FW: RHB FIC Monthly Review - 10/7/14

Monthly Review – June 2014

European Bond Markets Rallied on ECB Rate Decision; USTs and DXY Slide on Weak Economic Print; JACI Spreads Tightened

Highlights

RATES & FX MARKETS

¨   US & UK: Earlier rate hike expectations increasingly priced in for UK; FFR hike expectations mixed; DXY weakened on weak GDP data and dovish comments. Investors generally shrugged off the dismal 1Q GDP figure accruing to the harsh winter conditions but positive data prints towards month end failed to uplift the weak sentiment where investors remain sceptical of the sustainability of the recovery to fuel an earlier rate hike; DXY weakened 1.08% m-o-m. Similarly in UK, BoE’s financial policy meeting rolled out relatively mild policy measures to curb the housing market which has increasingly threatened to destabilize the country’s recovery. This followed mixed signals from Carney where positive data releases in the UK have progressively spurred expectations for BoE to hike as early as 4Q14.  USTs and Gilts closed weaker m-o-m resultantly; demand for the 2y, 5y, and 7y auctions were mediocre on the back of rising global yield expectations where indirect bidders showed keen interest in the 5y and 7y papers.

¨   Europe: ECB cuts rates; European bonds rally following Draghi’s assurance for low rates through 2016; EUR strengthened. ECB cut deposit and refinancing rates by 10bps alongside a 4y EUR400bn TLTRO following weak data prints where May’s CPI declined further to 0.5% y-o-y; tensions in Ukraine to continue weighing on business and consumer sentiment. Additionally, ECB revised this year’s inflation numbers downwards once more to 0.7%, 1.1% in 2015 and 1.4% in 2016 respectively while Draghi stressed ECB’s readiness to act with unconventional measures in line with IMF’s Largarde’s assertion for ECB to introduce QE to fend off deflationary risks. Draghi further highlighted ECB’s commitment to keep rates low through 2016 against intensifying geopolitical tension. Meanwhile, business activity continued to slow as suggested by weaker PMI prints but was partially offset by an uptick in regional industrial production led largely by businesses in Italy. European government bonds and EUR gained m-o-m following ECB’s dovish rate cuts; negative 10y SPGB-UST spreads (-3bps) seen in early June were subsequently erased following increasing risk aversion.

¨   Japan & Australia: BoJ optimism unfounded, further easing necessary to meet 2015 targets; 10y JGB sub-0.6%; RBA to remain accommodative. Although Kuroda remains optimistic towards achieving its aggressive 2015 inflation and growth targets, we assign a low probability to the outcome lest further easing is introduced over 2H14. The divide within BoJ intensified following weaker economic data released over the month; May’s CPI inched higher following the hike in sales tax but likely to be temporal. Meanwhile, BoJ widened its band on both bills and long-dated JGB purchases to JPY220-400bn and JPY750-1750bn respectively. Despite JGB yields inching lower where the 10y now sits below 0.60%, auctions in June remains well bidded where BoJ remains the largest single holder of JGBs (20.1%) as of March, surpassing insurance holders for the first time. In Australia, RBA meeting minutes revealed a dovish tilt after leaving interest rates unchanged where inflation remained subdued given dampened consumer sentiment following a tighter federal budget announcement. ACGBs remained attractive to offshore reserve and pension monies given the relatively high yields.

¨   AxJ: KTBs and CGBs outperformed supported by positive Chinese PMI prints; Inflation seen easing in Malaysia where we expect BNM to leave interest rates unchanged. KTB topped AxJ bond performance in June where foreign investors continued to adding Korean assets for the 3^rd consecutive month; KRW appreciated 1.17% m-o-m. Despite the dawdling economic activity shown in China’s beige book, CGBs were buoyed by the uptick in manufacturing PMIs and firm industrial production figures, recovering from the 1Q14 blip. PBoC also reduced the RRR by 50bps for small banks, attempting to ease credit conditions via targeted stimulus measures which we expected to continue. Meanwhile, Bank Negara held rates for the 18th consecutive month in May at 3% ahead of the GST implementation next year which is estimated to add 1.48% to inflation, according to MoF; inflation moderated to 3.2% y-o-y in May, (Apr: +3.4%), supporting our call for BNM to leave rates unchanged in July. In Thailand, offshore investors largely sidelined ThaiGBs in June given prolonged political uncertainty despite the junta’s populist approach; the appointment of Supapongse as the Asst BoT Governor leaves the committee dovishly tilted to support the weak economic. Meanwhile, IndoGBs and IDR posted large losses ahead of the tight presidential election on 9 July; we turn defensive on Indonesian exposure where a Jokowi-Kalla win largely priced in could provide little upside amid heightened volatility. Investors have turned favourable towards India where the “Modi-fied” budget is expected to be a fiscal positive; World Bank downgraded India’s GDP outlook to 5.5% in FY14/15 due to plausible inflationary pressure post-budget.

