(Bloomberg) -- If China is deleveraging, it seems someone forgot to tell the No. 2 toll-road operator of eastern Shandong province, which just bought a risky piece of debt in an effort to goose its returns.
An offshore unit of Shandong Hi-Speed Group Co. subscribed for about $10 million of dollar-denominated leveraged notes linked to Future Land Development Holdings Ltd.’s notes, according to a June 1 filing on the Stock Exchange of Hong Kong. China Shandong Hi-Speed Financial Group Ltd. said it wants to develop financial investment as one of its main business activities and expects this self-funded leveraged note to provide an enhanced annual return of around 12 percent.
"Leveraged investment is typical hedge fund behavior, which is probably not the best practice for a LGFV that doesn’t have foreign currency revenue," said Le Xia, chief Asia economist at Banco Bilbao Vizcaya Argentaria SA in Hong Kong, referring to the local government financing vehicle. "Especially in an environment where deleveraging and foreign-funding risks have just been reiterated by the regulator amid rising defaults."
China’s National Development and Reform Commission in May warned Chinese companies to be mindful of currency and interest-rate risks and other factors before issuing debt. Market watchers have been anticipating debt failures from local borrowers as China steps up efforts to rein in excessive leverage in the financial system.
The investment is in line with shareholder interests, a Hong-Kong based official at Shandong Hi-Speed Financial Group investor-relations department said by phone on Friday. The company made this investment for a stable enhanced return, the official said, asking not to be named.
"Under the current rising-rate cycle, using three times of leverage to enhance yield for investing in cash bonds may be a bit too risky," said Chak Lau, a credit investment manager at Dongxing Securities (HK) Asset Management Co. in Hong Kong. "It’s getting more difficult for LGFVs to secure funding nowadays both onshore and offshore," he added.
Future Land Holdings sold $300 million 7.125 percent notes maturing in 2021 on May 23, while China Shandong Hi-Speed Financial sold $400 million of 363-day bond at 4 percent in February and tapped the bonds for another $200 million in March.
"Leveraged investments are risky bets as a decline in the underlying asset will magnify the losses of the linked notes." said Christopher Lee, managing director of corporate ratings at S&P Global Ratings in Hong Kong. "LGFVs tend to have weak debt servicing, so any meaningful investment losses could affect their liquidity and potentially lender’s confidence."
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