Our analysts Andrew Sheets and Kelvin Pang explain why
international issuers may be interested in so-called ‘dim sum’
bonds, despite Asia’s growth drag.
Read more insights from Morgan Stanley.
----- Transcript -----
Andrew Sheets: Welcome to Thoughts on the
Market. I'm Andrew Sheets, Head of Corporate Credit Research at
Morgan Stanley.
Kelvin Pang: And I'm Kelvin Pang, Head of
Asia Credit Strategy.
Andrew Sheets: And today in the program
we're going to finish our global tour of credit markets with a
discussion of Asia.
It's Friday, June 20th at 2pm in London.
Kelvin Pang: And 9pm in Hong Kong.
Andrew Sheets: Kelvin, thank you for
joining us. Thank you especially for joining us so late in your
day – to complete this credit World tour. And before we get into
the Asia credit market, I think it would just be helpful to frame
at a very high level – how you see the economic picture in the
region.
Kelvin Pang: We do think that the talks and
potential deals will probably provide some reprieve towards the
growth for the region, but not a big relief. We do think that
tariff uncertainty will linger here, and it will keep growth low
here; especially if we do think that CapEx of the region will be
weaker due to tariff uncertainty. A weaker U.S. dollar, for
example, plus monetary easing will help offset some of this
growth drag. But overall, we do think that the Asia region could
see 90 basis point down in real GDP growth from last year.
Andrew Sheets: So, we've got weaker growth
in Asia as a function of high tariffs and high tariff uncertainty
that can't be offset by further policy easing. In the context of
that weaker growth backdrop, higher uncertainty – are credit
spreads in the region wide?
Kelvin Pang: No, they're actually really
low. They're probably at like the lowest since we start having a
data in 2013. So definitely like a 12 to 13 year low of the
range.
Andrew Sheets: And so why is that? Why do
you have this kind of seemingly odd disconnect between some real
growth challenges? And as you just mentioned, really some of the
tightest credit spreads, some of the lowest risk premiums that
we've seen in quite some time?
Kelvin Pang: Yeah, we get this question a
lot from clients, and the short answer is that, you know, the
technicals, right? Because the last two years, two-three years,
we've been seeing negative net supply for Asia credit. A lot of
that is driven by China credit. And if you look at year-to-date,
non supply remain still negative net supply. And demand side, for
example, has not really picked up that strongly. But it still
offsets any outflows that we see the last two-three years; is
offset by this negative net supply.
So, you put this two together, we have this very strong
technicals that support very tight spread. And that's why spread
has been tight at historical end in the last, I would say, one to
two years.
Andrew Sheets: Do you see this
changes?
Kelvin Pang: Yeah, we do think it's
changed. We have a framework that we call the normalization of
Asia Credit technicals. And for that to change, essentially our
framework is saying that Treasury yields use need to go down, and
dollar funding need to go down. Cheaper dollar funding will bring
back issuers. Net supply should pick up. Demand for credit tends
to do well in a rate cut cycle. Demand tends to pick up in a rate
cut cycle.
So, if we have these two supports, we do think that Asia credit
technicals will normalize. It's just that, you know, we have four
stages of normalization. Unfortunately we are in stage two now,
and we still have a bit of room to see some further
normalization, especially if we don't get rate cuts.
Andrew Sheets: Got it. So, you know,
we do think that if Morgan Stanley's yield forecasts are correct,
yields are going to fall. Issuers will look at those lower yields
as more attractive. They'll issue more paper in Asia and that
will kind of help rebalance the market some. But we're just not
quite there yet.
Kelvin Pang: Yeah, we feel like this road
to rate cuts has been delayed a few times, in the last two-three
years. And that has really been a big conundrum for a lot of Asia
credit investors. So hopefully third time's a charm, right. So
next year's a big year.
Andrew Sheets: So, I guess while we're
waiting for that, you also have this dynamic where for companies
in Asia, or I guess for any company in the world, borrowing money
locally in Asia is quite cheap. You have very low yields in
China. You have very low local yields in Japan. How do those
yields compare with the economics of borrowing in dollars? And
what do you think that, kind of, means for your market?
