PIMCO Asia Credit Perspectives Secular Trends in Asian Credit Markets PCACRP002

7/27/2019 PIMCO Asia Credit Perspectives Secular Trends in Asian Credit Markets PCACRP002

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Your Global Investment Authority

Asia Credit PerspectivesSeptember 2013

Secular rends in AsianCredit Markets Shape Long-erm Investment Temes

Te last several years have seen some extraordinary growth

in the Asian credit markets, and ongoing trends – supply

and demand dynamics, banking sector deleveraging,

increasing demand for energy across the region, among

others – paint a vivid picture for credit investment

opportunities over the secular horizon. Tat said, the

potential for volatility, as seen in recent months, along

with uncertainties in the global economy underscore the

importance of careful research when investing in the robust

market in Asian credit.

Rapid expansion across Asia’s credit markets

By two key measures – market capitalization and number o issues – U.S.-

dollar-denominated Asian credit, including corporates, sovereigns and quasi-

sovereigns, has more than doubled in just ve years (see Figure 1). We see

three main reasons or the dramatic growth in issuance – and, critically,

despite recent market volatility, we expect all three to remain in orce over the

secular horizon. First, there is a lack o U.S.-dollar-denominated sovereign

supply as countries develop, mature and increasingly preer to issue debt in

their own currencies. Second, we expect continued strong demand or spread

product as net issuance globally remains at ractions o pre-crisis levels. Finallypost-crisis deleveraging within the banking sector has companies looking

outside their traditional banking relationships or nancing – and to satisy

their growing appetite or mergers and acquisitions overseas.

Robert MeadManaging DirectorPortolio Manager

Raja MukherjiExecutive Vice President

Head o Asian Credit Research

Investment Products

Not FDIC Insured | May Lose Value | Not Bank Guaranteed



2 SEPTEMBER 2013 | ASIA CREDIT PERSPECTIVES

FIGURE 1: ASIAN EXTERNAL BOND MARKETS SEESIGNIFICANT GROWTH OVER THE PAST FIVE YEARS

100

150

200

250

300

350

400

450

0

100

200

300

400

500

600

700

Mar‘08

Mar‘09

Mar‘10

Mar‘11

Mar‘12

Mar‘13

M a r k e t c a p i t a l i z a t i o n

i n $ b i l l i o n s

# o f I s s u e s

# of issues (RHS) Market capitalization ($bn: LHS)

Source: J.P. Morgan Asia Credit Index (JACI). Data is through 30 June 2013.

Indeed, these three actors have opened a huge window or

Asian corporate issuers to come to the market or nancing,

whether to pursue long-term business plans or to employ

traditional corporate nance and leverage strategies. The

number o countries and range o issuer types in the

representative J.P. Morgan Asia Credit Index (JACI) continues

to broaden, even as the composition shits. For example,

Korea (including its quasi-sovereign Korea Development Bank)was or many years the single-largest issuer by country in the

JACI, but as o February 2013, China has taken its place (see

Figure 2), driven by strong corporate issuance. Over the

secular horizon, we expect the larger economies in the region

– particularly China, India and Indonesia – to continue to

increase their presence in the JACI index.

Sectors to watch: energy, fnancials, high yield,

local currency

Energy sel-suciency has almost unanimously declined

across Asia in the last decade, and the region’s energyappetite can only expand over the secular horizon as these

economies continue to develop and standards o living rise.

To meet increasing demand, many Asian oil and gas

companies have not only become requent buyers o oreign

assets, they have also regularly tapped the international

FIGURE 2: CHINA EDGES KOREA TO BECOME THELARGEST COUNTRY IN THE JACI INDEX

0102030405060708090

100

June

‘08

June

‘09

June

‘10

June

‘11

June

‘12

June

‘13

C o m p o s i t i o n o f J A C I i n d e x

b y c o u n t r y ( % )

Source: J.P. Morgan Asia Credit Index (JACI). Data is through 30 June 2013.

ChinaPakistan

Philippines

Singapore

Sri Lanka

Taiwan

Thailand

Vietnam

Other

Hong Kong

India

Indonesia

Korea

Macau

Malaysia

Mongolia

capital markets to meet their nancing needs. Credit investors

may nd numerous opportunities among high quality energy

companies with strong state support, solid undamentals and

a constructive outlook.

In the nancial sector, we expect to see continued issuance odollar-denominated bonds in several countries. Korea, or

example, issues mainly or renancing purposes, while Indian

banks want to und overseas expansion.

