Investors yield to chengtou notes' charms

On the supply side, most of the LGFVs issued their first debt in 2009 as the markets were awash with liquidity, the result of the central government's stimulus spending to offset the global financial crisis. Many of those issues were in the form of five-year notes, which come due this year.

Refinancing demand is strong, and rollovers were approved in late February by the National Development and Reform Commission, which oversees corporate note issues.

On the demand side, ample liquidity is driving enthusiasm. The tight monetary policy that caused a credit crunch in mid-2013 essentially ended in March. Analysts said that if liquidity is tightened again in the second half of this year, bond yields could spike again.

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Moreover, last year, the government began to limit banks' purchases of so-called nonstandard assets, such as trust loans, making chengtou relatively more attractive. Both types of assets have relatively high yields, making them useful for banks that repackage them into wealth management products for sale to clients.

But chengtou notes commonly offer at least implicit government backing, underwriters claim.

In late May, the Ministry of Finance for the first time allowed 10 provinces and cities to sell bonds independently in a pilot program, aiming to replace risky and opaque borrowing by LGFVs with a municipal bond market similar to that of the United States.

A document issued by the NDRC said the pilot program would expand and gradually replace bonds issued by LGFVs, whose debts generally do not carry explicit government guarantees. This document boosted expectations that the supply of chengtou notes will shrink, making them more popular.

Chengtou notes "are becoming a rare, high-investment-value option", said Lin Na, a bond analyst with China Galaxy Securities Co Ltd.

Another landmark event came in early March, when Shanghai Chaori Solar Energy Science&Technology Co failed to repay its debt, becoming the first corporate bond to default in China. The event reminded the market of the potential risks of corporate bonds, which unlike chengtou - have neither explicit nor implicit government guarantees.

"March was a watershed. Since then, sales of chengtou kept rallying," said Liu Dan, another analyst at China Galaxy Securities.