UBS wary as China seeks global help to clean up local debt mess

[BEIJING] China is turning to global markets to help clear up a regional debt mess. Not everyone wants to be involved.

At least six local-government financing vehicles have sold US$3.9 billion of bonds overseas this year, up from about three in 2014. They include Beijing Infrastructure Investment Co, which issued three-year euro notes at 1 per cent, lower than the 4.9 per cent yield on its similar onshore debt. The finance arms have to repay a record 702.6 billion yuan (US$113 billion) of bonds this year, compared with 304.1 billion yuan in 2014, according to data compiled by Bloomberg.

Premier Li Keqiang has decided to phase out LGFVs, set up before the government allowed regions to sell municipal notes, leaving the level of state backing unclear. Aberdeen Asset Management Asia Ltd said some of the securities should be considered equivalent to government debt, while UBS Global Asset Management Ltd said relying on bailouts wasn't wise. The pool of regional liabilities has swelled to 25 trillion yuan, bigger than Germany's economy, Mizuho Securities Asia Ltd estimates.

"As a credit investor, it's best not to have to rely on an uncertain bailout to be repaid your investment," said Ashley Perrott, head of Pan-Asia fixed income at UBS Global Asset, which hasn't bought offshore LGFV bonds. "It's important to make an assessment of the actual underlying balance sheet, profitability, creditworthiness and strength of the entity in its own right."

The market is acknowledging the risk. Four of the six LGFVs that issued foreign-currency bonds this year have seen their yields jump. That on US$400 million of three-year debt sold by Guangzhou Communication Investment Group Co increased 47 basis points to 3.45 per cent since they were issued on May 27.

While China last October barred local governments from borrowing through firms and said authorities have no obligation to repay debt that wasn't raised for public works, the slowing economy prompted the State Council to soften its stand this May. Some companies, including LGFVs, may be eligible to sell more bonds to repay maturing debt, people familiar with the matter said on June 24, citing a National Development and Reform Commission document.

Some investors don't fully understand LGFVs and over- penalize them for their poor profitability, said Carol Yuan, a Singapore-based credit researcher at Aberdeen Asset Management Asia Ltd, which oversaw US$101 billion as of June 30.

"We believe LGFVs that focus purely on government-led infrastructure projects without any commercial purpose should be viewed as part of the governments," said Ms Yuan, whose company holds LGFV foreign-currency debt. "Their credit fundamentals should be assessed based on the fiscal strength of the local governments instead of their own profitability."

Tianjin Binhai New Area Construction & Investment Group Co reported an operating loss of 181.9 million yuan last year and has 44.4 billion yuan in securities outstanding, a circular shows. The company, which is helping build China's replica of Manhattan, raised US$800 million in a two-part sale on July 15, according to data compiled by Bloomberg. The three-year securities carried a coupon of 3.10 per cent.

The Manhattan project, the latest illustration of China's build-it-and-they-will-come approach to development, is relying on Tianjin's new status as a free-trade zone and the upcoming connection of a high-speed rail line with Beijing. Its skyscrapers, many incomplete, are empty and overlook deserted streets.

Tianjin Binhai's bonds were graded BBB+ by Standard & Poor's, three notches above junk. The company has "almost certain extraordinary government support," meaning its rating can be equalized with that of the Tianjin government, S&P said in a July 16 note.

"LGFV bonds are within our investible universe and we will participate in this market if we believe the bonds offer attractive expected risk-adjusted return," said Arthur Lau, Hong Kong-based co-head of emerging markets fixed-income at PineBridge Investments Asia Ltd, which oversees US$78.1 billion.

In a sign that investors are starting to pay greater attention to issuers' creditworthiness, the onshore market saw its first failed municipal bond sale last week when Liaoning province raised 150 million yuan less than its 550 million yuan target at an auction of 10-year notes. The province was judged one of the three riskiest in a Bloomberg assessment of 31 Chinese regions conducted in June.

Dollar bond sales in Asia excluding Japan have declined to US$117.3 billion so far in 2015, from US$122.2 billion a year earlier, as slowing economic growth affects corporate fund- raising. While Tianjin Binhai doesn't list any contact information on its website, four calls to Beijing Infrastructure went unanswered.

More LGFVs will issue bonds offshore, at least into next year, as regional authorities' need for financing infrastructure will remain strong as they need to support economic growth, Nicholas Zhu, a Beijing-based senior analyst at Moody's Investors Service, said in a July 31 phone interview. The companies also want to build contacts with offshore investors, so as China opens its onshore bond market and capital flows in, they'll be more likely to receive funding, he said.

"This is a great channel for global investors to get familiar with China's local governments' and companies' credit fundamentals," Moody's Mr Zhu said. "LGFVs want to attract long- term, stable foreign capital, such as insurance and pension funds."

BLOOMBERG