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Now on China's Default Watch: $617 Billion in Regional Debt

  • No local financing-vehicle defaults yet amid 12 delinquencies
  • Potential for state support `weakened materially:' StanChart

China’s default watch is starting to include the 4 trillion yuan ($617 billion) debt of financing arms of regional authorities, so far spared amid at least a dozen bond delinquencies over the past two years.

While the resilience of local-government financing vehicle bonds has helped it trade at a lower yield than similarly rated corporate securities, that gap is starting to be eroded. The discount for five-year AA+ LGFV notes narrowed 6 basis points from a record high of 32 basis points in January. Total borrowing by 29 of China’s provinces surged to 16.2 trillion yuan at the end of last year, up 53 percent from 2013, according to a March 22 Bloomberg Intelligence report.

“It’s possible LGFVs will have defaults,” said Chen Gongwen, a fund manager in Shanghai at Wanjia Asset Management Co., which manages 23 public funds with total assets of 26.3 billion yuan. “We should watch out for default risks in regions that rely on few industries, have net population outflow, resource shortages and huge debt pressure.”

Regional debt started to explode in China after the 2008 global financial crisis, when the government urged provinces that were then banned from selling bonds to boost infrastructure spending. While regulators allowed the exchange of that debt into newly permitted municipal notes, there are still 4 trillion yuan of LGFV bonds outstanding, according to Bloomberg-compiled data, bigger than the size of Sweden’s economy.

Liabilities are swelling just as slowing economic growth reduces the ability of provinces to support the financing platforms, which typically don’t have enough cash flows to repay their obligations. As a ratio of provincial tax revenue, local government debt has risen to 195 percent in 2015 from 153 percent in 2013, the Bloomberg Intelligence report said.

Provincial risks based on fundamental factors (Source: Bloomberg Intelligence)

Dagong Global Credit Rating Co. took 16 negative actions on LGFVs from 2013 to 2015, of which 11 took place in 2015, it said last week. Last year, economic growth in 22 of 31 provinces in 2015 decelerated from a year earlier as China’s expansion slowed to the weakest pace in a quarter century.

Utilities company Yingkou Coastal Heating Co.’s 300 million yuan 2017 notes pay the highest coupon among the outstanding LGFV bonds at 10.5 percent, according to Bloomberg-compiled data. Huangshi Cihu High-tech Development Co.’s 700 million yuan 2021 notes have the second highest at 9.3 percent. The vehicles tend to disclose less financial data than listed firms, according to Huashang Fund Management Co.

"We haven’t been investing in LGFV bonds for the simple reasons of the lack of transparency in LGFV’s financial data and overvaluation of their bond prices,” said Liang Weihong, bond portfolio manager at the money manager. Huashang’s Double Bonds Plenty Income Bond Fund A returned 33 percent last year, the most among bond funds in China.

The central government allowed regional authorities to directly issue municipal notes that would replace the expensive corporate securities in 2015. The debt swap program was 3.2 trillion yuan last year. As part of the swap the government made it clear that any more bonds that are issued by financing vehicles won’t be contingent liabilities for the local governments, according to Standard Chartered Plc. 

“In that sense, the potential support by the local government has already weakened materially,” said Becky Liu, Hong Kong-based senior rates strategist at the bank.

LGFVs have sold 82 billion yuan of bonds so far this year, down from 121 billion yuan a year earlier, according to data compiled by Bloomberg. The 67 securities sold this year have an average coupon of 3.8 percent, compared to 5.6 percent on 456 notes issued in 2015, Bloomberg data show.

“The current prices of LGFV bonds aren’t attractive,” said Sun Binbin, a bond analyst at China Merchants Securities Co. in Shanghai. “If the economy continues to slow down and local governments don’t cut their leverage effectively, we may see risks.”

— With assistance by Yuling Yang, Lianting Tu, and Ling Zeng

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