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Sunday, June 11, 2023

How to rescue corporate bonds

By Assoc. Prof. Vo Dinh Tri, Ph.D

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Many enterprises, especially real estate ones, are now under huge pressure to settle bonds upon maturity, including bond interest, which stems from a lack of oversight in the recent overheated growth of the capital market.

To douse the fire on the bond market, all eyes are on the draft amendments to Decree 65/2022 on offers and transactions of bonds issued via private placement. However, in order to avoid risks repeating themselves in the future, control over the offer of corporate bonds to individuals needs to be tightened.

Smaller fire but still extremely hot

In three years, from 2019 to 2021, the volume of corporate bonds issued soared by leaps and bounds. The amount in 2019 jumped by 110% against 2018, from VND155 trillion to VND322 trillion, and the tempo continued, rising by 42.5% year on year in 2020 and 60.5% in 2021. The total amount of corporate bonds issued in the three years exceeded VND1,500 trillion, equivalent to US$62.5 billion.

The corporate bond bubble was deemed bursted when the court cases of Tan Hoang Minh and Van Thinh Phat (An Dong) were initiated, triggering a domino effect as other bond issuers faced the risk of insolvency. Many panic-strickened bondholders wanted to take back their money, and sought to offload their holdings at a high discount, even at nearly 20% as seen at a major bond investment fund. On the secondary market, certain corporate bonds were offered at a far higher discount. The domino effect was also possibly caused by cross holdings when a bond issuer invested in another issuer’s bonds. As the cashflow turned volatile, insolvency became contagious.

The corporate bond market cooled down in 2022, as the amount of this debt instrument plunged 66% against 2021 to VND255 trillion, while the average value of each issue also plummeted to only VND562 billion. Issuers also bought back their bonds before due date with a total value of VND210 trillion. In the fourth quarter of 2022, the amount of bonds on offer plunged by 99% year on year, while bonds worth VND40 trillion were bought back.

Nevertheless, a report by the Vietnam Bond Market Association (VBMA) stated that the pressure of bond maturity this year and next remains huge. This is evidenced when the Hanoi Stock Exchange lately has made public a list of 54 enterprises that delayed paying interest and principal to bondholders.

Awaiting amendments to Decree 65

A draft decree to amend Decree 65/2022 has been submitted to the Government, which is expected to give the nod soon. Apart from new changes to the qualifications of professional investors, credit ratings and time limits for bond distribution, two noteworthy points are changes to the bond tenure and conversion of bond interest and principal sums into other assets.

For corporate issuers grappling with difficulties, the extension of bond tenures or usage of other assets to service bonds can be seen as coming to their rescue, especially for real estate enterprises currently under huge payment pressure despite having properties as high-value assets.

However, whether the imminent decree will be the right cure or not depends on the subjects of the amendments. For reainstance, if the forthcoming decree applies to bonds now in circulation, that can be seen a rescue; but if it only applies to bonds issued after the new regulations take effect, there is no assistance to enterprises having issued bonds and been facing difficulties.

How to keep the market from being distorted

Corporate bonds are a special type of securities mainly for institutional and professional investors. Data show financial institutions hold around 86% of corporate bonds issued in the U.S. and Japan, some 93% in the eurozone, and 98% in the UK. In China, this rate in 2018 was even steeper, at some 99%. Most of the institutional investors are insurance firms, pension funds, investment funds, and monetary financial institutions.

In Vietnam, the corporate bond market has seen numerous individual investors who are not rated as professional. These investors have participated in the market via distribution channels of banks, securities firms, fund managers, with some even purchasing bonds without knowing they have done so.

Most of the bonds have been issued via private placement. The amount of bonds issued to the general public accounted for just 7.1% in 2020 and 4.1% in 2021. Such a situation spelt out huge risks for bondholders as they were not capable of assessing bond risks. Further, up to 60% to 70% of bonds were issued without collateral, or with collateral being shares of issuers. In case issuers struggled financially and became insolvent, bondholders could not claw back their money due to the absence of collateral, and even in case shares were used as collateral, prices of such shares would also plunge due to difficulties faced by such issuers.

Although corporate bonds are a necessary instrument for enterprises to mobilize funds and an indispensable investment channel, such bonds should only be reserved for institutional investors and professionals due to the high risks. Individual investors should only be offered corporate bonds under special conditions, such as via a fund offering investment-grade bonds only. At the same time, the proportion of bonds issued to the general public should be increased, alongside the development of credit rating services to minimize risks for individual investors.

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