But when investors last month placed more than $1tn worth of orders for a convertible bond issued by Shanghai Pudong Development Bank, about 140 times the $7bn raised, it was enough to shock even the most seasoned China investor.
That $1tn is almost as large as the entire stock-market capitalisation of Apple or Microsoft — two of the biggest companies in the world. “It was a ridiculous amount,” said Gerry Alfonso, head of research at Shenwan Hongyuan Securities in Shanghai.
As so often with runaway deals, the over-bidding in part reflects quirks in the way new debt and equity end up in investors’ hands. But it also reflects a surge in issuance of these equity-linked instruments in China — a rise helped by an unusual embrace of the product by policymakers better known for cracking down on financial innovations to ensure stability.
So far this year, Chinese companies have issued a record $40bn in convertible bonds, up more than 80 per cent from the full-year total in 2018, according to Dealogic.
Convertible bonds typically carry a lower coupon payment than normal bonds but they offer investors the right to switch them for equity if a company’s shares rise to a certain price. For companies, convertibles offer a way to raise money more cheaply than by issuing regular debt and do not immediately dilute shareholders’ equity.
Ronald Wan, chief executive at Partners Capital in Hong Kong, said Chinese convertibles had become more attractive to investors thanks to this year’s stock rally, while the government was promoting the instruments as a way to rein in financing done off-balance sheet, or through a fragile shadow banking sector.
Chart showing the outstanding balance for a Suntak Technology convertible bond maturing in 2023 (in million Renminbi). Bond lists with face value of 800 million Renminbi, and redeemed with remaining balance of 4.7 million in October 2019. Another chart below shows the share price and conversion price in the same time frame.
But Mr Wan cautioned that convertibles’ performance “depends on the quality of the issuer”, with investors typically favouring large banks and big blue-chip companies over small and mid-sized issuers.
Mr Alfonso echoed that, warning that while large issuers such as Shanghai Pudong have seen ample liquidity in their convertibles after listing, investors in smaller issuers faced the prospect of taking heavy losses in the event of a sell-off.
“The liquidity is bad but there is liquidity,” he said. “The thing is, the price you’re going to get there is pretty horrendous.”
China’s first domestic convertible bond was issued in November 1992, two years after the Shanghai Stock Exchange opened. The bond, which never converted to stock, was the only onshore convertible issued for more than half a decade.
Today’s market is different, as Chinese convertibles carry special features that set them apart from those in the US or Europe. For one, conversion levels can be reset after a bond is issued, significantly increasing the chances it will switch into stock.
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Convertibles also tend to be looked on favourably by regulators because they are treated as debt until conversion, meaning investors have a better chance than equity shareholders of getting some form of repayment if the company goes bust. Chinese companies are normally required to wait at least 18 months between offerings of shares, which makes convertibles a useful way to gain access to new funds quickly.
“The process of [convertibles] approval still takes time — half a year or so — but it’s faster than an IPO or secondary offering,” said Yulia Wan, a senior analyst at Moody’s in Shanghai.
Ms Wan said that while the floor for conversion prices at issuance was determined by criteria including average trading price, it could be lowered if the shares traded well below the initial level for long enough. She added that because convertibles usually have a maturity of five to six years, a company’s shares have plenty of time to rise high enough for conversion.
The convertibles’ equity-like features mean they offer higher returns to investors than regular debt. But that alone does not explain the huge over-subscriptions common to the local market.
Mr Alfonso of Shenwan Hongyuan said some of the rush is down to scarcity. Because existing shareholders are entitled to a large chunk of any convertible bond that is issued, the number of lots a company can offer more broadly is limited.
In the open market, the highest bids naturally win out, but buyers know that they will get only a fraction of what they request. And because no money is required up front to make an offer, there is no reason not to bid as much as possible to maximise the odds of a successful purchase. “You put up as much as you can and hope for the best,” Mr Alfonso said.
Before regulators banned buyers from bidding through multiple accounts in March, it was not unusual for convertibles to be even more heavily over-subscribed. Prior to Shanghai Pudong’s latest convertible, the largest issuance on record of nearly $6bn, from China Citic Bank, was about 5,500 times oversubscribed, according to local media.
