SHANGHAI — Shut out of the bond market and spurned by banks, a growing number of cash-starved Chinese local government financing units are tapping a loosely regulated funding channel to directly court yield-hungry retail investors.
Over recent years China has embarked on a deleveraging campaign to reduce systemic risks after Local Government Financing Vehicles (LGFVs) accumulated trillions of dollars worth of debt since the 2008 financial crisis.
Last year, Beijing further tightened the screws on lending to LGFVs, which are investment companies that build infrastructure projects on behalf of local governments.
The squeeze has sharply driven up “direct financing” debt products by LGFVs – typically registered via loosely-regulated local asset exchanges and sold to the public via the internet with a hint of government guarantee – over the past year.
LGFVs are offering to pay yields of more than 8% – roughly triple the benchmark lending rate – revealing their desperation to raise cash and meet political mandates to support a COVID-hit economy.
One such firm is Weifang Binhai Tourism Group Co, which is selling investors 500 million yuan ($74.04 million) of debt yielding 8.5%-9.5%, to fund engineering projects and replenish cash, according to a sales pitch.
The company wouldn’t have chosen this path “if we could sell bonds at a lower cost – we are not stupid,” said Liu Yang, a manager in charge of financing for Binhai Tourism, owned by the city government of Weifang, in eastern Shandong Province.
Liu says many LGFVs are struggling, as they are unable to raise money from the bond market or through trust firms. The major hit came last year when regulators curbed bond sales by LGFVs and restricted banks from providing loans to such state firms, and “all banks were rushing to call back loans.”
Weifang Binhai is not alone. About 50 LGFV debt products are on sale via investment website Junxing Wealth, luring individual investors with indicated annual returns of 8.0-10.2%. More such private investment products are being promoted via the internet, or through social media.
There’s no official data on the total size of such products, as they are not sold through regulated financial institutions. At least 245 such debt products have been sold since last year to quench LGFVs’ funding needs, according to an estimate by Huaan Securities. An LGFV typically raises several hundred million yuan via such a debt scheme.
“For LGFVs in economically weak regions, or owned by county-level, district-level governments, it’s tough for them to refinance through bond issuance, so they must come up with something innovative,” said Ivan Chung, associate managing director at Moody’s Investors Service.
Risk averse investors typically shun LGFVs in China’s southwestern, northwestern and northeastern provinces, as well as lower-rated bonds, Chung said.
Net bond sales by AA-rated LGFVs more than halved so far this year, according to Minsheng Securities.
But the practice of LGFVs selling private debt to the public via the internet, with a veiled promise of government guarantee, is raising eyebrows.
In a brochure promoting debt sold by Luoyang Gaoxin Industrial Group, little was mentioned about the issuers’ financial health. Instead, descriptions centered on the financial strength of the Luoyang city government, and the central Henan province, where the LGFV is based.
“This doesn’t look right. Any LGFV can issue debt, but the point is, you cannot hint that the local government is behind your back,” said Rocky Fan, economist at Guolian Securities, adding such promotion violates central government’s ban on implicit guarantees.
Such LGFV debt schemes also risk violating rules on private investment products, which must only sell to qualified investors, while limiting the number of investors to 200, said a lawyer who declined to be identified as he’s not authorized to speak to the media.
These products “appear to be illegal fundraising,” the lawyer said.
Wealth management sold through banks, trust firms and brokerages would be subject to much stringent scrutiny. A debt crisis in the property sector has already led to a years-long crackdown on illicit financing.
The Luoyang city government could not be reached for comment. China’s securities watchdog didn’t immediately reply to Reuters’ request for comment.
REASON TO EXIST
As debt-control deepens, a growing number of LGFVs will likely default on private debt in 2022, S&P Global Ratings predicts.
Bincheng Investment, an LGFV seeking to raise 100-200 million yuan from individual investors at yields of 8.2-9.0%, says borrowing from individuals makes sense.
“This new financing tool is legitimate, and meets the needs of individual investors,” said an official of Bincheng’s finance department, declining to be named.
“There are many products in the market offering much higher interest rates than those of bank lending … and there is a reason for them to exist.” ($1 = 6.7530 Chinese yuan renminbi) (Reporting by Samuel Shen, Jason Xue and Andrew Galbraith; Editing by Vidya Ranganathan & Shri Navaratnam)