First China Local Default Could Come in 2018, Aberdeen Says

(Bloomberg) -- It’s been years coming, but the latest Chinese moves to rein in leverage mean 2018 may be the year for the country’s first bond default by a local government financing vehicle.

The units that amassed record debt in the borrowing-and-building binge after the global financial crisis have faced increasing strains, and with their borrowing costs climbing Moody’s Investors Service and others have anticipated a default at some stage. Aberdeen Standard Investments says the groundwork is now ready for that to happen in 2018.

The annual gathering of China’s legislature, now underway, has showcased President Xi Jinping’s push to rein in financial risks, and local debt has been singled out. Huang Shouhong, head of State Council’s research office, highlighted that the central government won’t bail out regional debts.

“The government has talked about LGFV credit risks long enough to pre-warn people,” Edmund Goh, an Asia fixed-income investment manager at Aberdeen Standard Investments in Singapore, said in an interview this month. A default “would be a signal to investors, letting them know that they will have to be responsible for the risks they are taking,” he said.

The first bond to miss a payment would probably be a privately placed security issued by a small-scale LGFV, Goh says. He only considers investment-grade LGFVs offshore and avoids such bonds rated lower than AAA in the domestic market.

Goh said he’s quite bullish on China’s onshore bonds this year. He estimated the authorities will relax market regulations in the second half to help lower borrowing costs.

Among the signs of strain in the LGFV bond market:

  • LGFVs have a record 331 billion yuan ($52 billion) worth of bonds to repay in the onshore and offshore markets in the second quarter. The bond maturities from now to the end of the year will be 882 billion yuan.
  • A Chinese trust loan company was said to delay payments to investors on products tied to local borrowings.
  • Zhenjiang State-owned Investment Holding Group and Jiangsu Hanrui Investment Holding Co. sold 270-day bonds at a yield of 7.5 percent last month, a record coupon rate for LGFV notes of similar maturity.

©2018 Bloomberg L.P.

With assistance from Judy Chen

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