Euroweek offshore RMB report: synthetics

Euroweek, July 2011

Even by the exuberant standards of the offshore RMB debt markets, synthetic RMB – a market within a market – has had an extraordinary life. Invented only in December, it has thrived, broken records, and then apparently faltered again, all within six months.

It all began with a remarkably successful deal in December for Hong Kong-listed Shui On Land: the first straight bond to be launched in RMB, but settled in dollars.

Shui On Land is a solid name, but the scale of demand it attracted – an RMB32 billion (US$4.81 billion) book for a deal that had been marketed at RMB1.5-2 billion – surprised everyone. Shui on and its bookrunners, Deutsche Bank, Standard Chartered and UBS, increased the three-year deal to RMB3 billion and still had to scale orders back tenfold. Shui On, it is worth remembering, doesn’t have a credit rating.

The appeal of the synthetic format to investors was very clear. It allowed them to gain exposure to movements in the RMB, which are universally expected to be upward; and it did so without the investor having to navigate the swap markets should they hope to turn the investment into their home currency. The lack of depth in the swap markets had already, by December, become a clear potential bottleneck for RMB issuance. Dollar settlement also got around some restrictions global investors might face.

From the issuer perspective, it gave them an alternative method of reaching funds; at that time property companies had been struggling to access the dollar high yield markets (though they would regain momentum early in 2011). It avoided creating RMB proceeds in Hong Kong that may be troublesome to remit to the mainland. And the yield, while higher than on pure RMB dim sum bonds, was generally more attractive from an issuer point of view than a dollar bond would be. Shui On paid a yield of 6.875% (having tightened from guidance of 7-7.125%), which is higher than typical dim sum yields (unrated Macau casino operator Galaxy Entertainment had borrowed at 4.625% earlier in the month) but lower than the likely 8.5% or more it would have paid in the dollar markets. In deciding whether to buy, investors are clearly factoring in the likely increase in the value of the RMB itself as part of the equation.

While several issuers had previously conducted RMB-denominated, dollar settled convertible bonds – including Country Garden and Shui On Land itself – the new synthetic bond was seen as a momentous development for the market.

After Shui On, the floodgates opened. On January 7, China SCE Property raised RMB2 billion in a five-year dollar-settled bond through HSBC and Deutsche, paying 10.5%. Like Shui On, the deal was upsized and tightened along the way. China SCE is rated B1/B+, and its bonds B2/B; analysts said at the time that it would have paid around 13% for the same deal in dollars.

The following week came the biggest deal yet: Evergrande Real Estate Group, another Chinese developer, raised RMB9.25 billion (US$1.4 billion) in a synthetic dual-tranche deal. Just weeks after this part of the market had been launched, Evergrande had launched the biggest ever high yield bond in any currency from a Chinese property company. “The size that Evergrande have achieved in synthetic RMB is phenomenal: US$1.4 billion equivalent, which is by far the largest Regulation S deal ever seen for a high yield credit,” says Terence Chia, in debt syndicate at Citi, one of four lead managers on the deal alongside Bank of America Merrill Lynch, BOC International and Deutsche Bank.

Everything about this deal was dazzling. Its order book came in at RMB33.1 billion; 136 orders came in for the RMB5.55 billion three-year tranche, and 108 for the RMB3.7 billion five-year; and at 7.5% for the three year and 9.25% for the five year, in line with guidance, it was strikingly cheaper funding than the 13% Evergrande had paid for a $750 million five-year global one year earlier.

For Parry Tse, Evergrande’s CFO, the contrast between the two bonds was very welcome – and not just because of price. “In terms of procedure, they were very different,” he says. The Rule 144a bond in January 2010 required “three or four weeks” of preparation to meet the various regulatory requirements, he says. “When we issued a synthetic RMB bond, the majority of investors were located in Hong Kong and Singapore. Investors in this region have a better expectation of the appreciation of the RMB, so were very interested to purchase RMB bonds. Because we did not need to go to the US for marketing, it only took two weeks of preparation work. It saves a lot of time.”

