Global investor demand for Indonesian corporate paper increased substantially in 2012 and 2013 after the rating upgrade of Indonesia to investment grade early last year and investors looking for exposure in the country’s strong growth story (Indonesia’s GDP growth averaged above 6.0% over the last five years). Majority of the global bonds issued are USD-denominated and are non-investment grade due to the sovereign rating cap (Baa3/BB+/BBB-).
High yield bonds in Indonesia are typically issued through an SPV located in tax efficient jurisdictions like Singapore, Netherlands, or Cayman Islands. The bonds generally benefit from parent guarantee as well as guarantee from major operating subsidiaries, but in some instances certain key operating subsidiaries are excluded from guarantee. Investors should, therefore, carefully analyse the structure of the bond to ensure a tightly structured cash trap mechanism, which minimises chances of cash leakage. Also, given the fact that majority of the bonds issued are unsecured in nature, structural subordination and recourse to operating assets might be a concern if the bonds are loosely structured.
Covenants in the high yield bonds issued by Indonesian corporates are largely financial in nature, which restricts/ regulates the issuer’s financial activities within pre-determined limits. Generally, covenants fall into one of the following three categories:
· Affirmative Covenants: These covenants outline company requirements while the bonds are outstanding, and would include requirements such as maintenance and submission of quarterly accounts, payment of taxes, maintenance of insurance, payment of bank interest and fees, etc.
· Negative Covenants: These covenants limit company activities. For example limits on mergers/ acquisitions, asset sales, dividend payment, negative pledge, etc.
· Financial Covenants: These covenants require that the issuer maintain a minimum financial condition, usually in the form of ratios. Standard financial covenants include restrictions on debt incurrence (the most commonly used being Fixed Charged Coverage ratio), restricted payments, restriction on asset sales, Interest Reserve Accounts, etc.
High yield bond covenants in Indonesia are broadly in line with those in China, Hong Kong, Singapore, and India. They do act as an early indicator of any potential default. For example, certain high yield bond indentures require that the issuer to maintain an Interest Reserve Account with a Trustee Bank, where at least one interest payment amount on the bonds is deposited at all times. If the issuer of the bond fails to timely top-up this account, it acts as an early indication of liquidity issues within the issuer company.
As a result of global tightening bias and flight safer assets, the USD-denominated bonds issued by Indonesian corporates have consistently declined in price over the last two months. The long dated papers, in particular, have declined considerably reflecting increased inflation expectations amidst ongoing fuel reforms in the country. This trend is in line with other emerging market bond performance, as global investors moved funds out of emerging markets to safer assets. While it is difficult to say if the bond prices have bottomed at current levels, the running prices adequately price-in the expected Fed tapering and tightening interest rate environment in Indonesia. Therefore, the current low prices offer select good investment opportunities for global fixed income investors and wealth management firms.