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Cost of funds drive Chinese borrowers offshore into CNH

10 Jul 2011

Multinationals such as Unilever and Volkswagen might have stolen all the attention in the RMB offshore bond market of late but it has been Chinese companies that have been the real drivers of this booming sector over the past year. Philip Moore reports.

To date, for all the headlines about issuance from multinational companies such as McDonald’s, Unilever and others, the RMB offshore market has predominantly been a funding avenue for Chinese corporate borrowers.

This is because for the majority of regular borrowers in the international capital market, arbitrage opportunities in the RMB market remain elusive. This is why, although the opportunities in RMB are on most borrowers’ radar screens, the economics of issuance seldom add up for those without local funding needs.

"At the moment the RMB market only gives you a funding advantage if you have a requirement to use renminbi in China," says Joerg Huber, head of funding and investor relations at LBBW in Stuttgart. "Because we’re not very active in lending RMB, we would have to park the proceeds in the Hong Kong money market and incur a negative cost of carry."

This, bankers say, will change as the cross-currency market matures. For the time being, however, for most multinational companies the main attraction of the RMB market is the funding advantage it offers over the mainland, rather than any arbitrage appeal.

"When McDonald’s accessed the RMB market in late 2010 it printed the issue at 3%," says Ronan McCullough, head of Asian debt capital markets origination at Morgan Stanley in Hong Kong. "That was a much more attractive level to what it could have achieved onshore. But if it had swapped back into dollar Libor it would have been substantially wide of where McDonald’s would expect to fund in the US market."

Limitations in the swap market have dictated that in many instances, issuers have been driven by an identifiable requirement for RMB. For a borrower like the Asian Development Bank (ADB), which launched its first offshore RMB transaction last October, the drivers of issuance are very clear. The proceeds of its Rmb1.8bn 10 year deal were earmarked for local projects, notably in clean energy, including wind power, water treatment and infrastructure.

In the corporate sector, meanwhile, a vivid recent example of an offshore RMB transaction linked directly to activities on the mainland was the Rmb1.5bn five year issue led by Bank of China, HSBC and Standard Chartered for Volkswagen in May. All the proceeds from this deal were earmarked for investment in the company’s mainland operations, with an HSBC deal case study commenting that "the transaction reflects the importance of the Chinese market for VW. China is the largest national market for VW and the company plans further investment of Eu10.6bn until 2015."

That suggests that VW is a likely candidate to return to the RMB market in the future, especially if it can match or improve on the terms it commanded in May. The VW issue was priced to yield 2.15%, which compares with the 5.26% that Beijing Automotive Industry Holding, China’s fifth largest car company, paid for a five year Rmb400m onshore issue in April.

KfW: a natural issuer

Another German borrower that has a material and identifiable requirement for RMB is the prolific and ubiquitous KfW. At the last count, it had borrowed in 25 currencies and it is now preparing to issue in a 26th.

Horst Seissinger, the bank’s head of capital markets, told delegates at May’s conference not just that a debut KfW issue in the RMB offshore market is imminent, with a transaction likely to be for a minimum of Rmb500m. He also said that he sees KfW eventually becoming a regular borrower in the region’s capital market. "We don’t plan to do one issue and then disappear," he explained. "We want to build a sustainable model allowing us to issue first in the offshore market in Hong Kong and ultimately in mainland China as well."

The challenge for KfW, Seissinger added, is to identify an appropriate borrower with a project that requires RMB funding. Given the importance of Germany’s trading links with China, however, there should be no shortage of eager applicants for RMB funding over the longer term.

PR game

None of this means that international borrowers in the RMB market need be motivated purely by a compelling economic reason to repatriate funds to the mainland. Take the case of an issuer like Sweden’s Handelsbanken, which in February was the first non-UK European borrower to capitalise on the explosion of RMB liquidity in Hong Kong, issuing a Rmb170m ($25.79m) two year issue via HSBC.

