Bond deluge may keep market on tenterhooks

Slew of offerings likely in next six months as economic planner eases issuance norms

A deluge of local government-related bond offerings are likely in the second half of the year and could spook the market with possible price slumps due to oversupply.

According to analysts, the government's renewed focus on "stabilizing growth" has proved detrimental to the earlier policy of regulating bond issues by the financing arms of local governments. The National Development and Reform Commission, the nation's top economic planner and regulator of State-owned enterprises' bond issuance, had on June 24 permitted local government financing vehicles to sell more bonds and use the proceeds to repay maturing debt.

LGFVs that are rated AA or above are allowed to spend up to 40 percent of the proceeds from bond sales for repaying bank loans and replenishing operating capital. Those companies' bond ratings must be at least AA+, the NDRC said. Those that have ongoing projects with stable returns, or those with AA and above-rating, who use their own assets as collateral would not be subject to NDRC's quota limits.

"This is an apparent loosening of the policies pertaining to bond issues by enterprises. The 'legacy debt' part will replace previous high-cost debt with lower-yield bonds and prevent debt risks, while the 'increment' part will support economic growth," said Li Qilin, an analyst with Minsheng Securities.

The document is actually a supplement, and further loosening of a landmark document in May that eased the rules for bond issuance. The softening stance came on heels of the slowest GDP growth since 1990 in the first quarter. Last year, the State Council had banned LGFVs from raising debt on behalf of local governments.

The policy loosening in May was accompanied by a record sale of LGFVs bonds (known in China as Chengtou notes) in May. Issuance during that month hit 129.6 billion yuan ($20 billion), according to Wind Information Co Ltd.

However, analysts said the peak has hardly been reached. The NDRC has approved very few bond issues since last October. Issuance has tumbled and issuers since then, including this May, were mainly those who got approval before October.

A report by China International Capital Corporation said as it takes about two months for companies to prepare filings, the effect of the policy easing would not be seen until the third quarter. Chengtou note issuances in June remained slack (at 110.7 billion yuan, according to Wind), suggesting the outburst has not really happened.

Worry over supply explosion was compounded by the Finance Ministry's determination to push through a debt-for-bond swap program with another 1 trillion yuan local government municipal bond sale. The plan, announced last month, is an extension of an initial 1 trillion yuan swap program announced in March.

However, the 2 trillion yuan plan may not be the end. Under the program, 1.03 trillion yuan of municipal bonds have been sold since May, but CICC expects to see "a third round" of replacement, since the 2 trillion yuan still cannot cover the 2.9 trillion yuan debt falling due this year.

The looming supply surge has sparked fear that it would suck liquidity and reduce banks' capital to buy other bonds. Partly to stave off the fear, the central bank announced on Saturday its latest cut, and the fourth cut, in benchmark interest rates since November.

However, the problem is the ample liquidity and vast plunge in short-term market rate have not yet translated into a drop in the long-term rate. The stubbornly high long-term rate poses a grave threat to bond sales, usually for those with long maturity. Last month, the Finance Ministry twice failed to sell its stock of Treasury notes, due to a lack of demand.

Market's aversion to low-yield bonds (3.37 percent for an average three-year bond) has sparked concerns of a further intervention by the central bank. Jiang Chao, chief fixed-income analyst with Haitong Securities, said the PBOC should directly or indirectly buy local government bonds to ease concern that long-term interest rates will climb and damp the bond market.