The appeal of offshore renminbi (CNH) high yield bonds is likely to continue into the fourth quarter, helped by lack of supply and the search for yield.
The migration of CNH bond investors from a foreign exchange-centric to a credit-focused strategy continued in August, with the investors moving down the credit curve. This led high yield spreads to tighten by 36 basis points (bp) on average, more than the corresponding investment grade (IG) bonds, according to a report released by HSBC on September 12.
“Non-property names played catch-up and were the month’s best performers in terms of total return,” said Zhi Ming Zhang, head of China research at HSBC. “High yield names are expected to outperform due to limited supply and much higher risk premiums versus onshore names.”
Additionally, the overall CNH bond market performed relatively well, after witnessing a pick-up in total return of 0.65% in August from July thanks to the stabilising currency, adds HSBC. The monthly total return in US dollar terms rose to 0.70%, of which FX appreciation contributed 0.48%.
The bank maintains an overweight view on select corporate sector where it expects long-dated investment grade names to remain stable.
The decline in offshore renminbi supply this year was primarily due to minimal cost savings. In some cases, it is even cheaper to issue onshore, notes HSBC.
For instance, Chenming Paper Holdings priced a Rmb1.1 billion (US$173.9 million) five-year bond issue at par with a 4.91% coupon onshore at the end of June, when its offshore two-year bond was yielding 10.2%.
For foreign companies, especially the high grade names, the low rate environment in the US dollar space was even more attractive.
In the primary market, issuance dipped to a four-month low in August to Rmb13.6 billion. Year-to-date corporate issuance is only 33% of the total for the whole of 2011 and its percentage of total CNH bond or corporate deposits (CD) issuance slumped from 70% in 2011 to 28% year-to-date.
CGBs versus policy banks
On the other hand, offshore China government bonds (CGBs) underperformed, with yields rising 20bp to 30bp at the short to middle end of the curve as investors switched to policy banks for a yield pick-up. At the long end of the curve, CGB yields rose by 2bp to 10bp.
The bank highlights that there are two main drivers for the rise in CGB yields.
“First, rising onshore funding costs, weak cross-border renminbi trade settlement and expectations of future renminbi weakness caused tight liquidity in the offshore market,” said Zhang. “Secondly, investors have switched from CGB to policy bank notes to pick up yield. This is especially the case for foreign central banks that have gradually increased their risk appetite.”
Two- and seven-year bonds from policy banks offered as much as 70bp pick-up over the corresponding CGBs, while other tenors offer 40bp-60bp extra yield, notes HSBC.
Additionally, the bank advises investors to maintain their underweight position on CGBs and financial issues as offshore yields are now 30bp to 40bp below their onshore counterparts. Financial names are also likely to face supply pressure.
Weak cross-border renminbi trade settlement was attributed to the sharp decline in China’s export sector, which dropped 6% from July to Rmb244.1 billion by the end of August.
CNH liquidity will remain tight until cross-border trade numbers pick up.
“This will happen when the onshore macro situation improves on the back of fiscal stimulus such as a large number of fixed asset investment projects recently approved by the National Development and Reform Commission (NDRC), even in the absence of much-expected monetary easing,” said Zhang.
On- and offshore yield convergence
While onshore and offshore yield convergence remains a key theme in the medium term, the path would be volatile as large swings in the onshore interbank funding costs dictate the pace.
“Onshore yields are far more sensitive to expectations – or lack of – pending policy easing than offshore markets where FX remains a key driver,” said Zhang. “This was demonstrated in August when rising interbank rates on diminished expectations of immediate policy easing pushed up onshore yields more than offshore.”
“Offshore CGB yield is likely to continue to rise on expectations of persistent tight onshore liquidity,” he added.
Moreover, diminished expectations for immediate policy easing, despite the faster-than-expected economic slowdown have reinforced early concerns about worsening credit fundamentals, says HSBC.
In August, onshore yields rose more than the offshore market across the board. The offshore CGB yield rose an average of 18bp versus 21bp onshore. The five-year onshore CGBs underperformed with yields rising 32bp, which is 10bp more than offshore counterparts.
With regards to corporate names, high grade onshore credits – commercial paper and medium-term notes – weakened, with yields moving up 38bp-45bp across one to five-year tenors.
“This was due to decent supply and further tightening of liquidity in the domestic market,” noted Zhang.
Despite the volatility, HSBC believes yields of offshore CNH bonds will eventually move close to or even higher than their onshore counterparts to compensate for the less variety and liquidity in the offshore market.