The People's Republic of China returned to the international bond markets for the first time since May 2001 yesterday (Wednesday) with a $1.5 billion twin tranche issue that squeezed every last basis point out of the market.
Eschewing the temptation to built up a wildly inflated order book that would close many times oversubscribed, the sovereign decided instead to pursue the tightest price it could without losing a truly global investor base. And it appeared to have succeeded with the help of a huge domestic back-stop bid, an improving credit story and limited outstanding supply.
But few were prepared to argue the bonds held any relative value at all except in relation to the sovereign's own extremely tightly held and traded benchmarks. For international investors, they mainly appealed as defensive plays, offering little upside, but plenty of downside insulation from spread volatility as a result of the immense liquidity underpinning the Chinese banking system.
Six lead mangers oversaw two deals, with Goldman Sachs, JPMorgan and Merrill Lynch running the books on a $1 billion 10-year issue and BNP Paribas, Deutsche Bank and UBS the books on an Eu400 million five-year. Fees were a respectable 34bp.
The dollar tranche was priced at 99.426% on a coupon of 4.75% to yield 4.823%. This equated to a spread of 53bp over Treasuries and 10bp over Libor.
The euro tranche was priced at 99.978% on a coupon of 3.75% to yield 3.755%. This equated to a spread of 21.5bp over Bunds and 7bp over mid-swaps.
The dollar tranche closed with an order book of about $1.9 billion and the euro tranche with an order book of just under Eu1 billion. A total of 150 accounts participated in dollars and roughly 80 in euros.
By geography, the dollar tranche had a split of 44% Greater China, 25% US, 19% Europe and 12% Singapore. For the euro, the split was 38% Continental Europe, 32% Greater China, 25% UK and 5% other Asia.
By investor type, the dollar tranche was populated by banks on 52%, asset managers 23%, private banks 15%, central banks 8% and insurance 2%. With the euro tranche there was a similar split, with banks taking 50%, asset managers 20%, private banks 20% and central banks 10%.
Similar to May 2001, when the sovereign raised $1 billion and Eu550 million, the two tranches were priced flat to each other on a like-for-like basis. And similar to 2001, the dollar tranche priced through an existing sovereign benchmark on a Libor basis.
At the time of pricing, China's 6.8% May 2011 bond was bid on a relatively high cash price of 114.52% to yield 10bp over Treasuries, or 11bp to 13bp over Libor. This means the new deal has priced 43bp over the old on a Treasuries basis, but a couple of basis points through on a Libor basis.
Likewise China's euro-denominated 5.25% May 2006 was being quoted at about 10bp over mid-swaps, which means the new deal has also priced about 3bp through the old even though it has a two-year longer maturity.
As one participant explains, "It's a pattern we've seen with a number of Asian bond deals, where investors have been prepared to give up a little bit on the Libor side, because they will get the pick-up relative to the Treasury and yield curve."
They were certainly not getting any pick-up relative to any non-Chinese issuers in the Asian bond universe. China currently has an A2/BBB/A- (Fitch) credit rating and was felt to have benefited from a one notch upgrade by Moody's last week. Prior to the upgrade, the leads believed indicative pricing of 60bp to 65bp over Treasuries would be the right starting point for the dollar tranches.
In the immediate aftermath of the upgrades, Asian credits rallied 10bp to 15bp and the leads revised their opinion to 55bp to 65bp over Treasuries. In the end they went out with initial guidance around the 55bp area and were able to squeeze it down a further 2bp as the order book grew.
At final pricing, the dollar tranche came 18bp through CDS spreads for 10-year China paper. More tellingly, the deal came 23bp through the CDS level of 10-year paper for Hong Kong's A1/A+ rated MTR Corp, which has a one notch higher rating from Moody's and four notch higher rating from Standard & Poor's.
Although Moody's recent action has resulted in China and Hong Kong's sovereign credit ratings diverging for the first time in seven years, the trading differential between the two has been reversed the other way. For where once Hong Kong sovereign proxies and China used to trade flat to each another, China has progressively tightened, while Hong Kong has been the one to get upgraded.
However, given that Hong Kong credit spreads also benefit from China's halo effect, both sovereigns trade out of kilter with the rest of Asia. Last week, for example, Singapore Power rated a much higher Aa1/AA+ but priced a 10-year deal at 30bp over Libor, some 20bp wider than China.
As Barclays commented in a research piece published yesterday, "We see little value in Chinese sovereign bonds at these tight spread levels, certainly also as S&P is unlikely to upgrade China to A- which would result in inclusion of Chinese sovereign bonds in the Lehman Aggregate Bond index (by comparison, the Korea 2013, which is included in the index is currently trading at a wider Libor+36-25bp)."
And observers never fail to berate the rating agencies for their stance on China's sovereign credit. Standard & Poor's receives universal criticism for maintaining such a huge differential between Hong Kong and China, not to mention its failure to upgrade the country once in 10-years despite the massive shift from public to private sector in the intervening period.
Some also argue that Moody's foresight in putting Hong Kong and China on an equal ratings footing has now been squandered by its decision to place Hong Kong one notch higher. "There was a point where Moody's was way ahead of the market," says one Asian credit research head. "But it has corrected an earlier mistake by making a new one. It is China which should have the higher rating."
Vice minister Li Yong (left) is
All the lead managers credit Chinese vice minister of finance Li Yong with an extremely thorough and forthright presentation of China's economic development throughout the roadshow period. For the sovereign one of the main aims of the deal was to update investors with its credit story and re-open a capital markets dialogue.
Ironically, it may have got super tight pricing, but it will have cost it money to do so since the bonds will almost certainly incur negative cost of carry. And as one observer points out, "China's main problem is that it has too many dollars and this bond issue just exacerbates the situation further."
With reserves of $365 billion, many believe the sovereign has a fairly impenetrable external payments position. And all believe it is right to make regular visits to the international capital markets. "Personally I believe it should access the market every year," says one.