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Regional governments across China are escaping borrowing limits by shifting assets into the books of local investment firms to lower their official debt ratios, executives and officials say.
This practice has enabled local government funding vehicles to raise more money for infrastructure and other construction projects. But analysts warn that many assets are of poor quality, paving the way for an increase in bad debt after a wave of bond defaults at government-backed companies in recent weeks.
“A lot of our assets don’t generate much economic value,” Liu Pengfei, chairman of Taiyuan Longcheng Development Investment, a LGFV in northern Taiyuan City, said at an investment conference last month. “Taiyuan government gave them to us so that we could meet. [the debt-to-asset] requirements set by our creditor banks and bond investors.
TLDI focused on infrastructure projects. Today, it is a large, diverse operator of everything from parking lots to tourist attractions, many of which barely stay afloat.
According to public records, the total assets of 960 major LGFVs that regularly disclose their financial results have increased by 40% over the past four years. However, their income and net income only increased by 6% and 4% respectively.
“A Rmb100bn [$15.3bn] a company will be no less likely to default on its debt than a Rmb 10 billion company simply because of a size difference, ”said Bo Zhuang, chief economist for China at TS Lombard, a group of research.
The surge in acquisitions is expected to continue as local governments turn to LGFVs to boost the economy in the wake of the coronavirus pandemic. The Shaanxi provincial government said in a statement in October that it would transfer “as many assets as possible” to LGFVs so that they can double their borrowing over the next two years. The measure “would effectively eliminate the risks associated with public debt,” the government added.
“The bigger we are, the more we can borrow,” said an executive from Yan’an City Construction Investment Corp, another Shaanxi-based LGFV.
The executive said YCCIC has been entrusted with dozens of state-owned enterprises by the Yan’an municipal government since 2018, ranging from hotels to water treatment plants. Most of them struggle to make a profit.
Nonetheless, the executive added, YCCIC was able to borrow more as its larger size translated into a better credit rating, which was upped a notch to double A plus in October. Over the past two years, YCCIC’s outstanding bank loans have more than doubled.
Many local governments had previously ceded valuable land to their LGFVs free of charge in order to increase their borrowing capacity. But the practice was banned by the central government, forcing local governments to resort to lower-quality asset transfers.
Chinese banks, the largest LGFV lenders, are comfortable lending to the largest public investment firms, even as the quality of their underlying assets deteriorates.
“We have an obligation to support government-controlled enterprises as long as they meet core funding requirements,” said an executive from the Bank of Xi’an.
The rating agencies, on which LGFVs rely to access the bond market, are also generally favorable. An executive from the China Chengxin Credit Rating Group, one of the largest in the country, said the company paid more attention to total assets than earnings or cash flow. “The injection of government-controlled entities, whether profitable or not, into LGFVs is a sign of state support,” the official said. “It’s a plus for their credit rating. “
Some investors, however, are not convinced that the frenzy of LGFV acquisitions will make them less likely to default.
“Expanding LGFV balance sheets will not remove credit risk,” said Dave Wang, a Shanghai-based fund manager specializing in buying LGFV debt. “They may erupt at a later date, on a larger scale.”
Some LGFV executives have said they are aware of the potential risks as they seek to create more market-responsive businesses.
An executive from Jiangdong Holding, an LGFV in central Ma’anshan city, said his group had acquired two smaller peers and wanted to emulate Temasek, the Singaporean public investment group, even though it could not match its return on capital for the foreseeable future.
“Temasek has enjoyed a 16% annual return on investment for many years,” he said. “We would be satisfied with 1.5%. “