March 12, 2018

It is not even near month end or quarter-end, 5 weeks into the start of the dramatic widening Libor-OIS spread that not too many retail investors are overly concerned about, we got to wondering when the truth will hit home? When will investors start feeling the pain of higher funding rates and if it will begin to expose the cracks in the marketplace.

Over 2 weeks of post-CNY catch up lunches with friends, we had a private investor friend choke when he casually asked where 1-month Libor plus 0.8% was, while running some mental calculations, and we calmly informed him to use 2.5% for his estimates. “What? Since when did it rise so much?”, he asked, “Err, since they hiked in December,” was the reply.

We congratulated ourselves that Singapore mortgages were not near those terrifying levels especially when rental yields are hovering under 2% for some prime areas. Singaporeans are a lucky bunch indeed as our mailboxes jammed up with those offers from banks, persuading us to with $30 Takashimaya vouchers for every thousand dollars of credit card balances we leave unpaid, blissfully unaware of the wholesale funding problem that is plaguing the markets.

Then we had a good friend fuming about getting turned away when she asked for a bid for $200k of a A-rated USD bond with the bank declining to make a price, which she felt was very poor etiquette especially when it was an investment grade bond that they would have been happy to make a price for when they brought it out 2 years ago.

From an outsider’s perspective, we noted some warning signs over the lunar new year when an elderly uncle in his 70’s on his annual visit from Vancouver, proudly proclaimed he made his first foray into the Singapore corporate bond market in January, buying himself the Keppel Corp 4% 2042 paper on the recommendation of his local RM who probably does not rank him as a regular client.

The alarm bells rang in the head as we silently demurred to his trade, wishing that he would live to see the bond mature, for Keppel Corp 2042 is a rare bond indeed, not readily available in the many inventory lists we get from our own bankers and yet his bank had been quick to push him to buy back in January when prices were at their highs and the poor chap happy enough to be getting 3% for the next 24 years against his 0.5% fixed deposit rate.

The bond has just lost about 4% so far, a year’s worth of coupon and we would not worry for him too much, faraway in Vancouver, after all we had wrote about in January about our great humbling by 80 year-old aunties and all the others who have prospered on because they do not bother to think too hard.

Nonetheless the incident did trigger something we have been thinking about for some time now, and along with the new Ara Asset Management SGD 5.65% perpetual bond (initial guideline of 6%) this week that was 97% taken up by private banks, we think it is time to give our thoughts on the structural problems in the Singapore bond market, without old uncle in mind.

But Is It Worth Talking About the Singapore Bond Market?

Singapore’s local bond market ambitions have taken a hammering since 2012 which was the peak bond year for Singapore while the rest of Asia Pacific powered away.

The table below summarises how the market has come along in the last decade with Asia ex-Japan bond markets quintupling since 2007 when Singapore’s has just managed to double, in US dollar terms. Compared to similarly Aaa-rated Australia which managed to triple in issuance size, the Singapore-dollar bond market can be said to have lost ground as an asset class even as more issuers choose to list on the SGX.

The Unpleasant and Troublesome Liquidity Problem-1Table of annual issuance for Asia Ex-Japan, SGD-dollar and Australia domestic bonds

Is it worth talking about the SGD-dollar bond market then, when we hear of Japan investors complaining that the market is too small to be meaningful for their portfolios and after world’s largest SWF, Norges bank, decreed that their bond portfolio would now only comprise of G3 currency bonds, no doubt after having checked out and maybe got burnt in Singapore?

Yes, we think so even if it is just to play our part to share our 2-cents worth with the investors or would-be investors out there, to avoid trade-wars or to make the Singapore bond market great again?

The Day Before the Music Died

For some time now, we have wondered on what would happen the day the music died and for some time, we do not have the answers. For it would be so easy to call for a crisis of sorts but so many articles, posts, op-eds and research reports have been written over the year and the fact that the US Fed’s QE ended in 2014 when the Federal Reserve stopped their bond buying programme and the Fed began reducing their US$ 4.5 trillion balance sheet last Oct.

