China Local Government Financing Vehicle Opts to Skip Call Option on Yuan Bond

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

Jilin Transportation Investment Group Co., a financing entity for railway construction in China’s northeast Jilin province, said on Monday it plans to skip the call option on a 4.64% 1.5 billion yuan ($210.8 million) perpetual note. Instead, it will pay an increased coupon of around 8% on the note, according to Bloomberg calculations based on the initial offering terms. Calls to the company’s capital management department went unanswered.

“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 has skipped a bond call option to pay a higher interest rate, Bloomberg-compiled data show. It signals caution on the financial health of the sector, which is currently buoyed by policymakers’ bid to prop up economic growth via infrastructure investments. Investors may start demanding higher risk premiums for perpetual bonds sold by weaker firms, Mei said.

Debt Wall

Looming debt maturities are aggravating difficulties at China’s LGFVs, which face 3.8 trillion yuan 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 original coupon due date of August 22.

China Chengxin International Credit Rating Co. downgraded Jilin Transportation Investment to AA from AA+ in July, citing its weak profitability, short-term debt repayment pressure and liquidity crunch. The company had held 620 million yuan in cash as of the end of June, according to the company’s interim results.

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

To contact Bloomberg News staff for this story: Tongjian Dong in Shanghai at tdong28@bloomberg.net;Yuling Yang in Beijing at yyang329@bloomberg.net

To contact the editors responsible for this story: Neha D'silva at ndsilva1@bloomberg.net, Chan Tien Hin

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With assistance from Bloomberg