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It's practically a year since President Xi Jingping launched China's deleveraging campaign and the ripple effects are being felt in overseas primary bond markets, with Chinese local-government financial vehicles (LGFVs) in particular reining in their debt-funding plans.
At least a dozen, including Shenzhen Guangshen and Shandong Gaochuang -- the investment vehicles for the authorities in the city of Shenzhen and Shandong province, respectively -- have put their planned dollar debt sales on hold after recently meeting investors in Hong Kong and Singapore, two China-focused debt bankers told FinanceAsia.
“Foreign investors see rising default risk in the LGFV sector,” one of them said. “A dozen of the single B-rated LGFVs have received the regulatory approval to sell their debt overseas, but only a handful of the LGFVs have completed their transactions.”
Concerns over the growing risks in the Chinese LGFV sector as stimulus is withdrawn by the People’s Bank of China (as well as other central banks globally), were highlighted in a report released by credit rating agency Standard & Poor's in late January.
“The risk of LGFVs defaulting on their bonds has increased, which is why we may well see the first LGFV default in the bond market,” it said.
LGFVs deserve special attention due to their implicit government support. Many are highly leveraged and rely heavily on government subsidies. They would also probably not be viable without a lifeline from Beijing, which suggests investors are banking on a guarantee or bailout from central government if a LGFV fails to fulfil its debt obligations.
Backed by that implicit public sector support, LGFVs were for a long time able to get cheap financing onshore. However, the landscape changed last year when Xi intensified Chinese government efforts to contain the risks to the economy after a long stretch of excessive borrowing.
Beijing’s decision to revitalise the economy when it stalled in late 2008 as the global financial crisis engulfed the West resulted in trillions of dollars-worth of funding being routed by state-owned lenders through regional governments into LGFVs, which invest in a wide range of physical assets like social housing, shopping malls, and theme parks.
COLD WATER
But China’s Ministry of Finance threw cold water on this in March when it issued a statement to dissuade state-owned lenders from providing further credit to local governments, aiming to control the growth of debt and prevent systemic risk.
While Chinese LGFV funding remains a small part of the offshore debt market, back onshore it accounts for about 40% of China’s Rmb18.3 trillion ($2.9 trillion) corporate debt market, according to data compiled by Wind. Onshore LGFV debt including bank loans surpassed central government debt for the first time at the end of last year, Wind data shows.
Traditionally, onshore investors -- such as the treasury department of a commercial bank -- are major buyers of offshore dollar-denominated LGFV paper, as they have existing relationships with the borrowers in the onshore market through bank loans or other credit facilities. But this demand has shrunk significantly since Beijing issued its diktat.
Some of this fallout is being reflected in more volatile pricing. A perpetual bond issued by Tianjin Tewoo Group, a state-owned provider of energy and materials, for example, plunged as much as 5 points last Thursday after a news broke out that the government of Tianjin had deferred payment to a Rmb500 million onshore trust, before rebounding to 98.6 cents on the dollar.
“Besides a greater risk of defaults, the dilemma now is that investors have plenty of options to buy in the secondary market, while the LGFV borrowers are reluctant to pay at the current environment,” the banker said. “Bonds such as banks’ additional tier-1 bonds dropped 6 points to 94 cents on the dollar so far this year, providing attractive returns to risk-taking investors.”
The broader backdrop is also becoming more challenging, with benchmark 10-year US Treasury yields briefly popping above 3% and threatening to go higher, prompting investors in Asia and elsewhere to trim back their long-dated bond holdings.
“Prior to the 2008 crash, the 10-year yield averaged roughly 5%, so we still have a long way to go to back to that level,” a Singapore-based investor told FinanceAsia. “Issuers, especially those lowly-rated ones, have a difficult time to sell their bonds in a turbulent market.”
In a separate development in the secondary market in Asia this week, jittery investors pared positions in long-dated bonds issued by Baidu, Huawei and Lenovo, reflecting their concerns over the rising risk of US probes related to unauthorised telecommunication equipment sales to Iraq. Investors also continued to sell their Indonesia and India high-yield bonds, as part of the sell-off seen in emerging markets generally since last week.