Kelvin Pang: Yeah, I think the short answer
is that we are going to see more foreign issuers in local
currency market. And, you know, we wrote a report in in March to
just to pick on the dim sum corporate bond market. It
benefits…
Andrew Sheets: And Kelvin, just to stop you
there, could you just describe to the listener what a dim sum
bond is? And probably why you don't want to eat it?
Kelvin Pang: Yes. So dim sum bond is
basically a bond denominator in CNH. So, CNH is a[n] offshore
Chinese renminbi, sort of, proxy. And it's called dim sum because
it's like the most local cuisine in Hong Kong. Most – a lot of
dim sum bonds are issued in Hong Kong. A lot of these CNH bonds
are issued in Hong Kong, And that's why, [it has] this, you know,
sort nickname called dim sum.
Andrew Sheets: So, what is the outlook for
that market and the economics for issuers who might be interested
in it?
Kelvin Pang: Yeah. We think it's a great
place for global issuers who have natural demand for renminbi or
CNH to issue; 10 years CGB is now is like 1.5-1.6 percent. That
makes it a very attractive yield. And for a lot of these
multinationals, they have natural renminbi needs. So, they don't
need to worry about the hedging part of it. And what – and for a
lot of investor base, the demands are picking up because we are
seeing that renminbi internationalization are making some
progress. You know, progress in that means better demand. So,
overall, we do think that there is a good chance that the
renminbi market or the dim sum market can be a bit more global
player – or global, sort of, friendly market for investors.
Andrew Sheets: Kelvin, another sector I
wanted to ask you about was the China property sector. This was a
sector that generated significant headlines over the last several
years. It's faced significant credit challenges. It's very large,
even by global standards. What's the latest on how China Property
Credit is doing and how does that influence your overall
view?
Kelvin Pang: it's been four plus years,
since first default started. and we've been through like 44 China
property defaults, close to about 127 billion of total dollar
bonds that defaulted. So, we are close to the end of the default
cycle. Unfortunately, the end or default cycle doesn't mean that
we are in the recovery phase, or we are in the speedy recovery
phase. We are seeing a lot of companies struggling to come out
restructuring.
There are companies that come out restructuring and re-enter
defaults. So, we do think that it is a long way to go for a lot
of these property developers to come out restructuring and to get
back to a going concern, kind of, status – I think we are still a
bit far. We need to see the recovery in the physical property
markets. And for that to happen, we do need to see the China
economy to pick up, which give confidence to the home buyers in
that sense.
Andrew Sheets: So, Kelvin, we started this
conversation with this kind of odd disconnect that kind of
defines your market. You have a region that has some of the most
significant growth risks from tariffs, some of the highest tariff
exposure, and yet also has some of the lowest credit risk
premiums with these quite tight spreads. If you look more
broadly, are there any other kind of disconnects in your market
that you think investors around the world should be aware
of?
Kelvin Pang: Yeah, we do think that
investors need to take advantage of the disconnect because what
we have now is a very compressed spread. And we like to be in
high quality, right? Whether it is switching our Asia high yield
into Asia investment grade, whether it is switching out of, you
know, BBB credit into A credit.
We think, you know, investors don't lose a lot of spread by doing
that. But they manage to pick out higher quality credit. At the
same time, we do think that one thing unique about Asia credit is
that we have significant exposure to tariff risk. Asia countries
are one of the few that are, you know; seven out the 10 countries
that are having trade surplus with the U.S. And that's why we
think that the iTraxx Asia Ex-Japan CDS index could be a good way
to get exposure to tariffs. And the index did very well during
the Liberation Day sell off. Now it's trading back to more like
normal level of 70-75 basis point.
We do think that, you know, for investors who want long tariff
with risk, that could be a good way to add risk.
Andrew Sheets: Kelvin, it's been great
talking to you. Thanks for taking the time to talk.
Kelvin Pang: Thank you, Andrew.
Andrew Sheets: And thank you listeners as
always, for your time. If you find Thoughts of the Market useful,
let us know by leaving a review wherever you listen. And also
tell a friend or colleague about us today.
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