The first half of 2023 turned out to be a very different period for credit markets compared to recent history. While certain influences remained similar versus the last six months of 2022 including rate hikes, inflation and geopolitical tensions, a regional banking crisis erupted in the US as rising interest rates exposed vulnerabilities in bank balance sheets while weakness in sentiments contributed to Credit Suisse Group’s forced merger with UBS Group and the surprising write-down of Credit Suisse Group’s Additional Tier 1 bank capital instruments. During this time, volatility was almost unprecedented with two-year US treasury yields posting its biggest three-day decline since the stock market crash of 1987.
Some things remain the same
Despite this volatility that also impacted yields of the Singapore Overnight Rate Average (Sora), the Singapore dollar (SGD) credit market remained resilient with $8.9 billion of new issuances priced from January to June. Considering that Housing & Development Board (HDB), a government-related issuer with deals that are typically very large, was absent among SGD bond issuers in 1H2023, this year’s volume is comparable with 1H2022 levels of $8.8 billion and above 1H2021 levels ($8.4 billion) if we also exclude HDB’s issuances from prior years. By comparison, Asia ex-Japan G3 issuances in the first half of 2023 were down approximately 35% y-o-y according to Bloomberg.
With the hiking cycle in play for much of the first half of 2023 and markets plagued by periods of high uncertainty, there was clear favouritism towards issuance within the shorter-to-belly part of the curve. There was no issuance in the >15 years tenor basket (aside from Additional Tier 1 bank capital instruments) and no corporate perpetuals were issued in the first six months of this year.
The largest contributor to total issuance volumes in the first half was the Financial Institutions (FI) sector, making up around 69% of bond issuances. This was due to the absence of HDB issues as mentioned above, as well as the fact that FI are in constant need of capital and sensitive to movements in interest rates given their highly leveraged balance sheets and the impact on their cost of capital. In the context of likely higher future capital requirements, Financial Institutions may have been incentivised to issue before rates rise further.
With 14 issues coming from industry sectors other than FI in 1H2023 with a total issuance volume of around $2.7 billion. Of these, three issues with an issuance volume of $900 million were green bonds. Two of these green bonds were priced in the tricky month of March when, in our view, only high-grade issuers could tap markets. We observe that over time, higher-grade issuers have affirmed their commitment to becoming more sustainable with green, social, sustainability and sustainability-linked (GSSSL) funding as a key part of their capital-raising strategy. We expect more of these issuers to tap the SGD GSSSL credit market. In our view, at times of credit stress, GSSSL issuances may serve as an expedient market signal over likely credit quality.
Back to the future
Our outlook at the start of 2023 was somewhat of a holding statement considering the uncertainty that existed at the time and the range of possible scenarios depending on the interest rate trajectory and timing of any recession. Against these, we appear to be more closely tracking the second and more moderate of the three scenarios we previously contemplated — interest rate hikes potentially resuming after a pause, which is what eventually happened. The difference, six to seven months on however, is that despite the emergence of an unexpected new risk (banking sector volatility and the US regional banking crisis), an outright or painful recession in late 2023 or early 2024 is currently not the base case for our OCBC economists. This highlights the persisting uncertainty and multiple influences impacting global markets — that despite a 1H2023 where treasury yields were especially volatile, we are somewhat close in sentiments to where we started at the beginning of 2023. The march to Moscow by the Wagner Group in late June highlighted how the key themes in our Singapore Mid-Year 2022 Credit Outlook of slowing economic growth, higher borrowing costs and prolonged geopolitical risks also continue to persist.
Given these familiar influences, our credit outlook for the remaining six months of 2023 remains consistent with our six-month view from January’s Singapore Credit Outlook 2023 but with some adjustments. We continue to advocate staying short on duration including the shorter part of the belly. This tenor continues to offer the best risk-adjusted returns in our view with repayment risks mitigated by ample liquidity in the bank loan market for refinancing.
See also: US bond market halts brutal run as buyers pounce on 4.5% yields
Given prevailing risks and recession concerns amidst higher for longer rates, we favour going higher up the credit curve. In particular, we see increasing opportunities for Korean, Australian and Japanese issuers given China’s weak recovery and structural index changes. With possible laggard effects of higher rates and a better-than-even chance of credit spreads widening, we still see select opportunities in crossover credits. However, investors should continue to focus on bottoms-up analysis as the funding environment has become increasingly tighter for high-yield issuers.
We are turning “neutral” from “underweight” for long-dated high-grade issuers despite spread compression throughout 2023. According to our SGD credit market tracker, longer tenors have been the best performer in the SGD credit market year to date. We do not expect a risk aversion situation to lead to significant rates rally at the long end (such as what was experienced in 2020–2021). We continue to remain Neutral overall towards structurally subordinated papers including perpetuals and bank capital with some selective value. While these papers have found favour again given their structurally higher return and lower prices, structure and bottom-up selection remain key. For corporate perpetuals, this continues to mean a focus on non-call risk for those looking to receive their principal within a set timeframe. That said, given the small negative price reaction on high-grade perpetuals that were not called in the past nine months, we infer that there is currently a higher willingness among investors to accept non-call risk for higher yield-in-perpetuity. For bank capital instruments, we recommend focusing on more strategically important FI given higher credit dispersion in the FI sector. This will somewhat compensate for structural risks and potential sector volatility although investors are reminded to continue to look at the risk-return balance between Additional Tier 1 and Tier 2 bank capital instruments.
Uncovering opportunities
We are no longer underweight on any sectors within the SGD credit market — this is due to its relatively resilient performance so far in 2023 and that credit as an asset class can act as insurance against a possible recession. While value may be hard to come by given the chase for SGD-denominated papers so far in 2023, we think any potential drop in rates and credit spread widening will uncover opportunities for investors.
Andrew Wong, Ezien Hoo, Wong Hong Wei and Chin Meng Tee are credit analysts with OCBC