And so other issuers began queuing up. Later in January Shui On Land came back again, just five weeks after inaugurating the market, raising RMB3.5 billion of four-year paper at 7.625%, through Deutsche Bank, Standard Chartered, UBS, Barclays Capital and BNP Paribas. It attracted RMB17 billion of demand from more than 150 accounts. And Kaisa Group raised RMB2 billion in the first private placement of synthetic RMB bonds.

But after Evergrande, whose immediate secondary market performance was poor, sentiment in the market had started to change.

In February, the Chinese solar wafer maker LDK Solar raised RMB1.2 billion in three-year bonds settled in dollars, with a yield of 10%. Those numbers look solid enough, but the atmosphere around the deal was very different to those that had preceded it: it was downsized from RMB1.5 billion, and the yield had to be raised from a planned 8-9%. Even at those levels it was barely oversubscribed, and then dropped in the secondary market.

The deal, lead managed by Citi and Morgan Stanley, ran up against several headwinds: a tightening of reserve requirements shortly after the deal began trading, which was part of the reason for the drop in the secondary market, for example. And an unrated issuer in a new technology area was difficult to sell at the yields the borrower appeared to want.

Also, the deal did subsequently bounce back somewhat in the secondary market. But it was the first black mark against the synthetic RMB market, which really hasn’t recovered since. Around this time Country Garden successfully raised $900 million in a seven-year non-call four dollar bond, which then traded up, reminding people of the merits of longer-established vanilla markets. Names that had been expected to launch in synthetic RMB started to delay or cancel their trades; first Zhong An Real Estate, which had planned a Regulation S-only three-year bond in February, and then another for Global Dairy Holdings planned for April.

In fact, only one more synthetic issue has followed to date: from Powerlong Real Estate, which raised RMB750 million in three-year dollar-settled bonds in March through HSBC, Macquarie Capital and RBS. The coupon was 11.5%, priced at 99.383 to yield 11.75%. While this deal went well enough, it was notable that the pricing was just 200 basis points less than a dollar bond of the same tenor it sold in 2010, suggesting that the really big savings over dollar funding have already passed by.

Meanwhile mainstream dim sum bonds continue to thrive. By the time Guangzhou R&F successfully launched the first dual-tranche dollar and offshore RMB bond in April, it was clear that these markets were back in favour. Notably, by then, most synthetic bonds were trading below par, and most dim sum bonds, above. And so the market, worth about $3 billion in aggregate, is somewhat becalmed.

It’s interesting to look at who has bought synthetic deals. The Powerlong deal went 55% to private banks, for example; in Shui On and Evergrande, too, they topped 50% of allocation. When Powerlong had issued in dollars, private banks were 40% of the allocations, less than funds with 49%. These bonds clearly have a different, non-institutional target market to sell to.

It may be that the synthetic market dies away as some of the inefficiencies in the dim sum market that it seeks to remedy are resolved by the maturing of that market. For example, when longer tenor is available in dim sum bonds, when the swap market is more mature and repatriation of capital is easier, there will be less of a need for issuers or investors to consider the synthetic route.

Even issuers accept that the time in the sun may be fleeting, and that all RMB offshore bonds are benefiting from a currency play that may be temporary. “It may be a temporary situation,” says Tse at Evergrande. “You would expect the appreciation of the RMB to be vigorous in the next couple of years, but it will just be a transitional period. When the expectation of RMB appreciation is no longer so high, investors may not have the same interest in RMB bonds. The traditional US dollar bond market is still very important and will continue to be the main source of financing in future.”

The rise and subsidence of the synthetic market will eventually be seen as part of the broader market’s rapid evolution. “The China market was going down a two-pronged road,” says Henrik Raber, global head of debt capital markets at Standard Chartered. “Firstly the dim sum bonds, which started off as all local currencies do, being more oriented to high grade issuers, and as a mechanism to soak up some of the deposits building up in Hong Kong. Then, as the market started to develop, some of the dynamics around the market started to change: the US dollar market for Chinese high yield issuers started to get a bit weaker, and we started to see those issuers in the synthetic format.” Now, the dynamics are shifting again.