Synthetic offshore RMB format opens side door for issuers

A synthetic offshore renminbi bond could appeal to a number of property issuers that have difficulty remitting funds back to the mainland.

Bankers are pitching the concept of a synthetic offshore renminbi bond to issuers after property developer Shui On Land last week priced the first such deal in the public market.

The concept of a US dollar-settled renminbi-denominated bond could gain traction among mainland issuers that have assets in renminbi and require funds onshore, but would be unable to obtain approval from the Chinese government to remit the renminbi back to the mainland if they were to tap the offshore renminbi bond market, also referred to as the dim sum bond market.

Given the byzantine regulatory process that issuers routinely face, a synthetic format could make sense, provided the cost of funding is right.

“It is not easy to get approvals from SAFE (State Administration of Foreign Exchange) to remit renminbi. Only 20%-30% of our clients that apply to remit get approvals. It can take three to four months and after waiting, the approval is not guaranteed either,” said one banker.

Prime candidates for a US dollar-settled bond would be the Chinese property companies, which have difficulty borrowing onshore. Such issuers usually have assets in renminbi, which provide a natural hedge. Developers like Country Garden, Shimao Property and Agile Property are potential candidates. For Shui On Land, its Rmb3 billion ($450 million) three-year synthetic offshore renminbi bond came to fruition thanks to a unique culmination of factors. And a look at the genesis of the deal sheds some light on the type of issuer a synthetic format could appeal to.

Shui On Land is a Chinese developer, operating in a sector that the government is trying to clamp down on. Hence it would have been virtually impossible for the company to obtain approvals to remit renminbi back to the mainland, had it chosen to tap the dim sum bond market. But the synthetic, which was settled in US dollars, allowed Shui On Land to remit the funds raised back to the mainland with relative ease. Scores of Chinese property companies, including Yanlord Land and Country Garden, have tapped the US dollar bond market this year and remitted funds back to the mainland.

Shui On Land was also familiar with the structure, having already issued a renminbi-denominated convertible bond that was settled in US dollars. That also meant that there was a pool of investors that was familiar with the company and a synthetic structure (albeit for a CB). This helped, as some of the investors that participated in Shui On Land’s CB were also said to have bought the company’s synthetic offshore renminbi bond.

The leads -- Deutsche Bank, Standard Chartered and UBS -- also gauged investors' response to Macau casino operator Galaxy Entertainment’s three-year dim sum bond, which was in the market the week before Shui On Land. As a high-yield issuer, Galaxy’s bonds appealed to a different investor base than the slew of dim sum bonds that had come before it, and which were largely placed to Hong Kong investors with renminbi deposit accounts.

In contrast, a sizeable number of the investors who participated in Galaxy’s dim sum bond supposedly didn't have renminbi deposits. Instead, they were said to have bought the renminbi bonds through a broker using US dollars, and paid an additional fee to have the broker convert the dollars into renminbi. This suggests that if a synthetic structure was offered for a high-yield credit, there would be takers.

Galaxy's bond received a wildly enthusiastic response from investors. The Rmb1.38 billion ($207 million) three-year dim sum bond was more than 10 times subscribed even though it paid a coupon of only 4.625%, which one banker termed “crazy”.

From the outset, the leads on the Shui On Land deal targeted private banks, which knew both the developer and its founder Vincent Lo and hence were willing to accept the fact that the company was unrated. The strong participation from these investors – which took up about half the deal -- was crucial in gathering momentum in the order book, and without that brand recognition, the outcome could have been very different.

“Shui On Land has good brand recognition so we targeted the private banks. The fund managers are pretty much closed for the year. But private banks, as an investor base, are not as sensitive to the timing of the deal,” said one banker on the transaction.

From a cost perspective, it made sense for Shui On Land to issue a synthetic offshore renminbi bond, versus a straight US dollar bond. Coming late in the year, the latter would have been a risky move for the unrated developer and it probably wouldn't have been able to raise $450 million. As a comparison, China’s Yuzhou Properties raised $200 million on December 8 via a five-year bond that was callable in the third year and offered a yield of 14%.

“We saw how Yuzhou’s bond went. In a good market, we would have thought Yuzhou would pay 12%, but it ended up paying 14%,” said a banker.

Shui On Land’s cost of funding in US dollars for a three-year tenor was estimated to be around 9% to 9.5%. Assuming a pricing at the wide end of the range and taking out the cross currency swap, this translates into a funding cost of about 7.55%. Shui On Land’s synthetic came at a coupon of 6.875%, or more than 50bp inside of that.

For issuers that have approvals to remit renminbi back to the mainland or want to keep the funds raised offshore (as has been the case for some banks that have issued dim sum bonds and kept the funds in Hong Kong for trade settlement purposes), the dim sum market is clearly a cheaper option as a scarcity of offshore renminbi paper is keeping coupons low. But for those that are unable to remit funds, or that require cash flow in US dollars, a synthetic could make sense.

“The dim sum market is cheap if you can remit the funds back to mainland," said the banker. Issuers that cannot will have to pay an estimated 350bp-400bp on top of the initial coupon to swap the proceeds first into dollars to bring them onshore and then back into renminbi. "That is how illiquid the swap market is,” he added.

Given the rapid growth of renminbi deposits in Hong Kong, however, both the dim sum bond market and the synthetic renminbi offshore bond market are expected to stay relevant in 2011.

¬ Haymarket Media Limited. All rights reserved.
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