Fear of default in corporate bonds

The report by McKinsey in August 2019, “Signs of stress: Is Asia heading towards a debt crisis?”, focused on credit of institutions and individuals in some countries in Asia having reached dangerous levels.

Illustrative photo.

Illustrative photo.

While many companies in Asia have been very near the point where they have been unable to pay their periodic interest, many households in Australia and Korea remain trapped in high debt. What is the situation in Vietnam?

International market

About 35% of companies in China and 40% companies in India have reported an interest coverage ratio below 1.5. People may ask, why is 1.5 level a threshold? It is because if the interest coverage ratio falls below this level, big proportion of profit of the companies will be used for paying interest. Furthermore, if company profits fall by 20%, that profit will be just enough to cover the interest.

Companies’ debt default may be the first stage of a looming larger financial crisis. This topic is being discussed since the end of 2017 in many countries. The creative usage of many types of bond issuance and the support of non-bank institutions have caused the default risk to increase in many companies, not only in Asia, but also all over the world.

According to the Bank of International Settlements (BIS), many low credit rating companies in US and UK are currently at high risk level of debt. This condition looks similar to what happened in sub-loan market in USA in 2007.

Some companies, which had high risk, were able to issue bonds (junk bonds) at not-too-high interest rate because of their talent in manipulating financial tools and legal loopholes. The success in issuing bonds of these companies also contributed, by support of non-bank institutions which are not strictly governed by governments. There may be a wrong credit risk valuation when high risk companies are still successful in borrowing more funds.

What about the Vietnamese market?

Vietnam’s bond market has grown strongly over the last two years. However, Vuong Dinh Hue, Vice Minister of Vietnam, recently said if Vietnam does not manage well the corporate bond issuing activities, there will be huge risk for credit market and macro issues.

The most notable issue that many experts are concerned about is bond issuance activities of real estate companies. According to data of State Securities Commission, about VND 60,000bn of corporate bonds have been issued since beginning of this year. However, according to MBS this number was about VND 70,000bn, in which one third of this amount was of real estate companies.

In the article “Be careful with real estate bonds” by Luu Thuy of Sai Gon Investment, the three issues that have remained in bonds of real estate companies are: (1) high interest rate; (2) lack of credit rating; (3) hard to do credit rating because of unclear financial statements.

Importantly, most companies have grown fast in the last few years and are now stepping into the decelerated phase in some segments. This creates risk for bond buyers. Recently, many individual investors have invested in corporate bonds.

In the forum of real estate stock investment which was held on 30 July, Le Hoang Chau, Chairman of HoREA, said that the corporate bonds are investment products of professional institutions, however, about 7% of investors who bought corporate bonds in 6M/2019 were individuals. Are these investors informed clearly or are they able to evaluate the risk of the corporate bonds?

Tough choice

The experiences from the international markets do not help the Vietnamese market much in this case when the international corporate bond market has been distorted strongly in different forms recently. Furthermore, as mentioned above, the corporate bonds market in US or UK is still under the risk which is created from the over-development of the sub-bond market.

In order to limit the bond issuance activities of high risk companies, there should be an independent credit rating institution, more transparent information, and stricter requirements in bond issuance. The government should have a restriction to classify the bond buyers, for example, certain types of bonds should only be allowed to sell to institutional investors.

However, one should be careful if authorities set a strict requirement for bond issuing activities of real estate companies, as then they will find it hard to raise capital given the tightening of banks in lending to real estate companies. Furthermore, lack of liquidity also causes some companies to fall into freeze status and default.

The question is should authorities favor economic growth which is driven by the growth of the real estate market and its debts or a stable economic condition to maintain the systems security? There is no perfect solution for meeting these two targets simultaneously. Authorities have to trade off to reach an acceptable way.

To be well prepared for the worst case scenario, the government needs to create well in advance a solution to support the market if default in corporate bonds happens on a huge scale.

Dr. Ho Quoc Tuan, Lecturer, Bristol, UK

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