Indonesian High Yield Bond Market Structure and Opportunities

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.


Bond Underwriting Challenge

This is a real case that was handled by our surety bond experts… a doozie! See what you can make of it.

The facts:

  • This is a Performance Bond request for a multi-million dollar subcontract
  • The applicant / principal is a long established company
  • They have successfully completed similar sized projects
  • The company has a modest net worth, but is on a profitable trend. Ratios are OK.
  • Personal financial statements of the stockholders add more net worth to the picture
  • The company is owned by a father and son. Son is the primary stockholder.
  • We noted their SS numbers are only a few digits apart
  • Father has a substantial net worth. Son has a small net worth as indicated on his personal statement.
  • The applicant has started the subcontract
  • The GC / obligee has a mandatory bond form – very tough. It effectively makes it a forfeiture bond (obligee completes the job and sends you the bill.)
  • Father has a living trust
  • Son also indicated he has a trust

A lot of moving parts. What are the issues?

  1. Low company net worth. Too low for the size bond requested.
  2. “Close” SS numbers imply these individuals are immigrants (received SS numbers at about the same time). Are they U.S. citizens?
  3. Started subcontract. Why were they allowed to start without a bond? Degree of completion? Work acceptable? Bills paid? On schedule?
  4. Do we want to write a forfeiture bond form (financial guarantee?)
  5. What assets are in the trusts? Can they give indemnity? Will we rely on the indemnity of a trust?

– Think of your possible solutions –

Here is the approach crafted by our underwriters:

  1. Low company net worth. We do not prefer to require collateral because it may be counter-productive, making it harder for the client to complete the project. Instead, the client agreed to add capital to the company – an investment in their future. The funds could be a subordinated stockholder loan, or a stronger method: Additional Paid-in Capital. The latter is more permanent and therefore desirable. The client agreed to permanent capital that would be verified in writing by their CPA and supported by a current interim balance sheet.
  2. Close SS numbers. Why would we inquire about anyone with a social security number? It is because the number itself does not prove citizenship – nor does the filing of a US tax return. Non-citizens authorized to work in the U.S. can get a SS#. “Tax residents” are permanent residents and green card holders who are non-citizens required to pay U.S. taxes. All sureties are cautious when taking the personal indemnity of a non-citizen. They may easily flee the country to avoid their obligations. On this account we determined the father and son were immigrants as we suspected, and naturalized U.S. citizens.
  3. Started subcontract. This would be clarified by obtaining our All’s Right Letter from the obligee, stating the relevant facts on the project (degree of completion, on time, no problems, etc.)
  4. Bad bond form. We had previous dealings with this major GC and negotiated a bond modification that made the bond operate more normally. They agreed to use the bond mod again.
  5. Trusts. It turned out there was only one trust. The son was the beneficiary of the fathers trust, no separate trust of his own. A review of the father’s trust showed it was not prohibited from signing the indemnity agreement. However, living trusts are revocable, meaning the terms can be changed and assets moved out – making them unreliable indemnitors. And it contained the single most important asset, the father’s residence. How to overcome this last obstacle? Our solution: We will place a lien on the property giving us access regardless of changes in the trust.

There you have it. Did you come up with solutions to match ours? It was a tough / complicated case, but we worked hard to solve it.

We’ll work hard to solve your bond cases too. Bid bonds, performance and payment, and also site and subdivision!

Include us in your bond production efforts. We can make it happen.