CREDIT MARKETS

MALAYSIA

¨   MYR credit flows picked-up 14% m-o-m in June with focus on longer duration. MYR credit volumes picked up by 14% M-o-M in June with MYR8.47bn traded (May: MYR7.45bn), vs YTD average of MYR7.2bn. Attention was heavily seen in the longer-end, which comprised nearly 60% of total trades, followed by the short-end with about 30%.In terms of ratings, AA papers were the focal point of the month, comprising c.55% of total trades, followed by AAA papers with c.30% of volume transacted. The most actively traded was BGSM 12/15 (-20bps to 4.08%) and 12/22 (unchanged at 5.45%), which cumulative nominal trade of MYR682m.  Other notable trades were PBB’s IT1 trading at MYR200m (-1bp to 4.59%), HCS 5/15 with MYR190m (-3bps to 3.95%) and TNB Western Energy 1/30 with MYR155m transacted (-1bp to 5.18%).

¨   MYR primaries led mostly by AA papers. About MYR6bn was issued in June, led mostly by AA-issuers from financials, construction and property sector. Hong Leong Bank (AA2/Sta) and Hong Leong Islamic (AA2/Sta) collectively printed MYR900m (MYR500m and MYR400m respectively) of B3 T2 10NC5 at 4.80%. The property/ construction sector saw issuances from UEM (AA-/Sta) with a 6/19 (at 4.72%) and 6/21 (at 4.90%) collectively at MYR400m and IJM 6/22 (AA3/Sta) at MYR300m printing at 4.83%. At end-June, Sarawak Energy Berhad (AA1/Sta) also printed a tri-tranche MYR1.5bn issue with tenures of 5y, 10y and 15y priced at 4.50%, 5.00% and 5.50% respectively.    

¨   Rating activities were led by financial names. CIMB Thai Bank Public Comp Ltd was rated AA3/Sta by RAM for its MYR2bn B3 T2 subordinated debt programme. Societe Generale Bank’s proposed MYR1bn multi-currency Islamic MTB programme was rated AAA/Sta (RAM) and Bank of Tokyo-Mitsubishi UFJ was assigned a AAA/Sta for its USD500m multi-currency sukuk programme. Sepangar Bay Power Corp, an IPP with a concession for a 100MW power plant in Kota Kinabalu, received an AA1/Sta rating for its MYR575m sukuk murabahah. Meanwhile, Eversendai Corporation Bhd’s (AA3) outlook was revised to negative due to its weakened debt repayment profile and balance sheet strength.

¨   Liberalization of MYR bond market: PM Datuk Seri Najib announced during the Invest Malaysia KL (IMKL) 2014 some key changes to the domestic bond market: 1) Removal of mandatory requirements for corporate bond credit ratings (effective 1-Jan-2017); 2) Allowing foreign credit rating agencies and unit trust management companies to operate in Malaysia (effective 1-Jan-2017); and 3) Flexibilities to credit ratings and tradability of unrated bonds and sukuk (effective 1 Jan 2015). Our view: we view the move as long-term positive for the market development, immediate beneficiaries could be companies who are 1) frequent issuers (who doesn’t need a rating, since they have it before – i.e Maxis Berhad – could be AA2/AA3), SPSetia Perps could be A2, based on two-notch lower from its seniors; 2) listed companies (which the credit monitoring could be done via their quarterly results announcement which are easily available– Paramount Corp, Maxis, Bstead, SPSetia are all listed); also 3) small issuer with ‘quality assets’ such as LYC Mall; and 4) companies with strong holdco such as LTH (for THHeavy and THPlant), PNB (for SPSetia) and LTAT (for BStead) as the main subscriber to the papers. We opine that these changes probably will not affect the yield curve as investors in MYR market are matured enough to assess the implied rating of the non-rated issuers, based on the pricing of the existing papers and their credit-rating sensitivity. Nonetheless, we still think that smaller, less-known and first time issuers (or those who doesn’t fall under any of the four categories described above) will still need to be formally rated by independent agencies should they wish to tap the bond market.

¨   Malaysia banking sector remains healthy. BNM released the monthly bulletin statistic for May, with the data shows domestic banking sector remained intact. Gross NPL and coverage ratio were stagnant at 1.8% and 104.9% compared to April. Banking system remained strongly capitalized with tier-1 and total capital ratio stood at 12.8% and 14.5% respectively (April: 12.9%, 14.6%). Meanwhile, system loan grew by 2.9% YTD with steady residential mortgage growth, despite cooling measures enforced while loan-to-deposit ratio inched up to 81.2% (April 80.8%). YTD total loans approved were flat at MYR155bn compared to previous corresponding period.

