CDS rate higher but capped but investors unlikely to trim bond holdings


  • Business
  • Monday, 20 Jul 2015

Fong: ‘Foreign participation in the MGS market has remained resilient.’

PETALING JAYA: The cost of insuring Malaysian bonds through credit default swaps (CDS) has increased from a year ago but is unlikely to reach the 200 mark last seen in 2011, according to analysts and economists.

As such, the current high cost of insuring Malaysian bonds that are denominated in foreign currency, especially in US dollars, would unlikely see investors trimming their bond holdings and any spike upwards in CDS rates would only be a knee-jerk reaction to uncertainties, they added.

According to Reuters, the CDS of the 10-year Malaysian government securities (MGS) stood at 176.76 bps in July 13 from 132.59 almost a year ago. Since January to date, the CDS for the 10-year MGS has been hovering between the 160 and 190 mark.

CDS are contracts entered between a seller and a buyer to reduce the default risk on a bond. CDS spreads are one way for the market to rate creditworthiness. Widening spreads suggest increasing risk and narrowing spreads indicate the perceived risk of default is falling.

Commenting on the high cost of insuring the country’s debt, RAM Ratings economist Kristina Fong told StarBiz CDS levels continued to be elevated as domestic uncertainties remain in the forefront for foreign investors.

“Similar highs were experienced in the earlier part of the year when foreign investor sentiment shifted on news that there was a possibility of a sovereign rating downgrade for Malaysia. That said, after initial knee-jerk reactions to these developments passed, CDS levels reverted to close to 160-170 levels.

“Although foreign investor sentiment remain relatively volatile on the back of uncertainties prevalent in both domestic and global context, foreign participation in the MGS market has remained resilient,’’ she said.

In June, Fong said foreign holdings of MGS increased on both a month-on-month and year-on-year basis by 5.5% and 13.3% respectively. This indicates that fundamental long-term investment demand remains a key driver for investment decisions which weigh in a more structural assessment of market risks and prospects,’’ she said in an email reply.

The rating agency projects gross issuance of MGS and private debt securities (PDS) to remain at RM100bil-RM105bil and RM75bil-85bil respectively.

CIMB Group head of treasury and markets Chu Kok Wei said CDS market is primarily an off shore market, mainly in US dollar denominated obligations of a particular entity. He does not foresee Malaysia’s bond CDS level would widen up to the 200 points region given the relatively benign global credit spreads.

Furthermore, Chu said the CDS levels are driven by investors, which include foreign banks, asset managers and hedge funds and their fundamental views on Malaysia and overall market sentiment. One major driver of spreads is the overall risk sentiment of market participants, whether they are in a “risk on” or “risk off” mode.

A good example of the “risk off” episode was seen during the second half of 2011 due to the European sovereign crisis, he said. During this period, the increase in Malaysia’s CDS towards 200 bps was accompanied by a similar rise in the CDS levels for other Asian sovereigns like China and Thailand.

These moves did not reflect any change in the fundamental default risk of these countries but rather reflected the markets’ risk averse behaviour of buying CDS protection during periods of market stress, Chu said. As comparison, he said, during this same “risk off” period, the yield on 10-year MGS dropped from 4.00% to 3.70%.

Since the end of last year, he said the rise in Malaysia’s CDS level had been driven by various factors like the drop in oil prices, the depreciation of the ringgit and the anticipation of a ratings downgrade by Fitch (which did not materialise). The rise in spreads was a result of market participants’ actions of buying protection to hedging against their US dollar bond holdings as well as tactical trading positioning in anticipation of wider CDS levels.

“We expect the CDS level to tighten in the medium term as a reflection of the low sovereign default risk of Malaysia,” Chu said.

OCBC Bank (M) Bhd head of global treasury Ng Seow Pang said after Fitch Ratings upgraded the county’s outlook from negative to neutral, the CDS was relatively unchanged. “Any increase in cost can be expected to be driven by sentiment and not fundamentals given the present issues the country is dealing with. There are no particular levels toward which we see the CDS rising. Any upward movement should not be viewed as sustainable as it would not be reflective of fundamentals.”

Malaysian Rating Corp Bhd chief economist Nor Zahidi Alias said he did not expect the CDS spread to increase significantly in the near term as there was more stability in oil prices and Malaysia’s credit rating.

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