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China's LGFV Land Grab: Things That Can't Last Won't

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China's LGFV Land Grab: Things That Can't Last Won't

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Land grabs by China's local government financing vehicles (LGFVs) will likely be short-lived. This is because some of this behavior is speculative, circular, and raises moral-hazard risk. The actions have already attracted heat from regulators for inflating government revenues, and S&P Global Ratings believes this in turn will also likely constrain financing options.

LGFV land purchases among China's top-100 land buyers rose sharply in the first nine months of 2022 to more than Chinese renminbi (RMB) 200 billion; this compares with a 51% decline for total land spending by the top-100 land buyers over the same period, according to China Real Estate Information Corp., an industry body. Stop-gap actions to boost land-related revenues are particularly notable in several cities in Jiangsu and a few other provinces--top land sellers but suffering from slashed land sales revenue this year.

Things that can't last won't. In our view, land purchases by LGFVs could strain their cash flows and increase leverage, particularly if the land is sitting idle with no visibility on returns. A lot of the purchasing is taking place in lower-tier cities, or areas with weaker property markets, intensifying the risks.

Papering Over The Pain

We believe LGFV land grabs are aimed at softening the fall in land sales revenue, at least on paper. Property-related revenue is a key income source of local governments, representing around 30% of their revenue before 2021.

Some transactions may involve LGFVs purchasing land by financing through debt with the expectation that they will subsequently receive refunds from local governments. Although we believe unqualified refund commitments may not be widespread or extensive throughout China, this magnifies the moral-hazard risk and sets back LGFV reforms.

Commercial risks are high, given the ongoing property slump. Only a very small portion of LGFVs have proper qualifications and expertise, in contrast to central or local state-owned enterprises (SOEs) primarily engaged in highly competitive commercialized property development. Construction start delays have been prevalent since last year.

Refinancing risks could heighten in some selected cities with significant LGFV debt growth incurred by land buying. While the LGFV sector's overall credit growth remains contained, expanded land purchases could increase future borrowing needs. In some cities, no obvious acceleration in new LGFV debt could be partially due to loose payment terms or land premium refunds by governments (booked under government land transfer expenditure). In the first nine months of 2022, local governments reported an aggregate land transfer deficit of RMB511 billion, a drastic reversal from an RMB222 billion of surplus in the same period in 2021.

LGFVs in small cities are particularly vulnerable to liquidity crisis from boosting local land sales. Our view is based on their even more constrained financing capability, weaker local property markets, and stretched resources of government amid COVID restrictions and economic headwinds. Here, the priority may be to simply digest the high property stock instead of building more.

Prop-Up Effect Is Likely To Diminish Against Weak Real Demand

The bulk of LGFV land purchases this year is unlikely to be backed by sufficient real underlying demand for construction. In the first nine months, national property sales fell by 26% and new construction area by 38%. Area available for sale grew by 8%, pointing to a pile-up of property stock.

Chart 1

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While key LGFVs in big cities from economically developed coastal provinces maintain good financing capabilities, the brutal fact is that new property prices declined in 50 out of the top 70 cities in China in the year to September. Housing prices started to wobble this year even in top-tier cities like Beijing, Shanghai, Guangzhou, and Shenzhen.

A large number of private-sector developers, running into distress, vanished as previous top land buyers. Even the more developed provinces have seen a major setback in land sales as exemplified by dramatic drop in Jiangsu's land sales in the first nine months, from over RMB800 billion in the same period in 2021.

Although central and local property SOEs/LGFVs are likely to continue dominating the land purchase ranks over the next 12-18 months, from an absolute value perspective, they are hardly holding up the fort (see chart 2). Moreover, central or local commercialized SOE developers still are larger buyers than LGFVs.

Chart 2

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LGFVs "Purely" Boosting Land Market Could Face Liquidity Crunch

Idle land assets could further weigh on LGFVs' leverage and strain their cash flow, particularly for platforms that are under lower-tier governments with weaker financial standing. Liquidity could dry up quickly, if financing doesn't flow in or land premium refunds stall due to stretched governments. Uncertainty increases even if certain LGFVs have delayed the financial hit from land purchases--via delayed settlement terms; through government refunds; or employing offsets such as canceling receivables due from governments to settle some portion of land costs.

