Local debt market in disarray as govts back off guarantees

Two local governments have withdrawn support for bond sales by their financing vehicles in the space of a week, throwing the market into disarray.

Changzhou Tianning Construction Development Co in Jiangsu province said last week that it would not go ahead with a 1.2 billion yuan ($194 million) planned offering after city authorities said they would not support the debt.

Tianning district's finance bureau said that it would not categorize the notes as government debt, reversing a position outlined just a day earlier.

And this week, officials in Urumqi in the Xinjiang Uygur autonomous region withdrew backing for a planned 1 billion yuan sale by a local government financing vehicle.

The shake-up was signaled in October when the State Council (the nation's cabinet) said that governments have no obligation to repay debt that was not incurred for public works. That announcement raised the risk of mothballed construction and defaults.

The most recently released national audit showed regional liabilities stood at 17.9 trillion yuan as of June 2013, but the actual amount may be more, China Business News reported on Monday, citing a senior planning official.

"The two local governments' statements shocked investors," said Liu Dongliang, a senior analyst at China Merchants Bank Co in Shanghai. "Losing government support means losing the guarantee that there will be no default."

The yield premium over China's sovereign debt on one-year notes rated AA, the most common rank for local government financing vehicles, has surged 92 basis points so far this month.

The government's withdrawal of support has prompted LGFVs to cut note sales to an 11-month low of 67.7 billion yuan in December. They must repay a record 554.9 billion yuan next year.

First Capital Securities Co, which is JPMorgan Chase & Co's partner in China, recommended in a report that investors avoid the market.

"Identifying what will be considered local government debt is a black box," wrote Hu Zeli, an analyst at First Capital, referring to a complex system with hidden workings.

The Ministry of Finance has asked local governments to detail all outstanding debt by Jan 5 as it extends a municipal bond market trial and seeks to boost the transparency of regional obligations.

Regional authorities were barred from directly issuing bonds under a 1994 budget law, which prompted them to set up thousands of LGFVs to raise money for infrastructure projects.

Yang Xiaolei, a bond analyst at China Securities Co in Beijing, said the statements show the ministry is seeking to bar new LGFV bonds from being counted as local government debt.

"We will see more similar statements from other local governments," said Yang. "In the future, those LGFVs that aren't categorized as government debt may miss bond payments."