A transformative week for dim sum bonds

Asiamoney.com, December 15 2010

The offshore RMB bond market has enjoyed a transformative week. Since July, the market has evolved steadily in size, reach and diversity, but it has really been in the first weeks of December that it has taken a leap towards maturity.

When an unrated issuer whose only rated affiliate is ranked single B can raise funds at 4.625%, and when a Russian BBB-rated bank with no interest or presence in China can follow up the next day at less than 3%, something remarkable has happened in a market that didn’t really exist until July. And the diversification and innovation continues: Shui On Land is on the road with the first synthetic deal to tap the offshore RMB bond market.

It’s a strikingly swift evolution. It’s true that offshore RMB bonds have existed for retail investors since China Development Bank’s issue in 2007, but it’s really only since the middle of this year that issuers have been able to access the market without onerous approval requirements, and have been permitted to do what they want with the proceeds. The landmarks followed quickly: Hopewell’s RMB1.4 billion deal; McDonald’s, the first corporate deal for a brand-name multinational; the first certificate of deposit deal from Citic Bank, showing that financial institutions without a retail deposit base could participate in the market. Almost every subsequent deal – Caterpillar, Chexim – has brought some new innovation or depth.

Galaxy’s deal last week was, to all intents and purposes, the market’s first high yield deal. It’s tough to put an equivalent rating to it, since only its Galaxy Casinos affiliate has a rating, but it’s irresistible to compare it to what other high yield issuers around that affiliate’s rating are paying for funds. Yuzhou Properties is rated B by S&P, just like Galaxy Casinos, and when it went to the dollar high yield markets last week it paid 13.5%. Galaxy paid 4.75% for not much less funds or tenor (the equivalent of US$150 million for three years, compared to $200 million for five years non-call three for Yuzhou). And it’s not as if Galaxy priced the deal until it hurt: it got RMB13.5 billion in orders, almost 10 times the final deal size, and got more than 80 institutional investors in, mainly real-money.

VTB was equally striking because it’s not really known as a credit in Hong Kong, and has precious little to do with China so far so can’t do much with the RMB without switching it. But that’s the point: the low costs available in this new market have captured so much attention from borrowers worldwide that they are prepared to come here just to get cheap and diversified funding. VTB had paid 4.2% for a S$400 million two-year bond in Singapore dollars in July. Its RMB 1 billion deal last week, while admittedly for less money, got longer tenor (three years), at a much lower coupon (2.95%, well inside guidance) and attracting considerably more demand (RMB7 billion).

And so to Shui On Land, which not only doesn’t need RMB, it doesn’t even want to own them. This will use a synthetic currency structure, targeting RMB investors, but raising funds in dollars. It will also be the first property developer in the market.

Issuers like these, and the host of others in the pipeline (VTB will be followed by fellow Russian Rusal, the aluminium producer, shortly) are taking advantage of an unusually steep imbalance between supply and demand. But the fervour in the market – Chexim was 53 times covered on an institutional tranche the week before Galaxy – also raises questions about sustainability.

Clearly, these rates can’t last: they’re a function of an imbalance that must diminish with every new deal. The funding difference Galaxy illustrated isn’t a mismatch or an arbitrage, it’s a gulf. Imbalances like this don’t last forever. They work right now because people who hold RMB outside China don’t have many options to get a return. That won’t last either.

Also, since the last three issuers (Shui On included) don’t appear to have any particular need for the currency, another issue arises. The direction of the RMB offshore market is increasingly towards being a method of diversifying borrowings, and doing so cheaply, rather than for any need to use the currency. That’s fine, provided the swap market can support it. Right now borrowers may need to pay as much as 2% extra to swap back into dollars, which at the moment is still cost-effective particularly for high yield issuers like Galaxy, but in the longer term that swap market will need to become more efficient to be sustainable. For those that do need the currency, the problems of McDonald’s – a widely admired deal, but also remembered for the difficulty of remitting the funds back to the mainland where they were needed – need to be addressed.

In the meantime, what next? One little-noticed development came in the distribution of the Chexim institutional deal – 12% to Europe, whereas early deals had been placed almost entirely in Hong Kong. If the issuer base is becoming more far-flung, it stands to reason the investor base will too.