K bank capital market perspectives jun 22 opportunities to hedge borrowing costs


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K bank capital market perspectives jun 22 opportunities to hedge borrowing costs

  1. 1. KBank Capital Market Perspectives Market Updates Macro / FX / Rates Opportunity for to hedge borrowing costs 24 June 2011Overview:Since May, the interest rate swap (IRS) rates had declined steadily, causing thespread between bond yields and the IRS rates to narrow significantly. While many Nalin Chutchotitham - Kasikornbank nalin.c@kasikornbank.comforces are at play, the most prominent one comes from the falling of swap pointsor forward points. In our view, this is a good opportunity to fix borrowing costs.Given that the policy rate remained on the up-trend and the inflation rate is unlikelyto fall from 4.0% in the second half of this year, we expect interest rates togradually rise going forward. In fact, bond yields had picked up significantly thisweek, by 12-17bp from levels on June 17th. Investors are deemed to be aware of apossible policy rate hike on July 13th and selling bonds ahead of Q4/FY2011 bondsupply announcement next week. IRS yields could follow suit but they hadremained rather stable, offering opportunities to hedge costs.Factors at play: 1. As Greece’s debt crisis heightens, the financial markets began to raise awareness about possible shortage of USD liquidity. This causes commercial banks to avoid swapping out dollars (sell-buy USD/THB) i.e. hoard dollars on hand. At the same time, they engage in short-term swapping-in of the dollars (buy-sell USD/THB) to ensure adequate supply of U.S. dollar on hand. In sum, these trades reduce the USD/THB swap point or the THB forward premium. 2. Recent weakness in the Thai baht, especially against the U.S. dollar, reduces the need for aggressive FX intervention by the Bank of Thailand (BoT). Hence, the demand for sell-buy USD/THB from the BoT has also subsided in recent trade and offer less support for the swap points to climb higher. 3. Local mutual funds had been increasing investment in the offshore renminbi deposits (CNH) and other emerging markets e.g. Middle-Eastern markets. Such investments (called Dimsum funds for those involving CNH) allow for yield enhancement over the returns on short-term local debt securities. Commercial banks that engage in asset swaps with the funds would find their U.S. dollar on hands reducing, and may have to buy-sell USD/THB in the short-run whenever there is a concern for the availability of USD in the market. Once again, the latter trade helps to drive down swap rates. * We provide further details and explanations on the next pagesBond-swap spreads Interest rate swap rates bps % 120 5.0 100 4.5 80 4.0 60 3.5 40 3.0 20 2.5 0 2.0 -20 -40 1.5 -60 1.0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 2Y bond-swap spread 5Y bond-swap spread Policy rate 2Y 5Y 10YSource: Bloomberg, KBank Source: Bloomberg, KBank111
  2. 2. Comparing costs of borrowing: government, banks and Comparing costs of borrowing: government, banks andcorporate – 2Y corporate – 5Y % % 4.5 5.0 4.0 4.5 3.5 4.0 3.0 3.5 2.5 3.0 2.0 2.5 1.5 2.0 1.0 1.5 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Govt Bond 2Y IRS 2Y AA rating corporate bond 2Y Bond 5Y IRS 5Y AA rating corporate bond 5YSource: Bloomberg, KBank (ThaiBMA reported that more than 80% of the outstanding Source: Bloomberg, KBank, (ThaiBMA reported that more than 80% of the outstandingcorporate bonds in Thailand are rated in the “A” category) corporate bonds in Thailand are rated in the “A” category)Comparing the THB/THB interest rate swap curve Headline and core inflation rates % 4.5 10% 4.0 8% 6% 3.5 4% 3.0 2% 0% 2.5 24-Jun-11 -2% 2.0 