China Issues First Dollar Bond Since 2004, Bails Out Corporate Liquidity

Tyler Durden's picture

Despite downgrades from the rating agencies, China is issuing its first sovereign dollar bond issues in 13 years on an unrated basis (what do the agencies know anyway) and at tight spreads to US Treasuries. The 5 and 10-year issues come just over a month since S&P cut the nation’s rating one level to A+ on 21 September 2017. Moody’s had already cut to single A.

Bloomberg reports that China began marketing its first sovereign dollar bonds since 2004 following a week when Chinese leaders in Beijing outlined a greater role for the nation on the world stage. The Ministry of Finance is offering $1 billion of five-year notes at a spread of 30 to 40 basis points over Treasuries, and the same amount of 10-year debt at a premium of 40 to 50 basis points, according to people familiar with the offering, who aren’t authorized to speak publicly…China is offering the bonds unrated, in a break with traditional practice by sovereigns in the region when they sell dollar notes. S&P Global Ratings last month followed Moody’s Investors Service in cutting China’s sovereign rating, citing soaring debt and increased economic and financial risks. The debt sale is one of the most eagerly anticipated in Asia this year…

The sovereign itself has been a rare issuer in foreign currencies and has only ever sold the equivalent of about $11 billion of such notes, according to data compiled by Bloomberg.

The order books exceeds 22 billion dollars, according to Bloomberg.

The lack of a formal rating on the Ministry of Finance of the People’s Republic of China’s dual-tranche U.S. dollar bond offering isn’t impeding the sale as the order books are reported to exceed $22 billion at initial price guidance as the books move to Europe…

 

Key comparable bonds include Japan Bank for International Cooperation’s $1.25 billion 2.875% due July 2027 which was quoted around T +43 basis points, State of Israel’s $1 billion 2.875% due March 2026 which was quoted around T +41 basis points and Germany’s KFW’s $2 billion 2% due May 2025 which was quoted around T +4 basis points…

 

China’s first sovereign dollar bond offering since 2004 is being lead managed by Bank of China, Bank of Communications, Agricultural Bank of China, China Construction Bank, CICC, Citigroup, Deutsche Bank, HSBC, ICBC and Standard Chartered Bank

The scarcity of similar Chinese bonds was a factor having a positive impact on spreads as one analyst told Bloomberg.

“We believe that pricing will ultimately settle on the tight end of initial price guidance,” said Todd Schubert, head of fixed-income research at Bank of Singapore Ltd., citing strong demand for emerging market bonds, and the scarcity value of a Chinese sovereign bond.

 

The announced guidance “is in line with our expectation,” he said. BNP Paribas SA said this week the five-year and 10-year bonds may price at 30 basis points and 40 basis points respectively over Treasuries. The 10-year note is set to price at a spread lower than South Korea’s bond of the same tenor. South Korea, rated two levels higher than China, sold a 10-year bond at a spread of 55 basis points in January, and it was about 74 basis points on Thursday.

Cynicism regarding the modus operandi of the Chinese authorities might have played a role too – this from Reuters.

The MoF has previously manipulated offshore bond sales by force-feeding them to compliant Chinese banks. This simulates demand without market substance. This time around, however, the securities may attract more foreign interest: as the mainland economy has recovered, foreign anxiety has genuinely eased.

Reuters emphasises the favourable (but incorrect in our opinion) repricing of Chinese risk and China’s motivation for the dollar bond issue.

Beijing’s dollar bonds show how Chinese risk has been repriced. The country is selling $2 billion of five-and 10-year sovereign dollar bonds, the first such issue since 2004. Despite recent downgrades by global rating agencies, these are likely to yield just 30 to 50 basis points above U.S. Treasury bonds. Local banks can guarantee demand if needed, but there is also a genuine reassessment of China risk underway. China does not need the money, but the borrowing serves multiple purposes. It helps stabilize cross-border capital flows, refills hard-currency reserves, and makes it easier for companies to refinance in dollars, since there will now be benchmark issues to price against. It is also a rebuke to the credit rating agencies, showing China can brush aside their warnings.

Indeed, the anticipation that China’s sovereign issue would “price tight” helped push spreads on state-owned corporate debt lower.

Despite investors falling over themselves to get hold of these Chinese sovereigns, we have sympathy for Reuters’ warning about dollar lending to China’s over-leveraged corporate sector.

Even so, this is an unrated issue by a country infamous for credit-fueled growth, weak rule of law, and selective respect for international norms.

It’s one thing to lend money to the Chinese government, but this will serve as a benchmark for pricing debt sales by other Chinese borrowers, some of them far more opaque.

Too late.

If the Treasury General Account on the Fed’s balance sheet is replenished to late 2016 levels and the Fed begins to taper, bank reserves will be extinguished and dollar liquidity is going to tighten significantly in the coming months - as we explained here.

With about $10 trillion of offshore dollar debt – with maybe a $1-2 trillion belonging to China -  this will make it more difficult for EM banks to roll dollar funding. China’s dollar borrowing by its corporate sector has been on a tear - with Bloomberg reporting record dollar-bond issuance of $144 billion by Chinese companies so far in 2017.

Finally, Bloomberg provided feedback on the Chinese sovereign bonds from analysts and investors.

AllianceBernstein (Brad Gibson) - If you look at CDS, the market has already priced in that China is a stronger credit than Korea. I suspect China could issue a $2 billion bond at any given spread to U.S. Treasuries. There will be strong Asian support for this bond as it is the first China sovereign dollar issue since 2004. Ultimately, China’s ability to service a $2 billion bond is unquestionable.

