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Insolvency limbo: the SGD bond market

The Singdollar bond market is grappling with an unprecedented number of insolvencies. What lessons are there for the investment community?

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INSOLVENCY LIMBO: A climbing default toll continues to expose the vulnerabilities of the underdeveloped Singdollar corporate bond market.

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Learning by default.

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Sept 28 '16: (Above) A group of bondholders of Rickmers Maritime Trust filed an acceleration notice with the trustee of Rickmers, demanding 100% of their principal and coupon immediately at One Raffles Quay on Sept 28, 2016.

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Oct 25, '16: (Above, the massive Lewek Constellation, Ezra's sub-sea construction vessel that was sold during the downturn) Bond holders met with management at Ezra's office on Oct 25, 2016, and agreed to waive their rights before it filed for bankruptcy.

GOODBYE credit boom, hello insolvency limbo. In June, precision- engineering firm CW Advanced Technologies became the latest issuer to seek a court order to stave off creditors, after its plan to re-tap the bond market to redeem its first series of notes got quashed by poor market sentiment. Since November 2015, at least 13 issuers have defaulted on a total of 23 Singdollar bonds by missing coupon payments, failing to repay note holders at maturity, filing for judicial management, filing for bankruptcy protection and in one case breaching a financial covenant. The number excludes companies like Ezion, which strictly speaking has not legally defaulted on any notes since it got note holders to agree to swap their debt for equity through an out-of-court process before its next coupon was due.

That's S$3.2 billion in face value of Singdollar bonds and perpetual securities rocked by defaults, representing 2.6 per cent of the S$123 billion outstanding Singdollar corporate bond universe, which includes government agencies and statutory boards.

Among the defaulted, Marco Polo Marine has returned to solvency after note holders agreed to swap their debt for equity. But 10 other issuers remain stuck in various stages of restructuring while two have been liquidated.

Unlike Singapore's stock market, the Singdollar bond market is still in its infancy.

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It was only in 2012 that high-yield Singdollar bond and corporate perp sales really took off, with Genting Singapore tapping the market with a S$1.8 billion perpetual issue, followed by a second one that raised S$500 million.

That bull market offered companies a convenient way to diversify their capital structure by reaching out to affluent investors who didn't ask too many questions. Better still, perps could be accounted as equity rather than debt in a company's books.

Now, one sinking ship after another, that value proposition has been called into question.

A debt capital markets lawyer here told The Business Times: "When I first came in, I was actually very shocked by the whole process of how easy it is to raise a bond. Issuers want to issue bonds quickly but don't want to spend on fees, so that comes at the expense of credit ratings, and the due diligence process.

"A lot of corporate perps are geared to accredited investors who don't necessarily understand what they are buying. The Singapore market has developed to be cheap, good and fast... I understand cheapness, but sometimes the cheapness makes you shake your head."

Corporate perpetuals are often structured such that issuers do not guarantee fixed payments and have no legal obligation to redeem the principal. With the higher risks come higher yields - all well and good in a risk-on environment.

In contrast to the US, where lower-rated high-yield debt is targeted at hedge funds, private banking clients have been the driving force behind the Singdollar high-yield market. Last year, corporate perpetuals accounted for 16 per cent of aggregate issuance volumes.

No one really talked about defaults or restructuring risks. Prior to 2015, the last time Singapore witnessed a default was in 2009, when S-chip Sino-Environment defaulted on a S$149 million convertible bond issue. So, during the period of ultra-low interest rates that followed, folks here happily snapped up the debt of Singapore's more high-risk companies, which for a time yielded some juicy semi-annual payouts.

Now, the credit cycle has peaked, turning certain high-yield instruments into junk.

The right to payment

While note holders have priority over share investors in a liquidation event, they are often just as powerless as share investors if issuers (or the secured lenders who control them) choose to bulldoze their way through a restructuring, as those holding the debt of Trikomsel and Rickmers Maritime Trust discovered during the earlier parts of the default parade in 2016.

By convention, bond investors don't have influence over how a company is governed or conducts its business, with their right to demand immediate payment kicking in only in the event of a default. This is because they are lenders, not owners of the company, unlike shareholders. When creditors of all classes clash over the fate of a delinquent issuer, the only thing that underpins note holders' bargaining power is the threat to demand immediate payment. Even then, they can only take action through a bonds trustee that has limited incentive to enforce their rights vigorously, until it deems that it is sufficiently indemnified and funded.

This feature of collective action through the bonds trustee is not unique to Singapore. Justin Yip, partner at Withers KhattarWong explains: "What is different between Singapore and other jurisdictions is the composition of the investor base. In other jurisdictions such as the US, the majority of high-yield bonds are held by institutional and professional investors, and three or four funds may already constitute a majority position (in a bond tranche)."