1-month ago -4% 3-month ago tenor -6% 1.5 05 06 07 08 09 10 11 1W 1M 2M 3M 6M 9M 1Y 2Y 3Y 4Y 5Y 7Y 10Y 12Y 15Y CPI yoy Core CPI yoySource: Bloomberg, KBank Source: Bloomberg, KBankBackground/explanations:1. In expectation of higher inflationary pressure and policy rate hikes, local commercialbanks had been betting on higher implied THB rates. They reflect this view by bidding upthe forward points or swap points, leading to higher THBFIX rates, which in turn, pushedup IRS rates. There is no problem with such trades in normal market conditions. (pleasesee formula for THB fixing rates below)However, whenever there are major events with negative impact on the willingness ofbanks to lend or provide USD liquidity, such as the collapse of Lehman Brothers’ in 2008and the Dubai World’s insolvency in 2010, implied THB rates could reverse trend rapidly.Commercial banks with substantial long positions in the USD/THB FX swap had to offsetsuch positions via shorter-tenor USD/THB FX swaps in the opposite direction. At present,the Greece debt crisis is playing the role of such a negative trigger and swap points hadfallen substantially, reflecting reduced forward premium in the THB. Thomson Reuters calculation methodology for THB interest rate fixing THBFIX = ( { ( [1+(Fwd/Spot)] x [1+(Sibor x Days/360)] ) -1} x 365/Days)x100 Note – The formula above is derived from an economic concept called the interest rate parity condition. It states that, under no- arbitrage condition, (1 + i$) = (F/S)(1+ ic) where i$ and ic are the interest rates of two countries and F and S are the forward and spot exchange rates between them. Such a condition says that returns for depositing money in either currency would not be different, given the stated foreign exchange rates and interest rates.222
  3. 3. Further explanation - Commercial banks had been buying USD/THB FX swaps (Sell-Buy) due to expectation of continued policy rate hike and relatively stable U.S. interest rates. Such trades induced a higher forward premium in the THB, and swap points continued to climb. Banks usually fund such trades, usually done for long-tenor FX swaps such as 3m - 12m, with shorter-tenor swaps on the reverse side (Buy-Sell). When the swap point curve is steep, such trades are profitable for the banks going long (implied yield on THB increases with higher forward premium). Now, the counter-party for the Buy-Sell had predominantly been the Bank of Thailand and when the central bank reduces their FX swap volume, the swap points usually collapsed. This occurs from time to time when the central bank sees less need of FX intervention and commercial banks’ profits from such trades fall as a result.Fixing rates curve THBFIX rates 1m and 6m % THB fixing rates and IRS % 3.5 3.50 3.0 3.30 2.5 2.0 3.10 1.5 2.90 1.0 0.5 2.70 0.0 2.50 -0.5 1Wk 1M 2M 3M 6M 9M 1Y IRS 1Y IRS 2Y Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 current 5-day ago 1-m ago THBFIX1M THBFIX6MSource: Bloomberg, KBank Source: Bloomberg, KBank2. The Bank of Thailand seemed to have reduced their Sell-Buy USD/THB transactionsduring the past few weeks. This is mainly because of the depreciation of Thai bahtagainst many currencies during the same period or relatively high volume of Sell-BuyUSD/THB in earlier periods, especially in March and April. Due to the need for FXintervention, the BoT is the primary player in sell-buy USD/THB trades, and their absencecould cause swap points to suddenly slump.BoT’s forward positions and foreign reserves USD/THB rebounded in recent weeks USD bn Cumulative change since Jan 2010 USD bn 31.20 10 70 8 60 31.00 6 50 30.80 4 40 30.60 2 30 30.40 0 20 30.20 -2 10 30.00 -4 0 -6 -10 29.80 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 1-Jan 1-Feb 1-Mar 1-Apr 1-May 1-Jun BoTs forward positive (left) Foreign reserves (right) USD/THBSource: Bloomberg, KBank Source: Bloomberg, KBank333
