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CMBI Credit Commentary Summary

Core Content

The document provides a detailed analysis of the local government financing vehicle (LGFV) market in China, focusing on market dynamics, credit outlook, government support, and regulatory changes in the context of the second half of 2022 (2H22). It includes insights from CMBI, Moody's, and China Chengxin International Credit Rating Company Limited (CCXI), highlighting the evolving landscape of LGFVs and their implications for the financial sector.

Main Points

1. Market and Credit Outlook for LGFVs in 2H22

• USD Bond Market:

  • Offshore USD financing costs have increased sharply, similar to the 2017/18 rate hike period.
  • The pace of rate hikes is expected to slow in 2H22.
  • Short to medium-term USD bonds (≤3 years and 4-5 years) dominate new issuance.
  • Investment-grade (IG) bonds account for 75%, high-yield (HY) for 15%, and non-rated (NR) for 10%.

• LGFV Issuance Trends:

  • Total Chinese offshore USD bond issuance (including non-LGFV) dropped to USD64bn in 2022, a 37% year-on-year decline.
  • LGFV issuance increased significantly in 1H22, with more smaller size deals.
  • District- and county-level LGFVs with lower credit ratings are becoming more prominent.
  • SBLC (Standby Letter of Credit) issuance rose due to deteriorating financial profiles and weak market sentiment.

• CMBI Outlook:

  • Large refinancing needs due to maturing bonds in 2H22.
  • SBLC will remain a key structure for lower-rated LGFVs.
  • ESG (Environmental, Social, and Governance) factors will gain more attention.
  • More USD and offshore RMB bond issuance in free trade zones.
  • LGFVs will continue to represent a growing share of Chinese USD bonds.

2. CCXI: Government-LGFV Relationship

• LGFVs are primarily government-backed entities, with core business focused on government projects and subsidies/grants as the main cash flow sources.

• 6 Evolving Trends:

  • Clearer boundaries between governments and LGFVs.
  • More market-oriented business models.
  • More standardized government support for LGFVs.
  • Debt management is now more consolidated at the regional level.
  • Differences in local government support capabilities due to varying economic conditions.
  • Relationships are being reshaped through transformation, integration, and disposals.

• Future Reforms:

  • Insolvent LGFVs will be phased out.
  • Hidden debts will be cleared through pilot programs in stronger regions.
  • Transformation of LGFVs in areas like Guangdong and Shenzhen to more market-oriented operations.
  • Retention of LGFVs providing public services is still necessary.

• Key Rating Driver:

  • The willingness of local governments to support LGFVs remains a critical factor.
  • Economic slowdown may weaken this support.
  • Support depends on the size of the problem, difficulty of bail-out, and whether LGFVs are deemed "too big to fail".

• CCXI Concerns:

  • Hidden debt elimination may impact economic growth.
  • Guizhou’s maturity extension and coupon cut in Zunyi could influence other provinces.
  • Financial reforms at the provincial level may ease stress at district- and county-levels.
  • Limited LGFV debt supply under strict regulation.
  • CCXI forecasts RMB2.7tn in LGFV issuance for 2H22.

3. Moody's: Evolving Business Models and Government Support

• Special Local Government Bonds are increasing, which may hinder LGFV issuance.
• Property sector crisis has led to a significant drop in land sales revenue, contributing to a RMB8tn fiscal deficit.
• Land sales are a major source of local government income, with Zhejiang at 52.8%, Jiangsu and Fujian over 40%.
• Moody's is less concerned about the reliance on land sales in more prosperous provinces due to other industries.
• Credit spread differentials are widening between developed and weaker regions (e.g., Northwest and Northeast).
• Greater Bay Area is expected to see increased LGFV issuance due to RMB5tn in infrastructure investment under the 14th Five-Year Plan.

Key Concerns and Questions

• Uncompleted property projects may not significantly affect LGFVs, as they are not heavily involved.
• HY LGFVs may enter the market depending on their banking relationships and loan quotas, not necessarily on market reception.
• Public utilities may be considered LGFVs if their repayment depends on government subsidies.
• Guizhou's debt resolution could influence other provinces, but region-specific solutions are likely.

Important Disclosures

• The report is not investment advice and should not be relied upon for decision-making.
• Risks are inherent in all securities transactions.
• Conflicts of interest may exist due to CMBIS's involvement in securities trading.
• Distribution restrictions apply in the UK, US, and Singapore, with specific eligibility criteria.
• The information is subject to change and provided on an "as is" basis without guarantees.

Contact Information

• CMBI Fixed Income Department
  • Email: fis@cmbi.com.hk
  • Tel: 852 3761 8867 / 852 3657 6291
• Glenn Ko, CFA
  • Email: glennko@cmbi.com.hk
  • Tel: 852 3657 6235