YUAN bond sales in Hong Kong may double in 2012 as companies from the Chinese mainland take advantage of lower borrowing costs and European issuers seek alternatives to euro fundraising, the market's biggest underwriters predict.

So-called Dim Sum offerings may rise to 300 billion yuan (US$47.3 billion) in 2012 from 150 billion yuan this year, according to the median estimate from HSBC Holdings Plc, Standard Chartered Plc and Deutsche Bank AG, the three biggest bond underwriters. Yuan issuance by companies including Baosteel Group Corp and Air Liquide SA in the city exceeded sales in Hong Kong dollars by 45 percent.

While yields on Dim Sum debt have climbed to 5.91 percent on the Bank of China Offshore RMB Index, they are lower than the 6.56 percent one-year benchmark lending rate and the 10 percent yield for BBB+ rated issuers in the mainland. Average Dim Sum bond yields jumped almost 4 percentage points this year as traders pared expectations for yuan appreciation and debt ratings companies raised "red flags" on corporate governance.

"Looking at issuers' expectations, we're not seeing the euphoria of the early part of this year but it is still an interesting market for a lot of international investors and issuers," Gina Tang, head of debt capital markets for Hong Kong and the Chinese mainland at HSBC, said earlier this month. "We will see steady growth next year rather than another big step up."

Sales of yuan-denominated bonds in Hong Kong have quadrupled to a record US$23.7 billion in 2011, compared with US$16.3 billion of issuance in Hong Kong dollars, data compiled by Bloomberg News show. The number of Dim Sum bond issuers jumped to 87, from 19 in 2010.

Average yields on Dim Sum bonds have climbed 388 basis points, or 3.88 percentage points, to 5.91 percent this year, according to a Bank of China (Hong Kong) Ltd index.

One-year borrowing costs of BBB+ rated issuers in the mainland rose 284 basis points to 10 percent, Chinabond.com.cn data show. The official lending rate at banks set by the People's Bank of China is 6.56 percent.

Access to lower funding costs in Hong Kong was made easier after Vice Premier Li Keqiang pledged in August to allow domestic companies to borrow as much as 50 billion yuan each year through yuan bond sales in the city.

Baosteel completed Hong Kong's biggest corporate Dim Sum bond offering on November 25, raising 3.6 billion yuan. The 3.5 percent coupon on the company's three-year securities compares with the 4.9 percent notes due in 2014 of Baoshan Iron & Steel Co, the company's Shanghai-listed unit, yielded yesterday.

Swap market

China Longyuan Power Group Corp, a Beijing-based wind farm operator, sold 690 million yuan of two-year Dim Sum notes at 4.5 percent and 260 million yuan of three-year bonds at 4.75 percent on December 15, data compiled by Bloomberg News show. The yields compare to the 5.72 percent coupon offered on China Longyuan's three-year notes sold in the mainland this month.

"The mainstream issuers will still be those that can use yuan onshore," said HSBC's Tang. "But the swap market is now working in a way that means issuers can use offshore yuan as a funding currency and then swap it."

European issuers are looking at the yuan bond market to diversify funding sources amid investor wariness over the future of the 17-nation euro. Companies from Europe sold three times more Dim Sum bonds in the second half of 2011 than in the first six months.

London-based Lloyds Banking Group Plc raised 50 million yuan for three years at 3.6 percent on November 25, while Lloyds' existing 2014 euro bonds yielded 5.3 percent yesterday. Paris- based Air Liquide raised 2.6 billion yuan selling debt in September, paying a coupon of 3 percent on five-year debt. Associated British Foods Plc and Electricite de France SA are considering yuan bond sales in Hong Kong.

New rules

More multinational companies will sell Dim Sum bonds next year after China set rules in October allowing foreign direct investment with yuan raised offshore, streamlining approval processes, said Augusto King, Hong Kong-based co-head of debt capital markets for Asia at Royal Bank of Scotland Group Plc.

"Well-known multinational corporates with operations in China will find the new approval process to be more predictable," said King. "Given their name recognition, they can borrow offshore cheaper than onshore."

Borrowing costs are falling in the mainland this quarter. Yields on China's 10-year government bonds have fallen 39 basis points since June 30 to 3.47 percent and were little changed yesterday. The central bank issued 1 billion yuan of three-month bills at 3.1618 percent today, unchanged from the previous sale, said a trader at a primary dealer.

The central bank cut the amount of cash banks must set aside as reserves for the first time since 2008 this month as Europe's debt crisis dimmed the outlook for exports and growth. The 50 basis-point decrease in reserve-requirement ratios took effect on December 5.

Dim Sum bonds remain attractive because the size of China's economy will make them an essential part of investors' holdings, said Tee Choon-hong, head of capital markets for North Asia and Korea at Standard Chartered in Hong Kong.

Moody's Investors Service warned of "red flags" at all 61 companies from Chinese mainland it examined in a report in July, highlighting risky or opaque business models and questioning the quality of accounts. Short seller Muddy Waters LLP said in June that forestry operator Sino-Forest Corp over-stated the size of its plantations, causing its shares to be suspended on August 26.

Five-year credit-default swaps protecting China's sovereign debt have risen 68 basis points since June 30 to 152, according to data provider CMA, which compiles prices quoted by dealers in the privately negotiated market. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Highest yield

Lafarge Shui On Cement Ltd, a joint venture between Paris-based Lafarge SA, the world's biggest cement maker, and Hong Kong-based SOCAM Development Ltd, paid a 9 percent coupon on 1.5 billion yuan of Dim Sum bonds sold on November 9. That matched the highest yield paid since the Dim Sum bond market began in 2007. Credit China Holdings Ltd sold 100 million yuan of two-year bonds with a 9 percent coupon on September 1.

"Borrowing costs have risen in 2011 and are likely to remain at such levels until we see a more stable market," said Patrick Tsang, Deutsche Bank's Hong Kong-based head of fixed income capital markets for Asia. "But the offshore yuan bond borrowing cost is still competitive compared to onshore alternatives."

Brazil may become the first country other than China to tap the Dim Sum market, a move aimed at helping to set a benchmark for Brazilian companies, the nation's deputy treasury secretary Paulo Valle said this month. America Movil SAB, the Mexico City-based wireless carrier controlled by Mexican billionaire Carlos Slim, is planning a Dim Sum sale next year, Moody's Investors Service said this month.

"While the outlook for capital markets in general remains uncertain, we do expect continued healthy issuance in 2012," said Deutsche Bank's Tsang.