  4. 4. Further explanation – The BoT buys the U.S. dollar and sells Thai baht in the market to weaken the baht’s strength in periods when rapid appreciation of the baht (trade in the opposite direction has also been done). This is called FX intervention and it could prevent smooth out some volatility in the market and allow time for exporters and importers to adjust. There are two primary channels in which the BoT manages Thai baht liquidity in the market after FX intervention. The first is to issue BoT bonds and bills while the second is to Sell-Buy USD/THB. The effect of the second channel allows the BoT to both release excess USD in their holding (and return USD liquidity to the market) and reduces Thai baht in the market.3. Recalling the asset swap trades involving the Korean bond funds, investment inCNH deposits and other emerging market’s deposits are all based on similarprinciple. Local asset management companies (AMCs) seek out opportunities for yieldenhancement over the relatively low yields of local government treasury bills and centralbank yields by swapping out THB funds for foreign assets. In certain periods, marketconditions are such that asset swap trades could provide very attractive investmentreturns. Hence, AMCs would engage in more of such investments and the resultingimpact on the market is that commercial banks’ position would be biased towards one-sided trade, which is sell-buy USD/THB.To clarify further, the deposit rates in CNH are not particularly high. In fact, they are low;1-year deposit rate at 0.8-1.50%, depending on the demand of CNH deposits and loans.Nevertheless, the USD/CNH cross-currency swap curve (CCS) in recent months shows adeep forward discount in the CNH, despite that fact that interest rates in China are higherthan that of the U.S. (which violates that interest rate parity condition). The reason for thisis that the market expects continued appreciation of the renminbi i.e. spot USD/CNY andspot USD/CNH are likely to decline much lower from current levels. Further explanation – Commercial banks’ asset swaps with AMCs is usually done for 6-month to 1-year tenors. Banks provide USD to the AMCs by having to buy-sell USD/THB in the interbank market but using short-tenor trades, which are usually more liquid. As a result of maturity mismatch, commercial banks have to carefully manage their demand and supply of U.S. dollar carefully. In situations when banks are concerned with USD liquidity in the market, they would seek to maintain sufficient USD on hand, accelerating the buy-sell USD/THB trades and pressured the swap points lower. In serious shortage of the USD, the implied interest rates on THB (i.e. THBFIX) could be much lower than the local money market rates.Offshore yuan deposit rate vs. 1-year swap implied yield Approximate return on CNH/THB asset swap % % 2.5 9 1Y Thai bond yield 2 8 Approx. return on CNH/THB asset swap 1.5 7 Approx. return on KRW/THB asset swap 1 6 0.5 5 0 4 -0.5 3 -1 2 -1.5 1 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 0 1Y CNH deposit rate 1Y USD/CNH CCS implied yield Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11Source: Bloomberg, KBank Source: Bloomberg, KBank444
