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Synthetic-Bond Market Picks Up to Tap Yuan Demand: China Credit

Shui On Land Ltd Chairman Vincent Lo
While companies have sold convertible synthetic securities before, billionaire Vincent Lo’s Shanghai-based Shui On Land was the first to issue without equity features when it raised 3 billion yuan from 6.875 percent, three-year notes last month. Photographer: Jerome Favre/Bloomberg

Chinese developers started selling yuan-denominated bonds overseas that are settled in dollars, using a structure that makes it easier to remit money raised while tapping demand for the nation’s appreciating currency.

China SCE Property Holdings Ltd. sold 2 billion yuan ($303 million) of so-called synthetic bonds on Jan. 7 after Shui On Land Ltd. issued the first notes last month, according to data compiled by Bloomberg. Xiamen, Fujian-based China SCE priced five-year notes to yield 10.5 percent, or about 350 basis points less than if it sold dollar bonds, Finance Controller Paul Li said in a phone interview.

“Everyone expects there’ll be continued appreciation in the renminbi, so from the demand side it’ll be much greater than the purely U.S. dollar bond,” Li said, using the yuan’s alternative name. “You can see from some of the companies that issued purely renminbi debt that it’s very difficult to remit into China”.

The yuan will outperform the currencies of the other so-called BRIC nations this year, gaining 4.8 percent compared with 3.8 percent for India’s rupee and declines for Brazil’s real and Russia’s ruble, according to Bloomberg surveys of economists. China raised interest rates twice since October to curb inflation, attracting overseas capital and putting pressure on policies designed to prevent speculative inflows by restricting the convertibility and cross-border movement of the yuan.

Synthetic Bonds

While companies have sold convertible synthetic securities before, billionaire Vincent Lo’s Shanghai-based Shui On Land was the first to issue without equity features when it raised 3 billion yuan from 6.875 percent, three-year notes last month. With the synthetic structure investors can profit from appreciation in the currency of denomination while receiving coupon and principal payments in another.

“Nearly every bank in Hong Kong” has received inquiries from companies interested in selling synthetic yuan bonds, said George Sun, Nomura International’s Hong Kong-based head of credit sales for Asia ex-Japan.

Evergrande Real Estate Group Ltd., China’s biggest developer by sales, raised 9.25 billion yuan from three-year, 7.5 percent bonds and five-year, 9.25 percent notes, it said in a stock market filing today. At least 45 percent of the money will be used to repay bank loans, with the rest to fund property projects and for other corporate purposes, it said.

‘Excess Returns’

“For investors who want to bet on renminbi appreciation it’s a good asset class,” said Weipeng Kong, who helps manage $515 million as head of fixed-income at Haitong International Asset Management (HK) Ltd. “If the renminbi appreciates more than the market has priced in, then the investor would receive some excess return.”

China’s currency climbed 0.3 percent to 6.5881 as of 4:29 p.m. in Shanghai, according to the China Foreign Exchange Trade System. It has gained 0.6 percent this week as the U.S. makes renewed calls for China to allow appreciation before President Hu Jintao’s visit to Washington next week. Twelve-month non-deliverable forwards rose on the week by 0.5 percent to 6.4392, implying a 2.3 percent appreciation in the currency over a year, according to data on Bloomberg. The rate fell 0.01 percent as of 4:34 p.m. in Shanghai, the first decline since Jan. 7.

For the three companies that started the synthetic yuan bond market, dollar remittances to China will require less “red tape,” according to Herman Bake, head of global risk syndicate in Asia for Deutsche Bank AG.

“The real-estate sector is being monitored very closely by the central government, and the general perception is it will take a long time to get the approval” to send yuan back to China, Bake said in an interview.

Currency Curbs

Transferring yuan raised outside China requires approvals from the nation’s State Administration of Foreign Exchange and is vetted on a case-by-case basis. The Hong Kong Monetary Authority said in July that cross-border flows of the yuan will remain limited by People’s Bank of China rules.

The 21 Chinese property bonds in Bank of America Merrill Lynch’s Asian Dollar Corporate Index delivered a total return of 2.29 percent in December after returning negative 0.92 percent a month earlier, their first monthly loss of that half, when regulators ordered banks to set aside more capital against potential losses.

Inflation that’s rising at the fastest rate in 28 months threatens economic growth in China that averaged more than 10 percent over the past five years. The central bank will raise bank reserve ratios by 50 basis points, or 0.5 percentage point, to 19 percent, according to an announcement on its website today. Five-year credit-default swaps on the nation’s bonds rose 8.5 basis points this year after China increased the benchmark one-year lending rate by 25 basis points to 5.81 percent on Dec. 25.

Sovereign Risk

The contracts rose 2 basis point to 76 yesterday, according to CMA prices in New York. Credit swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements.

The yield on China’s 2.68 percent government bond due in November 2013 fell 1 basis point to 3.25 percent yesterday, Chinabond prices show. One-year interest-rate swaps, or the fixed cost needed to receive the floating seven-day repurchase rate, rose three basis points to 3.25 percent, according to data compiled by Bloomberg.

Demand for yuan-denominated assets from investors outside of China helped Hong Kong sales of yuan bonds increase 10-fold since 2008 to 35.7 billion yuan last year, Bloomberg data show. Sales in the so-called dim sum bond market, including bonds settled in dollars, may rise to 50 billion yuan this year, according to Sundeep Bhandari, head of global markets in Northeast Asia at Standard Chartered Plc, one of three banks that helped arrange Shui On’s synthetic bond sale.

“They’ve managed to attract a much wider base of investors who like exposure to renminbi but haven’t got access,” Bhandari said, referring to Shui On. “They’ve got dollar funding at better pricing for which they’ve given up very little. Because of their renminbi balance sheet structure, the currency is not a risk for them.”

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