China’s weaker LGFVs face default risks as property crisis hurts local authorities’ revenues, analysts warn

Some 84 per cent of Chinese LGFVs’ US$84.2 billion of offshore debt will mature by 2025, according to China Lianxin Credit Rating
Default risks among weaker local government financing vehicles, which rushed to issue offshore bonds last year, have increased, analysts say

Banking & finance

Iris Ouyang

Published: 12:00pm, 18 Feb 2023

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China’s weaker local government financing vehicles (LGFVs) are facing higher risks of default and missed payments amid rising financing costs, a wave of maturities and a property crisis that is taking a toll on local authorities’ balance sheets, according to analysts.

This is expected to exert upwards pressure on an already high delinquency rate among high-yield issuers in the Asia-Pacific this year.

One of the two main sectors for offshore bond issuance in China – the other being the beleaguered property industry – could see risk spill over to the broader bond market and threaten systemic financial stability in the world’s second-largest economy, analysts said, although missed payments are more likely to be seen beyond the public bond market in the short run.

“Individual LGFVs’ credit risks, especially in private equity, non-standard debt instruments, and commercial bills have increased to some extent, enhancing the tailwind risk for [other] LGFVs and regions,” said Ben Yau, senior director at China Lianxin Credit Rating Global.

LGFVs are platforms used by the local governments to borrow off-budget capital and facilitate local infrastructure and public projects, which would otherwise be unable to make ends meet.

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Lianxin warned that they will face increasing repayment pressure amid tighter refinancing conditions as the US Federal Reserve expects to continue raising interest rates.

The outstanding balance of LGFVs’ offshore debt is around US$84.2 billion, of which 84 per cent will mature between this year and 2025, Lianxin said at a briefing on Thursday.

Because local jurisdictions were hit hard by the high costs of Covid-19 control measures, a slump in revenue from land sales and an economic slowdown, LGFVs are finding it harder to service their debt. Zunyi Road and Bridge Construction Group in Guizhou province, for example, recently rolled over 20-year-old loans worth 15.6 billion yuan (US$2.27 billion).

Moody’s recently highlighted the fragile investor sentiment and likely spillover effect to the bond market.

“An unexpected LGFV bond default as a result of a gap in regional local government (RLGs) support … could lead to contagion in the onshore bond market, with implications for RLGs, financial institutions and [state-owned enterprise],” said analysts led by Martin Petch in a report on Wednesday.

S&P Global said the weaker LGFVs could face increased risk of default, after they rushed to the offshore bond market last year despite the high costs.

Issuers with no credit rating accounted for 67 per cent of those in the offshore market in the first 10 months of last year, up from 45 per cent in 2020, according to data from Lianxin. The proportion of lower-prefecture, district and county level issuers in the segment shot up to 50 per cent of the total offshore LGFV issuers in the first 10 months of last year, from 26 per cent in 2021, and 17 per cent in 2020.

“The weaker players are forced to pay the highest prices, amplifying credit risks and polarisation,” said S&P analysts led by Wu Yuehao in a report on January 9. “Should regulators crack down on cross-border borrowings, weaker players in the sector could face increased default risk.”

The heightened risk could endanger the fragile offshore credit market, which had already been hit hard by frequent defaults and payment extensions by heavily indebted Chinese developers. Such home builders accounted for all of the 23 defaults in the Asia-Pacific region last year.

The high-yield default rate among Asia-Pacific’s non-financial companies is likely to remain high this year, well above the 10-year average of 4.4 per cent, according to an estimate by ratings agency Moodys.

The LGFVs do not rely on offshore financing channels to the extent that commercial home builders do, which should help them avoid a major crisis like the one rattling the real estate sector.

“The chance of large-scale risk events, especially in the public market, will be relatively low,” said Lianxin’s Yau. “The government is willing to prevent a default in the public market, but whether they [individual jurisdictions] are capable is another story.”