Photographer: Kevin Lee/Bloomberg News

China's Local Debt Nightmare Is Getting a Rerun After Rating Cut

  • Rating of eastern province’s financing vehicle reduced by S&P
  • Tough year ahead for LGFVs as state support wanes: Moody’s

The first ever downgrade of a Chinese local-government financing vehicle by an international ratings agency is reigniting concern over the debt-saddled entities, amid angst there could be more cuts to come.

S&P Global Ratings reduced its credit rating on Jiangsu NewHeadline Development Group, a construction services provider and one of the largest financing firms owned by Lianyungang City -- in China’s eastern Jiangsu province -- by one notch to BB Thursday. S&P attributed the cut to the local government’s high debt burden and said the LGFV’s credit profile will remain under pressure for the next two years.

“I wouldn’t be surprised if we see more downgrades by rating agencies,” said Anne Zhang, executive director at the private banking arm of JPMorgan Chase & Co. in Hong Kong. “If S&P downgrades, we might see Fitch start to review their ratings as well.”

Leslie Tan, a spokesman for Fitch Ratings based in Singapore, declined to comment.

Thursday’s downgrade threatens to further dent demand for the debt of China’s local government financing platforms, which became the poster children for the country’s ballooning debt problem over the past few years despite not seeing any defaults. Their liabilities grew in the wake of the global financial crisis as municipalities used the vehicles as a way of meeting funding shortfalls.

Waning Sales

Offshore debt sales by LGFVs have trailed expectations this year, with $1.2 billion sold by four issuers, down from 21 deals worth $5.3 billion in the fourth quarter. Traders surveyed by Bloomberg News last month also preferred company bonds over LGFV notes, amid speculation Chinese authorities are reducing their support for the bodies used to source funding for provincial projects.

It’s set to be a tough year for the financing vehicles, says Ivan Chung, head of Greater China credit research at Moody’s Investors Service in Hong Kong.

“Government policy is constraining direct local-government support for them while the onshore bond yields are also rising amid the deleveraging measures,” he said. “They are also getting more competitors, such as Chinese developers, eyeing the same funding pool offshore.”

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City level LGFVs pose greater risk than those that operate on the provincial level, said Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group Ltd. in Singapore. “The downgrade shows that city-level Jiangsu LGFVs face a wider trend of negative ratings migration.”

Jiangsu NewHeadline’s $300 million of debt due 2019 fell 0.9 cents on the dollar to 102.23 cents as of 2:47 p.m. in Hong Kong Thursday, the biggest drop in a month, according to Bloomberg-compiled prices.

The deterioration in Lianyungang’s creditworthiness reflects the city’s weak revenue growth and investment in infrastructure that has swelled its debt burden, S&P said. The city’s tax-supported debt will exceed 270 percent of operating revenues, according to the ratings agency.