The recent near-default by a Chinese local government financing vehicle (LGFV) has underscored a potential contagion risk due to guarantees and cross obligations that are common in the sector, S&P Global Ratings said.
A unit of Xi'an Qujiang Culture Holdings Co. Ltd. made a last-minute settlement of an overdue sum of 91.74 million yuan that was outstanding as of Dec. 26, 2023, Ratings said. While this was a "relatively small amount," the event triggered a cross-default clause within the issuer's onshore bond, according to a local rating agency. That bond was guaranteed by Xi'an Qujiang Culture, a district-level LGFV in Xi'an, the capital of Shaanxi province.
A cross-default clause means that if there is a default in one area, this is carried over to other areas.
"The near-default in China's domestic bond market, together with prior such cases, shows fringe LGFVs are struggling to meet their financial obligations," said Ratings' credit analyst Yuehao Wu. "Contagion risk adds to the complexity of avoiding LGFV bond default."
China's LGFVs, which act as the funding vehicles for local and provincial governments, have been a source of concern in the world's second-biggest economy. Most LGFVs rely on land sales revenues as their main source of income. The property market in China has faced excessive inventories and falling sales, triggering defaults among developers and causing ripple effects through the economy. Investment in property developments fell 9.6% year over year in December 2023, according to the National Bureau of Statistics data, declining for 10 consecutive months. Property sales fell 6.5%, marking six months of declines.
Typical of many local-government financing arms, Xi'an Qujiang Culture had sizable intercompany loans and advances, as well as guarantees to subsidiaries, according to Ratings. It has also guaranteed entities that missed payments, but these were subsequently settled. The company has 205 billion yuan in total assets, Ratings said.
"Financial interlinkages between LGFVs create risks hard to untangle," Wu said, adding that this potentially cascades to other vehicles and dries up funding flows.
The overdue amount, as result of "weak operating capacity" and "adverse changes in external financing policy," was settled on Jan. 17, according to a Xi’an Qujiang Culture filing with the Shanghai Stock Exchange. There is no "material adverse impact" on its operation and debt repaying ability, the company said.
Xi’an Qujiang Culture did not respond to a request by S&P Global Market Intelligence for comment.
As of Jan. 22, US$1 was equivalent to 7.19 Chinese yuan
