2021 was a stand-out year for the Singapore corporate bond market. Issuances hit a nine-year high with total issuances of $25.3 billion on the back of a stronger macroeconomic outlook and deep liquidity in the market. It is understandable that most companies have yet to recover their pre-pandemic profitability, but unlike many firms in the Asia dollar space (Evergrande is quick to come to mind), no Singdollar (SGD) issuer defaulted last year.
Mega trends to steer the market
We look to 2022 with a stronger sense of optimism as countries are better prepared against the pandemic. However, several mega-trends which accelerated post-pandemic are expected to persist and steer the market. We highlight three mega-trends: (i) shifts in business profile, (ii) growth of the Green, Social, Sustainability and Sustainability-linked (GSSSL) market and (iii) a higher inflation/ interest rate environment.
Trend 1: Shifts in business focus
The pandemic has changed the operating landscape — what was relevant in the prior decade may no longer be so. Companies are shifting their business profiles, including through mergers, acquisitions, disposals and by changing business focus, necessitated by changes in risks and opportunities.
A recent example is the proposed combination of Mapletree Commercial Trust (MCT) with Mapletree North Asia Commercial Trust (MNACT) which will see an expanded focus to Pan-Asia for both REITs — the expanded REIT will have greater capital headroom to undertake larger acquisitions in more countries while individually the REITs have a limited acquisition pipeline. Merging REITs with differing profiles is becoming mainstream, following that of Frasers Logistics & Commercial Trust (born from the marriage of Frasers Logistics & Industrial Trust and Frasers Commercial Trust) and CapitaLand Integrated Commercial Trust (CapitaLand Mall Trust and CapitaLand Commercial Trust). Aside from the same sponsors putting sister REITs together, we may also see the combination of smaller REITs (similar to the merger of Viva Industrial Trust with ESR-REIT) which may enjoy economies of scale.
Business profiles can also change through shifts in mandates. One example is CapitaLand China Trust (formerly CapitaLand Retail China Trust), which is now targeting 70% mix in new economy assets (comprising business parks and logistics) and commercial/integrated developments. Prior to 2020, it was all in retail. Ascott Residence Trust, which formerly focused on serviced residences and hard-hit by the pandemic, is pivoting to the more resilient student accommodation segment. This now forms 16% of its portfolio value, with a target to increase to 20% in the medium-term. Cromwell European REIT is stepping up on acquisitions of light industrial and logistics assets to increase the exposure to this segment to 50%, up from sub-40%.
Property developers appear to be having their heyday, achieving much higher sales numbers in recent years amidst a boom in property prices (2021: +10.6% y/y). While we are expecting property prices to rise another 5% to 7% in 2022 despite the recent property cooling measures, a number of property developers have called it quits. In the words of Oxley Holdings, despite surging prices and volumes, “profit margins of property development projects in Singapore are expected to decline” and as such the focus will be on other countries. Similarly, we observe that the CapitaLand group and Frasers Property have significantly reduced their exposure to Singapore property in recent years (even before to the pandemic), with a much smaller land bank and no intention to stock up, being largely absent from land tenders.
Away from REITs and property developers, financial institutions are similarly in a state of flux, with several streamlining businesses while others looking to expand. Credit Suisse, which bore the twin impacts of Archegos Capital Management and Greensill Capital, will focus on strengthening its risk management and simplifying its model, exiting 10 non-core markets while emphasising wealth management relative to investment banking. Following the acquisition of Lakshmi Vilas Bank, DBS Group Holdings is reportedly interested in Citigroup’s Taiwan operations. Similarly, United Overseas Bank is looking to buy Citigroup’s Indonesian retail operations. While HSBC Holdings (HSBC) has been shedding risk-weighted assets (including through the sale of its French retail unit and US branches), HSBC is buying AXA Singapore to grow its ambitions in wealth management and Asia.
See also: US bond market halts brutal run as buyers pounce on 4.5% yields
Trend 2: Growth of the GSSSL market
GSSSL issuance in the Asia dollar market smashed annual records with a total issuance of US$1.04 trillion ($1.4 trillion) last year. Similarly, the SGD market saw $4.375 billion of GSSSL bonds issued last year, more than the cumulative issuance of GSSSL bonds in prior periods. There is still room for GSSSL bonds to grow as they comprised just 17% of the SGD issuance market in 2021. Increasingly, companies and funds are pivoting towards sustainability as societal pressure, investor demand and regulatory requirement pile on.
