Non-rating Action Commentary: Chinese LGFV offshore bonds see big uptick as SBLC prevails


05 May 2022

    By the end of April 2022the amount of offshore bonds issued by Chinese local government financing vehicles (LGFVs) had surged by 152% year on year.
    The amount of offshore bonds issued by Chinese LGFVs has seen an average annual growth rate at 53% in the period of 2015-2021, an overall high growth rate despite the dips in 2017 and 2020 owing to the market turbulence and policy restrictions. The number of issues in 2021 increased nearly eight times versus that of 2015, and the offshore bond market has become an important financing avenue for Chinese LGFVs. In 2022, despite the overall contraction of Chinese offshore bond issuance, LGFVs’ offshore bond issuance has expedited, with the issue amount and number of bonds issued soaring 152% and 184% year on year, respectively, as of 30 April. Under the guidance of the proactive fiscal policy in China, the domestic infrastructure construction has expanded rapidly and in turn spurred the financing needs of LGFVs given their pivotal positions in local infrastructure investment. The disparities in financing conditions and regulations between the onshore and offshore markets, as well as the relatively lower interest rate in the offshore market, are the main factors attracting LGFVs to borrow offshore. In addition, the offshore bond issuance can diversify financing channels for LGFVs, improve the international recognition of the local economies and LGFVs, and propel the fund inflow which can offset the regional capital outflow and facilitate the local economic development. We expect the amount of offshore bonds issued by LGFVs to increase substantially in 2022.

    The average issue yield of LGFVs’ offshore bonds continues to declineextending its advantage over that of LGFVs’ onshore bonds.

    The issue yield reflects LGFV’s borrowing cost. The average issue yield of LGFVs’ offshore and onshore bonds has been declining since 2018. The offshore bonds with maturities between one and five years made up the majority of the LGFV bonds, with their average issue yield dropping to 3.2% in 2021. This results in a broadening gap between the onshore and offshore LGFV bond borrowing costs, showing a greater advantage for LGFVs to finance offshore. As of the end of April 2022, the average yield difference between the onshore and offshore LGFV bonds was approximately 1%

    While direct issuance has been the predominant structure for issuing offshore LGFV bonds, SBLC-backed issuance is becoming more common.

    In general, LGFVs’ offshore bond issuance can be classified into two broad categories: the direct issuance and the indirect issuance, which includes guarantee, SBLC (Standby Letter of Credit) guarantee, and keep well agreement, among others. The direct issuance has dominated the market, whereas SBLC-backed issuance has been catching up quickly, with an increasing presence among the newly issued LGFV bonds.  As of 30 April, bonds guaranteed by SBLC accounted for 32.1% of offshore bonds issued by LGFVs in 2022. With the SBLC structure in place, the issue yield of bonds can be reduced considerably, as the creditworthiness of bonds is linked to the banks that furnish the SBLCs. As of April, the yield differential between LGFV offshore bonds with and without SBLCs was at 1.1 percentage points in 2021 and rose to 1.4 percentage points in 2022. In our opinion, as domestic crucial financing and investment entities, LGFVs have typically forged close relationships with local banks, and an increasing number of LGFVs are obtaining SBLCs from local banks as a credit enhancement, thus channeling an alternative structure to issue offshore bonds.

    The LGFVs from Zhejiang, Shandong and Jiangsu provinces have accounted for over 40% of LGFV offshore bond issuance for the past two years, suggesting a regional concentration in the market.

    The offshore bond market has seen a surge in the number of LGFV issuers from a variety of regions in recent years. In 2015, only six provincial regions’ LGFVs issued offshore bonds; by 2021, that number has increased to 24 (Exhibit 3). The LGFVs from Zhejiang, Shandong and Jiangsu are the most active borrowers, accounting for over 40% of LGFV offshore bond issuance between 2020 and 2021. Sichuan LGFV issuance is also growing rapidly and is establishing a strong presence in the offshore market. In terms of average issue yield, there are still significant discrepancies across LGFVs from different regions. Jiangsu and Zhejiang’s LGFVs have seen massive issuance in the past two years, with average issue yield of less than 3.5%. Shandong’s LGFVs, on the other hand, have a considerably higher average issue yield than the former two. The disparities in borrowing costs between issuers imply creditworthiness gaps among regional governments and LGFVs, which are increasingly attracting the attention of offshore investors.


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