What to Buy Amid China’s Stock Slump? LGFV Bonds, Survey Shows

Escalating downgrades can’t dent the appeal of China’s local government financing vehicle bonds amid a stock slump.

The LGFV notes were the preferred investment in China this quarter in a Bloomberg survey of 22 brokerages, banks, mutual funds and insurance companies. About 27 percent of respondents selected the securities, compared with 23 percent who chose high-grade corporate debentures and 14 percent for stocks.

China has eased bond sale rules for LGFVs and cut interest rates four times since November in a bid to help regional officials cope with the slowest economic growth in more than two decades. The Shanghai Composite Index has endured its steepest three-week decline since 1992 as measures to shore up Chinese equities failed.

“LGFV bonds still have implicit guarantees from local governments and we won’t likely see them default this year or next year,” said Cheng Peng, head of investments at Beijing-based Genial Flow Asset Management Co. “They’re safe and have high yields. Judging from the vantage of both risk and return, they’re the best to invest in.”

Thousands of LGFVs were set up in China to fund infrastructure projects like roads and bridges after a 1994 law banned regional authorities from issuing bonds directly. The units must repay a record 702.6 billion yuan ($113 billion) of bonds this year, compared with 304 billion yuan in 2014, according to data compiled by Bloomberg.

Falling Prices

China recently has softened its stance toward LGFV debt, after the State Council said last October that the financing arms could no longer raise funds for local authorities.

Some companies, including LGFVs, may be eligible to sell more bonds and use the proceeds to repay maturing debt, people familiar with the matter said June 24, citing a June 19 document from the National Development and Reform Commission.

The survey shows confidence in LGFV debt even as their financial strength has weakened this year amid slowing fiscal revenue. Four suffered reduced credit scores in the last six months, according to China Merchants Securities Co., compared with one in the first six months of 2014. That has meant lower prices and higher yields for investors seeking bargains.

The yield premium of AA-rated seven-year LGFV bonds over similar-maturity government notes has widened 14 basis points to 248 since the end of May, according to ChinaBond data.

The interest rate on Erdos Dongsheng City Development & Investment Group Co.’s 1.5 billion yuan of notes due 2018 has soared more than 10 percentage points to 21.3 percent since China Lianhe Credit Rating Co. cut its score to A+ from AA- on June 5, citing waning fiscal strength and increased borrowing.

“The government seems to be adjusting its policy on LGFVs,” said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shanghai. “Under pressure to stabilize growth, the government has shifted from limiting local governments’ leverage to again allowing them to increase it.”

— With assistance by Judy Chen, Laura Yin, Shuqin Ding, Xize Kang, Yuling Yang, and Jimmy Zhu

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