REPEAT: MNI CHINA ANALYSIS: LGFVs Unlikely To Default On Bonds

Repeats Story Initially Transmitted at 09:23 GMT Oct 17/05:23 EST Oct 17

--Local Govts Still Dependent On LGFVs, Despite Tighter Regulations

     BEIJING (MNI) - Although some local government financing vehicles (LGFVs)

said recently they would end their roles as fund-raisers for local governments,

analysts believe local governments will continue to back the LGFVs in the near

term because they still need them to finance infrastructure construction

projects, meaning the risk of any LGFVs defaulting on their bonds remains low.

     On Oct. 9, two LGFVs in Henan Province, Pingdingshan Development and

Investment Company (PDIC) and Zhumadian Public Asset Management Company, issued

statements saying they would no longer help local governments in getting

funding. The market reacted quite calmly to the statements, with the yield on

seven-year bonds issued by PDIC and maturing on May 8, 2019, only falling to

4.4666% the same day, from 4.4701% on Sept. 29.

     The calm of the LGFV bond market might reflect the fact that investors'

faith in "city investment bonds," which are bonds issued mainly by the LGFVs,

has not diminished, since they believe that local government guarantees on such

bonds means there is no default risk.

     The calm of the LGFV bond markets has been shaken before, the most recent

occurrence coming on Aug. 2, when The Ministry of Finance issued a document

urging local governments to issue their own bonds -- instead of using LGFV bonds

-- to fund specific projects whose returns would be used to pay back the bonds.

That measure was among a series of policies implemented this year to crack down

on financing using LGFVs.

     The yield on seven-year bonds issued by Chengde Economic Development and

Investment Co., which issued a statement claiming that it had quit its role as

an LGFV on July 25, climbed around 40 basis points on Aug. 3, reflecting

investors' concerns that the local government in Chengde would no longer back

Chengde Economic Development and Investment Co.'s bonds, and raising larger

concerns about the overall LGFV bond market. 

     Such "official" statements by LGFVs, claiming to quit their roles, are

nothing new. In 2016, 25 LGFVs issued statements that they would no longer be

raising funds for local governments. This year, that number has risen to 33 so

far, according to data compiled by the Institute of Financial Supervision, a

private consultancy. 

     The main reason LGFVs feel compelled to issue such statements has to do

with the tightening of financial regulations. 

     "In 2017, the local government debts regulation storm, including the

National Financial Work Conference held in July, which stated that it would

'strictly control the growth of local government debts' and that 'the debt

issuer will hold lifelong responsibilities for the debt,' caused high pressure

for local governments," Qin Han and Gao Guohua, analysts at Guotai Junan

Securities, said last week. "LGFVs issued statements to clarify the

relationships between them and local governments" so that they could continue to

receive financing, Qin and Gao said.

     Xu Hanfei, an analyst at China Merchant Securities, said all the LGFVs'

"quitting statements" were made to comply with the new rule requiring LGFVs to

"actively make statements to debtors that they will not serve as a funding

vehicles for local governments" when they raise funding through either loans or

debt issuance.

     However, ties between LGFVs, especially those with weak profit-making

capabilities, and local governments are often hard to break, despite the

"quitting statements."

     All the profits in the first half of 2017 at PDIC, for example, came by way

of local government subsidies. Without the subsidies, PDIC would have reported

losses every year since 2014. 

     But local governments also also dependent on LGFVs, analysts said.

     "LGFVs are the main fund-raisers and thus fund providers for infrastructure

construction. Although LGFVs might not fully comply with regulations, their

existence is a necessity to some extent," Shenwan Hongyuan Securities said last

week in a report. "Especially considering that the economy is trending down

right now, revenues generated by land sales become more restricted while the

need to carry out infrastructure construction to maintain high economic growth

becomes even larger."

     "Progress in developing municipal bonds for local governments to fund

projects is slow, so LGFVs cannot be replaced in the short term," Shenwan

Hongyuan Securities added.

     The analysts also said that local governments have no incentives to let

LGFVs bonds default, as doing so could set off a market panic. Investors' faith

that bonds issued by LGFVs will never default will diminish gradually and will

only happen after certain conditions are met, Shenwan Hongyuan said. 

     "First, Public-Private Partnerships and municipal bonds issued for specific

projects need to play a more important role in the infrastructure development

process, replacing the role of LGFVs," Shenwan Hongyuan Securities wrote.

"Second, local government debt pressures have mounted and they are not able to

pay back debts raised by LGFVs. Third, local governments are able to set up

formal guarantee mechanisms for LGFV bonds, enabling investors to separate those

[into the categories of] LGFV bonds with government guarantees and those without

guarantees."

     But the default risk for bonds issued by LGFVs has not risen significantly

in the short term. 

     "In the short-term, the main risk for LGFVs is refinancing risk. And for

now, the refinancing will not tighten up significantly as banks prefer to issue

loans to government-related entities," Qin and Gao said. "Although the

regulation of LGFV bonds can be strict [in a literal sense], the implementation

[of the regulations] needs to find a good balance between preventing new risks

and alleviating existing risks of LGFVs, suggesting the policy might be softened

if needed," Qin and Gao said.

     But the value risks and liquidity pressures coming from investing in LGFVs

can be quite large.

     "LGFVs whose credit profiles are not quite solid offer an attractive coupon

rate. So investing in LGFVs that offer a coupon rate higher than 7% can be a

good strategy for investors who can hold them until maturity and can hold a

well-diversified portfolio," Qin and Gao said. "However, for investors who will

constantly suffer from market value risks and liquidity risks, the LGFVs might

not be a good option because they are likely to suffer from high price

variations and their liquidity conditions are not quite good, especially when

bad news for LGFVs occurs."

     Other analysts concurred.

     "For most investors, the best option is to invest in high-graded bonds

issued by LGFVs whose durations are short," China Merchant Securities said.

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com