Opening door to developing the corporate bond market – Chapter 2: Hidden risks

Few corporate bonds were guaranteed for payment by banks, while most corporate bonds were issuance underwritten. Source: Internet

Signs of risk in corporate bond market

With a competitive interest rate structure and unbinding, the corporate bond market quickly attracted cash flow and developed rapidly. The shift of cash flow has led to “overheating” development of corporate bond market in 2017-2020 and clearly reveal limitations and risks that need to be identified and adjusted by the regulator to ensure healthy and sustainable development.

Recently, corporate bonds have been issued mainly through the form of private placement while public offering accounted for a very small proportion. Commercial banks and real estate firms are the main issuers in the market. According to Fiin Rating, in 2020, real estate firms were the largest issuers with a value of VND 162 trillion, accounting for 38.5% of the total value of bonds issued. Commercial banks and financial institutions accounted for 31.6% of the total value of bonds issued.

In fact, many firms issue bonds with high-interest rates, with 1.5 times on average or even double compared to deposit rates of banks to attract capital while they have not had collateral, no issuance underwriting unit, no credit on "financial health" of the firms. Investing in this type of bond is like holding a knife because if the issuer encounters cash flow difficulties, investors will not only lose interest but the principal is difficult to recover. So not only will investors bear the risk but the financial environment is also severely affected.

Newly updated data from the Vietnam Bond Market Association showed that in June, about 72.4% of the volume of corporate bonds issued without collateral that is mainly in the banking and stock industry.

Nguyen Quang Thuan, Chairman of the Board of Directors of Fiin Ratings, noted investment in corporate bonds had to be spent in 5-10 years, even longer, if only looking at high-interest rates to invest without paying attention to information transparency, the investor would suffer risk when the firm faced problems even the safety of the system might be threatened.

According to financial expert Nguyen Tri Hieu, retail investors went after corporate bonds because they saw the shadow of a bank behind the bond. However, few corporate bonds were guaranteed for payment by banks, while most corporate bonds were issuance underwritten. Banks were not responsible for whether the firm could repay the bond principal and interest upon maturity or not. This meant that the risk of investors was very large if the issuer defaults. This expert warned that the number of corporate bonds in circulation was mainly without collateral or secured by shares, while stocks fluctuated following the market. Meanwhile, investors have no power to keep cash like a bank for other collaterals.

“Even when the firm defaults, the collateral would also have to be paid in order of priority: paying taxes to the Government; pay wages to employees; debt repayment to the bank then the buyer of the bond will be paid near the end. Currently, the corporate bond market had many potential risks due to Covid-19 pandemic, which made firms unable to operate but they still borrowed capital and all risks were concentrated on bondholders," Hieu said.

Do Ngoc Quynh, General Secretary of the Vietnam Bond Market Association said that although recently, firms had not seen the situation of insolvency, leading to the need to handle collateral. However, even as large as banks struggle to handle collateral to recover bad debts, ordinary individual investors who want to squeeze business assets will never have a door.

Acts of "bending the law"

According to Nguyen Hoang Duong, Deputy Director of the Finance Department of banks and financial institutions (Ministry of Finance), in 2019-2020, the Ministry of Finance has noticed signs of risks in the corporate bond market and offering many recommendations to target groups of market participants.

“In fact, there were firms that mobilise capital through issuing a lot of bonds on the principle of self-borrowing, self-paying and self-responsibility for the effective use of capital with high-interest rates but the inefficient use of capital or business operation facing difficulties, firms could not return bond principal and interest to investors, causing instability to the bond market and the financial market," Nguyen Hoang Duong said.

Along with self-issuance of corporate bonds, banks are also a group of investors who hold the majority of corporate bonds and are also distributors and underwriters of other companies' bonds. Fiin Ratings reported that banks owned 71.5% of the total value of corporate bonds in circulation at the end of the third quarter of 2020, while this figure in 2019 was 75%.

In August 2019, the State Bank of Vietnam sent a document to domestic commercial banks requesting they control risks in corporate bond investment activities when a number of commercial banks had a corporate bond investment balance accounting for a large proportion of total assets and continues to increase rapidly. Risks pointed out are that the balance of corporate bond investment in the construction and real estate sectors are large when the real estate market has not recovered firmly; some commercial banks invest in bonds for other purposes at a high level and high volatility, difficult to control; some commercial banks continue to invest in bonds for the debt restructuring of issuers in 2019.

To protect investors, the new legal framework has tightened many regulations on corporate bonds. For example, the regulation on private placement can only be offered for sale and traded between professional securities investors. However, Nguyen Hoang Duong said there was an act of "bending the law" to become a professional securities investor to buy corporate bonds that are private placement but failing to assess and analyse the risks, not knowing the terms and conditions of bonds, even bonds have collateral or not, quality of secured assets. At the same time, he emphasised that there was a phenomenon of service providers (securities companies, commercial banks) soliciting and distributing corporate bonds to the wrong subjects who are professional securities investors. Those cases would be sanctioned in accordance with the law.

Nguyen Quang Thuan indicated that if looking at 3-5 years from now, the risk for Vietnam's financial market was this kind of bond. This was an issue that had to be monitored and completed to avoid collapse. Although it was small, with 15% of the total loan balance of the whole system, the corporate bond market deserves more consideration, especially in the context of Covid-19 pandemic that has caused cash flow disruptions for many firms.