- Commodities-dependent regions struggle as economy shifts focus
- Municipal bond spreads widen as banks wrestle with bad debts
After snapping up the 3 trillion yuan ($473 billion) of debt issued in China’s nascent municipal bond market this year, banks are finally getting picky.
Liaoning, the northeastern smokestack industry hub with the nation’s worst decline in fiscal revenue, failed to sell some of the notes targeted at an auction in August, while commodities-focused Anhui last week had to pay a 40 basis point premium over central government debt. That contrasts with spreads of zero when the market started in May. Finance center Shanghai was able to sell at the sovereign yield level on Oct. 23.
The emergence of pricing that better matches a region’s financial strength will be welcomed by fund managers, but not so much by provincial leaders struggling with the economy’s transition to a focus on services. A rising tide of bad debt is putting pressure on banks to better manage their risks, including from regional authorities that are often their biggest customers.
“Issuance has surged and secondary market trading is still illiquid,” Nicholas Zhu, a Beijing-based senior analyst at Moody’s Investors Service, said in a phone interview on Tuesday. “While the prospect of getting deposits from local governments as a return for investing in municipal notes is a real attraction, banks are now beginning to pay more attention to the actual fiscal strengths or weaknesses of local governments.”
Liaoning province, whose fiscal revenue declined 23 percent this year, managed to sell only 400 million yuan of 10-year bonds in a planned auction of 550 million yuan. In the eastern province of Anhui, where income rose 11 percent, the government issued similar-maturity notes at a coupon of 3.45 percent on Oct. 27, while Shanghai, with revenue growth double that of Anhui’s, sold securities at 3.08 percent in the preceding week.
“Regions that rely heavily on commodities for development will be increasingly under pressure, while those with diversified economic structures, such as Guangdong, Shanghai and Zhejiang, are more likely to have low coupons,” said Li Qilin, a Beijing-based analyst at Minsheng Securities Co.
Local authorities set up thousands of funding units to finance projects from sewage systems to subways after a 1994 budget law barred them from issuing notes directly. The often-opaque fundraising of local government financing vehicles contributed to a more than doubling of liabilities from the end of 2010 to 24 trillion yuan at the end of last year, prompting Premier Li Keqiang to try and phase them out.
The changes include a plan to convert high-yielding LGFV notes into lower-cost municipal bonds, which will lead to issuance of at least 3 trillion yuan of notes in each of the next four years if the program is to be completed by 2019. This is in addition to the debt that will be sold to fund new government spending.
The 3 trillion yuan of municipal bonds issued so far in 2015 make up about 75 percent of the 4 trillion yuan plan for this year. Secondary market trading of municipal bonds was only 30 billion yuan in the first nine months, or 0.07 percent of the total 41.4 trillion of transactions, according to the China Central Depository & Clearing Co.
Commercial lenders, the biggest investors in the local bond market, are under pressure. Bank of China Ltd.’s profit fell in the third quarter for the first time since the global financial crisis while China Construction Bank Corp. reported little-changed earnings. Bank of China’s 154 percent ratio of provisions to bad loans is now close to the regulatory minimum of 150 percent. Construction Bank’s is at 179 percent.
China’s annual economic growth should be no less than 6.5 percent in the next five years to realize the nation’s goal of doubling 2010 gross domestic product and per capita income by 2020, President Xi Jinping said on Tuesday.
To stimulate appetite for local government notes, Chinese regulators have allowed commercial banks to pledge the securities to get central bank funding, treasury deposits and local government fiscal savings.
“Completely market-based pricing, like for corporate credit, looks to be difficult at the moment,” said China Securities Co. analyst Zheng Lingyi in Beijing. “It’s inevitable for the government to play a role in the issuance, but such intervention will become smaller and smaller.”
— With assistance by Helen Sun