Bad Calls Hurt Junk Borrowers In a Once Hot Emerging Market
(Wall Street Journal) -- Indonesian companies are struggling with a weak currency and poorly hedged dollar debts - hurting investors in Southeast Asia’s largest economy, which was until recently a hot destination for emerging markets specialists.
The strain is another illustration of how a stronger dollar and higher U.S. borrowing costs are hitting poorer nations. The moves have boosted the appeal of relatively safe U.S. assets, threatening what had been a reliable source of funding for countries like South Africa and Argentina.
Foreign investors had flocked to Indonesian junk bonds in recent years, wooed by juicy yields and robust economic growth. Outside of mainland China, Hong Kong and Japan, Indonesian companies are Asia’s biggest issuers of below investment-grade bonds, with nearly $33 billion outstanding, according to data from Thomson Reuters.
The rupiah’s more than 8% slide in 2018, however, has pressured companies with dollar debts. Earlier this month the currency touched its lowest against the greenback since the Asian financial crisis.
“Currency is the biggest threat we are facing,” in Indonesia, said Nate Weisshaar, portfolio manager and senior analyst at Motley Fool Asset Management. He said the country was “an opportunity in the long term but our approach is very skeptical now” .
Indonesia’s central bank has required most companies to hedge some currency exposure since 2015, after an earlier bout of rapid depreciation. However, many firms economize by using a combination of options. These are derivatives that give the holder the right, but not the obligation, to buy a currency, a bond, or another instrument at a certain price and by a certain time.
Indonesian borrowers would typically both buy and sell options, using a strategy known as a call spread. This way, hedging costs might only total 1.5% to 3% of the debt protected, compared to roughly 4.5% for other kinds of hedges, traders and analysts said.
In this system, a bond issuer might buy call options to purchase dollars at a rate of 12,000 rupiah, for example, and offset the cost by selling call options at, say, 14,000 rupiah per dollar.
That locks in an exchange rate for repaying the bond or meeting interest payments. But the second part of the trade means the company is only fully protected until the rupiah weakens to 14,000 per dollar. Because it has agreed to sell dollars at this rate, it is not protected against any further weakness. This plan has not worked out in a year of dramatic currency moves.
Companies whose hedges have fallen short, and which make most of their sales domestically will now have a tougher time servicing hard-currency borrowings. They can buy new hedges, but at an additional cost. If investors remain wary of riskier emerging market debt, these enterprises could also struggle to issue new dollar bonds, leaving them dependent on higher-cost local debt.
Property developers are among those that have sold international debt and employed call spreads, entering derivative deals with Deutsche Bank , JPMorgan , Morgan Stanley , Nomura, and other international banks.
Billionaire tycoon Mochtar Riady’s Lippo Group, one of Indonesia’s biggest conglomerates, is among those caught out. Its property development unit, Lippo Karawaci , has borrowed largely in dollars—but most of its hedges only protected it against the rupiah weakening to 14,500 per dollar, which happened last month. One dollar bought 14,816 rupiah recently.
Similarly, fellow property developer Alam Sutera Realty ’s safeguards won’t offer more protection if the rupiah weakens beyond 15,000 to the dollar, its latest earnings report shows. Lippo Group declined to comment. Alam Sutera did not respond to requests for comment.
Many other companies will be exposed if the rupiah passes 15,500, market participants said.
The stresses are reflected in a steeper selloﬀ than the wider credit market. The yield on an index of Indonesian corporate junk bonds in dollars has topped 8.2%, up from roughly 4.8% at the end of last year. Yields on a broad gauge of emerging market debt are roughly 7.8%, up from about 5.9% at the end of 2017, ICE Bank of America Merrill Lynch indexes shows.
“The market has a tendency to paint Indonesian companies with a broad brush whenever the rupiah weakens,” said Paul Lukaszewski, head of Asian corporate debt at Aberdeen Standard Investments - although he said currency risks vary markedly from business to business.
Most Indonesian dollar debt isn’t due until 2020, giving borrowers some breathing room. Nonetheless, a spate of postponed deals shows how much market sentiment has worsened, fueled by global investors’ hesitation to jump into emerging markets right now.
In April, Alam Sutera hired bankers for a dollar deal that never happened. Last month, fellow developer Intiland Development pulled a bond issue citing tough market conditions, despite oﬀering a yield of 11.5%. And power producer DSSP Power Sumsel hasn’t been able to launch a deal due to lack of investor demand.
“Companies will find it very difficult now to access the dollar market,” said Trung Nguyen, a senior analyst at Lucror Analytics.
Sept. 23, 2018 2:00 p.m. ET
By Manju Dalal and Saumya Vaishampayan