Risk Comes Home as LGFV Dollar Debt Cocktails Sold in China

  • Regional financing vehicles sold $12 billion USD notes in 2016
  • Retail investors don’t fully understand underlying risks: NN

The local-government financing vehicles behind urban infrastructure development in China have been selling a record amount of dollar bonds offshore to bring in more international investors. It hasn’t had the desired result.

Chinese financial institutions remain the dominant buyers of the bonds, which are being packaged in wealth-management products and then sold to individuals.

“Some dollar LGFV bonds are repacked by securities brokerages and banks into WMPs and sold to onshore investors because of the comparatively higher returns,” said Sebastian Ha, head of debt syndicate at Bank of China. S&P Global Ratings and NN Investment Partners also say Chinese financial institutions have been buying the bonds and packaging them in WMPs.

Chinese regional financing platforms have been trying to woo offshore investors as it has become harder to get financing onshore due to regulatory restrictions on new LGFV debt sales. LGFVs sold $12.4 billion in dollar bonds last year, three times more than in 2014, according to data compiled by Bloomberg. The latest LGFV marketing its bonds to offshore investors is northwest China-based Qinghai Provincial Investment Group Co., person familiar with this offering said last month.

About 51 percent of the LGFV dollar notes issued since the beginning of October were taken up by banks, according to data compiled by Bloomberg using available deal statistics. Bond arrangers don’t release details on where the banks are based. The average coupon last year was 4.2 percent, 77 basis points higher than the average for offshore notes issued by Chinese companies.

Chinese banks are trying to avoid losses on wealth-management products that raised $3.8 trillion from savers amid a bond rout that began in October. While LGFVs have never defaulted on bonds, their leverage is much higher than the average for Shanghai-listed firms. Six high-yield, or unrated LGFVs that sold dollar bonds in December had an average total debt-to-Ebitda ratio of 40 times, based on the data available in their offering circulars, versus 2.4 times for all Shanghai-listed companies, according to data compiled by Bloomberg.

“Some investors in wealth-management products may buy them without a full understanding of the underlying risks,” said Leo Hu, an emerging-market debt portfolio manager at NN Investment Partners in Singapore. “Those products also lack both geographic and sector diversification and some of them might have a concentrated holding in LGFV bonds.”

In November, China’s banking regulator warned lenders of rising credit risks from their exposure to LGFVs, people familiar with the matter said. S&P said in a Nov. 8 report that China is signaling there won’t be direct bailouts.

“While the expectation for implicit government support is still high for state-owned credits, implications of a default will be larger for LGFVs in terms of access to funding because the expectation of government support is very high given their weak stand-alone credit profile,” said Christopher Lee, managing director of corporate ratings at S&P. 

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