Default test looms for LGFVs
Bonds Qinghai aluminium producer struggling to meet upcoming dollar maturities
BY DANIEL STANTON
Investors are waiting to find out
whether they will see the first
default of an offshore bond from
a Chinese local government
funding vehicle, when an issue
from struggling QINGHAI PROVINCIAL
INVESTMENT GROUP comes due this
month.
QPIG, which is based in north-
western Qinghai province and
produces aluminium, electricity
and coal, has a US$300m bond
maturing on September 26, but
is facing a cash crunch.
On September 6, S&P
downgraded QPIG to B+ from
BB–, saying that it considered its
capital structure unsustainable.
It said that QPIG was likely to
be able to meet the September
repayment, either by issuing
new renminbi debt onshore or
seeking government help.
The State-owned Assets
Supervision and Administration
Commission of Qinghai has a
controlling interest of 69.26%
in QPIG.
However, S&P said QPIG
lacked a concrete plan to deal
with a US$300m maturity on
December 11.
QPIG’s US$250m 7.875% 2021
bonds had plunged to a cash
price of 65 by Wednesday, the
last quote available, yielding
around 24%. They had been
trading at 91 in May, according
to Tradeweb, having been issued
in March at par.
“I wouldn’t be surprised if
the local government let it
go because there have been
a number of defaults for this
kind of commercial-driven SOE
in the onshore bond market,”
said Terry Gao, head of the Asia
Pacific international public
finance team at Fitch.
The developments at QPIG are
unwelcome news for investors
in offshore LGFV bonds, even
though some question whether
the local government should
ever have treated it as a LGFV in
the first place.
“QPIG is a strange case, as
it’s a pure aluminium producer
and doesn’t carry out any
public welfare projects for the
government,” said Edmund Goh,
Asian fixed-income investment
manager at Aberdeen Standard
Investments. “Aluminium is
supposed to be a competitivebusiness, not to have
government protection.
“I don’t think this is a good
proxy to say that if a company
runs into trouble then local
governments will not support
LGFVs.”STATE SUPPORT?
China in 2014 drew a line in
the sand to make it clear that
LGFVs should be responsible
for their own debt, as part
of reforms allowing regional
governments to issue municipal
bonds directly. Regulators have
reiterated the point many times
since then, especially as China
pushes ahead with deleveraging
plans, but investors and rating
agencies still assume some
support, depending on the
nature of the issuer.
This has been an up-and-
down year for LGFV bonds. They
rallied in July when the People’s
Bank of China unexpectedly
injected Rmb502bn
(US$74.36bn) into the financial
system via its one-year medium-
term lending facility and the
State Council announced a more
accomodative fiscal policy, as
well as encouraging financial
institutions to extend financing
to LGFVs.
Then, on September 12, S&P
downgraded seven LGFVs on
weakening links with their
local and regional government
owners, even though it saidsome of them were almost
certain to receive extraordinary
support in times of financial
stress. It had reviewed 15 of the
LGFV issuers that it rates.
“I believe there is a
willingness to help struggling
LGFVs, especially if a particularLGFV is of significant social
impact to that province, such
as employment and systemic
importance to the financial
system,” said Leo Hu, senior
portfolio manager for emerging
markets debt at NN Investment
Partners.
“However, such willingness
is increasingly tapered by
the central government’s
deleveraging reform, which is
positive for the country in the
long run.”
China’s trade war with the US
is expected to weaken domestic
growth in the near term, and
there are fears the economy
could suffer more if local
governments were banned from
stepping in to help struggling
LGFVs.
“For the majority of LGFVs,
one of their key mandates is
to keep supporting economic
growth,” said Fitch’s Gao.
“The local government
economy is underpinned by
exports, internal consumption
and infrastructure investment.
Since the trade war started and
internal consumption started
to slow down, investment in
infrastructure increased, so
LGFVs have been a key tool to
achieve this policy objective.”TIGHTER CREDIT
NNIP’s Hu said that it was
hard to predict whether local
governments would actuallyallow an LGFV to default on its
bonds. While some state-owned
enterprises such as Dongbei
Special Steel have defaulted,
investors have so far yet to
lose money on an LGFV bond,
despite some late payments
onshore.
“Nevertheless, should
a default happen, local
governments are likely to find
a way to smooth the path and
limit any potential negative
impact,” he said.
S&P said it saw a high
likelihood that the provincial
government would provide
extraordinary support to QPIG
if needed, either in the form of
direct funding or by helping it
issue domestic debt.
“The magnitude of help
may be subject to QPIG’s own
refinancing progress,” wrote
S&P.
QPIG has relied heavily
on Chinese investors for its
offshore financings, in common
with some other higher-risk
LGFV issuers. For instance,
Tianjin Lingang Investment
Holdings did not even seek
international ratings for its
360-day bond issue in August,
suggested that Chinese
investors were the main target.
That source of funding,
however, has thinned in recent
months after rising default
risks and emerging-market
jitters drove a sell-off in lower-
rated Chinese bonds.
Fitch’s Gao expects LGFV
issuers to rely more on
domestic financing, as few
need foreign currency to fund
offshore acquisitions and the
policy shift in July has made
it easier and cheaper to raise
funds onshore.
But he notes that domestic
investors have also tempered
their expectations of state
support in the sector following
a series of credit scares.
“Funding conditions are still
pretty tight for low-quality
LGFVs onshore,” said Gao.
“Investors have begun trying
to differentiate between
them. The LGFV bond market
is transitioning to become
more like the US muni bond
market.” For daily news stories
visit http://www.ifrasia.com“I wouldn’t be surprised if the local government
let it go because there have been a number of
defaults for this kind of commercial-driven SOE in
the onshore bond market.”