Caution grows in 'dim sum' bond market against weakening yuan

Continued depreciation of the RMB yuan has made investors more cautious in credit checks of offshore yuan bond issuers as the fear of a market reaction has caused some Chinese companies to turn to dollar bonds to raise cash.

On Monday, the central parity rate of the yuan against the U.S. dollar weakened 5 basis points to 6.1591, a new seven-month low, according to the China Foreign Exchange Trading System.

Since mid-February, the yuan has depreciated by nearly three percent, meaning investors snapping up "dim sum bonds," or yuan-denominated bonds issued outside the Chinese mainland, can no longer speculate on a rising yuan.

The high and stable yield of these bonds, plus the potential for yuan appreciation, have provided nice returns for investors, causing excessive demand in the bond market over the past three years, said Wallace Lam, head of HSBC's high yield markets business in Asia. He said that many investors had been attracted by the stronger yuan.

As the yuan becomes volatile and the expectation of unilateral appreciation of the yuan ends, investors need to reevaluate dim sum bonds and focus more on the credibility of bond issuers, said Lam.

Fu Peng, dean of the Chinese Academy of Macro Hedge, said that with the yuan depreciation factored in, the real returns of many of these bonds were negative.

"But considering the limited channels for offshore yuan investment, the dim sum bonds remain a choice," he said.

In the long term, once mainland and Hong Kong investors are allowed to conduct cross-market trading on the Hong Kong and Shanghai stock exchanges, market enthusiasm for dim sum bonds will be dampened, Fu said.

"The remedy is to offer higher yields to allure investors," he added.

Chen Yang, a board director with Shenyin & Wanguo Securities, remains optimistic about dim sum bonds. However, he said it remains difficult for companies to raise cash on the Chinese mainland's financial markets.

"Credit conditions remain tight on the Chinese mainland, and many companies have a strong wish to issue corporate bonds. Given that domestic interest rates are relatively high, most of them prefer to issue bonds overseas. We expect more companies to issue dim sum bonds this year," said Chen.

Standard Chartered Bank predicted that by the end of this year, the total volume of dim sum bonds could exceed 750 billion yuan, most of which will be fueled by refinancing demand.

In the first quarter of this year, the total issuance of new dim sum bonds in Hong Kong surged to 125 billion yuan (20.1 billion U.S. dollars), more than doubling the amount of the previous quarter, official statistics showed.

Analysts said that the strong market performance was boosted by a spate of factors, including the participation of heavyweight issuers, such as state-owned enterprises (SOE), onshore financing difficulties and loss of price difference between onshore and offshore yuan.

Zhong Wenquan, vice president of Moody's, said that SOEs, particularly banks, made up the majority of the bond issuers.

"It is noticeable that single bond issuance has reached billions of yuan," Zhong said.

Hong Hao, the chief strategist of BOCOM International Holdings Co., Ltd., forecast that the dim sum bond market will basically stay put, as it is generally believed that the latest round of RMB depreciation is policy-guided.

"The offshore yuan bond market still boasts sufficient liquidity," he said.

Hong was echoed by Bai Ming, a researcher with the Chinese Academy of International Trade and Economic Cooperation.

"It is good to see investors no longer blindly speculating on a stronger yuan. Moreover, expectations for yuan internationalization remain strong, which will provide a solid foundation for the long-term development of the offshore yuan bond market," Bai said.

HSBC has projected a warning line for dim sum bond investors if the yuan weakens to 6.2 against the U.S. dollar.

When Chinese companies raise cash overseas, dollar bonds appear to be a strong alternative to dim sum bonds.

Latest figures show that Chinese companies have issued dollar bonds worth as much as 5.3 billion U.S. dollars since April, including an issuance of 3 billion U.S. dollars made by Sinopec, China's second-biggest oil producer.

Liu Dongliang, senior financial analyst with China Merchants Bank, said that the dollar now boasts greater liquidity, a longer term of bond issuance and lower bond rates, making it more appealing to issuers.

Fear of lukewarm market reactions over dim sum bonds has led two medium-sized Chinese companies to give up their issuance plans and turn to dollar bonds, according to official reports.

Economic analyst Zhou Hongli with DBS China said that if the yuan continues to weaken in the next quarters, companies will become reluctant to issue dim sum bonds.

Liu said that issuers with solid credibility and financial conditions would continue to be favored in dim sum bonds.

In the long term, business development needs and financing costs should outweigh exchange rates as the key factors affecting the bond issuance decisions of companies, said Liu.