The dim sum bond market grows up

Euroweek, February 2012

2011 was the year in which the dim sum market grew up. No longer could any issuer, regardless of its lack of a rating or covenants, raise cheap funding from desperate investors; instead, buyers began to develop standards and expectations, and issuers have had to adapt accordingly.

There was certainly no shortage of issuance, and bankers expect it to continue. “We’re still fairly optimistic about seeing steady growth this year,” says Gina Tang, managing director and head of debt capital markets for Hong Kong and China at HSBC. “Last year there was about RMB160 billion of issuance, versus RMB40 billion the year before; roughly four times growth. This year we won’t see the same magnitude of growth, but we do expect between RMB260 and 310 billion of issuance.”

What’s changed, though, is that investors no longer need to slavishly chase the paper. There are a number of reasons for this.

The first is macro: the European debt crisis, and consequent wobbles in global markets, could not help but have an effect on dim sum issuers. In truth, the market held up rather well, with new issuance feasible pretty much throughout, but there was undeniably a change in risk appetite among investors that was affected by the global picture.

The second involved changing expectations on the currency. “RMB is not a one way bet anymore,” says Tang. “The expectations have been shaken, particularly during last September.” Few people expect an outright decline, and the view of HSBC’s latest currency outlook, predicting 3% appreciation over 2012, is fairly typical of the market. “Appreciation will be less gradual and instead more volatile. RMB depreciation is highly unlikely, but not impossible, should the USD suddenly be much stronger.”

This development has proven extremely influential for the dim sum market, because many investors were including an expectation of a near-guaranteed 5% currency appreciation into their bond investment decisions. This helps to explain why some weird and wonderful high yield bonds were able to get away in 2010 and early 2011, despite no ratings and no obvious investor protection, and without paying a particularly high yield; it’s because although the bond in its own right might have seemed a bad risk-reward tradeoff, the dynamics were changed if you assumed the currency appreciation too.

“The high probability of currency appreciation has been a major reason for many investors buying CNH bonds,” says Aaron Russell-Davison, managing director and head of Asian debt syndicate at Standard Chartered. A questioning of that assumption changed the sort of names that are appealing to investors. “This has led to solid demand for blue chip credits, even if it meant accepting lesser coupons.”

On top of that, the supply-demand imbalance started to shift. After months of exponential growth, RMB deposits in Hong Kong actually declined in October – modestly, by 0.6% to RMB618.5 billion according to the HKMA, but a far cry from the apparently unstoppable growth in 2010 and earlier in 2011. At the same time, issuance continued to grow dramatically, so that asset managers no longer had to fight to get allocation in any new deal that came along, but could begin to become more selective.

None of this is particularly bad news for anyone other than shaky issuers. “For us, we see that the major theme of RMB internationalization is very much intact as a China policy,” says Tang. “The world will need a new currency alternative and that is still the macro backdrop. We would expect the market to continue to develop further from the rapid initial growth in the last 12 to 18 months – with a better balance between risk and reward evaluation. Both issuers and investors will be more sensible in coming up with rational expectations on pricing. The market will continue to incorporate the usual elements of an international credit market: credit ratings, relative value analysis and covenant package.”

In this environment, there are various groups we should expect to see more or less of – another sign of the market’s growing maturity is the increasing delineation between distinct sectors of issuance in CNH.

One group being closely watched includes the bigger mainland banks and large state-owned corporations. Market talk is of the big banks preparing issues, and at the time of writing Agricultural Bank of China and China Development Bank had deals underway. “There has been a lot of discussion about the big Chinese banks getting approval to issue in dim sum,” says Chao Li at RBS. “That is going to be one of the major sources of supply, and other high quality corporates will be a big group of issuers.”

In this vein, one highly significant deal in late 2011 was a RMB3.6 billion three-tranche series of bonds from Baosteel in November. The significance was that this was the first time a Chinese company had received permission to sell a bond directly rather than through an offshore subsidiary. Baosteel, a major steelmaker, is part of the vast stable of enterprises controlled by the State-Owned Assets Supervision and Administration Commission (SASAC), and is expected to be the first of many issuers from that group.  That deal flew out the door in horrible markets: all three tranches, from two to five years, were oversubscribed and priced at the tight end of guidance, with a total order book of RMB9 billion from 200 orders. A month earlier, a RMB3 billion deal from another state-backed behemoth, China National Petroleum Corp, which owns Petrochina, re-opened the dim sum market after a three week gap and demonstrated that appetite for these big, powerful names had the ability to withstand the worst of market disruption internationally.

