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Asian credit risk not as bad as it looks

HONG KONG: Asian credit risk is at its worst level in nearly six months -- or is it?

Bond spreads against U.S. Treasuries have blown out to their widest levels since November, suggesting that investors are growing pessimistic about Asian risk despite the region posting economic indicators depicting robust, accelerating recovery.

In fact the region's supposedly sick risk profile is nothing to do with Asian fundamentals at all, analysts say.

"Effectively, Asian risk is being held hostage by U.S. fundamentals," John Woods, head of research at HSBC Markets in Hong Kong, told Reuters Television.

"Ultimately it boils down to a budget surplus in the U.S. which has triggered a supply reduction and a debt buy-back programme," Woods said.

The U.S. government has said it will buy back as much as $30 billion of its outstanding 30-year bonds, sending prices up and yields down and widening the benchmark spread to other credits.

Add to this the recent global equity market volatility and investors' flight to high-quality, low-risk U.S. Treasury bonds that has sent yields to new lows and the widening spread gap is explained.

But the volatility in spreads and the skewed image they give of Asian risk has a damaging effect on even the best-quality borrowers in the region, forcing them to pay a higher price for capital despite their improving fundamentals.

"There is a very good argument to be had in the market place about whether we should be establishing new benchmarks other than Treasuries (to measure risk)," Michael Dee, head of debt capital markets at Morgan Stanley in Hong Kong, told Reuters.

Dee led the team which placed $500 million in Aa3/A-minus rated 10-year bonds for Singapore's DBS Bank DBSM last week.

Taking the conventional benchmark, DBS issued at 216.5 basis points over comparable Treasuries -- 16.5 basis points more than it paid when it issued $750 million in 10-year bonds in August.

But DBS swapped the notes into floating-rate debt to give a measure against the London Interbank Offered Rate (Libor) which was 10 basis points below last year's offering, despite Asia's apparently worsening credit profile.

Morgan Stanley marketed the deal to be priced against Libor rather than Treasuries and plans more of the same, given that Dee sees a better correlation of Asian and other corporate credits to swaps rates rather than Treasuries.

"A lot of high-quality borrowers are very highly correlated to swap spreads. For example, U.S. government agencies trade with a 95 percent correlation to swap spreads," Dee said.

"What drives the spread to Treasuries is the spread to Libor I believe that's particularly important for those borrowers that ultimately raise floating-rate funding," Dee said.

Merrill Lynch analysts said in their March fixed-income strategy report that Asian credits saw spreads against swaps tighten to their best level in two years at the same time as spreads against Treasuries were ballooning, adding that swaps may be a more accurate proxy for measuring Asian risk.

But not everyone is convinced that short-term volatility in Treasuries is sufficient reason to abandon the old benchmark, even if a measure against Libor is a logical pricing metric for financial institutions and some large corporates.

"A benchmark is a benchmark. It should survive a good day, it should survive a bad day," Raja Visweswaran, head of Asia securities research at Bank of America in Hong Kong.

"Yes it is very volatile -- a lot more volatile than it has been in the recent past -- but is that a reason to change it? Do you go and change a stock index just because it changes by 100 points in a day? I don't think so," he added.

Even with the cut in long bond supply, Visweswaran says there is ample liquidity to price other securities from Treasuries.

And given the volatility, HSBC's Woods says Asian bonds have become a better value investment, particularly the region's more liquid bonds, like South Korean sovereign paper due 2008 which has seen its spread move out in recent weeks.

"I suspect they have potential to move out further. But Korea's upgrade potential and a move to the triple-B-plus area by the third quarter or fourth quarter of this year suggests an improving underlying fundamental story and relatively cheap risk at current levels," Woods said.-Reuters