Gansu Provincial Highway Aviation Tourism Investment Group Co. Ltd. is the latest China state-owned enterprise to improve their capital structure through a mega-refinancing. Just recently, the China-based highway developer and operator entered into an agreement with a 16-member bank consortium to refinance and replace Chinese renminbi (RMB) 167.3 billion (US$23.6 billion) of principal on its outstanding toll road-project loans. The financing lowers Gansu Highway's interest expense and lengthens its maturity profile to better match cash flow from its underlying operational toll roads.
S&P Global Ratings believes this refinancing is an opportunistic transaction, endorsed by both the local government and the company's lenders. Interest rates are set off China's new prime lending rate and are in line with market rates, in our view.
However, at this point, disclosure on the Gansu transaction is limited. In particular, we lack details to fully determine whether the new transaction raises structural subordination risk for the company's other debt.
In this article, we also explore risks associated with any potential transition of Gansu Highway's toll road operating model, and the evolution of government support in the longer term. We address investors' questions on the deal below.
Frequently Asked Questions
How much of Gansu Highway's debt is being refinanced?
About half. On May 25, 2020, Gansu Highway signed syndicated loan agreements with a 16-bank consortium led by China Development Bank (CDB), the state-owned policy bank, to refinance RMB167.3 billion of project debt in relation to 37 government toll roads that the company currently operates.
Public information on the transaction includes:
- All participating banks are existing lenders on these project loans;
- New syndicated loans will be secured against the toll rights for the 37 roads;
- The loans will be fully amortized over 30 years with average annual principal amortization reduced by RMB20 billion;
- The loans will have lower funding costs than existing debt, saving RMB1.5 billion of interest expense annually; and
- The company targets three years to complete the transaction.
We estimate, upon completion of the transaction, the weighted average maturity of the relevant project loans and other borrowings related to the 37 roads, will be lengthened to 15-20 years from 5-10 years. Interest rates will be reset by China's newly launched Loan Prime Rate (LPR), which we estimate will lower Gansu Highway's funding costs on the new loans to 4.4%-4.5% from the previous 5.3%-5.4% (see table 1).
|Key Elements Of Gansu Highway's RMB167.3 Billion Debt Refinancing|
|After debt refinancing* (bil. RMB)||Before debt refinancing* (bil. RMB)||Change**|
|Debt maturity||Avg. 15-20 years||Avg. 5-10 years||Extended by about 10 years|
|Annual principal repayment||5-10||25-30 (2020-2024)||RMB15 bil.-RMB20 bil. lower per year|
|Average funding cost (%)||4.4-4.5||5.3-5.4||90 bps lower|
|Annual interest payment||7.5-8.5||9-10||RMB1.5 bil. lower per year|
|*Forecasts and other figures in this table are based on S&P Gobal Ratings estimates. **Changes only cover the RMB167.3 billion refinanced debt. RMB--Chinese renminbi. Bil--Billion. Avg.--Average. bps--basis points. Sources: Company disclosure, S&P Global Ratings.|
The refinancing will cover slightly more than half of Gansu Highway's total borrowings, which we estimate is about RMB320 billion-RMB330 as of end of 2019. Other obligations include onshore and offshore bonds and loans for toll road projects still under construction and other business segments.
Why is Gansu Highway doing this?
We believe this refinancing will help improve Gansu Highway's capital structure by extending its debt maturity profile, avoiding debt repayment concentrations, and reducing funding costs. It will also help the company to improve its asset and liability management given the long-term nature of its highway assets.
Liquidity is another key beneficiary. Before the transaction, Gansu Highway had more than RMB80 billion of debt maturing over 2020-2022, or RMB25 billion-RMB30 billion coming due each year. In addition, the highway operator has to pay annual interest expenses of RMB15 billion-RMB16 billion. The company also plans to allocate RMB30 billion-RMB32 billion for spending on new road construction every year. Clearly, Gansu Highway relies heavily on the banking system and capital market to meet its financing and liquidity needs.
We note the transaction is fully endorsed by the provincial government and major lenders of Gansu Highway. The company's highway assets represent the most strategic and sizable transportation infrastructure assets for Gansu province. Gansu Highway is the single largest state-owned enterprise in the province, backed by its huge highway investments operated on behalf of the government.