At May’s Hong Kong conference, Handelsbanken’s head of central treasury for Asia, Göran Tullberg, joked that he had asked his PR department to pay some of the costs associated with issuing in the offshore RMB market, given that marketing the bank’s name in the region was such an important driver for the Handelsbanken deal.

Other multinational borrowers have also derived substantial PR benefits from their issuance in the RMB offshore market. "If you look at the press coverage of Unilever’s deal, it packed amazing power from a media perspective for a tiny $50m equivalent issue," says one Hong Kong-based banker. "Issuing in this market is a very effective way for companies to emphasise the strength of their commitment to Asia and to generate a lot of local goodwill."

Bankers say that to look at the opportunities in the RMB market purely on the basis of immediate funding needs in the Chinese currency is to miss the longer term significance of the market. "Rather than look at the immediate use of proceeds, we should be looking at the wider motives of issuers," says Patrick Tsang, managing director and head of Asian fixed income capital markets at Deutsche Bank in Hong Kong. "Deal sizes compared with what borrowers can achieve in dollars and euros are still very modest, but in many cases issuers are coming to this market to ensure they are comfortable with the issuance procedure and with the requirements of the regulators."

Compelling alternative

For the Chinese corporate sector, however, the economics of issuance in the offshore RMB market are more immediate and persuasive. This is chiefly because the RMB market presents a very compelling alternative to domestic funding options that are becoming pricier and less accessible. Morgan Stanley puts the yield differential between onshore borrowing and offshore CNH issuance at 210bp.

This matches calculations from other banks. According to a recent Deutsche Bank survey of 44 multinational companies, the offshore RMB market continues to offer a funding advantage relative to other currencies. While the average cost of funding for a two year US or Hong Kong dollar loan or bond in the Hong Kong market would be 2.8%, according to respondents to this survey, the cost for the same maturity in an offshore RMB issue would be 2.6%.

It is not just the cost of onshore credit that is a key driver of RMB bond issuance for Chinese companies. Access is also an important influence. One of the variables assessed by Morgan Stanley in its China Business Conditions Index (CBCI) is corporates’ access to credit. As recently as November 2010, only 2% of respondents to this survey indicated that credit is "more difficult" to come by, with 7% saying it was easier and the remaining 90%-plus reckoning credit conditions were unchanged. Spin forward to March 2011, and 21% said credit was becoming more of a challenge.

These findings are highly volatile. Besides, as Morgan Stanley points out, lending to Chinese corporates amounted to Rmb4tr in 2010, almost 56 times as much as was issued in the RMB market. "What matters, however, is the trend on the margin," says Morgan Stanley.

But perhaps the key figure is the 12% which now expect access to credit to become more difficult. When that access is available, it won’t be cheap. Onshore benchmark loan rates in China are regulated by the PBoC, with corporate borrowers — irrespective of their implied credit rating — eligible for a 10% discount. According to Morgan Stanley, the current one to three year rate is 6.4%, which puts the cheapest available rates at 5.76%.

"If you look at the basic figures it may not look as though too much liquidity has been withdrawn," says McCullough at Morgan Stanley. "But there is plenty of anecdotal evidence that Chinese corporates are concerned about the bank market, and that the banks are still reluctant to extend liquidity. There is no question that these factors are driving more and more borrowers offshore."

The change that is being brought about in the Chinese corporate sector as a result of this dynamic can scarcely be underestimated. "Until very recently the idea that companies like China National Petroleum Corp (CNPC) or Sinochem would need to borrow in the international market would have been unimaginable," says one local banker.

"Historically, large state-owned companies would just have needed to approach their local relationship banks to raise all the funding they needed," says Augusto King, co-head of debt capital markets for Asia at Royal Bank of Scotland. "Now, the banks themselves are having to borrow abroad as well.

"This is a very steep change that has come about in a very short space of time driven by tightening in China," says King. "And if it is having a big impact on the largest and most influential companies in China, it is clearly going to have an even bigger effect on smaller private sector borrowers."

