By staff reporters Yu Ning, Zhang Man and Fang Huilei
Part I: Banqueting on Local Finance Options
Part III: Growth Targets Fan Shaanxi's Finance Flame
Part IV: Full Steam Ahead for New Financial Troikas
(Caijing Magazine) Government finance office in the scenic city of Liuan juggles a modest budget with annual revenues of about 3 billion yuan. But the city, an hour's drive from Hefei, the capital of eastern Anhui Province, recently needed a large cash infusion to finance expensive water projects.
So in March, the government-sponsored Liuan City Investment Co. raised 1.5 billion yuan by issuing hybrid municipal bonds, joining a local government financing movement that's grown popular in communities across China since the central government loosened credit policies early this year.
Investors who snapped up the bonds in short order were told the funds would be used to finance treatment of major rivers in the Liuan area, among other tasks.
Liuan is not the only Anhui city that's financed local projects in recent months through creative credit. Many towns and cities in the province joined the chorus. Even the sleepy burg of Chizhou recently issued bonds worth 500 million yuan.
Local government borrowing has accelerated since January, and most issuers are investment companies working with local officials trying to round up capital for local infrastructure investments, said an official at the Anhui branch of the NDRC.
About 2.8 billion yuan in local government bonds were issued across the province last year. But so far this year, municipal bond issues have totaled 8.5 billion yuan. And 7.9 billion yuan in borrowing is pending NDRC approval.
Shanghai was the first city to launch a fund-raising investment program in 1992, when the central government approved its plan to borrow 500 million yuan a year through 1995 to develop the Pudong area.
NDRC-approved debt for local governments was restricted until 2008, when quotas were lifted. Since then, city debt has mushroomed. And the central government's push to boost domestic consumption since January has encouraged even more financing projects.
NDRC's Fiscal Financing Department says 88 municipal bond issues raised 144.7 billion yuan between the beginning of the year and June 1 across the country. Of these issues, 46 were arranged by city-level investment companies tied to local governments, raising a total 60.5 billion yuan.
Each of these debt packages usually raise between 1 billion and 3 billion yuan. Maturity periods range from seven to 10 years. They're often issued on the interbank market or stock exchange.
Investors include cash-rich city commercial banks, rural credit unions and funds attracted by high interest rates. Liuan's debt issue in March raised about 450 million yuan through the Shanghai Stock Exchange and half a dozen private funds. The bonds sold out in two hours.
To issue these specially designed municipal bonds, city governments must coordinate profits and assets integration.
A city government normally provides hundred of millions of yuan in subsidies to guarantee a positive bottom for one or more designated city investment companies. City governments also allocate a variety of assets from different government agencies, all under the financing platform, to back the bonds.
A source who underwrote several municipal debt instruments noted city governments support and guarantee bonds in various ways. Practices include injecting assets and land, or simply changing accounting methods to beautify financial statements.
"As long as government officials agree among themselves, assets reallocation can be very simple," said an official from the NDRC office in eastern Jiangsu Province.
According to Huang Huidong, the general manager of Liuan City Investment Co., the city's government has a 1.5 billion yuan budget gap. The company borrowed 1.24 billion yuan from banks and issued 1.5 billion yuan in bonds. Income from land leasing seems to be the only way to make ends meet.
"We can make about 3.6 billion yuan by leasing land to balance the 2.7 billion yuan in debt," Huang said.
However, Huang admitted leasing will be difficult if the real estate market sours. "If land is not leased, and there are no government subsidies, city investment companies will go bankrupt."
Liuan collateralized its bonds with 28 properties valued at an estimated 4 billion yuan. But Caijing learned from the local land bureau that the Liuan government earned only 800 million yuan from land leases last year, and the city has had no major real estate sales so far this year. Flats in six buildings near Liuan's best school are currently for sale at 3,200 yuan per square meter – cheap by Beijing standards, but the most expensive housing in Liuan.
Financial risks in the town of Haiyan, in eastern province Zhejiang Province, are even more serious.
Haiyan's local assets administration issued 1 billion yuan in bonds in late March. The government then transferred 250 acres of land to a local government-owned subsidiary as collateral. The value was an estimated 1 million yuan per acre.
In the official announcement, the land was described as suitable for "commercial use and large buildings," and "near scenic Nanbei Lake." But the site was no more than a large, undeveloped tract when Caijing visited in late May. And a source at the Nanbei Lake administration said the area is a provincial "AAAA" scenic site, where real estate development is forbidden.
Moreover, the price tag or estimated value of lake-area land is only 780,000 yuan an acre, according to the local home land bureau – far less than the 1 million yuan per acre touted by the city's fund-raisers.
As the Haiyan case shows, however, a local government filing can be used to easily transform a plot of land into a valuable asset marketed by a city investment company. And high estimates are not limited to the Nanbei Lake area. A credit rating agency source told Caijing about an experience with a city investment company that "showed us one piece of property between two mountains, with a few rural households. They called it 'our future commercial business district.'"
Investment projects often carry de facto local government guarantees. This provides powerful insurance for banks and investors, since a loan repayment promise from a local government is crucial to a fund-raiser's success.
Repayment guarantees can include future city subsidies to the investment company, receivables, equity in local state-owned companies, and land. These guarantees also affect credit ratings.
Guo Chenglai at China Chengxin Credit Management, a credit rating agency, argues that none of these guarantees are reliable. Such financing platforms are actually structured products, with good and bad assets bundled in a way designed to shield systemic risk.
Haiyan City Investment's Zhu said the company can count on two main sources of income in the future: 30 million yuan in net income from land leases, and earnings from housing construction projects. In addition, Haiyan's state assets administration has been assigned policy missions, including water treatment and transportation infrastructure construction.
Zhu said the government has promised to award subsidies to help repay debts if the city investment company gets into financial hot water.
Eventually, though, the ability of city investment companies repay debts greatly depends on increased fiscal income and rising land prices. However, no one can say for sure whether even the latest economic growth rates are sustainable. Risks can accelerate if the economy turns down.
Many debts issuers, underwriters and rating agencies like to put trust in local government guarantees. A typical argument is, "We don't think the government can go bankrupt and not repay. This is China's special situation. Even if there is short-term liquidity crunch, a government will figure out a way to repay."
In reality, however, even the central government's fiscal income growth has been decelerating this year. As a result, Beijing authorities are now keen to dampen enthusiasm for hybrid municipal bonds and other local borrowing platforms.
"We will hold a meeting to cool off city investment debts," said Xu Lin, an official at NDRC, the government body in charge of overseeing local government debt.
NDRC has started considering risk factors. Some government assets cannot be counted as net assets by city investment companies, debt issues should not rely on future government subsidies, and some instruments with low credit ratings should not be sold on the stock exchange.
"Meanwhile, we are considering requiring local investment companies to provide local, composite liability ratios," Xu said.
Intern reporter Wang Ziwu contributed to this article.