China's new crowd pleaser for fixed income investors

After a two-and-a-half-year wait, China''s new sovereign benchmark prompts a feeding frenzy among investors.

When China picks the right moment to launch a capital markets transaction, the whole world wants to buy it. This time round, the US was not offered that opportunity and the sovereign followed a highly successful strategy last pursued to equal acclaim in 1996, targeting European and Asian investors instead.

Both proved highly receptive to the twin $1 billion and Eu550 million deal, with the former issue closing nearly five times oversubscribed and the latter four times oversubscribed. Following last week's well-publicized mandate scuffle, which led to the appointment of three European banks to run the euro-denominated tranche, it did, however, seem as if there were almost as many lead managers as investors.

Because of a last minute change of heart by the Chinese government, the three bookrunners mandated on a dollar deal  - Goldman Sachs, JPMorgan and Morgan Stanley, were joined by three European banks - Barclays, BNP and Deutsche to separately run the euro. The two latter French and German banks had both previously been informally mandated for a euro transaction and were not surprisingly extremely upset to discover that they had been apparently cut out. Such was the dissension caused that BNP was even said to have lined up French President Jacques Chirac to plead with Chinese President Jiang Zemin.

The eleventh hour appointments gave the Europeans no time to organize themselves, however, with the result that all roadshows presentations fell under the aegis of the Americans. In terms of pricing, it also appeared that the market was sounded out at dollar levels and then backed into Euros at a comparable level.

In itself this was a remarkable achievement given that most first time borrowers in the currency would normally be expected to pay a slight premium. Final pricing for the 10 year dollar deal came at 99.192%, with a coupon of 6.80% to yield 6.799%, or 133bp over Treasuries. Final pricing for the euro came at 99.71% on a 5.25% coupon and spread of 64.4bp over the February Bobol, or 33bp over Euribor.

On a Libor basis, the 10 year came at about 53bp over and the five year about 35bp over. Both were comparable on a like-for-like basis. Bankers also highlight that the Libor equivalent pricing of the new 2011 bond came about 6bp inside of the existing 2008 bond, which was trading at about 60bp over at the time.

This pricing anomaly matches the recent trading pattern of a number of highly sought after Asian credits including Hutchison Whampoa, whose recent 2011 bond is currently being quoted inside its 2007. "A run of highly successful 10 year transactions by Asian credits have pushed the Asian bank bid down the yield curve and this is where liquidity and demand currently resides," comments one banker.

Pricing of the China bond also came in line with the secondary levels of paper for Hong Kong's MTR Corp and KCRC. Both have 2010 bonds outstanding, with the former trading yesterday (Thursday) at a bid/offer spread of 133bp/123bp and the latter at 136bp/127bp.

In a pattern familiar to past Asian deals, the home bid was huge and enough of a lever to persuade European investors to move about 10bp inside their desired pricing levels. Total demand from Asia on the dollar book topped the $3 billion mark, with Europe accounting for about $1.3 billion.

Allocations, on the other hand, were skewed towards Europe to meet China's strategic objective of diversifying its investor base. This resulted in 55.7% of dollar paper going to Asia and 44.3% to Europe. For the euro, where there was a stronger Continental bid, 56% went to Europe and 44% to Asia.

More detailed breakdowns show that in the dollar book, roughly 35% went to Greater China accounts, 25% to Asia (ex-Greater China), 21% to the UK, 7% Germany, 5% Benelux, 5% France, 2% other.  In the euro book, Germany accounted for 14%, the UK 10%, Italy 10%, Benelux 7%, France 6%, Switzerland 4%, Offshore US 3%, Spain/Portugal 2% and Austria 1%.

The dollar book contained a total of 173 investors and included six orders above the $100 million and 10 above $50 million. The euro book had 110 accounts and four orders over $50 million. According to the rumour mill, at least two of these jumbo orders came from Chinese banks, with ICBC, for example, said to have put in an order for $500 million. Singapore's GIC was likewise said to have bid for $250 million.

The sheer strength of domestic demand meant that for buy and hold European accounts, China would still seem like a safe bet on a total return basis despite the fact that its spread is trading out of kilter with its A3/BBB credit rating. Only a month ago, the 2008 bond was trading at about 170bp over Treasuries and its spread contraction now down to a 120bp level shows little sign of slowing.

This marks a sharp contrast to the recent past, when tightly held China paper has shown slow but steady appreciation. "The only US investors that ever show much interest in China are insurance funds that put the paper in their investment rather than their trading portfolios," says one banker. "It's never really regarded as a trading punt and particularly now that it's trading so far inside US single-A comps. But some funds see the strong domestic bid as a good backstop against spread slippage in the event of a market downturn."

The reluctance of US investors to commit to tight pricing when a single-A comp such as AT&T is quoted up to 100bp wider was one of the main reasons why the focus was switched to the eurodollar market about a month ago. A second was politics and the souring of relations between the two nations following the spy plane incident.

A second notable departure highlighted by bankers concerns a shift in the type of investors that bought into the transaction. Where previously a China deal might expect to see 70% of paper allocated to the banking market, it was more like 40% for the dollar tranche, with a further 18% placed with asset managers and 20% to supranationals and government accounts. The euro tranche, however, had a more traditional pattern of distribution, with about 55% to banks, 40% to asset managers and 5% retail.

As Goldman Sachs' Asian vice chairman Carlos Cordeiro puts it, "Yesterday afternoon in advance of the new deal pricing, I looked back at the distribution figures for the last China deal in 1998 which we led. Comparing the two, it shows that there has been a big shift from banks to asset managers. It also underscored China's growing appeal to Europe, which only accounted for about 15% of 1998's global offering and amounted to just over 30% of this transaction."

New investors to the China credit were said to account for about 35% of both books, with few orders placed as switches. "This deal was very heavily skewed towards cash," reports Morgan Stanley's London syndicate head Rob Rooney. "There were no sellers of the 2008 and just a few third party switches. This probably amounted to less than 20% in total."

The China deal also benefited from fortuitous timing, the fundamental appeal of its credit story and the fact that there has been little sovereign issuance from the single-A sector. "The issuer selected the right timing to successfully capitalize on the positive market momentum following the Fed rate cut and the light new issuance calendar," says JPMorgan managing director Bob Fernandez.

Where the credit is concerned, there is a consensus among analysts that China remains fairly insulated from a global slowdown. For Asian investors this has long been a given and the Hong Kong presentation prompted just one question from Goldman's head of fixed income research. In Europe, where the country's growth story is less widely known, bankers report a slew of questions concerning ratings upgrade potential and GDP growth.

"Investors in Paris or Frankfurt know that China is big and strong, but they don't necessarily know why," Goldman's Cordeiro concludes.

Currently rated A3/BBB, few observers expect any immediate move from the agencies, particularly Standard & Poor's, which some bankers feel has unfairly held the credit down because of a particularly strong political mindset.

In terms of growth, the Asian Development Bank recently predicted that the country should be able to maintain annual GDP growth of 7.3% this year and 7.5% next, propelled by increasing domestic consumption.

Alongside six lead managers, there were a further seven co-managers on the dollar deal and five on the euro. The dollar deal numbered: Bank of China, CSFB, Daiwa, HSBC, Merrill Lynch, Nomura and Salomon Smith Barney. On the euro there were: ABN AMRO, Casenove, Mizhou, WestLB and UBS Warburg.