The swit emergence o high yield corporate issuers in Asia

over the past several years came rom a confuence o actors

rapid GDP expansion, broad political stability, an

underdeveloped inrastructure, a move toward privatization

and a growing need or unding fexibility. This year to date

has set a record in new high yield issuance with 76 new

issues totaling over $30.4 billion – and the new deals are

oversubscribed by an average o 10 times (source: Citi andBloomberg as o 15 August 2013).

Within the high yield portion o the JACI index, the largest

component – and one o the most volatile – is China’s real

estate sector. With the given long-term trends toward

urbanization and people’s desire to hold property as a

nancial investment, we expect this sector to continue to



ASIA CREDIT PERSPECTIVES | SEPTEMBER 2013 3

grow and consolidate over the coming years despite the

rising costs and intensied competition. Policymakers need to

tread a ne line between reining in rising home prices and

sustaining the sector’s contribution to the overall economy.

Thereore the supply pipeline, especially renancing needs

rom existing issuers, should remain strong.

China’s retail and consumer sectors are also issuing more in

2013, driven by organic expansion, balance sheet

management and domestic and oreign acquisitions. We

expect more issuers to come to market over the secular

horizon, thanks to growth in personal income andconsumption power along with urbanization. Across the real

estate, retail and consumer sectors, assessment o the

macroeconomic environment together with diligent research

is critical. Investors need adequate compensation or

execution and deault risks.

Asia’s local currency corporate credit markets are developing,

but credits currently accessible to international investors –

such as Chinese-yuan-denominated “dim sum” bonds – are

ew. We expect urther development in this market and other

local credit markets over the longer term, though over the

next ve years, dollar-denominated credit markets will likelyexperience the bulk o issuance.

Secular trends in credit quality and risk

Sovereign credit ratings have moved generally upward across

Asia in the last ve years (see Figure 3), in notable contrast to

trends in most o the developed world. During the same

period, the average S&P rating o the broad JACI index has

gradually decreased (see Figure 4), primarily due to the

increase in corporate issuance, which tends to be lower-rated.

The index average remains investment grade at BBB+. Over

the next several years we expect corporate issuance and awider spectrum o corporate issuers to continue to drive

index growth.

FIGURE 3: S&P SOVEREIGN CREDIT RATINGS HAVE RISENIN MUCH OF ASIA SINCE 2008

BB+BBBB-

B+BB-CCC+

BBB-BBBBBB+A-AA+AA-AAAA+AAA

‘08 ‘09 ‘10 ‘11 ‘12 ‘13

Source: S&P, Bloomberg. Data is through May 2013.

Hong KongSingaporeChinaTaiwanKoreaMalaysia

ThailandPhilippinesIndiaIndonesiaVietnam

FIGURE 4: AVERAGE CREDIT RATING OF THE JACI INDEXHAS GRADUALLY LOWERED AS CORPORATE CREDITCONTINUES TO DRIVE INDEX GROWTH, BUT STILL

INVESTMENT GRADE

20%10%0%

30%40%50%60%70%80%90%100%

None

CCC

B

BB

BBB

A

AA

AAA

June‘08

June‘09

June‘10

June‘11

June‘12

June‘13

Source: J.P. Morgan Asia Credit Index (JACI), S&P, Moody’s. Data is through

30 June 2013. Average rating is based on higher of S&P or Moody’s.

Asian corporate bond spreads have been consistently higher

than comparably rated U.S. corporate spreads during the past

several years (Figure 5 shows two examples), likely due in

large part to higher sovereign spreads embedded in Asian

corporate bond spreads. Over the secular horizon, we expect



4 SEPTEMBER 2013 | ASIA CREDIT PERSPECTIVES

this gap to narrow as markets continue to revalue Asian

sovereign risk to refect stronger balance sheets and

economic growth prospects.

FIGURE 5: RATING-EQUIVALENT CORPORATE SPREADSREMAIN HIGHER IN ASIA VERSUS U.S., BUT GAP MAY

NARROW OVER TIME

0

200

400

600

8001000

1200

1600

1400

June‘08

June‘11

June‘12

June‘13

Source: J.P. Morgan, Barclays. Data is through 30 June 2013.