 

ANZ (Owen Gallimore) - We see the technical driven fair value as T5+20 (2.2% yield) and T10+25 (2.7%), a relatively flat 15bp Z-spread curve, with our expectation of non-Chinese demand for this ‘collector’s item’ in primary and onshore ‘policy’ demand in secondary. These levels would be moderately tighter than the similarly-rated Chile and Israel but more befitting China’s status in the world and proven policy firepower

 

Bank of Singapore (Todd Schubert) - The announced IPT is in line with our expectation. Given the still strong bid for Emerging Market bonds, the scarcity value of a Chinese sovereign bond and the favorable capital treatment from the HKMA, we believe that pricing will ultimately settle on the tight end of initial price guidance.

 

Columbia Threadneedle (Clifford Lau) - A lot of expectations and enthusiasm are built into this offering, so there’s been tightening of spreads going into the deal. We have taken some positions in the quasi-sovereign area, and would certainly consider participating in the new USD bonds offering, partly because it’s a rare and small deal.

 

Pimco (Luke Spajic) - Coming straight after the 19th Party Congress, the timing of issuance was spot on. The upbeat tone of the congress will be mirrored in the demand for bonds. Though the deal size is relatively modest, the symbolic nature of this issuance will give state owned enterprises, and banks, a marker for valuation. Over time, we would like to see a full sovereign curve be established with longer maturities. Demand will outstrip supply by significant multiple, so pricing is going to be at the tighter end. No surprise there.

 

JPMorgan Private Bank (Anne Zhang) The 10 year is in line with the comps released. In context, 5 year appears generous, however, I’d expect final pricing to be tighter from IPT. The market has built up the hype in the last week with very high expectation of very tight spread.

 

Nomura (Nicholas Yap) - Given the relatively small deal size (just USD2bn in total) and the fact that it will likely be well anchored by domestic financial institutions, China essentially possesses the ability to print the new bonds wherever it wants, and estimating fair value (FV) is arguably more of an academic exercise, one that we will nevertheless attempt to undertake! Comparing with suitable Asian and global sovereign peers, Nomura estimates fair value for the new China 5Y/10Y at around 25bp/35bp over Treasuries

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LawsofPhysics's picture

In a global game of fraud, perception is still everything, so China is now percieved  to be "safer" and "more stable"...

Does this really matter if it's only central banks and government pensions that are buying this paper?

can a real bond trader explain this to me...

chickadee's picture

It smart to borrow in a longer term falling currency. The demand for USD will go down when it loses petrodollar status.

Kayman's picture

"The demand for USD will go down when it loses petrodollar status."

Assuming everything else remains equal and static is usually an error. 

screw face's picture

...bullish risk off!

 

bitchez

Seasmoke's picture

Someone should tell that to paper Gold !!!

RagaMuffin's picture

Another devious blow to the Dollar Hegemonists..............  ;-)

Son of Captain Nemo's picture

But still... Delaying the inevitable!

This is what is sending two more U.S. carriers to North Korea!... BEHOLD THE "NUCLEAR OPTION" WITH NO EQUAL (http://www.zerohedge.com/news/2017-10-24/its-huge-story-china-launching-...)!!!

anonymike's picture

Brilliant move. Pay it back 5 or 10 years out with severely devalued US dollars as a result of petro-yuan and other dollar weakening actions being taken by the Chinese and their trading partners. Buyers of these probably have better odds of getting their dollars back compared to treasuries of the same duration. They should sell as much of this as they can as a hedge against remaining holdings of treasuries and use the proceeds to buy gold or something else that will retain real value.

Kayman's picture

Assuming/Concluding the Yuan is going to rise above the USD over the next 5 to 10 years ?

Let me know when little child China stops holding the USD hand through the dark forest of currencies, alone and on it's own without the managed Peg.

anonymike's picture

Yuan has nothing to do with it. Receive dollars from already owned treasuries to pay Chinese dollar denominated debt off when they mature. Meanwhile, invest in hard assets that will hold value compared to both currencies and exist long after the paper.

Rex Andrus's picture

Now that everybody is strapped together, Give us the rest of your shit and die or we'll jump, fuckers!

Herdee's picture

Has China swapped-out of the last trillion in U.S. Treasuries into other currencies?  They can pull the plunger out of the toilet bowl any time they want it looks like.

DaBears's picture

China is facing a dollar shortage, no wonder they try to buy oil with their Mao-nopoly money.  

J Mahoney's picture

Lets say for simplicity the exchange rate is currently 1 USD to 7 RMB, so this 2 billion is 285 million RMB. So, if the RMB gets more valuable, say it goes to 6 per USD then 333 million RMB is needed to pay off the bonds. Could the Chinese think their currency is going to DEVALUE? I dont think the "worst currency manipulator" per US officials thinks that for a second---so why? I think oil hedging things are at work.... if the Chinese want to start up the petroyuan, mideast countries may be hesitant to accept them maodollars (cause that will get you bombed). So, maybe the Chinese will just take those dollars and contract buy future tankers of oil then turn around and sell them in yuan. If the US wants to push up the value of the yuan, they wont be affected cause they have dollar purchased oil and only exports to us will cost us more. Basically a case of the "great currency manipulator" protecting itself from the other "great currency manipulator"