Credit differentiation is emerging (see charts 3 and 4). The top few land-buying LGFVs in the cities of Wuxi, Zhengzhou, Taizhou, and Wuhan accelerated their debt-raising in the first half of 2022. However, borrowing decelerated in Nanjing (partially due to large net-debt increase in the first half of 2021), Shangrao, and Mianyang. In each of the selected cities, LGFVs represented 38%-88% of total land auction value over the first nine months of 2022.

Chart 3

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Chart 4

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While market confidence is lower for private-sector developers, SOE/LGFV status won't offer much of an edge if overall conditions remain tough. Lower-tier cities are particularly vulnerable to weak demand for new properties.

Lower-tiered LGFVs generally lack adequate capacity and expertise for marketized property development. Their experience is mostly in primary land development and social housing. The two sectors have totally different business models and magnitudes of competitiveness. It's hard to apply LGFVs' experience to that of developers experience in the country's highly competitive market.

We also don't think China's broader push for affordable rentals will offer a solution for offloading acquired land. Affordable rentals should represent 30% of new housing supply by 2025, per China's 14th five-year-plan. This may seem like a good exit strategy for unloading the land purchased but the match may not be all that great.

Demand is highly concentrated in large cities with demographic growth rather than smaller cities where much of the land is being purchased by LGFVs. With protracted investment payback period for the large upfront outlays (even with low land cost and government subsidies), only mature projects in large cities may generate any reasonable return in the foreseeable future. In addition, local governments prioritize renovating or making use of existing properties for affordable housing, rather than new land supply.

Debt Control Constrains LGFV Role In Boosting Property Market

LGFVs are once again balancing policy roles against the mandate to keep debt in check. We believe the priority remains debt risk control see "China LGFVs: Debt Control Will Outrank Infrastructure Stimulus In 2022," published on RatingsDirect on April 21, 2022). Despite a depressed property market and the economic headwinds, China's financial regulators have maintained a persistent policy stance against strict control over "hidden-debt" since last year. In the first half year, the sector's debt growth slowed to about 13% from 20% in the same period last year.

Yet to preserve social stability and restore market confidence, local governments are at the same time taking the lead in initiatives to assist with the delivery of presold but unfinished properties. LGFVs may assist by financing such initiatives, but the sector is unlikely to borrow heavily given the tightened financing regulations. In certain cities, local governments or LGFVs could buy back some property stock to sustain the property market, or for social housing usage. We believe they would match such spending with their resources.

It helps that local governments have wider options for direct financing than before. Special loans by policy banks are a key financing resource, together with some other measures. The central government has launched RMB200 billion quota for loans to boost completion of presold projects and it's possible the quota will enlarge (see "Only China's Government Can Revive Property Confidence," Sept. 15, 2022).

Are LGFVs Making Rational Bets On Future Market Appreciation?

We can't rule out the possibility that this gamble will over time pay off for some LGFVs, since most of the land acquired is at depressed prices that could one day rebound. But visibility is limited, particularly in lower-tiered cities. Hence it's hard to justify the added debt burden/funding cost to LGFVs in expectation of any land price appreciation.

Moreover, trying to make such a gamble is a setback for LGFV reform. While such land purchases will become more constrained than past such sprees, we still consider it a reversion to poor practices. The old LGFV model of relying on long-term land appreciation to service huge upfront debt-funded input only ever worked for a few top cities or during periods of property boom. In our view, LGFVs could be dragged into the problem instead of the solution.

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Laura C Li, CFA, Hong Kong + 852 2533 3583;
laura.li@spglobal.com
Kendrew Fung, Hong Kong + 852 2533 3540;
kendrew.fung@spglobal.com
Secondary Contact:Christopher Yip, Hong Kong + 852 2533 3593;
christopher.yip@spglobal.com
Research Assistant:Rick Yoon, Hong Kong

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