Shanghai-listed China Yangtze Power extended the recent streak of equity-linked issuance in Asia ex-Japan, selling a dual-tranche bond that is exchangeable into China Construction Bank’s H-shares.
The deal provided a novel opportunity for investors to buy a euro-denominated exchangeable bond, and gave bankers the challenge of selling both euro and dollar tranches referencing the same stock but with vastly different exchange premiums.
Yangtze Power defied a weakening tone in Hong Kong’s stock market, launching its bond after the Hang Seng Index slipped 1.5% on Wednesday to close at its lowest level in two months. Bankers are blaming the weakening stock market on the US presidential elections next week, which have made investors across asset classes take steps to reduce risk.
But this ‘risk-off’ mentally had limited impact on demand for the exchangeable bond, according to a source. The deal was well-flagged in the market and was covered at launch by anchor orders. That meant the leads were left with the task of pushing up the prices to the tightest end of the guidance, rather than being forced to find demand at any price.
Dual-tranche structure
Yangtze’s exchangeable bond caught the eye of many investors at launch because it came with a euro-denominated tranche, a very rare structure for equity-linked issuance in Asia ex-Japan.
The five-year, three-year put bond was spilt into a $300 million and a €200 million tranche, with both offered at offered zero coupon and zero yield. The dollar tranche was pitched at a conversion premium of 30% to 40% over CCB’s HK$5.64 Wednesday close, while the euro tranche came at a premium of between 40% and 50%.
Final pricing for both tranches was fixed at the top-end of guidance. That gave the bond an exchange price of HK$7.896 for the dollar tranche and HK$8.46 for the euro tranche.
The dual-tranche structure allowed the issuer to take advantage of the steeper yield curve for the euro against the dollar, which was seen by some traders as an effort to target different groups of investors.
One bond trader told FinanceAsia that the two tranches would be largely identical had they been offered with different yields that reflect 108bp difference between the three year US dollar and the euro swap rate, which was quoted at 97bp and minus 11bp, respectively, on Wednesday.
But the issuer offset the higher-yielding euro tranche with higher exchange premiums, while investors in the dollar tranche were given lower premiums to compensate for the bond’s lower yield compared to US treasuries.
“It is interesting,” the bond trader told FinanceAsia. “The key question is whether it is worth paying a 10% exchange premium for getting a higher yield.”
A source familiar with the situation said it was the euro tranche that got slightly more demand at closing with orders from 50 different accounts. It was also quoted higher. The euro bond was quoted at a bid/ask of 100.875%/101.375% early on Thursday, compared with 100.375%/100.875% for the dollar bond, according to a trader.
The relatively lower euro curve means the bond has a higher bond floor and cheaper embedded option value compared to the US tranche, making it a more attractive option to hedge funds and arbitragers.
Still, some outright accounts have shown interest because of the rarity of a euro-denominated exchangeable bond in Asia, the source said.
At final pricing, the euro tranche had a bond floor of 97.4% and an implied volatility of 21% based on underlying assumptions of 100bp credit spread and a 50bp stock borrow cost. For the dollar tranche, the bond floor was about 93.8% while implied volatility was higher at about 25.5%.
Comps
The new deal offered a good switching opportunity for holders of Baosteel Group’s $500 million three-year bullet exchangeable into CCB due 2018, according to bond traders.
This was largely because the new deal is cheaper in terms of the option value in both tranches. The Baosteel exchangeable was quoted at an implied volatility of 26% and a premium of 30% over the reference price.
Traders said the option value is the main indicator of how the bond should be valued because CCB — the underlying equity — is a high-beta stock with little sensitivity.
In fact, traders said the new bond should be much cheaper because of the credit difference: the A+ rated Yangtze is two notches higher than Baosteel’s A- rating by Fitch. Yangtze is a subsidiary of state-owned hydropower company China Three Gorges Corporation.
In addition, Baosteel’s bond has a weaker credit profile because it was issued by a subsidiary that was supported by a keepwell deed, while Yangtze’s new deal was fully guaranteed.
For convertible bond traders, the deal was yet another addition to a series of new issues in the equity-linked space in recent months, fuelling hopes that the market is on course to return to the heady days of 2013.
Total Asia ex-Japan new issue volume of $5.3 billion over the last five months has already surpassed the full-year volume of $4.9 billion in 2015. There were both new and repeated issuers, and issuance was spread across different sectors and came from almost every region including Hong Kong, China, Taiwan, Malaysia, Singapore, Korea, India and Australia.
Equity-linked bankers have no plans to let momentum flag. One equity-linked banker said the strong demand for the Yangtze/CCB deal will bolster the confidence of other potential issuers — including China’s Huaneng Renewables and Korea’s KCC — to complete a deal before year-end.
Yangtze’s exchangeable bond sale was led by Bank of America Merrill Lynch, BOC International and Deutsche Bank. JP Morgan, CCB International, CLSA, CMB International, ICBC Internatioanl, SocGen, UBS and Huatai Financial were joint bookrunners.
