Always closely observed by the markets, China’s local government financing vehicles (LGFV) sector has recently benefitted from two key developments. Firstly, in the first half of 2019, the country maintained structurally easy monetary policy; secondly, in light of changes to Chinese macro-economic regulation aimed at balancing growth stabilisation and risk prevention, the financing environment for LGFVs improved.
Under the requirements of growth stabilisation, LGFVs need to focus on developing key fields and major projects. Because of this LGFV bonds’ issuance and trading increased over the same period last year. However, risk prevention requirements remain stringent and the regulatory authorities continue to urge reduction in implicit debts.
As such, the future for LGFVs will continue to diverge. The number of defaults on LGFVs' shadow banking loans rose year-on-year (YoY) and LGFVs will still suffer from the maturing and sell-back pressure in the second half of the year. We set out below the performance of the LGFV industry in the first half of 2019, and provide insight into the opportunities and risks of the LGFV industry in the remainder of 2019 in combination with the policy trends and maturity status of LGFV bonds.
Net proceeds remain positive
Source: CCXI
Lower-rated debt issuance on the up
In the primary market, low and medium-rated bonds and debt refinancing bonds took up a larger proportion of issuance. The issue amount of LGFV bonds rose sharply in the first half of 2019, with 1,928 bonds being issued totaling Rmb1,587 billion, up 41.8% YoY. In terms of net proceeds, the amount reached was Rmb572.87 billion, more than double over the same period last year.
In terms of the cost of issuance, the average interest rate of primary LGFV bonds lowered due to the reasonable sufficient market liquidity and continued structural looseness of monetary policy in the first half of the year. The issue costs declined for LGFV issuers at all administrative levels.
Overall liquidity remained high in the first half of the year. Money markets witnessed lower interest rates and LFGV bond market sentiment improved remarkably. Spot bond transactions totalled Rmb3.98 billion, representing a sharp YoY rebound. Yields varied distinctively with maturities, with short-term yields falling substantially. The credit spread for the AA- rating showed the largest contraction since the end of last year. In contrast, Hainan Province recorded the highest credit spread of LGFV bonds.
Trading volumes of spot LGFV bonds (YoY)
Source: CCXI
Defaults still a problem
LGFV’s shadow banking loan defaults at lower administrative levels remained serious and defaults on trust products increased significantly; 17 LGFVs were involved in shadow banking loan defaults. However, no downgrades occurred in the first half of the year. Any upgrades were mainly attributable to regional economic development, increased government support, and improved operating capability. The volume of early redemptions shrank YoY, while the share of medium and high-rating bonds rebounded.
However, maturity and sell-back pressure is still high. LGFVs bonds due to mature and sell back in July to December exceed Rmb1.2 trillion, of which 73% are due to mature and 27% to sell back. The maturity and sell-back pressure is particularly heavy in September with a scale of over Rmb240 billion, and the issuer ratings of maturing bonds are still mainly categorised as medium to high. For the remainder of the year, the maturity and sell-back pressure, especially in September. Most issuer ratings for bonds to mature and sell back are AAA grade.
For example, Jiangsu Province still has the largest volume of maturing bonds. The proportion of bonds with special terms and conditions continues to increase, accounting for 50.27%, up about 2 percentage points compared to the end of last year.
More than 60% of the issuers with maturing or sell-back debt show characteristics of insufficient operating cash flow to cover interest-bearing debts. Issuers are under an obviously higher pressure of serving debt with their own operating cash flows than at the end of last year. Meanwhile, their dependence on refinancing and realisation of current assets has increased.
Cost of LGFV bond issuance
Source: CCXI
Outlook: Opportunities and risks coexist
Due attention should be paid to structural opportunities in the context of LGFVs’ mixed performance.
In the first half of 2019 money market liquidity was reasonably ample, since interest rates were falling. The primary and secondary markets of LGFV bonds recovered remarkably.
However, LGFV bonds are subject to market-oriented transformation requirements and show rising structural divergence. LGFVs that undertake major infrastructure projects in key fields and weaker sectors will receive more support. For the remainder of the year, LGFVs will still face heavy debt service pressure. Against the backdrop of increasing downward pressure on the economy, mitigating risks will remain the focus of the LGFV regulatory policies.
Investor focus should be placed on the following aspects in the forthcoming stage:
1) Pay attention to the positive effects of the new rules for special bonds on the financing environment of LGFVs
2) Monitor the positive effects of implicit debt reduction and market-oriented transformation of LGFVs
3) Look for opportunities for LGFVs in the renovation of aging residential buildings
4) Analyse shadow banking loan and contingent debts of LGFVs to prevent risk resonance
5) Pay due attention to the credit risk of LGFVs in financially weaker areas amid the higher downside pressure to the macro-economy
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China Chengxin International Credit Rating Co., Ltd.
• Founded in October 1992 and approved by the head office of the People’s Bank of China to be the first nationwide credit rating agency in China.
• Professional service provider of the bond market that is widely acknowledged by both regulators and market participants, and a brand that has won top honor and awards in various industry appraisals.
• First Chinese credit rating agency from the Mainland to operate in the international arena as China Chengxin (Asia Pacific) Credit Ratings Co., Ltd. (“CCXAP”), a wholly-owned subsidiary of CCXI, acquired the Type 10 License (credit rating services permit) from the Hong Kong Securities and Futures Commission in June 2012.
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