Red flags waving over Asian corporate debt

November 3, 2013 5:06 pm

Red flags waving over Asian corporate debt

By Jeremy Grant

Anyone looking for signs of coming strains on Asia Inc as the end of easy central bank money looms needs look no further than the voracious borrowing by Chinese companies in the US dollar bond markets. The Bank for International Settlements estimates that foreign currency loans in China grew 35 per cent in the 12 months to March this year – more than twice the rate for renminbi loan growth, and much of that in US dollars. For some, this is the classic “canary in the coal mine” warning of problems just around the corner. Bryant Edwards, a lawyer with law firm Latham & Watkins, says the situation is “scarily reminiscent” of Europe in 2001, when the high-yield market was similarly dominated by telecoms and IT companies that subsequently crashed. “It really worries me that there is so much concentration in this sector,” he says.Indeed, concerns over Chinese companies’ appetite for borrowing in US dollar bond markets point to a wider worry emerging over Asian corporate debt.

While attention has been focused on how companies in the west have been deleveraging since the 2008 global financial crisis, analysts are warning that trouble is brewing in Asia where companies are doing the opposite – leveraging up, reversing a trend of efforts to cut debt and repair balance sheets since the region’s own crisis in the late 1990s.

In other words, you’d better stop thinking of Asia as a place where companies are doing just fine. Many are, but, as Morgan Stanley noted starkly in a recent note: “Corporate Asia now has the world’s most leveraged balance sheets.

The months ahead “could feel like recession” for some companies in an environment of slower economic growth and tighter credit availability, as Asian banks grow more cautious about lending.

Standard Chartered estimates that the average corporate debt-to-gross domestic product ratio in Asia excluding Japan rose from 76 per cent in 2007 to 97 per cent last year. Corporate debt makes up the biggest proportion of debt in the emerging economies of Asia such as Indonesia, Malaysia, Thailand and South Korea.

The proportion of unrated – and thus more risky – issuers in the region also has been steadily rising. So far this year 11 per cent of US dollar issuance has come from unrated companies, compared with 8 per cent for the whole of last year, according to Crédit Agricole. In contrast to the US and Europe, bank lending still makes up the biggest source of that, since many Asian companies are controlled by families that prefer borrowing from banks with which they have a relationship.

But that is changing. HSBC estimates the size of corporate bonds across Asia to be a third of the all bank lending to companies. About 80 per cent of Asian corporate bonds were issued in local currencies but the US dollar share is rising fast. The BIS recently warned that as dollar interest rates rise and once-easy liquidity starts to evaporate, Asian companies will find it harder to repay.

In addition, a weakening of economies across the regionrising labour costs and increased domestic competition are starting to dent Asian corporate profits. Yet there has been no let-up in companies’ mostly debt-funded capital expenditure.

The result, according to StanChart, is that aggregate debt has risen at a compound annual growth rate of 19 per cent since 2007, much faster than the 9.8 per cent year-on-year average rise in earnings in the same period. “Balance sheets are fine; we are not talking about a credit crisis tomorrow. But the credit metrics have clearly started to turn,” says Kaushik Rudra, the bank’s global head of credit research in Singapore.

In India, worries over a build-up of corporate debt were highlighted in August when Credit Suisse said debt servicing ratios had deteriorated at 10 of the country’s biggest industrial conglomerates.

Certainly, Asian companies’ approach to the bond markets has matured, shown by borrowing for longer maturities, across the whole yield curve. The big refinancing and repayment cycle doesn’t hit until 2015. But we just don’t know what economic conditions will be like by then.

The other worry is Basel capital requirements, and how they will start to crimp lending. While bank lending looks healthy for now – Singapore’s biggest bank, DBS, last week reported 15 per cent loan growth so far this year to Southeast Asia and China – it is not hard to imagine a squeeze coming when banks start to fall short of the level of capital needed to support loan growth, assuming that such demand keeps pace with nominal GDP growth. The lesson in all of this, is to look beyond today’s headline numbers.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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