JACI Corporates (BB)Barcap U.S. HY (BB)JACI Corporates (BBB)Barcap U.S. Credit (BBB)

Another credit indicator to watch in the coming years is debtratio, which can help uncover value in corporate bonds. One

example o debt ratio is the “single turn o leverage,” the

one-to-one ratio between debt and EBITDA (one-year

earnings beore interest, taxes, depreciation and

amortization). Currently, most corporate bonds rom Asia

have higher spreads (over comparable maturity U.S. swaps)

per turn o net leverage compared to corporate bonds rom

the U.S. (see Figure 6). This will likely remain the case over the

secular horizon, but we expect the gap to continue to narrow.

Many countries across Asia are also improving the quality o

their institutional rameworks, regulatory bodies andbankruptcy regimes. That said, over the secular horizon we

ully expect to see instances where these rameworks, bodies

and regimes will be tested – challenges which, in turn, may

help Asia’s credit markets evolve and develop urther. Among

issues in the JACI index, over the next two years the

renancing needs across the region are minimal, hence

deault rates will likely remain low. In 2016–2018, 35% o

debt in the index matures and this could be a period with

FIGURE 6: SPREAD PER TURN OF LEVERAGE ACROSSASIAN AND U.S. CREDIT SUGGESTS POTENTIAL VALUEOPPORTUNITIES IN ASIA

Source: Bank of America Merrill Lynch. Data is as of 31 March 2013.

AsiaU.S.

0 50 100 150 200 250

A

BBB

BB

B

Spread per turn of net leverage, bps/x

heavier renancing risk. And over the secular horizon and

beyond, we do expect some volatility rom increased cash or

price deaults.

Investor implications: research and relationships

are critical

Given that potential or volatility along with weakness in the

global macroeconomic environment, good credit research,

fexible resources, experienced local portolio management

and strong relationships with local stakeholders are all crucial

to uncovering attractive opportunities in Asia’s credit markets

At PIMCO, our belies in the resilience o many emerging

Asian countries and vibrancy o credit markets in Asia have us

evaluating attractive opportunities in high quality corporate

credits. We scrutinize the bond structure to gauge the degree

o sovereign shareholder support, and rely on rigorousbottom-up credit research to assess risks and identiy best

candidates within each sector. We expect the next several

years will present many intriguing opportunities in Asia’s

expanding, evolving credit markets.



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A word about risk:

Past performance is not a guarantee or a reliable indicator of future results. Investing in the bond market issubject to certain risks, including market, interest rate, issuer, credit and ination risk; investments may be worth more or lessthan the original cost when redeemed. Currency rates may uctuate signifcantly over short periods o time and may reducethe returns o a portolio. Investing in foreign-denominated and/or -domiciled securities may involve heightened riskdue to currency uctuations, and economic and political risks, which may be enhanced in emerging markets. Corporatedebt securities are subject to the risk o the issuer’s inability to meet principal and interest payments on the obligation andmay also be subject to price volatility due to actors such as interest rate sensitivity, market perception o the creditworthinesso the issuer and general market liquidity. The value o real estate and portolios that invest in real estate may uctuate dueto: losses rom casualty or condemnation, changes in local and general economic conditions, supply and demand, interestrates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. The credit quality o aparticular security or group o securities does not ensure the stability or saety o the overall portolio. There is no guarantee

that these investment strategies will work under all market conditions or are suitable or all investors and each investorshould evaluate their ability to invest long-term, especially during periods o downturn in the market. Investors shouldconsult their investment proessional prior to making an investment decision.

The J.P. Morgan Asia Credit Index (JACI) tracks total return perormance o the Asia fxed-rate dollar bond market. JACI is amarket cap-weighted index comprising sovereign, quasi-sovereign and corporate bonds and it is partitioned by country,sector and credit rating. It is not possible to invest directly in an unmanaged index.

This material contains the current opinions o the author but not necessarily those o PIMCO and such opinions are subject tochange without notice. This material has been distributed or inormational purposes only and should not be considered asinvestment advice or a recommendation o any particular security, strategy or investment product. Inormation containedherein has been obtained rom sources believed to be reliable, but not guaranteed. No part o this article may be reproducedin any orm, or reerred to in any other publication, without express written permission. PIMCO and YOUR GLOBALINVESTMENT AUTHORITY are trademarks or registered trademarks o Allianz Asset Management o America L.P. and PacifcInvestment Management Company LLC, respectively, in the United States and throughout the world. ©2013, PIMCO.

PIMCO Investments LLC, distributor, 1633 Broadway, New York, NY, 10019 is a company o PIMCO.

PIMCO Asia Credit Perspectives Secular Trends in Asian Credit Markets PCACRP002

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