Tightening in China is coming at a time when the corporate sector still has very substantial funding requirements, driven by a strong appetite for expansion by acquisition. "The larger SOEs in particular are under pressure from the State Council to go out and make acquisitions, but at the same time they are being told that liquidity will be in shorter supply," says one Hong Kong banker. "So for the first time, many Chinese companies are having to look at their options for M&A financing."

Don’t forget the dollar

For all the sound and fury that has accompanied the emergence and growth of the offshore RMB market, however, it is the dollar sector that has been the principal beneficiary of these rising borrowing needs in the Chinese corporate sector.

"Historically, the profile of Chinese issuance in offshore markets has been skewed towards the real estate sector," says McCullough at Morgan Stanley. "But this has been a break-out year for Chinese credit generally, with a wave of international supply across all sectors from investment grade to high yield borrowers. The offshore RMB market represents a growing part of that overall supply."

In contrast to the offshore RMB market, the dollar market has been able to deliver jumbo-sized liquidity across the yield curve. When Sinochem launched its $2bn benchmark last November, for example, split into a $1.5bn 10 year bond and a $500m 30 year tranche, it was the largest ever international issue from a Chinese borrower. CNPC seemed poised to break that record in April 2011, when it was said to be readying a $3bn jumbo. In the event, its $1.8bn issue raised $700m in five year funding, alongside a $650m 10 year tranche and a $500m 30 year issue.

Not that dollar funding has been to all Chinese corporate borrowers’ taste. At HSBC, head of Asia Pacific debt capital markets origination, Roderick Sykes, says that a notable feature of China Wind Power’s Rmb750m three year issue in March was that the offshore RMB option was chosen in preference to a US dollar high yield bond for which the company had previously appointed two lead managers.

The dollar market has, however, clearly been a very popular source of funding in the first half of 2011 for Chinese borrowers. Daniel Mamadou of Deutsche Bank in Hong Kong points out that by mid-May, total hard currency issuance by Asian borrowers had reached $42bn, of which $19bn was from Chinese corporates.

Synthetic variant

A variant on straight dollar issuance is the synthetic structure, in which bonds are settled in dollars but denominated in RMB. "These are effectively US dollar bonds with an embedded RMB option," explains Wallace Lam, managing director of debt capital markets at HSBC in Hong Kong.

To date, there have been eight synthetic transactions, seven of which have been from Chinese real estate companies. Lam explains that synthetic bonds tend to be larger in size than straight RMB issues, averaging Rmb2.6bn compared with Rmb1.3bn. They have also been longer dated issues, typically with maturities of between three and five years, compared with the two to three year maturity which is the sweet spot for the straight market.

Another key difference between the synthetic and straight markets, says Lam, is that while borrowers need approval from Safe to issue in synthetic format, there is no requirement to jump through the hoops of the PBOC approval process.

The first synthetic issue was launched in December by Shui On Land, with a Rmb4bn ($450m) three year transaction which was led by Deutsche Bank, Standard Chartered and UBS and offered a coupon of 6.875%. Shui On returned to the synthetic market the following month with a longer Rmb3.5bn four year deal with a 7.625% coupon.

The same month, meanwhile, China SCE Property closed an Rmb2bn Reg S/144A transaction, led by Deutsche Bank and HSBC, which generated orders of Rmb10bn.

Not all borrowers have been able to command such strong demand in the synthetic market, with a Rmb1.2bn three year transaction from LDK Solar in February, for example, notable for having struggled in the secondary market.

Bankers say that demand for synthetics has weakened for a number of reasons, in spite of their generous coupons and generally larger sizes, which ought to underpin better liquidity. "When we did the first issue for Shui On there was an expectation of very strong interest for synthetic bonds," says Paul Au, head of debt syndicate at UBS in Hong Kong. "But institutional demand was limited compared to private banking demand. Not all dedicated RMB funds have a mandate to buy bonds that settle in dollars. And on the other hand, many mainstream dollar funds don’t have a mandate to take RMB exposure in their buy and hold portfolios, even though the principal and interest are paid in dollars."
10 Jul 2011