  5. 5. In any case, we do not expect that the rise in CNH deposit investment to cause much of aproblem going forward. The large amounts of Korean bond funds maturing in June andduring the rest of the year would help to provide USD liquidity to the market. At the sametime, the rollover of investment funds are likely to be much smaller compared to the sizeof the funds flowing back home. Retail investors are also reallocating their savings intolocal time deposit accounts and local money market funds as deposit rates begun to pickup. Moreover, the levels of USD libor and sibor show that there is no big concern for USDliquidity. The lower swap points in the FX swap is trading lower only because of localbanks’ position and is only suggesting of an increased in awareness of the possibleliquidity problem due to Greece’s debt crisis. Hence, we do not think that the condition oflow IRS rates would remain for a long period of time.THBFIX6m – overnight repo rate Fig 8. USD Libor rates bps % Lehman brothers fall 2.0 150 Dubai World 1.8 debt crisis local USD 100 1.6 liquidity 1.4 50 shortage 1.2 0 1.0 0.8 -50 0.6 -100 0.4 0.2 -150 0.0 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Difference between 6m THBFIX and policy rate Libor 3m Libor 6m Fed funds rateSource: Bloomberg, KBank Source: Bloomberg, KBank555
  6. 6. Table 1. Monthly Key Economic Indicators Oct 10 Nov 10 Dec 10 Jan-11 Feb-11 Mar 11 Apr 11 May 11Manufacturing index (ISIC) 188.0 189.1 189.9 192.9 188.7 187.0 180.8 % YoY 6.0 5.7 -3.4 4.1 -3.0 -6.7 -7.8Industrial capacity utilization rate (%) (ISIC) 63.9 63.6 62.4 62.3 59.5 66.1 54.6Retail sales (% YoY) 5.3 8.1 7.8 9.3 8.6 3.9 n.a.Total vehicle sales (units) 72,012 78,874 93,122 68,398 77,213 93,008 67,283Motorcycle sales (units) 143,791 152,767 167,707 165,152 188,248 191,437 174,244Unemployed labor force (000 persons) 355 389 268 374 268 276 n.a.Unemployment rate (%) 0.9 1.0 0.7 1.0 0.7 0.7 n.a.Consumer prices (% YoY) 2.8 2.8 3.0 3.0 2.9 3.1 4.0 4.2 core 1.1 1.1 1.4 1.3 1.5 1.6 2.1 2.5Producer prices (% YoY) 10.0 7.1 4.7 6.0 7.4 5.9 6.6 6.2External Accounts (USD mn, unless specified otherwise)Exports 17,046.0 17,584.0 17,220.0 16,523.0 18,406.0 21,072.0 17,243.0 % YoY 16.6 28.7 18.6 21.4 29.1 31.0 24.7Imports 14,773.0 17,094.0 15,911.0 17,111.0 16,375.0 19,180.0 17,720.0 % YoY 14.4 35.0 8.8 31.2 18.6 27.2 26.3Trade balance 2,273.0 490.0 1,309.0 -588.0 2,031.0 1,892.0 -477.0Tourist arrivals (000) 1,360 1,500 1,840 1,810 1,822 1,765 1,498 % YoY 6.3 10.3 9.5 12.8 12.8 22.7 35.2Current account balance 2,740.0 1,019.0 1,750.0 1,090.0 3,823.0 1,881.0 -165.0Balance of payments 5,822 820 2,263 1,689 4,271 1,365 3,570FX reserves (USD bn) 171.1 168.0 172.1 174.0 179.5 181.6 189.9Forward position (USD bn) 12.6 15.1 19.6 19.3 17.9 21.0 21.4Monetary conditions (THB bn, unless specified otherwise)M1 1,202.3 1,235.4 1,302.4 1,326.2 1,346.4 1,345.6 1,347.6 % YoY 11.4 10.8 10.9 15.5 13.4 13.8 14.0M2 11,323.3 11,497.6 11,776.4 11,817.2 12,152.9 12,280.3 12,469.3 % YoY 11.2 11.1 10.9 11.5 13.7 13.1 15.1Bank deposits 10,206.0 10,387.9 10,584.9 10,606.3 10,834.2 10,891.3 10,964.4 % YoY 8.5 8.1 8.7 8.8 10.3 9.0 9.9Bank loans 9,580.3 9,751.1 9,947.0 10,064.5 10,209.7 10,308.2 10,375.0 % YoY 12.1 12.3 12.6 14.5 15.1 14.9 15.3Interest rates (% month end)BOT 1 day repo (target) 1.75 1.75 2.00 2.25 2.25 2.50 2.75 2.75Average large banks minimum lending rate 6.00 6.00 6.12 6.37 6.37 6.62 6.75 6.75Average large banks 1 year deposit rate 1.11 1.11 1.32 1.51 1.51 1.67 1.86 1.86Govt bond yield 1yr 1.98 2.11 2.38 2.54 2.68 2.83 3.00 3.15Govt bond yield 5yr 2.83 2.98 3.26 3.40 3.48 3.41 3.38 3.50Govt bond yield 10yr 3.18 3.59 3.77 3.85 3.89 3.75 3.70 3.79Key FX (month end)DXY US dollar index 77.27 81.20 79.03 77.74 76.89 75.86 72.93 74.64USD/THB 29.94 30.21 30.06 30.93 30.60 30.28 29.88 30.32JPY/THB 37.18 36.11 37.01 37.60 37.47 36.42 36.80 37.17EUR/THB 41.76 39.22 40.23 42.35 42.25 42.86 44.24 43.64Source: Bloomberg666
  7. 7. Disclaimer For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained herein. Further information on the securities referred to herein may be obtained upon request.777