“Currently, financing from banks is more competitive as compared to the debt capital market. This is due to the low OPR [overnight policy rate] vis-a-vis the bond yields.

“The current one-year swap rate and 12-month inter-bank rate are half a percentage apart which will make bank loans more enticing than bond issuances from the issuer’s point of view,” Malaysian Rating Corporation Bhd (MARC) said.

The ratings agency said the volatility in bond yields and heightened market risk had also made financial institutions reluctant to underwrite bond deals, further dampening the market.

“On the demand side, investors are increasingly favouring bilateral loans as opposed to bond investments due to aversion to mark-to-market losses which somewhat discourage investments in bonds.

“It seems plausible given the circumstances that loans would be favoured over bonds until some measure of certainty returns where interest rates are concerned,” MARC told The Edge Financial Daily via e-mail.

“However, we do not expect this anomaly to persist over an extended period of time. Recently, bond yields have trended slightly lower as traders have re-priced their bets with regard to OPR direction right after the unexpected outcome of the previous monetary policy meeting.

“While it is uncertain how long this trend will continue, a sustained reduction in bond yields will increase the attractiveness of the debt capital market (again),” the ratings agency added.

MARC said due to the uncertainty over future interest rates, issuers who wished to lock in their costs of financing would likely issue conventional or Islamic sukuk in the current environment.

“Banks have become aggressive in competing with bond financing, especially for oil and gas accounts,” RAM chief operating officer of Islamic ratings Liza Mohd Noor told The Edge Financial Daily.

However, she believed the market would continue to see a healthy pipeline of issuances due to the bond market’s ability to give long-term funding. “The uncertainty surrounding interest rates may cause banks to be cautious about long-term lending,” she said.

“We expect companies that will tap into the domestic bond market, be it conventional or Islamic, to be the more highly rated companies such as oil and gas related, plantation companies, structured finance and selected project and infrastructure companies,” said MARC.

Liza believed that the largest users of Islamic sukuk would continue to be infrastructure as well as oil and gas players, with some competition expected from the banks as a source of funding.

MARC, which is expecting a slow-down in both Islamic sukuk and conventional corporate bond issues in the second half of the year, attributed the scenario to uncertainty over bond yields and “a moderation in the economy translating to lower financing needs”.

On the outlook for sukuk versus conventional issues, MARC expected the market share between conventional and Islamic sukuk issues to be around 40% and 60% respectively, as had been the case historically.

“The ratio between conventional and Islamic corporate bond issues will probably touch 50:50 assuming the pipeline goes through,” Liza said.

While investor interest in the sukuk market was still healthy, Liza said ringgit bond issues by foreign issuers would boost the conventional bonds pipeline.

“There are quite a number of ringgit bonds by foreign issuers in the pipeline, they are more inclined to conventional bonds,” she said, adding that in future, the domestic market could see foreign issuers exploring Islamic papers.

MARC expects corporate conventional and sukuk issues to pick up from the second half of 2009.

“By then, we hope there will be more certainty with regard to interest rates, especially Bank Negara Malaysia’s OPR and greater stability on the macro-economic front such as the outlook of the US economy. We also hope that by then clarity will also emerge on the political front and this will result in an improvement in business and consumer sentiment,” it said.