Big, it seems, is better. “When the secondary market sells off, the better, larger credits hold their value better than the high yield issues,” says Russell-Davison.

There are signs, too, of the range of issuers from overseas increasing significantly. Many of the most feted deals last year were for foreigners: BP, Tesco, Air Liquide, BSH Bosch und Siemens. And they are coming from progressively further afield. Mexican telecommunications group America Movil began marketing a dim sum deal in December, and late last year the governor of the Central Bank of Nigeria told the author he was considering a dim sum bond. While some issuers initially sought to raise funds in RMB and swap them out – and some still do – more and more companies have a genuine onshore need for the RMB they raise. “We are expecting more issuance from MNCs,” says Tang. “Most of the international companies have trading relationships and investments in China. The dim sum market will provide a viable alternative in the funding plan in relation to their China business.” Bankers believe the process for bringing funds back to China, and the regulatory approvals involved, should become more straightforward and transparent in future; issuers will certainly hope so, since this has been one of the key glitches in the market’s early days.

Big corporates who don’t need the RMB may also be attracted by improvements in the swap market, another barrier in the market’s early days. “The swap market has become much more liquid,” says Li. “You can reach three years in fairly decent size. It provides an issuer with the opportunity to issue in CNH and swap into dollars; some Korean issuers who have been active in MTNs are now starting to do that.”

That’s not to say, though, that there will be no buyers for high yield. “There is certainly room for an active CNH high yield market, where investors make their decisions based on individual credits, rather than FX trends,” says Russell-Davison.

What is going to suffer, though, is the group that are not just high yield but unrated. “People are now paying much more attention to the covenant. You’re not going to see a really low rated, low end credit without covenant anymore,” says Li. Even here, though, there are exceptions. “There are some non-rated SOEs who can still get support from Chinese investors. They can still get a deal done, though it’s not as easy in the first half of 2011.”

There is also likely to be room for greater structural variety in dim sum bonds. The standout here was ICBC (Asia), whose RMB1.5 billion issue of tier two subordinated bonds at the end of November could prove highly influential. This was not only the first subordinated debt in the dim sum market, but also the first lower tier two bond from an Asian bank to be Basel III compliant. On top of that, it was a 10-year non-call five bond (no mean feat in the dim sum market where swap curves, at best, are liquid only to three years), it raised RMB5 billion of orders from 83 accounts, priced at the tight end of guidance (6%), and continuously closed up in value in a week when dollar bonds were widening dramatically. “Investors will welcome more of the longer dated and capital issues with solid names behind them,” says Tang.

ICBC illustrated other trends too. While the majority, as with all dim sum bonds, went to Hong Kong and China investors, their 77% representation was actually relatively low – 90% used to be the norm. Singaporeans took 9% and Europeans and others 14%, suggesting another direction in which the market will likely evolve in future. Investor types, too, are becoming more broad. “We are seeing the real, long-term investors – pension funds, asset managers, reserve managers – now seriously considering having CNH as part of their portfolio,” says Tang.

Another interesting thing about the ICBC deal was that it came at roughly the same time as another, far less successful RMB deal, a RMB 400 million issue from Dalian Part, which came far smaller than a rumoured RMB1  billion and arrived at the wide end of pricing. The contrast, since both were RMB deals marketing in the same volatile market conditions, demonstrated the increasing credit differentiation that investors were beginning to undertake. Dalian had to pay 5.8% to complete its three-year deal; around the same time, LSOC, backed by France’s Lafarge, had to pay 9% for a RMB1.5 billion three-year deal of its own.

“It’s a matter of issuers coming to terms with having to offer a higher yield than they used to,” said a portfolio manager of an offshore RMB fund at the time. “You are no longer at the stage of ICBC issuing two-year bonds at 1.1% and the market lapping it up. Going forward issuers will have to offer something more commensurate with their risk. Demand is no longer overwhelming supply.” Indeed, around this time issues from names as big as CNPC and Khazanah had to revise their initial expectations and offer more money to get their deals away.  “The days of everyone buying into every issue without assessing credit risk, just because they have to hold something, are gone.”