This is the global QE tune that has been playing since the great financial crisis of 2008 that has led to global central banks now holding US$ 21 trillion in assets on their balance sheets, some 40% of global GDP; the Bank of Japan holding 40% of domestic government bonds and the Swiss National Bank (SNBN SW, +43.48% year to date) owning nearly US$ 100bio worth of US stocks (mainly in Apple, Microsoft, Facebook and the likes).

The Unpleasant and Troublesome Liquidity Problem-2Source: Zerohedge

This week, another central bank caved in. The ECB decided to turn off the cash spigot by dropping their pledge to buy more bonds if needed after halving their bond purchase program to €30 bio per month since October last year with the program expected to end in September this year.

As it is, the amount of bonds trading at positive interest rates have been on an uptrend since early 2017 from the graph below, with roughly just $8 trillion negative yielding bonds left, as estimated by Deutsche Bank. This is less than half the amount from peak-negative.

The Unpleasant and Troublesome Liquidity Problem-3

Otherwise signs of anxiety are showing up from 1M Libor and 2Y US yields at their 9 year highs, to Singapore 2 year interest rates at their 2 year highs, and 1M Sibor closing in on its 9 year highs set earlier this year, after a flash crash in January (around the time the old relative was sold the Keppel 2042 bond).

The Unpleasant and Troublesome Liquidity Problem-4Chart of 1M Sibor rates since 2009, noting the flash crash of over 0.3% in Jan 2018

The Uncomfortable Truth about The Singapore Bond Market

We had written earlier this year that 2018 is not a time to be bullish Singapore bonds after the peak-default year of 2017 which saw some SGD$ 2 bio worth of defaults.

With global debt levels at record highs, central banks scaling bank on QE and hiking rates, credit spreads at their tights and possible localised liquidity problems, we suggested that investors should buy at their own risk.

2018 could well turn out to be a watershed year for the Singapore bond markets which hopped off with a furious month of issuance in January that saw half the bonds that were issued trading underwater or barely treading water as interest rates rose in line with the rest of the world.

The worst performing bond would be the HDB 10-year paper that paid a 2.32% coupon and never saw the light of day again as it traded to a discount of nearly 4% since. Even the ARA perpetual issued last Thursday to great retail fanfare, with 97% taken up by private banks, has dipped below its issue price.

February 2018 was the worst month for issuance since 2013 and never has the market seen so few issues brought out (4 in total) in the past decade.

It is not a pretty picture which threatens to get worse as the Singapore Budget 2018 promises even more debt to come and interest rates edge higher around the world.

Let us try to summarise the problems with the market as concisely as we can and we would welcome feedback and ideas from readers to add on the “bitch-list”, a fair term to use in the year of the Dog.

The Lack of Liquidity and Market Depth

A general survey has estimated the number of banks actively participating in the market to be just 6 with DBS, the dominant Alpha of the pack and the rest trailing behind.

We have been informed that dynamics of market participants have changed in recent years with the departure of sovereign wealth funds and some central banks who found the market too illiquid and immature for their liking. Their places have been taken over by the growing presence of retail investors, which is supposed to be a good sign given the stickier albeit smaller sizes of their trades.

As a result, asset managers have also been fleeing the shores for the brighter prospects of North Asia which has been on a growth rampage as China opens up her doors to foreign investors.

We brought up the issue with the lack of liquidity earlier this year when we pointed out an article from the IFR that highlighted the liquidity alert for Singapore bonds.

The Unpleasant and Troublesome Liquidity Problem-5Taken from an email alert from the IFR

Now, if sellers continue to outnumber buyers in a market where there are only a handful of banks willing to make prices for Singapore dollar bonds, we can see a potential situation developing which we are already seeing as friends and readers continue to inform us of their difficulty in getting bids anywhere close to the Bloomberg indicated prices.

