The SGD corporate credit market in 1H2022 has offered relative shelter. Total returns of SGD credit related indices and funds are higher than Asia (Ex-Japan) bonds in general. The amount of SGD issuances has also held up better, increasing around 6% y-o-y to $11.7 billion, while Asiadollar volumes fell around 40% y-o-y.
However, this relative strength is being tested as existing issues are repriced by new issuances that come in at higher yields, wider spreads and larger new issue concessions. Unlike previous years where investors sought longer-dated bonds and perpetuals in a hunt for yield, the tone has become defensive, with an increased number of issuances with shorter maturities.
Today’s environment is significantly more challenging than that of the past decade. Aside from slowing global economic growth and geopolitical risks, inflation rates have shot up to multi-decade highs. For the credit market, the rapidly rising rates, which depresses bond prices, have resulted in total returns turning negative, even in nominal terms, across most papers regardless of tenor and credit profile. Despite already better-positioning within subordinated and cross-over papers, our model portfolio recorded its first half-year loss of 0.69%.
Credit fundamentals remain sound
While prices of fixed income securities have been under pressure, credit fundamentals of industries under our coverage remain stable, including that of financial institutions, REITs and property companies.
For financial institutions, the rise in interest rates is a double-edged sword. Benefits from expansion of net interest income from the rise in interest rates are being offset by potentially reduced credit demand and concerns of loan quality/performance. Rising rates also impact asset valuations that caused mark-to-market losses to the tune of billions at several financial institutions.
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That said, the credit profiles of financial institutions should remain stable, as they typically enjoy strong domestic market positions and diversified businesses. Regulators provided further affirmation as they found financial institutions able to withstand current and stressed operating conditions, including a severe recession. Financial institutions have also maintained capital positions that remain above the minimum requirements, which should be further augmented through the recent issuances of bank capital papers.
The credit metrics of the average REIT within our coverage remain stable, with aggregate leverage kept below 45% (average: 37.6%) while interest coverage remains manageable at 4.3x, which should provide a buffer against rises in interest rates. In any case, the average REIT is moderately hedged against rate movement with over 70% of the debt fixed. Meanwhile, the operating outlook for REITs, depending on sub-segment, should remain stable to positive.
The sub-segments with the most positive outlook would be retail and hospitality, which benefit from the lifting of pandemic-related restrictions and reopening of borders. According to the Singapore Department of Statistics, May retail sales in Singapore rose by 22.6% y-o-y excluding motor vehicles, following a strong increase of 17.4% y-o-y in April 2022. We believe this is led by pent-up demand and higher tourist spend. Hospitality should also benefit from more companies allowing employees to travel internationally and domestically, with a robust pipeline of meetings, incentives, conventions and exhibitions (MICE) events.
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Meanwhile, the office and industrial sectors are expected to remain stable. While the office sector has benefited from high growth in rental rates, and to some extent should continue to benefit from the return of workers to offices, growth in rents should taper in 2H2022 as demand from previously hot sectors like technology (which contributed 39% of leasing demand in 2021) starts to fizzle. For industrial, the trajectory is similar, with rental growth expected to remain stable as supply from previously delayed projects gets added to the Singapore market.
Singapore property developers should benefit with stronger certainty to move units due to a buoyant market. We expect private residential prices to rise by 5–7% in 2022 to set another all-time high in Singapore, which we think will be driven by firm demand, dwindling supply and higher development and construction costs. Although mortgage rates have risen and may rise further, strong household balance sheets with the rise in rents should mitigate the rise in mortgage repayments.
Repositioning to be more nimble
As the credit fundamentals of SGD issuers remain largely stable, we are not overly worried over potential defaults though the focus is shifted to capital preservation given the volatility in the macroeconomic environment. As such, we shun longer-dated papers, and lower our recommendations for perpetuals and bank capital instruments to neutral while increasing our preference for crossover short-dated bonds and near-cash issues. This should reduce any mark-to-market impact while increasing the flexibility to redeploy into new issues should they be priced at even wider spreads.
Thus far, spreads are being driven wider as seen in bank capital issues and corporate perpetuals. These issues face higher non-call risks with economics coming into play, as issuers find it more expensive to issue a replacement capital or perpetual. That said, economics is not the only factor driving non-call risks, as demonstrated by Credit Suisse, which redeemed its AT1 with 7.125% distribution rate by replacing it with a new AT1 priced at 9.75%. Bottom-up selectivity should play a major role, with emphasis on issue structure and relative valuation.
This article is adapted based on the OCBC Mid-Year 2022 Credit Outlook.
Andrew Wong, Ezien Hoo, Wong Hong Wei and Toh Su-N are credit research analysts at OCBC Bank’s Global Treasury Research & Strategy
