Hebei Bohai’s bonds were skewered by Xu Xiaoqing, head of fixed income research at CICC, in a May 26 report.
“This issuer’s own profit and cash flow is very little, its cash shortage is extremely big, its debt load is very heavy, and it doesn’t possess the ability to pay this bond,” Xu and his team wrote. The local government’s fiscal income “is very limited, there will be a lot of pressure on it to support the payment of this bond,” they added.
Hebei Bohai’s long-term debt of more than 7 billion yuan at the end of 2010, before the bond was issued, was greater than the city’s annual revenue of about 5 billion yuan for that year, according to the prospectus.
The debt-to-government revenue ratio was higher than that of Vallejo, the northern California city that filed for bankruptcy in 2008. Vallejo cited falling revenue from real-estate transactions as a reason for its bankruptcy.
Banks on the hook
Banks including Industrial & Commercial Bank of China and China Construction Bank Corp., the country’s two biggest by market value, may have problematic loans equivalent to 30 percent of their books, says Victor Shih, a professor at Northwestern University, who studies China’s local government debt.
The banks also are among the leading holders of China’s mushrooming corporate debt, according to data compiled by Chinabond, China’s Beijing-based bond clearing house. This year, mutual funds have been the biggest buyers, according to CICC. They’ve snapped up half the corporate bonds issued in the first five months of this year, 70 percent of which were to finance local government projects.
Buyers are attracted to high yields and have faith that the central government will bail out any in trouble, says George Weisi Tan, head of bond investments at Fortune SGAM Fund Management Co. in Shanghai.
“They think the interest is risk free,” says Tan, who says some brokerages leverage themselves by as much as three times their capital. “This is really a big systemic risk.”
Such pessimism is overblown, says Nicholas Lardy, a senior fellow at Washington’s Peterson Institute for International Economics who specializes in China’s financial system. The buildup of debt is slowing and many local infrastructure projects will raise revenue and add to economic growth, he says.
“A majority of the projects that are being undertaken by these companies are probably projects that have very high economic rate of return,” Lardy says.
Wang Tao, a Beijing-based economist for UBS, wrote in a June 7 report that a crisis from bad local debt is “unlikely in the near future.”
Of most concern, she said, is borrowing obtained with no collateral at all.
That’s the case in Yichun, a Maryland-sized area of about 1.3 million people deep inside the birch and pine forest on China’s border with Russia.