China wows Europe

Sovereign secures large order book for benchmark bond despite aggressive pricing.

The People's Republic of China returned to the international bond markets for the first time in a year on October 21 with one of its most striking bond offerings to date. The twin tranche Eu1 billion ($1.26 billion) and $500 million deal was incredibly well timed, coming on a day when 10-year US Treasury yields dipped below 4% for the first time in six months.

However, bankers believe the deal has far greater long-term significance and may mark a key inflexion point for Asian borrowers, which have long struggled with euros and principally stuck to dollars instead. Typically, euro deals price at a premium to dollars and transaction sizes have often been constrained by more limited investor appetite.

But in this instance, few non-syndicate bankers were prepared to argue that China's 10-year euro tranche was anything other than a stunning success. This was particularly surprising given the A2/BBB+/A- (Fitch) rated sovereign's aggressive attitude to pricing, which mirrored its strategy last year when a similar twin tranche deal came unstuck during secondary market trading.

In a neat role reversal over 2003, the dollar component was much smaller this year and a shorter five-year deal was forced into a distinctly secondary role, with placement largely pushed back into China itself.

The three lead managers of the euro tranche - BNP Paribas, Deutsche Bank and UBS - had much to prove, but appeared to have delivered in spades. The euro tranche generated an order book of Eu4.2 billion and the interest of 220 accounts, of which 84 were completely new to the credit. About 15 to 20 accounts placed orders for more than Eu50 million.

The distribution statistics also reveal how successful the sovereign was at tapping into new investor demand. By geography, the deal had a split of 83% Europe, 16% Asia and 1% other. Further breakdowns show that Germany took 27%, Singapore 10%, Italy 8%, France 8%, the UK 6%, Ireland 5% and Greater China 4%.

"Who'd have thought that Ireland would buy more than Hong Kong and China," says one participant.

Key to attracting this level of interest was the decision to specify how much the sovereign intended to raise up front. "In the past, Euro investors have often got fed up that deals have been too small and aren't included in any of the indices," says one observer. "With this deal they knew that wasn't going to be the case."

He notes that the dynamics of the European investor base are also changing, albeit slowly. "All these insurance companies in Germany and pension funds in Scandinavia are taking a much more active approach to managing their national assets these days," he comments. "Over the years they've migrated from Bunds, to supranationals, to European sovereigns, European corporates and now Asian sovereigns."

By investor type, the book was also dominated by 'real money' accounts with pension funds, insurers and central banks taking 31%, fund managers 36%, banks 27%, retail 5% (33 accounts) and others 1%.

Final pricing came at 98.926% on a coupon of 4.25% and yield of 4.385%. This equates to 52.8bp over Bunds and 40bp over mid-swaps. Fees were 20bp.

Previously China has raised Eu400 million from an October 2008 maturity and Eu550 million from a May 2006 maturity. The former was said to have been trading at 23bp over mid-swaps when the new deal priced.

This secondary market level equated to about 23.5bp over Libor, which represented a premium to the sovereign's December 2008 dollar issue, which bankers were quoting at 19bp over Libor.

However, on a like-for-like basis, bankers believe the new deal has priced through the sovereign's dollar curve. As well as the December 2008 deal, China has a May 2011 deal outstanding and an October 2013 deal. 

Some banks were quoting the former yesterday (Thursday) at 25bp over Libor and the latter at 38bp over Libor. Others, by contrast had the May 2011 at the same level as the 2008 bond and the 2013 as low as 32bp over Libor.

Taking the first set of quotes equates to 6bp on the Libor curve between 2008 and 2011 and 13bp between 2011 and 2013. The strange differential can be explained by the fact that the short end of the curve is trading at very high cash prices since the bonds have all been asset swapped back into China and are tightly held.

Based on a 4bp average per annum, a new China 2014 dollar bond would price around the 42bp mark. This prices the new euro deal roughly 2bp through the dollar curve. Taking the second set of quotes, on the other hand, prices the new euro about 6bp over dollars.

Either way, there was little doubt the new dollar deal was even tighter than the euro. With an issue price of 99.603% the dollar tranche carries a coupon of 3.75% and a yield of 3.838%, equating to 60bp over Treasuries and 18bp over Libor. Again assuming 4bp on the Libor curve, a new five-year should have priced around the 23bp level.

The dollar deal was led by Goldman Sachs, JPMorgan, Merrill Lynch and Morgan Stanley on fees of 16bp. It attracted an order book of $1.5 billion and 95 accounts, of which 50% came from onshore China, 30% the rest of Asia and 20% Europe and offshore US. About $600 million of the total came from anchor investors, with most, though not all, from China.

By investor type, banks took 70%, funds 14%, private banks 8% and other 8%.

The sovereign's one remaining hurdle is the secondary market. At 4bp through its Libor curve on the dollar trade, the sovereign has been even more aggressive than last year when it priced about 2bp through.

However, on an absolute basis, pricing does not look quite so tight since the $1 billion 10-year deal of October 2003 came with a headline spread of only 10bp over Libor. This was about 18bp through its CDS spreads, whereas this year it is about 12bp.

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