For the banking sector, we can look at the European Union (EU) for an indication on how the governance of the GSSSL market will evolve. In the EU, there will be inclusion of more formal requirements for financial institutions to include an assessment of environmental, social and governance risks and to adequately disclose these risks and their constituency with the EU’s overall sustainability strategy. Financial Institutions will also be stress-tested in relation to resiliency to climate risk.
Separately, disclosures are increasingly becoming mandated, following the establishment of the Sustainable Finance Disclosure Regulation (SFDR) which came into effect on March 10 last year. Asset managers and financial market participants will need to disclose their analysis of 50 key sustainability factors and address potential adverse impacts of their investments. In Singapore, all issuers must provide climate reporting on a ‘comply or explain’ basis in their sustainability reports for the financial year commencing 2022.
According to Climate Bonds Initiative, under its study of selected Euro and US Dollar green bonds, it was found that such bonds trade tighter (with a lower yield, for example) than equivalent vanilla bonds with higher book cover — implying that green bonds are more sought after by investors. While we have yet to observe distinct pricing advantage in the SGD space for GSSSL bonds, the growth in demand could lead to differentiated pricing and attract further GSSSL issuances.
Trend 3: Higher inflation and interest rate environment
Higher rates of inflation may be here to stay. US officials have dropped the word ‘transitory’ in describing inflation while our rates strategist expect 10Y US Treasury yields to reach 1.85% by the end of 2Q2022. If high rates of inflation and rates climb higher, there will be impacts felt by issuers and investors.
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Issuers will have to contend with higher borrowing costs, which in turn hurts their credit metrics as interest coverage is expected to weaken. If wage-push inflation ensues, profitability will be dampened. Already, several banks in Singapore have reported that their cost-to-income ratio have risen despite stable or improving earnings because of higher staff costs. Profitability may be impacted further as companies pay more for interest expense and price in a higher hurdle rate for projects. That said, taking fewer but projects with higher quality can improve credit profiles of issuers if gearing levels were to be reduced.
For investors, inflation and rates are well-understood to be the bane of bonds, eroding real returns and depressing nominal bond prices. This is especially true for higher-grade vanilla bonds which are longer dated.
Adjusting and repositioning
Investors may wonder if there is still any relevance for bonds in today’s climate given the macro environment today. We believe investors can reposition to stay ahead.
Business risk profiles of issuers are expected to change, especially if this is driven by an evolving operating environment. Companies may no longer keep to the same profile (for example, Singapore Press Holdings disposed of its mainstay media segment and Sembcorp Industries demerged its marine segment). Investors should follow closely and relook at the fundamentals of companies, especially if credit metrics shift for example through gearing up (or down) to acquire (or dispose).
Given the GSSSL trends, there could be potential upsides for investors by taking positions and participating in such issuances if GSSSL bonds were to trade tighter eventually. Hopefully, investors will do well by doing good.
Finally, to generate returns, we think perpetuals may be in a sweet spot — while there is an intuition to shun perpetuals in a rising rates environment due to its ‘perpetuity’ (for example, no fixed maturity date), prices of perpetuals have held up well since January last year relative to vanilla bonds (including shorter-tenured ones).
We believe that perpetuals have held up better as higher rates reduce the likelihood for distribution rates to be reset lower while the likelihood of the call being exercised increases with higher rates. Higher spreads and higher carry offered by perpetuals also cushions the impact from rising interest rates to keep total returns positive. Our SGD bond model portfolio has returned 5.11% in 2021 due to distributions and coupons (around 4%) delivered by the perp-heavy portfolio and enjoyed some net capital gains (around 1%) through careful issue selection.
Going forward, given rates volatility, we continue to favour taking some credit risk and subordination risk over interest rate risk to generate returns. Rising rates should also open opportunities to invest as higher-grade bonds have been trading tight. If economic growth continues, profitability should recover and credit profiles may be restored to pre-pandemic levels.
Andrew Wong, Ezien Hoo, Wong Hong Wei and Toh Su N are credit research analysts at OCBC Bank’s Global Treasury Research & Strategy
Photo: Albert Chua/The Edge Singapore
