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Short of cash to support projects local governments search for alternatives to bank loans
As we covered last week, China’s National Development and Reform Commission (NDRC) has approved a flurry of local infrastructure projects since the third quarter of 2012 worth Rmb 5.06 trillion (closer to $1 trillion accumulated for the whole of 2012). These central government approved projects represent a proportion of the Rmb 10 trillion in investment plans released by 13 Chinese provinces and municipalities so far this year. Many analysts believe these infrastructure projects are timed to serve as stimulus to support China’s weakening investment growth.
If the stimulus is to be credible, supporting such an increase in infrastructure projects will require money. Last year, total social financing – domestic credit - in the economy fell by 8 percent as the central bank sought to slowdown growth in real estate and local government infrastructure projects after 2009 stimulus. This trend has already reversed course in the first nine months of the year with total social financing growth by 20 percent year over year, and this may only be the beginning.
According to China Scope social financing will increase dramatically in the fourth quarter of this year to support the recently approved projects. Such projects tend to receive 25-50 percent of financing from local government fiscal revenue, leaving the rest to come from bank loans, corporate bonds, guaranteed loans, and trust loans.
Don’t bank on banks
In 2009 stimulus much of the remaining 50-75 percent of financing came from bank loans to local financing vehicles but there is increasingly a sense that this will not be the case this time around.
Most banks are struggling to maintain capital requirements, while rolling over much of the debt accumulated by local governments in the 2009 stimulus into longer term loans. According to the social financing figures released by the People's Bank of China, accumulated bank loans in September 2012 have only grown by 15 percent compared with the same period last year, representing 55.5 percent of total social financing. Although loan growth is up from 2010 and 2011, it is still a far cry away from 2009 when RMB loans grew by 99 percent over its 2008 base, representing 67.8 percent of all social financing that year.
In an interview with Reuters last week, a banking officer from the Bank of Communications – one of China’s big five banks – said that his bank would be willing to lend to Beijing approved local infrastructure projects with high credit ratings “but we will not lend to infrastructure projects in a big way. The funding of some projects should not be borne by banks. Those who wish to borrow do not meet our criteria, while those we want to lend to can sell bonds or have no need for loans.”
Short of bank loans local governments have turned elsewhere to finance infrastructure projects. More so than in 2009, many local governments and their financing vehicles have turned to bond markets to meet their financing needs.
As of September of this year, accumulated corporate bonds – many of which are issued by local government financing platforms - as a component of social financing has grown by 85 percent compared with the same period last year; as a result, corporate bonds are now the second source of credit in the economy after banking loans, representing 13.3 percent of all social financing so far this year, up from 11% at the end of 2011.
Last week, the Qinghai Provincial Department of Finance announced the release of Rmb 10 billion in 15-year medium term notes to fund construction of infrastructure, urban agglomerations, and other projects in key industries – this comes on top of an Rmb 5 billion sale of private placement bonds to support local construction of low-income housing projects in August.
In addition to corporate bonds issued by local government financing vehicles, local governments are issuing collective municipal bonds directly via the Ministry of Finance. On September 17, the Ministry of Finance announced that local governments have issued ten batches of local government bonds worth Rmb 221.1 billion.
Yet despite the enthusiasm, the bond market is still not a fully developed financing platform for local governments. In June, the State Council ended a trial program launched in November 2011 which allowed local governments such as Shanghai, Shenzhen, Zhejiang, and Guangdong to issue bonds directly. A senior economist with the Industrial bank, Lu Zhengwei, told the Global Times that “the top legislator's decision is based on the grounds that China has not formed an effective mechanism to monitor and regulate local government bond issuances.”
Without the option of direct bond issuance, local governments still must rely mostly on local government financing vehicles, and to a lesser extent on collective bond issuances approved by the Ministry of Finance – such as those described above. However, investors may be weary of purchasing bonds from local government financing vehicles, which often lack credibility and transparency, limiting the potential for this channel in its current form.
A trust gap
The difficulties in accessing bond markets may be why trust financing has become a growing source of financing for infrastructure projects. Trust companies have become a major source of credit this year. Their rapid growth since April has allowed them to usurp commercial bills as the fourth largest source of credit in the economy after local bank loans,corporate bond issuance, and guaranteed loans. In September their accumulated issuance represented 6.5 percent of total social financing in September - up from a low of 3.8 percent in the beginning of the year.
Chinese trust companies pool funds from institutional investors and high-net worth individuals for investment - mostly in real estate, infrastructure projects, industrial enterprises, and financial assets. In the past, real estate investment was one of the largest destinations for trust investment representing 38 percent of the value of collective trust investment in 2011, yet government efforts to limit growth in real estate prices have hurt returns in this sector. Now, with the government warming up to infrastructure projects in this round of stimulus, trust companies have increasingly turned to infrastructure investment – now the largest source of trust investment, representing 26 percent of all 2012 investment as of August, compared with only 10 percent in 2011. In contrast, the investment by trust companies in real estate has shrunk to 21 percent.
Accumulated value of collective trust investment by sector (%)
A growing reliance on trust products for financing local infrastructure projects is likely a concern for central government policy makers. As discussed in a previous post, on September 17, Xu Lin, Director of the Development Planning Department of the National Development and Reform Commission (NDRC) warned that the lack of long-term financing tools was a problem for supporting infrastructure projects could potentially lead to a liquidity crisis if “the debt term does not match the return period of these projects.”
Such a mismatch was a problem in the last round of stimulus, where many of the loans issued by banks to local government financing vehicles were only 3-4 years, while many of the projects may not see robust returns for a decade. After a 2010 National Audit made it readily apparent that local governments were unable to repay many of these loans in time, banks were require to reclassify some loans as non-performing while rolling over others into longer term loans.
A similar problem could emerge with reliance on trust financing. In contrast to banks which - benefiting from a more stable deposit base - are capable of financing low interest, longer term loans, trust loans are typically structured as high interest, one year loans with an implicit promise that should the borrower not encounter any financial difficulties and investors are still interested, the loan will be extended. Their investors are now receiving 12 to 15 percent yields on such infrastructure investments, suggesting project borrowers may be paying a higher interest on trust loans.
The current social financing figures only offer a preliminary gauge of potential funding sources for the newly approved local infrastructure projects, it remains to be seen whether trust financing will evaporate on the heels of continued efforts to increase bank liquidity or regulations designed to ease the use of bond markets.
Nonetheless, there is clearly concern in the leadership over the issue of local government debt and more so, the financing of future deficits. Many recognize the faults of over-reliance on bank lending or trust financing, and in particular, the folly of matching short-term lending with longer term infrastructure projects. Yet with few alternative funding channels for local governments to complete existing projects and support their next round of investment targets, it will be a challenge to get the long-term term funding necessary to make this round of stimulus credible.