22 January 2019
Eric Cheung
Eric Cheung

INTERVIEW: Bank rates to stoke SOE dim sum bond appetite

They’re a financing flavor of the moment and set to stay that way as more of China’s state-owned enterprises (SOEs) look overseas for funds. So much so that a private bank and law firm is tipping that offshore yuan-denominated bonds, also known as dim sum bonds, will push through into new territory and break the 200 billion yuan (US$32.7 billion) mark this year.

But 2014 could also be a banner year for offshore companies looking to issue bonds in China as the central government takes further steps to open up the financial market.

Eric Cheung, associate director of markets and investment solutions of Credit Agricole (Suisse) SA, is confident that more SOEs will opt for dim sum bonds as an alternative to borrowing from the big four Chinese banks.

“There will be more dim sum bond issuances this year because companies might want to secure longer-term funding as interest rates are expected to rise. There will probably be about 235 billion yuan issued, excluding certificates of deposit (CDs),” Cheung told the Hong Kong Economic Journal’s EJ Insight. He expects the figure to reach 500 billion yuan if CDs are part of the picture.

“I believe the Chinese government would like to see … financing channels be diversified.”

About 116 billion yuan in dim sum bonds was issued worldwide last year, up from 112 billion yuan a year earlier, according to data from the Hong Kong Monetary Authority. Of that, 80 percent of the bond issuance was from Hong Kong and mainland companies.

Cheung said the bonds are most likely to be issued by well-know companies that can easily attract interest in the offerings as well as subsidiaries of SOEs that already have a name and economic standing. 

But the bonds still might not be the top choice for big companies because the funding pool might not be large enough to meet their needs, he said. Most yuan bond issues are in the range of 1 billion yuan, compared with standard US dollar-bond issuances of US$500 million to US$800 million, he added.

“Also, investors who buy dim sum bonds usually take a ‘buy and hold’ strategy, so it makes the bonds even harder to be liquidly traded on the secondary market,” Cheung said.

Bryant Edwards, a partner of law firm Latham & Watkins, also sees expansion ahead in the offshore renminbi bond market as the amount of offshore Chinese currency grows. But there is something to watch for.

“To date, the dim sum bond market has been primarily a currency play, with investors willing to accept below-market interest rates because of their expectation that renminbi will appreciate against the US dollar,” Edwards said. “That may change as concern over China’s own debt challenges increases.”

Closer to home

As investors keep an eye out for a shift in offshore yuan winds, change could also be afoot back onshore. Daimler AG’s Mercedes-Benz is expected to be the first foreign non-financial institution to issue yuan-denominated bonds on China’s interbank bond market, the Economic Information Daily reported Jan. 21.

“[We're] likely to see at least one offshore company issuing bonds onshore this year as the government would like to test the market and slowly open up the bond market,” Cheung said, adding that the issue size should be quite small.

Bank of China (BOC, 03988.HK, 601988.CN) will be the lead underwriter but it’s not clear if the Chinese regulator will approve the proceeds for overseas investment, the report said. If it does go ahead, the issue could be a big step in the opening up of the Chinese bond market, it said. 

Onshore yuan-denominated bonds are on the rise. The central bank said 9 trillion yuan (US$1.487 trillion) of the bonds was issued last year, up 12.5 percent from a year earlier. Of that, 3.7 trillion yuan was in corporate bonds, the Shanghai Securities News reported Jan. 29.

Edwards said the major issue holding back the development of the international bond market for Chinese companies is the inability of offshore bondholders to get credit support, either guarantees or collateral, from onshore Chinese companies.

“Sophisticated institutional investors are cautious about investing in bonds that are structurally subordinated to onshore debt and that have no onshore legal remedies. So long as such restrictions stay in place, Chinese companies will have to pay a significant premium for international capital,” he said.

But it is possible, he said, that a tightening of bank credit in China will prompt Chinese regulators to ease these restrictions to give Chinese companies access to “the massive amounts of debt capital available from the vast international institutional investor base”.

This probably won’t be an option for firms like property developers, which Beijing is trying not to encourage. These kinds of companies will instead have to go in search of dollar bonds. Cheung expects Chinese firms to issue about the same amount of US dollar bonds as they did last year — in the range of US$50 billion. He also says these kinds of corporate bonds are a better bet than sovereign bonds because they’re less sensitive to interest rates.

Edwards also sees a growing appetite for corporate bonds. “As the middle class grows in emerging markets, more and more assets are invested in retirement plans and pension schemes. The managers of such plans must find investments whose returns match the long-term obligations of such plans. Corporate bonds provide these managers with the long-term fixed returns they need. So that results in a very steady growth in demand for corporate bonds,” he said.

Default risks

Cheung’s pick of corporate bonds are high-yield bonds, especially those issued by property developers. This real estate group posted “quite good performances” last year at 8.3 percent, but high-yield products from industrials did not do well — at 2.6 percent — as they grappled with falling commodity prices and oversupply.

“High-yield property developer bonds would be a better choice for investors not only because of the performance, but also the transparency, because developers announce their sales every month, which is a good way for investors to do their risk management,” he said.

“The default rate has stayed quite low at an average of 0.75 percent in recent years because high-yield bond issuers have not been aggressive, with all the low funding costs and deleveraging by small companies.”

Another reason for the lower default rate is that firms are cutting capital expenditure and there is not enough demand to support aggressive growth. “Companies with management that experienced the 2008 financial crisis will act more cautiously as well,” he said.

– Contact the reporter at [email protected]


Ayishah Ma is a financial reporter on Greater China issues.

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