This article first appeared in Forum, The Edge Malaysia Weekly on January 17, 2022 - January 23, 2022

The writing on the wall is becoming increasingly clear. An imminent interest rate hike in the US will likely push highly leveraged companies into making difficult decisions that they have been delaying in the past two years.

When the US Federal Reserve puts an end to the loose monetary policy environment, the immediate consequence will be that the mispricing of debt will be rectified.

Over the last two years, the pandemic forced governments to take measures to ensure that corporates did not go bust during these difficult times. Malaysia, like many other countries, sanctioned a slew of laws that allowed for a moratorium on debt repayments or gave relief to companies whose businesses had been affected by the pandemic.

Creditors were unable to force companies to make difficult decisions to fulfil their loan obligations. Government intervention was disruptive to the financial system but necessary because the pandemic had brought the economy to an unprecedented halt.

The predictability of government intervention in the capital markets is about to end, with the US taking an aggressive stance to raise interest rates. Top officials in the Fed have stated that they are looking at more than three interest rate hikes, if the situation arises, to tame inflation.

For the US and other developed markets, taming inflation is the main task for this year and the common tool to do this is to raise the interest rate.

Hence, when interest rates in the US go up, the cost of new debt all over the world will become higher. An indication of how much more companies will need to pay for any new debt they take on is evident from the rising yields of short-term bonds.

Yields on the five-year and 10-year US Treasury bonds, which are most sensitive to near-term interest rate hikes, have been rising. Consequently, the yields on Malaysian Government Securities, which is the benchmark for the issuance of ringgit-denominated debt paper, have also been rising.

To add to the problems of corporates, the protection that highly leveraged companies enjoyed in the last two years is waning. In the last 10 days, two embattled major corporations have experienced jolts.

First, it was announced that Genting Hong Kong Ltd’s shipyard in Germany, MV Werften, had filed for bankruptcy after talks between the company and a provincial German government ended. The provincial government blamed Genting Hong Kong for the closing down of the shipyard.

It has been reported that the liquidation of MV Werften could spark a potential cross default of up to US$2.7 billion (RM11.3 billion) at the Genting Hong Kong level. Genting Hong Kong is owned by the Lim family of Genting Group.

Last Wednesday, AirAsia Bhd was classified as a company under the Practice Note 17 list after the stock exchange rejected the low-cost carrier’s (LCC) appeal for an extension of the relief it had been allowed since June 2020.

The external auditors of AirAsia had raised the red flag on the company “as a going concern” in its audited results for the financial year ended December 2019. But AirAsia was granted relief from being classified as a PN17 company as the collapse of its business was due to the pandemic.

The LCC is seeking up to RM2 billion in new funds to tide it over during the pandemic and being a PN17 company would not help it achieve its objective.

AirAsia’s share price fell following its classification as a PN17 company. Although it has a good business model, it will only work well if restrictions on air travel are lifted. Going forward, AirAsia should be able to raise new money to tide it over the tough times. But there is always the question of the pricing of the new debt and equity.

The gross mispricing of debt on a larger scale is more obvious in government-linked companies (GLCs).

Heading the list is the troubled 1Malaysia Development Bhd (1MDB), an entity once led by former prime minister Datuk Seri Najib Razak. It has two US dollar debt papers amounting to US$3.5 billion that are due this year and another US$3 billion paper that expires next year.

The amount of money recovered so far is RM19.1 billion and the Ministry of Finance has said that it has enough to pay only the principal amount for the bonds due this year. It does not have the amount due next year in its coffers yet.

The fact that 1MDB has land for development, which it got at relatively low prices from the Najib administration, does not mean much to bondholders. What they want is reassurance that the papers will be redeemed.

Fortunately, the fund is under the federal government and bondholders have been assured that the obligations will be met.

The same, however, does not apply to highly leveraged GLCs.

For instance, Boustead Holdings Bhd has debts of RM7.8 billion that need to be reduced. It has perpetual bonds of RM609.3 million, for which it is forking out between 7.75% and 9.6% in interest annually. The rates will increase by 1% every year, up to a maximum of 15% per annum.

Boustead, which is under Lembaga Tabung Angkatan Tentera (LTAT), is rich in assets but it does not have a strong cash flow. The question is how long can it carry the expensive perpetual bonds, which are considered as equity.

Since 2009, most central banks around the world have adopted an easy monetary policy to stimulate their economies. This is because inflation has been rather low. The Fed has been printing money, a move that caused asset prices globally to increase in value.

The best time for leveraged companies to de-gear would have been in the last two years, when the economy was continuously inflated with huge stimulus programmes by governments. But not many were prepared to make difficult decisions.

Now, with inflation at 7% in the US, the Fed is not leaving anything to chance in its bid to tame inflation. When it starts to raise interest rates, which is expected to happen in March, the currencies in emerging markets will go into a tailspin.

This is because money will flow back to the US and the greenback will appreciate in value. In contrast, the ringgit will decline. Analysts are already expecting the ringgit to trade at 4.30 against the US dollar.

What this means is more trouble for highly leveraged companies.

M Shanmugam is a contributing editor at The Edge

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