Asian credit markets have become a harsher place for borrowers in the past year as widening spreads and falling currencies saddle firms with elevated debt-servicing costs in another sign of increasing stress in emerging economies.
The problems in Asia are being felt more acutely in the high yield sector as slowing economies mean firms aren't earning enough to cover their cost of capital, triggering a vicious cycle of shrinking investment, lower economic growth, faltering profits and defaults.
The sector has boomed in recent years thanks to China, which now accounts for roughly 50 percent of the outstanding market in Asia - a dominance that is now all the more concerning as its economy cools to its slowest pace in a quarter of a century.
"In an outlook of slowing growth and worsening profitability, the high yield sector is particularly vulnerable and most investors we talk to are staying clear of that space," said the head of credit trading at an Asian bank in Singapore.
In many ways firms are now paying the price for binging on dollar-denominated debt when the U.S. Federal Reserve launched a burst of liquidity during the 2008-09 financial crisis lasting several years, making it extremely cheaper to borrow dollars.
Fast forward to 2016 and it's a different story, particularly as a slowdown in China's economy and a turn in Fed policy have tightened financial conditions and driven up defaults.
Analysts warn of more corporate defaults over the next year, citing widening spreads that typically signal growing concern about the ability of borrowers to service their debt.
A JP Morgan index of dollar-denominated high yield corporate debt in Asia showed spreads over 10-year U.S. Treasuries widened to more than 600 basis points at the start of this week, from around 450 basis points in July 2014, according Thomson Reuters data.
"While Asia is relatively better positioned among emerging market peers, spreads are likely to continue to head higher," said Shankar Narayanaswamy, head, credit strategy and financials at Standard Chartered Bank based in Singapore.
THE COST OF DEBT ADDICTION
Data from the Bank of International Settlements showed total credit to the private non-financial sector in emerging market economies nearly doubled to $32.19 trillion at the end of the third quarter in 2015, from 2010, versus a mild reduction to $66.9 trillion in their developed market counterparts.
While that strategy has paid off rich dividends previously, the combination of a stronger dollar and falling commodity prices has pressured corporate balance sheets in recent months and forced investors to reduce their exposure, particularly in emerging markets.
Moreover, as growth has slowed – the IMF cut its forecasts for the global economy to 3.4 percent in 2016 – investors have started worrying about the ability of some companies, especially in the mining and the oil and gas sectors, to meet their debt obligations.
A Reuters analysis last month of all companies on the Shanghai and Shenzhen bourses with a market value of more than $500 million, showed an average wait of 59 days for payments by customers, compared with 37 days in 2011.
Defaults have already started rising in the Asian high-yield bond space with the corporate default rate nearly doubling to 6.4 percent in 2015 from a year earlier, according to Moody's Investor Services.
Of the 9 defaults in 2015 - the highest since 2009 - six of them were Chinese issuers. Overall, there were 5 defaulters in 2014.
The tough market conditions is seen further crimping issuance this year, with overall supply from the Asian high-yield corporate sector expected at $13 billion, slowing from 2015 and less than half of the $27 billion in 2014, according to Deutsche Bank estimates.
"Credit markets may not be signaling a full blown recession yet but it is going to be a pain point for investors who have blindly chased yields previously,” said a bond fund manager at a credit fund.