taiwan’s central bank is also paving the way for a rate increase,” Cindy Yu, an economist at Taipei Fubon Commercial Bank, said in a phone interview yesterday. “International bonds are squeezing out insurers’ demand for domestic debt. Insurers are snatching up the international bonds now, in case the policy changes in the future.”

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