China debt: distressed state-owned financing vehicles eye long-term restructuring, even as ‘default is the easiest choice’
- Mounting debt at local levels across China back in the spotlight after 20-year rollover raises concerns about how far banking sector has to go in handling the blow from cash-strapped firms that cannot repay loans on schedule
- Transparency in borrowings and use of funds is often weak, prompting Beijing to become increasingly wary of so-called hidden-debt risks
The controversial loan restructuring of a troubled state-owned company in one of China’s most indebted provinces reflects long-running credit problems facing various regions across the country, and analysts warn that this could be merely the tip of the iceberg when it comes to local governments’ mounting debt piles.
Zunyi Road and Bridge Construction Group, which is responsible for building infrastructure projects in Zunyi and other cities in Guizhou province, said in a stock-exchange filing on December 30 that creditor banks had agreed to a 20-year rollover of loans worth 15.6 billion yuan (US$2.28 billion).
The move made the company, which is also a local government financing vehicle (LGFV) for Zunyi to issue debt, the first LGFV to restructure its bank loans in China.
China’s local officials misused US$5 billion of special purpose bonds: auditors
Analysts say the 20-year loan rollover is relatively rare, and that new interests payable on the loans are lower than current market rates, raising concerns about how far the banking sector has to go in handling the blow from cash-strapped LGFVs that are not able to repay loans.
Laura Li, a senior director at Standard & Poors Global Ratings, said such sizeable loan-restructuring deals would not be able to go through if not sponsored by local governments.
“The company has run into severe financial distress, after years of aggressive debt-funded investments with very poor cash-flow generation for debt servicing, and its financing access keeps deteriorating,” Li said.
“The loan tenor is extended for a long time, 20 years, implying a much more conservative estimate over cash-flow recovery and long-term growth of the LGFV and its government owner.”
Zunyi Road said that it would pay off only the interest on the loans during the first 10 years, with the principal repaid in phases over the following decade. Annual interest on the loans was adjusted to between 3 and 4.5 per cent.
The names of the banks were not disclosed in the stock-exchange filing. In comparison, the new rates are also lower than the current one-year loan prime rate, which is 3.65 per cent, while the five-year loan prime rate is 4.3 per cent. Long-term rates tend to be higher than short-term rates because both interest rate risk and default risk go up over time.
Although the company has pledged to repay bond investors in the listed market, it remains unclear as to whether Zunyi Road has also negotiated the rest of the outstanding debt held by other creditors.
“The extension applies only to bank loans, not the public bonds nor other shadow banking loans, which are more difficult to negotiate given the diversified investor base. The announcement also dictates a strong willingness to honour the repayment of public bonds,” said Davis Sun, a senior director with Fitch Ratings’ international public finance team.
Local authority ‘land grabs’ raise China debt concerns amid tumbling revenues
Tianfeng Securities estimated that, in 2021, Zunyi Road had a total of 62.15 billion yuan in interest-bearing debt, including 44.12 billion yuan worth of loans, such as bank loans.
The securities firm said in a note on January 2 that bank loans might have accounted for only around 18.9 per cent of Zunyi Road’s outstanding debt.
GF Securities analysed 123 other LGFVs – located across 15 provinces, and with similar debt valuations to Zunyi Road as of December 31 – and found that the size of their interest-bearing debt totalled 1.49 trillion yuan with a total of 389.64 billion yuan in listed bonds, of which 187.04 billion yuan will mature and may be repaid in full principal in 2023.
As such, these LGFVs are likely to seek support from financial institutions and local governments, GF Securities said in a note on Thursday.
11:31
As mainland China reopens, what is the market outlook for the mainland and Hong Kong?
“Currently, default is the easiest choice, but all LGFVs, including Zunyi Road, are actively resolving the risk of outstanding debt. If new debts can be strictly controlled, and various methods can be used comprehensively to reduce the interest burden on existing debts, the outstanding bonds can be rolled over smoothly, and it may still be possible to buy some more time,” GF Securities said.
Sun at Fitch Ratings expects more isolated, issuer-specific risks of default for LGFVs in economically weaker regions, where refinancing remains difficult, despite the low likelihood of systemic risks for the sector.
Despite growing fiscal pressure facing many local governments from the fallout of coronavirus outbreaks and a slump in the property market, Beijing has pledged to tightly control debt risk.
The central government has issued a series of directives over the past few years, including restricting some highly leveraged LGFVs from selling new debt in the listed market. The State Council last year allowed government-owned borrowers in Guizhou to negotiate with banks to extend debt repayments – part of a programme to restructure debt and mitigate debt-default risks.
China’s local officials misused US$5 billion of special purpose bonds: auditors
Guo Shuqing, the head of China’s Banking and Insurance Regulatory Commission, was quoted by Xinhua on Saturday as saying that local government debt swaps would be carried out in an “orderly manner” to manage financial risks.
Without naming any local government, Guo also said that the structure of debt maturity would be “optimised”, and that the interest rate “burden” would be reduced on local-level debt.
Analysts at China International Capital Corporation said Guizhou’s debt-restructuring programme is difficult for other regions to emulate, at least not without Beijing’s support.
“Considering that the relevant handling of Zunyi Road and Bridge has been supported by the central government and is reasonable to a certain extent … the actual implementation of debt restructuring in other weak regions still needs to pay attention to the changes in their own capabilities and to the guidance of central government policies,” China International Capital said last week.
The reason we are worried about the debts of local governments is that many of the hidden debts are in LGFVs
Liu Shangxi, president of the Chinese Academy of Fiscal Sciences, said last month that restricting some LGFVs from borrowing may actually increase their debt risk, and that the central government should consider “new standards” when it comes to evaluating LGFVs assets and liabilities, to avoid misjudging the underlying risks.
Liu explained that the dual role of many LGFVs as commercial entities and state-owned firms means that risks should not be assessed in a one-size-fits-all approach.
“The reason we are worried about the debts of local governments is that many of the hidden debts are in LGFVs,” Liu said in a presentation on LGFVs and urbanisation on December 9.
“In fact, this is because our understanding of the assets and liabilities of LGFVs may need to be further deepened.”
