HKMC focuses on fixed income

The Hong Kong Mortgage Corporation wants to see the development of Hong Kong's domestic debt market. Its strategy includes issuing interest rate-linked structured products to retail investors. By Amanda Lee

Established in 1997, the Hong Kong Mortgage Corporation (HKMC) has always had a challenging remit: offering a reliable source of liquidity in the Hong Kong mortgage market, thereby reducing the concentration and liquidity risks of mortgage lending by the banks. As part of its efforts, the government-owned entity has been issuing retail mortgage-backed securities and other debt securities. HKMC has also been promoting fixed-income products, such as conventional fixed-rate bonds and interest rate-linked structured products, to help achieve its goal.

HKMC's retail bond programme has raised a total of HK$12 billion (US$1.5 billion) in bonds since 2001, through the issuance of structured products such as fixed-inverse floating-rate bonds and fixed-rate extendable bonds. The latest offer, which closed in September 2006, included a 10-year zero-coupon bond, which alone raised HK$205 million (US$26 million).

Although institutional investors such as pension funds and insurance companies in Hong Kong have long been active in the corporate and government bond markets, this is not the case for retail investors, says Raymond Liu, senior vice-president at HKMC in Hong Kong. While most retail investors in Hong Kong are familiar with equities and property, very few of them have chosen to invest in fixed-income securities.

The retail corporate bond market was relatively immature when HKMC launched its first retail bond. "We issued our first conventional fixed-rate retail bond in 1999 by initial public offering," Liu says. "The total subscription amounted to about HK$100 million (US$13 million), which wasn't very encouraging."

As a result, the distribution mechanism was reviewed in 2001, and since then all the bonds have been sold by retail banks in the territory. The number of retail banks that offer the bond has risen to the extent that 17 retail banks participated in the latest issue.

HKMC also encourages take-up of the bonds by advertising in print and electronic media. And to persuade more investors to allocate capital in fixed-income investments, HKMC organises seminars where investors can learn more about the details of the products.

Developing the fixed-income market

Interest rates on savings deposits in Hong Kong had been tumbling since 2001 and fell to the historical low of 0.001% in 2004. This figure now hovers around 2.5% but the low interest rates of previous years initiated the issuance of interest rate-linked structured products, such as the fixed-inverse floating-rate note introduced in 2002 to give retail investors more choices in bond products to help diversify portfolios and gain better returns.

That five-year note carried a 5.5% fixed-rate coupon for the first year and was followed by a semi-annual floating-rate coupon linked to Hong Kong Interbank Offer Rate (Hibor). Investors received a minimum coupon of 0.5%, and the floating-rate coupon was 6% minus the six-month interbank rate.

Along with fixed-rate bonds, with tenors of between one and 10 years, HKMC has also issued several extendable fixed-rate bonds, also known as callable bonds. The last callable bond, launched in August 2005, was also HKMC's first US dollar-denominated bond. The note had a one-year tenor but the investment period was extendable by another two years. Investors received a semi-annual 3.1% coupon for the first year, 3.5% for the second year, and 4% for the third year.

Other than interest rate-linked structures, Liu says HKMC can provide equity-linked or credit-linked structures. But he is also keen to point out that bond investors often look for capital preservation and security. "Most credit-linked and equity-linked structured products are available from the high-street banks," he says. "After years of issuing retail bonds, HKMC has built up a conservative reputation. We don't try to offer anything too exotic." Typically, HKMC structured all of its own products, only entering into necessary hedges with investment bank counterparties.

Meanwhile, HKMC's issuance of retail bonds has helped kickstart the growth of the fixed-income market in Hong Kong. For example, corporates such as the Hong Kong Airport Authority and MTR Corporation have followed suit. Retail banks have also launched plain vanilla bonds and structured retail certificates of deposits with extendable maturity dates, which offer investors regular coupons. According to figures provided by HKMC, the total loan-to-deposit ratio has fallen from 152% in 1997 to the current level of 55%.

Rated Aaa by Moody's and AA by Standard & Poor's as local currency issuer, HKMC can also borrow short-term funding of up to HK$10 billion (US$1.3 billion) from the Hong Kong Monetary Authority's Exchange Fund. Liu believes that fixed-income products issued by HKMC and others should have a long-term future in Hong Kong. "We believe products that provide a steady income stream are key to the development of a mature capital market," he says. n