The use of local currency (LCY) bonds will continue to grow in the financing mix of companies in Southeast Asia. But there is the possibility for more defaults due to weak corporate credit metrics and the smaller sizes of companies, which may complicate refinancing.

A study by S&P Global Ratings of 265 of the largest listed corporate bond issuers in the region, excluding financial services, says that bonds – the bulk of which are LCY bonds – account for about 35% of aggregated reported debt and have become an essential and permanent constituent of capital structures. Five years ago, bonds accounted only for about 30% of the 265 companies’ debt.

Based on Asian Development Bank data, the aggregated LCY corporate bond markets in Southeast Asia have grown steadily at about 12% annually on average in the past decade, compared with 8% average GDP growth in emerging and developing Asia during the same period.

The study notes that the 1997-1998 Asian financial crisis, the 2008-2009 global financial crisis and more recently the bumpy aftermath of the 2013 US taper tantrum have all demonstrated that foreign currency risk bites during times of macroeconomic turbulence.

“We believe this will incite companies with limited to no operating exposure to US dollars to resort increasingly to LCY bond financing,” S&P Global Ratings says. “Some countries are encouraging this trend. Indonesia, for instance, requires the use of the rupiah for domestic transactions, while seeking to improve the depth of its local capital market”.

The study notes that growth in the corporate bond market during the past decade was uneven across the region, with the less developed markets, such as Indonesia, the Philippines and Vietnam, posting strong growth in bond issuances. “The degree of development and openness of local companies, together with participation of government-related entities, primarily shape the characteristics of LCY bond markets,” says S&P Global Rating credit analyst Bertrand Jabouley.

Credit metrics suggest that credit quality in Southeast Asia has broadly stabilized in 2016 compared with the previous year. The study notes the aggregated liquidity – the ability to repay short-term debt through existing cash balances and operating cash generation – of the 265 companies appears sufficient.

Of those companies, 39 of them are highly leveraged with both an Ebitda below US$200 million and an Ebitda interest cover below 2.0x. They account for almost US$30 billion in total debt and have largely resorted to refinancing to repay their short-term debt in the past quarters. That indicates their dependence on lenders’ comfort to roll over maturities.

As such, S&P Global Ratings sees the possibility for more defaults in LCY bonds, with about 40 companies in its sample with weak credit metrics and a small size, which may complicate refinancing. It notes the most fragile companies in Southeast Asia typically have interest cover below 2.0x, leverage well above 5.0x and operations in real estate, energy, capital goods or construction.

Long-dated maturities and attractive costs have underpinned the growth of the LCY bond markets. The study says, though, the recent string of defaults has shown that such development has so far failed to result in a clear improvement in domestic debt capital markets liquidity, as measured by their depth and turnover. It adds that bond defaults may have been difficult to anticipate in Southeast Asia in light of often limited disclosure requirements or nascent regulations.

“We believe secondary trading has been historically limited in these markets, given the “buy-and-hold” behaviour of many domestic investors,” S&P Global Ratings says. “This translates into relatively wide bid-ask spreads and limitations in the volume of trades doable without affecting market prices. For instance, we believe many investors found themselves stuck with papers they could not sell on satisfactory terms in the Singapore market in 2016 after the well-publicized difficulties of a few issuers”.

S&P Global Ratings expects the LCY bond markets will continue to play an important role in supporting the resilience of the domestic economy and financial systems in Southeast Asia.

However, the transparency of these markets could remain a prevalent issue for investors at a time of macroeconomic turbulence and policy uncertainty. The scarcity of data on secondary market liquidity and trading, and sometimes limited financial disclosures from companies with bonds outstanding or nascent sophistication from legal domestic investors more used to investing in sovereign securities could undermine issuers’ access to markets.