China's local government financing vehicles, or LGFV, sector faces an increasing risk of debt financing stress, as it witnessed the first LGFV issuer declining to buy back perpetual bonds on the call date, according to S&P Global Ratings.
Perpetual bonds do not have a maturity date but are expected to be redeemed by the issuer on a certain call date. "If issuers don't call, the securities will generally bear a higher coupon payment. For this reason, investors expect perpetual bonds to be bought back on the call date," the rating agency said.
"Non-call" actions indicate an entity lacks funds to redeem securities, thereby reflecting that it is under "financial distress." Further, failure to redeem bonds at the call date may increase funding costs and restrict capital market access for issuers, it said.
Jilin Transportation Investment Group Co. Ltd. on Sept. 9 became the first LGFV issuer to cancel the buyback of a perpetual bond since the launch of the securities in 2013. The company raised the annual coupon rate by 300 basis points to 8%. S&P Global Ratings believes more such weak issuers would choose to hold off buying the bonds back.
Chinese state-owned enterprises have increasingly issued perpetual bonds, regarding them as equity rather than debt because of their no-maturity date feature.
Heavy issuance raises the risk for entities that have a high debt burden and weak operating cash flow. Lack of sufficient funds also points to refinancing risks that make up a major chunk of "hidden" government debt, the rating agency said.
S&P Global Ratings estimates over a trillion yuan in perpetual bonds are callable over the next few years.
