Red-chips turn to China's onshore bond market

China Merchants International raises $587 million onshore through its parent and becomes the latest in a string of Hong Kong-listed Chinese companies to take advantage of lower interest rates across the border.

The parent company of Hong Kong-listed China Merchants Holdings (International) last week raised Rmb4 billion ($587 million) from the sale of 10-year bonds in China's domestic bond market. The proceeds will be lent to the Hong Kong-listed subsidiary to be used to expand its business, which is focused on ports and ports-related services. The transaction is part of a new trend in which Hong Kong-listed red-chips are taking advantage of the ample liquidity and lower interest rates in China to fulfil their capital raising needs.

Two other Hong Hong-listed companies, conglomerate China Resources and power producer Huaneng Power International, also sold domestic bonds last week with China Resources raising Rmb5 billion from a 10-year bond and Huaneng Power securing Rmb4 billion from a five-year deal.

While red-chips (state-backed companies incorporated outside of China and listed in Hong Kong) have been issuing debt in China since 2007 -- either directly or via a Chinese associate -- the trend has gained pace since the start of the financial crisis when the international bond market virtually shut down, leaving the renminbi market as pretty much the only market globally that was still open for new debt issuance. China has also relaxed restrictions on how the proceeds can be used, which has made it easier for companies to use bonds for their various funding needs.

But China is not just about access. Hong Kong-listed companies such as China Construction Bank, CNOOC and China Cosco Holdings, also prefer to borrow in China because of the lower interest costs available. China Merchants priced its domestic offering with a 4.35% coupon, while its existing dollar bonds maturing in 2018 currently trade at a yield of about 6.15% -- a significant cost saving over the duration of the bond, especially when you add on the new issue premium that the company would likely pay to sell new bonds in the international market. And this is achieved by what is essentially the same credit. However, the issuer is rated triple-A in the domestic market by China Cheng Xin International Credit Rating (49%-owned by Moody's), while the Hong Kong-listed unit, commonly referred to as China Merchants International, is rated Baa2, which is Moody's second lowest investment grade rating.

The ratings agency changed its outlook on China Merchants International to negative in mid-April amid expectations that the company's credit metrics will continue to deteriorate this year as the operating environment remains challenging.

"Moody's expects the recent global economic downturn will impact international trade and container flow which will in turn put pressure on China Merchants International's sales and profitability. Its near term credit metrics are therefore expected to fall below levels commensurate with its current rating," senior credit officer Elizabeth Allen, said in a statement at the time.

In other words, there is a possibility that the company would have had to pay even more to attract investors to a new international issue.

The renminbi bonds were issued by China Merchants Steam Navigation, which is wholly owned by China Merchants Group and holds 55.7% of the Hong Kong-listed unit. As is common in China, the price was fixed before the bonds were offered to investors and then essentially allocated on a first-come, first-serve basis during the subscription period, which ran from May 8 to May 14. However, some bonds do use a bookbuilding process, where the level of demand dictates the final price.

About 75% of the China Merchants deal went to insurance companies, while the remaining 25% was bought by banks, according to sources. This is a relatively common distribution pattern for longer-dated bonds as insurance companies tend to jump at the opportunity to buy assets that more closely match their liabilities. The majority of bond issues in China have a maturity of either five or seven years.

The bonds were issued at par, which means the coupon of 4.35% is also equal to the yield. At the time of pricing, this translated into a 250bp spread over the Shanghai interbank offered rate (Shibor). According to bankers, this was one of the lowest coupons for a 10-year deal in the onshore market this year. By comparison, the China Resources bond, which was priced on the same day, was priced 5bp wider. In February, China Construction Bank raised Rmb40 billion ($5.85 billion) from a dual-tranche deal, including a Rmb28 billion 15-year tranche that pays a coupon of 4% for the first 10-years and, if not redeemed at that time, a coupon of 7% for the final five years.

The China Merchants deal was arranged by Goldman Sachs Gao Hua Securities and China Merchants Securities and timed to come before what is expected to be a flood of triple-A-rated bonds in the coming weeks.

China's onshore bond market issuance has more than quadrupled in the past couple of years from Rmb19.5 billion in 2006 to Rmb94.5 billion in 2008, according to data provided by Dealogic. This year has already seen Rmb65.8 billion worth of issuance, which suggests that, if this pace continues uninterrupted, the market is set for another record year. And as long as the interest rate differential stays in their favour, bankers say red-chips are bound to continue to contribute to that total.

This could provide a good opportunity for the international banks that are allowed to underwrite debt and equity issues in China's domestic market, although so far many of the red-chip deals have been arranged by local securities houses. Aside from Goldman Sachs, the international banks include UBS, through its joint venture Beijing Securities, and Credit Suisse, through its Founder Securities JV, which received a license in January this year. Deutsche Bank is awaiting its final go-ahead.

Goldman Sachs Gao Hua earlier this year led a $146 million issue for Bank China Chongqing Bank, and UBS has been in the market with three bonds issues so far this year -- for China Minsheng Banking Corp, BBMG Group and China National Gold Group.

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