The Hong Kong SAR government launched its long awaited debut sovereign bond issue yesterday (Wednesday) after the lead managers worked around the clock to get documentation in place for an early July issuance date.
The dual currency offering has three main components.
A 10-year 144a offering with a minimum issuance size of $1 billion is expected to be upsized to about $1.3 billion and has early indicative pricing in the low 20bp range over Libor.
The second component is a Hong Kong dollar denominated institutional tranche. This will have five and 15-year maturities. The third component is a Hong Kong dollar denominated retail tranche with two and four-year maturities.
Books for the retail offering open today and close on July 16 when all three components of the deal are expected to be priced.
The two retail tranches have coupons of 2.13% and 3.38%. This equates to 9bp and 20bp over Hong Kong government Exchange Fund Notes (EFN's) and 29bp and 12bp through Hong Kong dollar mid-swaps.
The government is expected to issue half of the total transaction in US dollars and half in Hong Kong dollars, but has given itself flexibility to match demand to the relevant tranche.
No LAF
There are two key differences between the sovereign bond and EFN's. The former is a direct obligation by the Hong Kong government, while the latter is a Hong Kong Monetary Authority (HKMA) obligation, backed by the Territory's reserves.
The second difference concerns LAF eligibility (Liquid Adjustment Facility). The sovereign bond will not be eligible for discount and Repo purposes and as such will automatically need to be priced at a premium to EFN's, which are.
Some bankers believe this is a strange anomaly, which can be attributed to rivalry between the two issuing entities. Pre-financial crisis, the Hong Kong government granted LAF exemptions to a number of highly-rated domestic and international credits.
However, it clamped down after massive speculation against the currency peg in 1997, which it attributed to misuse of the discount window. Since then, only EFN's have been eligible.
Specialists say the main benchmarks for the Hong Kong institutional tranche will be issues by the government-owned Hong Kong Mortgage Corporation (HKMC) and MTR Corp. The former recently issued a four-year bond with a coupon of 3.55% to yield 30bp over EFN's.
Given that the coupon on the sovereign's four-year retail tranche has been set at 20bp over EFN's, it is expected the institutional tranche will likewise price about 10bp through the HKMC.
At the longer end of the curve, the MTR Corp has a 2018 bond that currently yields 5.08%.
All four Hong Kong dollar tranches will price at a premium to the large number of supranationals, which regularly access the Hong Kong dollar market. The most recent benchmark issue was a HK$1 billion transaction by the triple-A rated ADB, which bought a three-year deal last month at 2.85%, to yield 4bp over EFN's and 20bp through mid-swaps.
Specialists also believe the government's recent HK$6 billion ($769 million) securitization of its tunnel revenues has whetted investors' appetite. "There was a lot of unsatisfied demand from that deal," says one. "The new deal is much simpler to understand and it should appeal to the vast number of investors who have recently moved back out of the local equity market."
Benchmarks for the dollar bond
Where the US dollar bond is concerned, the main benchmark is the Hong Kong Airport Authority. The quasi-sovereign credit has a September 2013 bond that is currently trading at roughly 77bp over Treasuries and 35bp over Libor.
In Korea there is a 35bp to 40bp differential between the sovereign and its proxies and in Malaysia a 20bp differential. However, specialists say the government is wary of pushing for this kind of pricing differential.
It does not want to follow the heavily criticized strategy pursued by the PRC last year, which relied on a huge backstop bid from its home market, only to watch the deal trade poorly in the secondary market.
China has an A2/BBB+/A- series of ratings. Compared to Hong Kong's A1/A+/AA- ratings, China is rated one notch lower by Moody's and three notches lower by Standard & Poor's and Fitch.
All three agencies now emphasise the differences between the Mainland and its Special Administrative Region. S&P has always notched the two differently and its recent release noted that Hong Kong should be higher than China because of its, "strong credit fundamentals, including its ability to run a separate monetary system, strong institutional framework and its financial autonomy."
The PRC's October 2013 bond is currently trading at about 75bp over Treasuries, or 31bp over Libor. The other main sovereign benchmark is the A3/A-/A rated Republic of Korea, which has a June 2013 bond trading at 69bp over Treasuries and 28bp over Libor.
Credit stats
All three sovereigns share low levels of foreign debt relative to GDP and huge foreign currency reserves. Hong Kong's credit stats for 2003 show a 26.7% ratio of foreign debt to GDP and reserves of $118.4 billion, up from $111.9 billion the previous year.
By comparison, China ran a 13.7% foreign debt to GDP ratio backed by reserves of $403.3 billion and Korea a 30.3% foreign debt to GDP ratio backed by reserves of $141 billion.
But the three diverge when it comes to fiscal deficits. Korea has generally been in surplus in 2000, although it ran a slight deficit of -0.1% in 2003. China by comparison ran a deficit of -2.5% and Hong Kong -3.2% or HK$40.1 billion ($5.14 billion).
After accumulating a surplus of 6.5% in 1997, Hong Kong has been consistently in deficit since then, though it was able to reduce the amount from 4.9% in 2002 because of strong gains across the property and stock market in 2003.
Proceeds from the bond issue are being used to plug the deficit. The government's credit rating was recently boosted by S&P, which amended its outlook from negative to stable at the beginning of the month. Moody's upgraded it one notch last autumn.
But some houses have voiced concerns. Last month a CSFB economist described how the political climate may hamper efforts to control the deficit.
"September's LegCo elections and local opposition to Beijing's decision to delay democratic reform will likely compound the stalemate between the government and LegCo," the US house said in a research report. "We think the administration's inability to plug the deficit could lead to a ratings downgrade in the medium term."
The Hong Kong government will put forward its case via two roadshow teams. Financial Secretary Henry Tang will lead one team and Financial Services and Treasury Secretary, Frederick Ma, will lead the other.
Bankers believe the whole deal has been turned around exceptionally quickly with two months of documentation work completed in the space of just two weeks. After a few weeks of doing nothing post mandate, the government finally fast-tracked the deal because officials are unavailable to travel in late July and syndicate bankers are worried what carnage the FOMC may inflict on global bond markets come September.
The government has appointed a large and unwieldy syndicate of seven bookrunners to run the deal, of which BOCI, HSBC and Merrill Lynch will be global co-ordinators.
The US dollar tranche will also encompass Goldman Sachs and Morgan Stanley as bookrunners, with Citigroup acting as a bookrunner on the Hong Kong dollar institutional tranche and Standard Chartered a bookrunner on the Hong Kong dollar retail tranche.
There will also be 22 placing banks in the retail tranche. Fees are just 8bp.
A full write-up of the government's controversial mandate process entitled "Snow White and the seven bookrunners" can be found in June's edition of FinanceAsia magazine. For further details, please contact [email protected] or [email protected].
