Debt revamp opens door for global investors

More local governments may look to overseas markets for financing needs

China's overhaul of local government financing will create more opportunities for global investors in 2015.

Global ratings agencies Standard & Poor's and Moody's Investors Service predict municipalities facing severe financing needs may follow the lead of Beijing's subway builder in selling debt overseas to cut costs. Beijing Infrastructure Investment Co became China's first metro provider to sell global bonds this year, raising $1.3 billion, including a $1 billion offering in November.

Yields on local government financing vehicle notes surged this month and the market was thrown into disarray after regional authorities pulled their support for two borrowing arms, raising the risk of defaults.

LGFVs, facing 558.7 billion yuan ($89.7 billion) of maturing debt next year, raised 67.7 billion yuan selling bonds in December, the least in 11 months.

"The evolving status of LGFVs will definitely produce more dollar bonds, especially for the stronger names, as certain LGFVs morph into State-owned enterprises or even financing vehicles akin to Beijing Infrastructure," said Raymond Chia, the Singapore-based head of credit research for Asia ex-Japan at Schroder Investment Management Ltd, which had $447.7 billion under management as of Sept 30. "The fundamental aspects of the company need to be valued as opposed to just looking at the government support."

Beijing Infrastructure raised $1 billion selling 3.25 percent notes due 2020 and 2.625 percent 2017 notes on Nov 13.

The subway operator's $300 million of 2019 debentures were trading at 189 basis points more than similar-maturity Treasuries on Monday versus an issue spread of 210 bpts when they were sold in March, prices on Bloomberg show.

Yield premiums on dollar bonds for Chinese companies have narrowed 29 bps in the same period to 343.2 bps last Friday, according to JPMorgan Chase & Co indexes.

The extra yield over sovereign debt for one-year corporate notes rated AA－the most common ranking for LGFVs－instead of sovereign debt has risen 94 basis points this month to 250 bps on last Thursday, the widest since June, ChinaBond data show. Spreads on seven-year AA rated local debt are up 69 bps to 2.78 percentage points as of Friday.

Questions about the future of LGFVs began in October when Premier Li Keqiang queried the implicit guarantees on the companies, set up to fund infrastructure projects after a 1994 budget law banned regional authorities from directly issuing bonds. The State Council said on Oct 2 that the finance arms can no longer raise funds for local authorities, and that the governments have no obligation to repay debt that was not raised to fund public projects.

Changzhou Tianning Construction Development Co, based in the eastern province of Jiangsu, announced on Dec 12 it would not go ahead with a planned 1.2 billion yuan sale just one day after authorities said they would not support its debt.

Less than a week later, officials withdrew backing for another planned LGFV issue in the northwestern Xinjiang Uygur autonomous region.

Gloria Lu, an analyst in Hong Kong at S&P, said: "Now that local governments have stringent balance sheet requirements, many municipalities will have to consider diversifying their income source in order to expand their metro networks. Overseas funding, at least in the near term, provides cost benefits compared with domestic funding."

Beijing Infrastructure also sold 1.2 billion yuan of three-year dim sum bonds at a yield of 3.75 percent in June. In the onshore market, the company priced 4 billion yuan of one-year notes to yield 5.06 percent in May. The yuan has declined 2.7 percent this year against the dollar.