This suggests that it could escalate into a sort of “trade war” situation where banks will refuse to make prices for bonds issued by other banks or even bonds they had sold, like the experience our friend had with her A-rated USD bond issue.

The Persistent Refusal to get Ratings

Part of the blame for the non-development of the market and diversifying the pool of available investors has been the persistent refusal of Singapore companies to get ratings.

Despite the MAS initiative in 2017 which offered subsidies to corporations for their rating fees with international agencies, local MNCs and government-linked firms have not taken the cue.

We bring up the example of Capitaland which requested for their BBB+ rating by the Standard & Poor’s to be withdrawn back in 2009. As we understand, the rating was an unsolicited one, given free of charge by the agency then.

The Unpleasant and Troublesome Liquidity Problem-6Source: Bloomberg

Since then, the bulk of Temasek firms have refused ratings which sent an important message to the rest of the bulk of prominent issuers in the Singapore dollar space who rejected the idea of being rated when they could issue bonds anyway to a servient and hungry audience.

No Way to Hedge and No Floating Rate papers or CP’s

We have to highlight that one of the main reasons why the Australian bond markets have done so well is because the bonds are largely on float-rate and there can be no better illustration than last week when DBS launched their inaugural AUD subordinated bond as a floating rate note and abandoned the idea of a fixed rate paper on poor demand.

This is easily understood by one who knows the Australian interest rate curve which has been inverted for a larger part of the past decade and flattish for the rest.

Thus it made sense to buy papers on floating interest rates to avoid the pain of loss when interest rates went up.

In Singapore, interest rates have been low for most of the past decade, declining to negative zone in 2011. Investors have all caught on to the idea of the non-existence of monetary policy which left Singapore only in a position to usually appreciate the Singapore dollar meaning that short-term interest rates would be low as punters speculate on further appreciation.

Thus, the market for hedges never developed and Singapore never got around to bond or interest rate futures like the Australian market did. These are perhaps the instruments that would have attracted a more diversified set of investors to the market and yet it is complicated enough for current investors who hedge in SOR and fund in SIBOR (an industry joke that we would not expect an average reader to understand).

Without an avenue to hedge and the expectation for perpetually low short-term interest rates, the market for floating rate papers never took off. Floating rate papers that could be finally in demand after all these years as some friends who were around in the late 1990’s claimed there was a buoyant market then just as the short-term papers market died out some time mid-2000’s when banks realised they were to too much a hassle when the SIBOR and SOR rates started to distort.

Global Trends—Passive Investment (ETFs), Foreign Competition

The global trend towards passive investment has been nothing short of breathtaking, ETF assets growing 36% in 2017, even as we note the irrelevant point that technology has been accused of lowering IQ levels in Scandinavia in the past 2 decades.

It is somewhat more difficult for the Singapore dollar bond market to jump on the bandwagon of passive investment and ETFs, for all the reasons listed above.

In addition, the rest of the Asian bond markets are upping the ante and giving investors more bang for the buck, creating massive headwinds for the growth of the Singapore dollar bond market, completing a vicious cycle.

Relax, Don’t Panic!

The blame game picture, if we had to draw one, would possibly look like the hastily done one below where we deliberately left out the root cause for “distortion between Sibor and Sor”.

Then again, who says the rest of the world will have it easier with the $8 trillion bucks worth of negative yielding papers? We will not even get started on that $200k of A-rated USD bond that could not get a decent price.

The Singapore dollar bond market will not disappear tomorrow and we are pretty darn sure no major credit crisis will erupt onshore given the market comprises mainly of statutory boards, financials, GLC’s and real estate.

If anything, demand for bonds will remain healthy as the en-bloc monies are paid and Singapore’s population continues to age.

When one buys a bond, one should really have the maturity date in mind, just like the wise Uncle from Vancouver and his Keppel 2042. And for those who have to get and cannot get a bid, leaving a working order is a good idea.

And if one wants a floating-rate note to avoid rising interest rates, Australia is not too far away.