S&P Global Ratings believes a recent authorize, build and operate (ABO) agreement between the Beijing municipal government and Beijing Infrastructure Investment Co. Ltd. (BII) could become the model to follow for many of China's local governments with strong motivation to curb debt levels. For BII, the agreement is likely to have neutral implications for the ratings on the company (A+/Stable/--; cnAAA/--).
"We don't believe the ABO agreement will change our assessment of the likelihood of extraordinary government support for BII, if needed, over the next two to three years at least," said Standard & Poor's credit analyst Joseph Lin. "But we do expect BII to gradually deleverage, and its service fees are likely to increase operating cash flows, which could improve the company's financial risk profile."
The ABO agreement partly reflects the impact of the national policy (Circular 43) that requires the freezing of government debt incurred by local government-owned financing vehicles (LGFVs). LGFVs primarily finance the construction of urban infrastructure facilities and social welfare housing under the mandate of their respective local or regional governments, and they are usually highly leveraged. Local governments will now finance infrastructure investments and other social services from their own budgets, including through the issuance of local government bonds.
In our view, the key change for BII under the agreement is that BII will receive sizable service fees for its financing, construction, and operations of rail projects that are authorized by the Beijing municipal government. The service fees shall supersede and be well above the previous rail construction project funds from the government. The fund had been Chinese renminbi (RMB) 15.5 billion (US$2.325 billion) annually between 2011 and 2015. However, no details have been disclosed as to how the service fees are determined.
In view of the agreement, all new debt incurred by BII will no longer be treated as local government debt and shall be directly repaid by the company. For the outstanding debt classified as local government debt (over 90% of BII's gross debt of about RMB200 billion as of the end of 2014), the government will repay most of it under its debt-for-bond swap program and other funding support from the government.
Our rating on BII is primarily driven by our view of the credit profile of the Beijing municipal government because we see an almost-certain likelihood of government extraordinary support for BII if the company came under financial distress. In our view, BII provides an essential public service that could not be easily replaced by any private entity, and the government has very tight control over the company's strategy, operations, and management appointments.
The ABO agreement won't alter our view that BII plays a critical role and is an integral part of the Beijing municipal government. BII, which is wholly owned by the government, operates the largest metro system in Beijing and plans to further expand its rail network to 900 kilometers (km) by 2020 from over 554 km by 2015. The company is also an important participant in executing the national policy of integrating Beijing, Tianjin, and Hebei through the interconnection of rail transport.
Governments that adopt a similar ABO agreement are likely to have robust fiscal income to support the procurement of public services provided by LGFVs in the area where the public private participation model is not preferred or commonly used.