'The Chinese bid': don’t count on it
Ask any debt banker in Asia about 'the Chinese bid' and they will tell you how dramatically demand from the country has transformed the dollar bond market. But a handful of recent deals from the country’s local government financing vehicles should give borrowers pause. This source of demand cannot be taken for granted.
Chinese debt issuers are in an enviable position during periods of volatility, being able to rely on a horde of Chinese investors to get their deals over the finish line. Domestic accounts are generally loyal to their country’s issuers and are willing to settle for tighter spreads than their Western counterparts. This means that when investors elsewhere are too worried — or, during the Christmas break, too busy eating turkey —Chinese issuers can still tap the offshore bond market.
Most debt bankers talk about “the Chinese bid” as if it’s entirely unique from the rest of the Asian investor base, defined by its extreme loyalty to one country, its minimal concern with diversification and its lack of price sensitivity. Of course, the reality is more complicated. The term is a convenient shorthand for a mix of investors with wildly different levels of experience and risk appetite. But taken as a whole, the Chinese bid has clearly proved a key driver of deals from the country.
How long can this last? The willingness of Chinese investors to swallow sometimes aggressive pricing has not been dramatically called into question over the last few years, since buoyant markets have created a market where even international funds are reduced to the level of price-takers. But there are signs that the party may be winding down.
Although Asia’s bond market is incredibly liquid at the moment, it is also being driven by tenuous assumptions: about the health of the Chinese economy, about the direction of US interest rates and about the ability of borrowers to continue to find financing. That means borrowers are being forced to walk a tightrope. When they fall, it is not clear the Chinese bid is still willing to provide a safety net.
Take a recent deal from Gansu Provincial Highway Aviation Tourism Investment Group Co, a local government financing vehicle. The company pinned too much hope on the China bid last week, when it rolled out a $300m three year bond.
The issuer announced its transaction at 3.3%, thinking that it could price around 3% following the tight pricings secured by other LGFVs this year. But Chinese orders failed to materialise in large enough size. Bankers on the deal admitted the issuer overestimated its ability to attract mainland orders.
The misstep left other investors thinking the LGFV had lined up anchor orders to allow it to take an aggressive approach to pricing. They bowed out as a result, unwilling to buy into what they expected to be a tightly priced trade. The Gansu issuer ended up pricing its trade at 3.25%, but failed to attract many investors even with an added premium.
It was a more serious problem for Zhongyuan Yuzi Investment Holding Group Co, which attempted to print a five year deal in the middle of last week. The LGFV was hoping to ride on a recent ratings upgrade to price a tight bond. But investors ended up balking, forcing the company to pull its transaction altogether.
The firm was followed by Shandong Iron & Steel Group Co, which was forced to pay 50bp more than it wanted to raise $500m from a three year trade.
All the three issuers came to the market during a difficult week — as volatility began to tick up ahead of the US presidential election and after a bumper few weeks of bond issuance in Asia. It didn’t help that Gansu, Zhongyuan and Shandong are not the strongest of provinces in China. But they were all hoping the Chinese bid would be enough to ensure an easy execution. It wasn’t.
Chinese investors may have had abundant liquidity over the last few years but they are not committing money blindly. They are keeping a close eye on the spread of Covid-19, the ramifications of swings in polls ahead of the US elections and, of course, the credit risk of individual companies. They still have plenty of money to put to work but they’re no longer willing to settle for bonds that are priced well inside fair value.
That, at least, is how things look for now. Funding officials at Chinese companies will hope this is a short-term blip, with normal service to resume shortly. But power is seductive. Once Chinese investors start to realise their ability to call the shots, they will increasingly ask for more generous pricing. Issuers would be wise not to push them too far.