Sep 11, 2019 04:40 AM

LGFV Under Financial Pressure Skips Call Option on Yuan Bond

China’s LGFVs are facing escalating liquidity problems as debts come due in 2019-2021. Photo: Bloomberg
China’s LGFVs are facing escalating liquidity problems as debts come due in 2019-2021. Photo: Bloomberg

(Bloomberg) — A Chinese local government financing vehicle opted for the first time to pay a higher interest rate on a local bond instead of fully repaying it, a surprise move that’s seen as adding to investor concern over credit risks in the sector.

Jilin Transportation Investment Group Co., a local government financing vehicle (LGFV) for railway construction in China’s northeast Jilin province, said Monday that on a 4.64% 1.5 billion yuan ($210.8 million) perpetual note, it plans to skip the call option, when debt holders can seek repayment. Instead, it will pay an increased coupon of around 8%, according to Bloomberg calculations based on the initial offering terms.

Calls to the company’s capital management department went unanswered. The LGVF’s credit was downgraded in July to AA from AA+ as China Chengxin International Credit Rating Co. cited weak profitability, short-term debt repayment pressures and a liquidity crunch. The company had 620 million yuan in cash as of the end of June, according to the company’s interim results.

“This case may deal a huge blow to bondholders,” said Mei Dongya, executive director at Shanghai Maodian Asset Management Co. “Regional LGFVs and other state-owned enterprises may face some refinancing difficulties because Chinese investors usually have strong expectation that companies would redeem perpetual notes.”

This would be the first time a China LGFV skipped a bond call option and chose to pay a higher interest rate, Bloomberg-compiled data show. It signals caution on the financial health of the sector, which is buoyed by policymakers’ efforts to prop up economic growth via infrastructure investments. Investors may start demanding higher risk premiums for perpetual bonds sold by weaker entities, Mei said.

Debt Wall

Looming debt maturities are aggravating difficulties at China’s LGFVs, which face 3.8 trillion yuan of onshore bonds coming due in 2019-2021, S&P Global Ratings said in a report late last month. Some of these strains are evident in the offshore market as well. Qinghai Provincial Investment Group, considered by some as an LGFV, didn’t pay interest on its 2020 dollar bonds until five business days after the coupon due date of Aug. 22.

Jilin’s new coupon estimate is based on the sum of the average yield of three-year Chinese government bonds, the note’s original risk premium of 2.22% and an additional 300 basis points, or 3 percentage points.

Perpetuals are a relatively new instrument in the Chinese onshore bond market. Issuance of such notes started in 2013 after the China Securities Regulatory Commission published a framework for such sales.

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