ASIA-PACIFIC ex-JAPAN

¨   Continued accommodative stance from Fed and ECB spurs demand in APAC HY. The JACI Composite tightened by -10bps to 240.2bps, led by the HY which saw a narrowing of -30bps to 463.4bps while the IG saw a corresponding smaller movement of -4bps to 173bps. With the perceived continued accommodative stance of both the Fed and the ECB, investors are moving into the HY space searching for better yields and returns. Meanwhile, the UST curve saw a flattening, with the 2y rising 7bps to 0.46% while the 10y inched up 1bp to 2.53% as markets raised concerns of rising inflation, questioning Yellen’s post FOMC reassurance to keep rates low for a considerable period of time.

¨   USD APAC primary issuances led by familiar Chinese names and financials. USD APAC issuances dipped by over 40% to USD21.2bn in June, to bring the 1H14 total issuances to USD162bn. The banking space saw sizeable deal from OCBC B3 T2 with a USD1bn 10y (A2/BBB+/A+), Krung Thai Bank (BBB-) B3 T2 of USD700m 10NC5 at 5.20% and Woori Bank’s USD1,000m at 4.75%. Chinese credits such as Baidu Inc issued USD1bn 5y (A3/NR/A) and Sinopec with a 3y and 10y at USD300m and USD400m respectively.

¨   Quieter SGD market. SGD issuances dipped around 65% m-o-m in June to SGD928m, with prints averaging c.SGD100-150m. SMRT (NR;AAA/Neg; NR) issued a SGD100m 10y at 3.072% while we saw higher yielding prints from issuers such as Banyan Tree with a SGD125m 5y at 4.875% as well as offshore support vessel (OSV) players like Swiber (SGD130m 2y at 5.125%) and Ezion (SGD150m 7y at 4.875%).

¨   Moody’s negative outlook for HK banking system. Moody’s maintains a negative outlook on Hong Kong’s (HK) banking system due to banks’ growing exposure to Mainland China (c.34% of system assets as at end-2013), which is seeing deteriorating credit conditions, and asset market imbalances in HK. Our view: We view this as negative event as Moody’s outlook reflects potential, modest deterioration in credit profiles from a strong base, second highest (only after Singapore) on a weighted average basis.  

¨   India banks continue to face asset quality risks from power sector weaknesses, Moody’s comments. As per Moody’s announcement, public and private-sector banks will continue to be exposed to asset quality risk stemming from India’s power sector if the poor financial profiles of state electricity board distribution companies (discoms) do not improve through further structural reforms. Moody’s also noted that the percentage of public-sector banks’ impaired loans to discoms is about 20%, with the percentage ranging as high as 48% at some of the most exposed banks. Our view: Election results in May which saw a landslide victory for the Bharatiya Janata Party increases the likelihood of structural reforms for India’s power sector. Additionally, discoms receivables are backed by a letter of credit issued by tripartite agreements between the state, central government and Reserve Bank of India (RBI), with recourse to the RBI in the case of defaults. Notwithstanding, we think it is prudent to reduce exposure to banks with high power sector exposures; this includes Canara Bank and Union Bank of India.   

¨   Neutral credit outlook on China banks. The China banking system has shown signs of credit deterioration as 1) system non-performing loans in China saw its largest quarterly increase since 2005, rising 9.1% to CNY646.1bn, which translates to a system NPL ratio of 1.04%, up from 1.00% in the previous quarter 2) China’s credit levels have declined as its aggregate financing level fell 9% to CNY1.40trn in May (April: CNY1.55trn), continuing a declining trend since January as the government maintains a generally stricter stance on credit growth. The PBOC, however, did recently announce new guidance to support mortgage lending to enhance efficiency of mortgage approvals 3) though macro headwinds improved in May with improved retail sales data (+12.5%), industrial output data (+8.8%) and fixed asset investment (+17.2%), all of which was in line market expectations. This is reinforced by June’s strong manufacturing data. (June PMI 51.0; May PMI 50.8). Our view: While we maintain a neutral credit outlook on China banks under our coverage, we think exposure to Chinese bank debt should be reduced, particularly senior debt issues as valuations are tight and yields have become increasingly less attractive. We also think the ongoing uncertainty on shadow banking will deter some investor participation in the bank space; hence, we can expect upward spread pressure going forward. That said, we think there are still opportunities in subordinated debt, both old-style and new style. Old-style debt is deemed to be more likely to be called and still offer investors a way to capture short-term gains. On the other hand, new-style debt tends to have higher non-call risk by design, but returns may be attractive provided there is a sufficient PONV premium. We would also prefer banks with lower exposure to the industrial and property sector, all else equal.