Flood of offshore yuan bonds may spark higher yields

HONG KONG Thu Jan 23, 2014 12:30am EST

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HONG KONG Jan 23 (Reuters) - A wave of bond sales from Chinese firms in Hong Kong has led nervous investors to seek higher yields to compensate for weak debt structures that offer less protection against default.

Companies have rushed to raise relatively cheaper funds offshore compared with the mainland where benchmark interest rates have spiked recently on concerns over tight liquidity.

January is shaping up to be the second-biggest month for issuance on record in the offshore "dim sum" market.

Riding on widespread consensus that China's yuan will lead Asian currencies this year after a 3 percent rise against the dollar in 2013, about 15 billion yuan ($2.48 billion) of debt has been raised in the first half of the month.

That flood of sales has also washed up weak bond structures on Hong Kong's shores.

This week, Ping An, China's No.2 issuer, issued a 1.6 billion yuan bond which barely scraped past the finishing line, while Powerlong, a property developer, had to postpone its offering as investors demanded higher yields.

"The dim sum market is an issuer's dream," said Adam Mccabe, head of Asian fixed income at Aberdeen Asset Management who manages more than $5 billion in assets.

"If demand is in excess of supply, then there is going to be some mispricing of risk and that is the problem with the dim sum market."

From its humble beginnings in July 2009, the dim sum market has exploded with outstanding volume of more than half a trillion yuan and maturities stretching out to 30 years.

Despite robust growth, the dim sum market is awash with unrated paper and bonds carrying weak covenants as investors seek leveraged bets on yuan appreciation and banks trapped with excess deposits have nowhere else to go.

The percentage of rated bonds to total debt issued by Greater China corporates was 47 percent in 2013, respectively, according to Moody's. That compared with more than 80 percent issuing in dollars, euros or yen, various estimates show.

Ratings and strong covenants offer protection to bond investors either by preventing issuers from selling more senior debt or spending excess cash unless bondholders' agree.

But compared with the stricter covenants in the dollar-denominated high-yield debt, dim sum bonds usually do not have stringent controls such as fixed charge coverage, more debt incurrence and the scope of triggers are limited, said Ivan Chung, a senior credit officer at Moody's Corporation in Hong Kong.

But as optimism over further yuan appreciation fades, returns from dim sum bonds will reflect more of the underlying credit risks, he said. And without adequate protection from covenant package, investors will be more hesitant to invest in high-yield issuance, he added.

Refinancing pressure and a widening yield gap between the onshore and offshore markets may also accelerate that change.

More than half of the outstanding dim sum debt estimated at more than 300 billion yuan will mature within the next 12 months, prompting some issuers to look at raising funds earlier to avoid a possible liquidity squeeze.

The gap between the onshore and the offshore market has only widened in recent months. One-year offshore treasury bonds yield 2.50 percent compared with nearly 3.8 percent onshore, according to Thomson Reuters data.

China Shipping's latest bond this week may be a sign of things to come for the dim sum market.

While the shipping company sold $500 million of five-year debt, the order book was disappointing despite the bond having a relatively stronger structure.

The bond had a standby letter of credit structure which meant that in case of default, a bank would fork out money to bond holders, a stronger structure compared with the usual one of a parent company in onshore China backing its subsidiary selling a dim sum bond.

Due to this very reason, SBLC-backed bonds have been popular since 2012 but have seen a slowdown in issuance after reports that Chinese regulators told banks to stop using that structure on concerns that SBLCs should be used for trade financing rather than offering bond guarantees.

($1 = 6.0513 Chinese yuan) (Additional reporting by Nethelie Wong; Editing by Jacqueline Wong)

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