China Local Debt Crisis Spells Global Opportunity in 2015

By Tanya Angerer

Photographer: Nelson Ching/Bloomberg

Commuters ride the metro subway train in Beijing, China. There are nearly 40 cities in... Read More

China’s overhaul of local government financing spells opportunity for global investors in 2015.
Standard & Poor’s and Moody’s Investors Service predict municipalities facing severe financing needs may follow the lead of Beijing’s subway builder in selling debt overseas to cut costs. Beijing Infrastructure Investment Co. became China’s first metro provider to sell global bonds this year, raising $1.3 billion, including a $1 billion offering in November.
Yields on local government financing vehicle notes surged this month and the market was thrown into disarray after regional authorities pulled their support for two borrowing arms, raising the risk of defaults. LGFVs, facing 558.7 billion yuan ($89.7 billion) of maturing debt
next year, were able to raise 67.7 billion yuan selling bonds in December, the least in 11 months.
“The evolving status of LGFVs will definitely produce more dollar bonds, especially for the stronger names, as certain LGFVs morph into state-owned enterprises or even financing vehicles akin to Beijing Infrastructure,” said Raymond Chia, the Singapore-based head of credit research for Asia ex-Japan at Schroder Investment Management Ltd., which had $447.7 billion under management as of Sept. 30. “The fundamental aspects of the company need to be valued as opposed to just looking at the government support.”

Yield Premium

Beijing Infrastructure raised $1 billion selling 3.25 percent notes due 2020 and 2.625 percent 2017 notes on Nov. 13, according to Bloomberg-compiled data. The metro operator’s $300 million of 2019 debentures were trading at 189 basis points more than similar-maturity Treasuries on Dec. 22 versus an issue spread of 210 basis points when they were sold in March, prices on Bloomberg show. Yield premiums on dollar bonds for Chinese companies have narrowed 29 basis points in the same period to 343.2 basis points on Dec. 19, according to JPMorgan Chase & Co. indexes.
The extra yield over sovereign debt for one-year corporate notes rated AA -- the most common ranking for LGFVs -- instead of sovereign debt has risen 94 basis points this month to 250 basis points on Dec. 18, the widest since June, ChinaBond data show. Spreads on seven-year AA rated local debt are up 69 basis points to 2.78 percentage points as of Dec. 19.
Questions about the future of LGFVs began in October when Premier Li Keqiang queried the implicit guarantees on the companies, set up to fund infrastructure projects after a 1994 budget law banned regional authorities from directly issuing bonds. The State Council said Oct. 2 that the finance arms can no longer raise funds for local authorities, and that the governments have no obligation to repay debt that wasn’t raised to fund public projects.

Sales Scrapped

The Finance Ministry has also asked local authorities to detail all outstanding borrowings by Jan. 5 as it extends a municipal bond market trial. Shandong last week became the first province to outline implementation of the campaign to curb regional debt, which swelled to 17.9 trillion yuan as of June 2013, according to a national audit.
Changzhou Tianning Construction Development Co., based in the eastern province of Jiangsu, announced Dec. 12 it wouldn’t go ahead with a planned 1.2 billion yuan sale just one day after authorities said they wouldn’t support its debt. Less than a week later, officials withdrew backing for another planned LGFV issue in the northwestern province of Xinjiang.
“Now that local governments have stringent balance sheet requirements, many municipalities will have to consider diversifying their income source in order to expand their metro networks,” said Gloria Lu, an analyst in Hong Kong at S&P. “Overseas funding, at least in the near term, provides cost benefits compared with domestic funding.”

Dim Sum Bonds

Beijing Infrastructure, tasked with almost doubling the subway network in five years, also sold 1.2 billion yuan of three-year Dim Sum bonds at a yield of 3.75 percent in June. In the onshore market, the company priced 4 billion yuan of one-year notes to yield 5.06 percent in May. The yuan has declined 2.7 percent this year against the U.S. dollar.
Beijing Infrastructure is rated AAA by China Cheng Xin International Credit Rating Co. and A1 by Moody’s, which said it doesn’t consider Beijing Infrastructure as an LGFV.
“The allocations in the budget have been there for many years,” said Ivan Chung, a senior vice president at Moody’s in Hong Kong. “The subway has to be approved by the central government first, meaning there’s a legitimate way for them to allocate directly from the budget.”
Beijing has 200 meters of track for every 10,000 people, compared with 500 meters in New York, according to S&P. There are nearly 40 cities in China that have approval to build a metro by 2020. By that time, the central government targets 6,000 kilometers (3,728 miles) of metro lines will be built, which S&P estimates will require as much as 2.5 trillion yuan.
“The success of future bond deals in the sector may hinge on the efforts that every issuer takes to explain the reasons why they are going offshore,” said Alan Roch, head of Asia-Pacific bond syndicate at Royal Bank of Scotland Plc in Singapore.