Chinese LGFVs Get Record Investor Demand for Short-Term Debt

Demand has surged for shorter-term yuan bonds from local government financing vehicles, led by lower-rated borrowers, in the wake of China’s efforts to stem debt risks in the sector.

(Bloomberg) — Demand has surged for shorter-term yuan bonds from local government financing vehicles, led by lower-rated borrowers, in the wake of China’s efforts to stem debt risks in the sector. 

Orders for new LGFV notes maturing in less than a year have exceeded issuance by 4.6 times so far this month, which would be a record, according to a report from Huaan Securities Co. The subscription ratio is 3.9 for notes maturing in 1 to 2 years, the highest in nearly a year. 

In contrast, notes of at least three years in tenor haven’t seen a notable increase in August order rates, the firm said, signaling that past worries have been moved on from. “The current market remains cautious about exposure to longer-term LGFV debt,” Huaan Securities said. 

Bonds rated AA have had an order rate of 7.9 times this month, while the figure for AAA issuers is 4.3, according to the securities firm. Both subscription ratios are poised for record highs, it added.

“Under the background of lower rates, it is inevitable that subscriptions for LGFV bonds are active,” said Li Han, a fixed-income analyst at Citic Securities Co. “This is further compounded by downturns in the equity market and the real estate sector. Investors now favor shorter-term, higher-interest bond products.” China’s central bank surprisingly cut a key interest rate last week by the most since 2020.

There have been growing concerns about the $9 trillion debt market for LGFVs, which were created to finance infrastructure projects but rarely generate enough returns to cover their obligations. Rising debt and cash-flow issues as China’s economy slows amid the real estate crisis fueled the angst.

Amid those worries, the average tenor of LGFV yuan bonds sold in the first half of 2023 hit a record low of 2.51 years and coupons jumped, according to data compiled by Bloomberg. 

But late July’s Politburo meeting, where China’s top policymakers vowed to speed up issuance and use of local government special bonds, was enough for a top fund manager to boost her LGFV holdings. Bloomberg News reported earlier this month that China will allow provincial-level governments to raise about 1 trillion yuan ($137 billion) via bond sales to repay debts from LGFVs and other off-balance sheet issuers. 

Exemplifying the turn in investor sentiment was last week’s 1.5 billion yuan note sale by an LGFV from Tianjin, one of China’s most indebted cities. The subscription ratio for Tianjin Infrastructure Construction & Investment Group Co.’s deal topped 70, people familiar with the matter said. For all LGFV bond sales from Tianjin province, August’s order rate is at a record 13.6, according to Huaan Securities.

“Due to the market’s pursuit of short-term bonds, we believe that regions or entities with a relatively large scale of bond issuance and a relatively high proportion of short-term bonds, like Tianjin Infrastructure Construction, may still have some room for spread compression and at the same time have liquidity advantages,” the securities firm said. 

Spreads for one-year LGFV yuan notes rated AA- versus government notes have narrowed by 30 basis points since the Politburo meeting to their tightest level in nearly three years, according to Bloomberg-compiled data. Premiums for bonds from AA- rated corporate issuers have narrowed 21 basis points. 

(Updates with more details and comments in the third through seventh paragraphs.)

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