How does this transaction compare with the recent debt refinancing by Shanxi Transportation Holdings?
In our view, the motives are similar. As the dominant highway groups in China's northwest and northern provinces, both companies grapple with low asset returns, high leverage and ongoing cash flow deficits. Hence, the transactions improve the capital structure of the companies by extending debt maturities, lowering funding costs, and better managing refinancing risk.
Gansu Highway was established much earlier than Shanxi Transportation Holdings Group Co. Ltd. (SXTH, unrated) as a dedicated provincial government toll road platform. It has maintained a stronger creditworthiness and better access to credit markets, with lower funding costs and less reliance on alternative means of financing. SXTH was established in November 2017 for the purpose of consolidating all the assets and liabilities of toll roads directly owned by the Shanxi provincial government, and the overall funding costs of those toll roads were much higher than Gansu Highway.
|Gansu Highway Debt Refinancing Versus SXTH's|
|Location of assets||Gansu province||Shanxi province|
|Date of incorporation||Jan. 2011||Nov. 2017|
|Consortium banks||16 banks led by CDB||7 banks led by CDB|
|Refinancing amount||RMB167.3 billion||RMB260.7 billion|
|Security backing the new loans||Toll rights for 37 operational government toll roads||Toll rights for 55 operational government toll roads|
|New loans' amortized maturity||30 years||25 years|
|New loans' funding cost* (%)||4.4-4.5||4.9-5.0|
|Annual interest saving*||RMB1.5 billion||RMB3 billion.|
|*As estimated by S&P Global Ratings. SXTH--Shanxi Transportation Holdings Group Co. Ltd.. CDB--China Development Bank. RMB--Chinese renminbi. Sources: Company disclosure, S&P Global Ratings.|
Can other highly leveraged SOEs replicate this transaction?
Yes and no. In our view, the refinancing is a "buy-time" strategy more likely to be offered to companies that have scope to improve operations and cash flow, or be supported by governments. Transportation infrastructure projects like highways have a fairly long operating period. Over time, increased traffic levels, greater flexibility in adjusting toll rates, and ongoing government support may help to improve borrowers' cash flows and debt service ability. However, such improvement also hinges on a stable regulatory environment and financial discipline on new investments. Based on media and other reports, we estimate there have been 11 similar refinancing proposals from highway and metro operators over the past two years (see "Credit FAQ: How Can China's Highway Operators Survive The Toll Moratorium?" published on RatingsDirect on March 16, 2020).
We also believe sectors more directly involved in meeting local development goals are more able to broker such deals. Local government financing vehicles (LGFVs) also seek to restructure their borrowings. Local governments are under pressure from the center to rein in hidden debt (such as part of the LGFV debt). Indeed, refinancing/restructuring is one of the "solutions" for China's hidden debt issue that is encouraged by both central and local governments, because it can lead to lower funding costs and better capital structures (see "Restructuring Won't Fully Unlock Infrastructure Debt Traps," Aug. 29, 2019).
In our view, state-owned industrial firms saddled with high leverage are less likely to convince banks to execute similar transactions. Apart from leverage and liquidity issues, the credit outlook for many industrials firms are clouded by risks including overcapacity, waning competitiveness, and shrinking margins. When SOE industrial borrowers are in financial distress, the lenders may form a creditors' committee for better coordination rather than provide the type of deal that Gansu Highway got.
Banks are selective. In China, CDB and other major state-owned banks traditionally extended credit largely to primary infrastructure companies and key LGFVs in China's bigger cities. (tier one and two). Infrastructure-related debt is sizable and sometimes backed by underlying assets or related revenue. Banks tend to be comfortable with the credit quality and government support of infrastructure debt in the longer term. Similarly, we believe banks will make a balanced evaluation on the risk and return (including potential new business in the region) before proposing to refinance debt for LGFVs and other SOEs.
Does S&P Global Ratings view Gansu Highway's refinancing as a "distressed exchange"?
No. In our opinion, this is an opportunistic transaction that reflects Gansu Highway's long-term financial management strategy. The transaction spreads out its short-to-mid-term repayment/refinancing concentrations. We don't see it as distressed since we don't believe the company would have failed to make debt payments absent a refinancing deal. We currently assess its stand-alone credit profile as 'bb-', and assign it a 'BBB' long-term issuer rating when factoring into the almost certain likelihood of extraordinary government support if needed. The outlook is stable.
