Offering credit caution for corporate bond players

Thomas Kollar, partner of law firm Mayer Brown based in Hong Kong

The Ministry of Finance has repeatedly warned about a number of risks stemming from corporate bonds of some credit-challenged corporations.

In September alone, there were 42 corporate bond issuances which were carried out in a separate form to mobilise more than $1.29 billion, according to the Vietnam Bond Market Association.

The banking group continued to lead the game in terms of issuance volume with a total value of more than $600 million, of which nearly $270 million was used to increase tier-two capital of major banks such as BIDV, Vietinbank, VIB, and MB.

Real estate ranked second in private issuance value at over $365 million, of which about 11 per cent of bonds were either secured by stocks or unsecured. The issuance interest rate of this group is relatively high compared to market average, from 9.5 per cent to 12 per cent per year and the common tenor is generally 1-5 years.

In the first nine months of the year, the market recorded nearly 600 issuances. Over 580 of these are private placements to raise around $15.2 billion; 14 issuances to the public raised nearly $522 million; and three issuances to the international market with a total value of nearly $1 billion.

From historical data, banks and property providers have long made up the majority on corporate bond market due to various reasons.

Banks and real estate developers are involved in vastly different businesses that are regulated at opposite ends of the spectrum. However, one trait that both businesses share is a continued demand for capital, and issuing corporate bonds enables them to raise that capital.

Banks are strictly regulated by the State Bank of Vietnam (SBV) and subject to periodic reporting, including strict prudential ratio requirements. So, the banking system has the infrastructure in place to avoid over-leverage.

Real estate developers, however, are not regulated and, therefore, they could find themselves over-extended in certain circumstances. Bond covenants for credit-challenged issuers could be very strict, effectively limiting the activities of an issuer and its ability to operate freely. Sometimes issuers in these circumstance cannot operate and grow their business effectively and could ultimately face liquidity pressures.

However, there are significant risks for issuers of corporate bonds, including over-leverage and failure to comply with covenants or other obligations under the bonds that would trigger defaults and potential insolvency of the issuer. If these defaults occur on a large scale, it can result in a systemic shock as investors will ultimately bear these losses.

There appears to be strong liquidity in the market at attractive yields, which promotes bond activity and issuance. Bonds present banks with a vehicle to raise tier-two capital and meet their prudential ratio requirements to stay within regulated stability requirements at a lower cost (and with ceding less management control) than through issuing equity.

Foreign ownership limits of equity in banks – generally 30 per cent – also impact banks’ ability to raise capital through equity issuances. These tier-two capital bonds can be issued either locally in VND or on the international markets.

Real estate developers that are looking to build up land banks or invest in early stage projects are in continual need of capital. Bonds provide real estate developers access to relatively low-cost funding, and whilst credit-challenged issuers may face strict covenants and restrictions on their business activities, these may be less restrictive than the conditions that commercial banks are customarily willing to offer, given the banks’ requirements to meet prudential ratios and single customer limits. Even in other countries, such as China, corporate bonds defaulting from large corporations have been wreaking havoc on the financial market.

In Vietnam, it is important to have a high-quality disclosure regime in place so that the bond prospectus gives investors all of the information they need about the issuer and related risks in investing in the bonds. In order to develop a proper disclosure regime, the cooperation of the relevant actors – including the State Securities Commission, the SBV, securities firms, law firms, and the issuers themselves – is critical from both the legal and commercial perspective.