China high-grade corp dollar bonds — bargain

Investors see attractive value in Chinese corporate issuers’ US dollar bonds, especially from the investment-grade space, as onshore credit conditions ease.

The US Federal Reserve’s dovish stance and European Central Bank monetary easing have not only compressed their regions’ corporate credit spreads but also those in Asia, creating pockets of value.

Since the summer of 2013, corporate credit spreads of US dollar bonds issued by investment-grade Chinese issuers have underperformed against their US and European peers.

A few domestic factors contributed to this phenomenon, including China’s struggle with shadow banking, mounting local government debt and short-term interbank liquidity crunch.

But many investors believe the performance of the asset class is set to rebound over the next six months. “The underperformance of US dollar bonds issued by investment-grade Chinese corporate issuers may have run its course as a lot of negative news and adverse sentiment is already priced in,” Ken Hu, chief investment officer for Invesco’s fixed income division in Asia-Pacific, said.

“Looking forward, there are several positive developments in China to potentially reverse such underperformance,” he added.

For starters, consumer price inflation is expected to fall in the second half of 2014, buoyed by declining food and property prices, which have been softening since the start of the year.

In fact it is already happening. Inflation in China eased slightly in June, standing at 2.3% compared with 2.5% in May, the National Bureau of Statistics said. The gauge of inflation remains below Beijing’s annual target of 3.5% for 2014.

This has given flexibility to the Chinese authorities to ease monetary policy. Since April, the authorities have twice cut the required deposit reserve ratio for medium and small banks. Given the ratio for some major financial institutions is high at 20%, there is room for further cuts, experts said.

In addition, authorities have relaxed the calculations of loan-to-deposit ratio of banks, which has been set at a very conservative level of 75%.

Supply to decline

Market yields of top-tier Chinese corporate issuers shot up by more than 100bp in the domestic bond market in China after the short-term interbank liquidity crunch last summer but such yields have started to decline from April 2014 on the back of softening CPI and monetary easing.

This indicates improving refinancing costs for top-tier Chinese corporations in the onshore market, which in turn would lead to the decline in offshore dollar supply, resulting in better performance of the asset class, experts noted.

“As the domestic funding costs of top-tier Chinese corporations are declining and the availability of funds is likely to further improve upon further monetary policy easing, there will be fewer incentives for such corporations to issue US dollar bonds in the global bond markets,” Hu said. “If they do issue US dollar bonds, they will have a stronger bargaining power to give less yield concessions to investors.”

No doubt easier credit conditions onshore have caused Chinese credit to outperform over the past two months. Chinese investment-grade spreads have rallied 20bp in that time, while the country’s high-yield sector has rallied 150bp, according to Morgan Stanley in a recent report.

Also, the Chinese high-yield spreads are now at 615bp, 32bp tighter than where we started the year, the investment bank added.

However, given the riskier nature of the high-yield space and its higher sensitivity to the volatile nature of onshore funding conditions, investment-grade names are much preferred.

“We remain equal-weight on China investment-grade and underweight on high-yield,” Viktor Hjort, credit analyst at Morgan Stanley, said. “Following the rally, high-yield valuations are again back to the more challenging end, and given the increased reliance on external funding, we see high yield as more vulnerable to any reversal in credit conditions.”

Sino-Ocean land bond

After a week-long hiatus, the Asian US dollar primary market sprang back to life on Wednesday with Sino-Ocean Land’s dual-tranche benchmark-sized five- and 10-year dollar deal — the latest investment-grade Chinese name to come to market.

The Chinese property developer’s new five- and 10-year offerings have initial price guidance of Treasury plus 335bp and 380bp respectively, according to a term sheet seen by FinanceAsia.

Credit analysts highlight that Sino-Ocean’s new bonds are attractive and are able to offer an additional pickup of 50bp and 35bp versus similarly rated Greenland’s notes expiring in July 2019 and 2024 for the five- and 10-year tranche respectively.

“Although further China investment-grade property supply clearly remains a risk, we think the deal still has room to perform in secondary if it prices at Treasury plus 310 for the five-year and Treasury plus 360bp for the 10-year or better which still represents a 10bp-25bp pickup to Greenland,” Mark Reade, Asian fixed-income trader at Mizuho Securities said.

However, Mizuho’s preference leans towards Sino-Ocean’s 10-year offering given that the tranche’s more than 6% yield would make it among the highest-yielding investment-grade bonds for that tenor.

Sino-Ocean Land is a Baa3/BBB-/BBB- rated Chinese developer and investor with a focus on mid-to-high-end residential properties as well as office and retail premises. In 2013, home sales contributed to 91% of total revenue, with 7% from property management and related services and 2% from real estate investment.

Bank of China International, Deutsche Bank, Goldman Sachs, HSBC and JPMorgan are the joint bookrunners of the transaction.

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