Defaults among lower tier government-backed bond issuers in China could rise as US$560 billion matures in next two years
- Risk profile of bond issuers varies as it depends on the strength of the government backing the note
- Moody’s expects offshore LGFV bond issuance in 2019 to exceed last year’s record US$22 billion
China’s debt market is at a crucial juncture. With 3.8 trillion yuan (US$560 billion) of bonds issued by government affiliates maturing in the next two years, defaults among lower tier issuers could rise, according to S&P Ratings.
But the chances of default vary widely among China’s state-owned enterprises (SOEs) and local government financial vehicles (LGFVs) as a debilitating trade war with the US slowed China’s economy to a record low of 6.2 per cent in the second quarter.
“Large state-owned enterprises (SOEs) with a large impact on the market are likely to see increased support from the government, but the smaller, lesser known, less impactful SOEs, particularly those engaged in sectors hit by the trade war, might see defaults rise,” Charles Chang, an independent analyst covering the China credit market, said during S&P Ratings annual credit roadshow in Hong Kong, on Wednesday.
Gloria Lu, an infrastructure analyst at S&P, said local governments remain committed to supporting SOEs and LGFVs’ fundraising plans to finance infrastructure development. But the fundraising capacity varies between governments at different levels.
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“For example, a provincial government with stronger sources of income will have much more resources that could be moved around to support an LGFV, compared to a city-level or county-level government,” she said.
The ratings of LGFVs vary, depending on their risk profile. Investors used to have implicit faith in government-backed bonds issued by SOEs and LGFVs. However, recent incidents, including late payment of interest and skipping of call options has left investors wondering if the chances of default are rising if the governments backing these issuers are unable to bail them out once they are in trouble.
Jilin Transportation Investment Group, an LGFV in northeast Jilin province, said on Monday that it plans to skip the call option on a 4.64 per cent 1.5 billion yuan perpetual note. Instead, it will pay an increased coupon of around 8 per cent on the note.
In August, Qinghai Provincial Investment Group, another LGFV, delayed interest repayment on its 2020 dollar bonds for five business days from the original coupon due date.
“The burning question is whether debt-strapped governments will be able to quickly bailout LGFVs that become distressed,” said Lu.
“If defaults or bankruptcies among high-profile LGFVs become epidemic, it would erode market confidence, tarnish government reputations, and destabilise the financial system.
“It could also shut down financing to other local state-owned enterprises, at least initially. This would be highly disruptive at a time when China is counting on infrastructure development, along with other fiscal stimuli, to sustain economic growth and social stability.”
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In a separate report on Tuesday, analysts from Moody’s Investors Service said that they expect offshore LGFV bond issuance in 2019 to exceed last year’s record US$22 billion, while at the same time they see some US$21 billion of bonds maturing from the second half of this year through 2020.
Strong issuance growth in the first half of the year was driven by China speeding up infrastructure investment as a way to arrest a slowdown in the economy. The momentum will continue in the second half, spurred by the US Federal Reserve’s interest rate cut in August, it said.