Gansu Highway manages its liquidity risk by actively pre-funding its planned cash outlays for the upcoming six months including maturing debt, interest expenses, and capital expenditure (capex). This refinancing practice works well with the support of the company's major banks and good access to bond markets. Gansu Highway has undrawn banking facilities of up to RMB100 billion from policy banks and major state-owned banks, as of end-2019. It also has access to the domestic bond market, which it utilizes frequently. It has kept issuance quota at about RMB10 billion in China's interbank-based bond markets to meet its working capital and general corporate needs. In the offshore dollar bond market, Gansu Highway is one of largest SOE issuers owned by local provincial governments. By the end of 2019, it has outstanding offshore bonds stood at US$1.26 billion.
In our view, the lower interest rates on the new obligations are not "bilateral" or "negotiated" rates. They are in line with market rates under the LPR benchmark rate introduced in late 2019. We expect the credit premium over LPR for the refinanced debt to be commensurate with the credit risk of the borrower and the terms of the syndicate loans. All of the 16 banks in the consortium are lenders of existing project loans of Gansu Highway.
This refinancing will also help the provincial government of Gansu to manage its off-budget debt. Gansu Highway develops all the "government-operated toll roads" in the province which represents the assets of the provincial government. This is different from those franchise toll roads operating on a concession basis. Hence its road development-related debt is essentially part of the off-budget debt of the Gansu provincial government.
Are there any other credit implications arising from this transaction?
Limited disclosure about the motives for this transaction and China's evolving policy and regulation on toll roads make the assessment of other credit implications quite challenging. We will keep monitoring the following factors, and re-evaluate their credit implications as needed:
Operating model of toll roads. If Gansu Highway changes to a franchise toll road operator, which generally involves operating concessions for 25-30 years, we could review the levels of government extraordinary support to the company. We have no information and visibility on this change so far; however, we recognize that such a model switch would be line with other fiscal reforms at the provincial level. The company still operates all government toll roads in Gansu, where toll revenue and expenditure are treated as part of government fiscal budget. Essentially, Gansu Highway acts as platform of the government to develop and operate those toll roads, and all road development related debt are the government off-budget debt.
We currently equalize our issuer credit rating on Gansu Highway with the credit profile on the provincial government as we assess the company to have an almost certain likelihood of receiving extraordinary government support should it experience financial distress. However, if the company transforms to primarily operate franchise toll roads which are more commercially driven than government toll roads, we could re-evaluate its linkage with the government. If we start to normalize our assessment of its relationship with the government to be more comparable toward other provincial SOEs in Gansu, this could put downward pressure on the issuer rating of the company.
Whether refinanced debt has a higher claim on toll revenue. We could also review our issue rating on Gansu Highway's offshore bonds, if we believe the bondholders would be materially disadvantaged vis a vis the newly refinanced debt. This could happen if the revenue from the 37 toll roads supporting the refinancing, which represent the strongest assets of Gansu Highway and contribute majority of its operating cash flow, would be segregated and not available to service other debt. At this point in time, we do not know this to be the case.
We currently equalize the issue rating on Gansu Highway's outstanding offshore bonds with the issuer credit rating. We do this even though Gansu Highway's ratio of secured debt to total debt is above our notching-down threshold of 50%. This is because we expect that senior unsecured debt will benefit from government intervention in times of stress, given the company is the sole investor and operator of government toll roads in Gansu province and the government is heavily involved in day-to-day toll revenue collection and apportionment.
- Credit FAQ: How Can China's Highway Operators Survive The Toll Moratorium?, March 16, 2020).
- Gansu Highway's Proposed Bank Rescue To Strain Its Cash Flow, April 22, 2020
- Gansu Highway 'BBB' Ratings Affirmed; Outlook Stable, Feb. 26, 2020
- Restructuring Won't Fully Unlock Infrastructure Debt Traps, Aug. 19, 2019.
This report does not constitute a rating action.
|Primary Credit Analysts:||Laura C Li, CFA, Hong Kong (852) 2533-3583;|
|Gloria Lu, CFA, FRM, Hong Kong (852) 2533-3596;|
|Secondary Contact:||Richard M Langberg, Hong Kong (852) 2533-3516;|
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