In any case, note holders could do very little when issuers such as Swissco or Hyflux chose to suspend their coupons after having distributed dividends to shareholders while kicking the can down the road.

And it's no longer just accredited investors who are facing losses, but more than 20,000 non-accredited mom-and-pop investors as well. Hyflux is seeking to restructure S$900 million in face value of perpetual securities and perpetual preference shares and will soon make contact with retail investors. The pain here could cut deep as investors were allowed to use their Central Provident Fund (CPF) savings to ballot for Hyflux's S$400 million preference share offering in 2011.

Although many investors viewed perpetual preference shares as bond-like instruments no different from perps, the CPF board considers preference shares as shares rather than bonds, so the requirement that CPF-qualified bonds must be rated at least A2 by Moody's or A by S&P or Fitch did not apply.

On the other hand, Hyflux's unrated perps issued later in 2016 did not qualify as CPF-investable.

In its assessments, the CPF board does not conduct independent checks on an issuer's financial health. But as a blanket safeguard, no more than 35 per cent of one's CPF funds can be invested in shares, property funds or corporate bonds, a CPF spokesman said.

Another little-known detail about how Hyflux's preference shares differ from its perps is that pref shareholders lack an appointed trustee to represent their interests as a group.

Towards a more discerning market

Indeed, gaps in investor education need to be addressed. Most observers agree that banks should crack the whip on better information disclosures to aid that learning process.

Lim Sin Teck, partner at Morgan Lewis, flags that due diligence and disclosure standards in the international high-yield market are more robust than here: "Right now we're seeing a whole range of standards in disclosure in the Singapore market.

"For example, we don't typically see detailed descriptions of an issuer's existing loans, whereas that is common in the US dollar high-yield bond market - one to two paragraphs on each material loan."

Information like that helps bond investors and their relationship managers understand the main terms of loans that, in many instances, rank ahead of the bonds which are unsecured.

After the outcry in 2016, when it emerged that many accredited investors had been sold junk bonds without fully understanding the risks involved, the Monetary Authority of Singapore suggested that issuers should disclose key financial metrics, such as their interest coverage ratios, more clearly to investors.

Asked if DBS Bank, the biggest bookrunner here, has taken steps to improve disclosures during the bond IPO process since then, Clifford Lee, head of fixed income at DBS, tells BT: "DBS has consistently through the years, applied best practice disclosure standards used in international offerings for its bond deals across markets, including the Singdollar bond market.

"This entails making applicable business and risks disclosures in offering documents, together with financial disclosures from audited and/or reviewed financials."

Conditions are ripe for change. Today, as interest rate hikes become obvious, investors are no longer bidding aggressively for bonds on the basis of headline yield alone.

In the international markets, many "fixed-for-life" perpetuals - which let issuers borrow at a fixed rate that never increases throughout their life thus creating no incentive for them to call - trade below par now despite being over-subscribed at issuance as recently as last year.

In Singapore, the high-yield market has been thrown into limbo. The last high-yield issuance through the door was GSH Corp's listing of S$50 million, 5.15 per cent notes on May 3. Issuers such as Perennial Real Estate have shelved plans to retap the market.

Broadly, total new issuance volumes across the entire Singdollar corporate bond market are down close to 40 per cent from the same period last year, according to DBS.

In the past, the era of cheap money diminished bond investors' clout, making it nearly impossible to negotiate better terms and protective clauses during the book-building process.

Now, a more nervous market and the gradual awakening of investors who have had their first brush with credit stress could help improve the health of the high-yield market.

Simon Jong, head of fixed income research at DBS Bank, says: "Bond holders have become more discerning, and perhaps more assertive about the stuff they want. This has led to an overall maturity of the market, greater pricing disparity across bonds and more discipline amongst investors."

Other observers have suggested that activist bond funds, absent here, could be a good countervailing force to make sure that Singapore companies don't over-stretch themselves as they lever up to grow.

Meanwhile, painful as they may be, defaults are a necessary part of the process as Singapore's corporate bond market matures.

Mr Lee explains: "While the bankruptcy laws in Singapore are clear and the legal system is well trusted, our economy is still relatively new. As such, there is also less default history and recovery data in the event of liquidation. This situation, combined with the fact that the public debt market here is still not as developed and deep, makes the valuation and trading of distressed debt more difficult."

He adds: "It is normal for the Singdollar market to be less developed for high-yield issuers, because even in the US dollar bond market, the last segment of the bond market to develop was the high-yield bond market."

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