Local government bond issuance in China for the month of January is on track to see a robust showing, with regulators dialling down price guidance following a spate of record oversubscriptions.
As of 29 January Chinese local governments had issued 249.854 billion yuan in bonds, with the total amount on track to exceed 400 billion yuan according to a report from Yicai.
Government-mandated yields are declining however, falling to 25bp above the minimum threshold for issues in Jiangxi, Hubei and Sichuan, as compared to the recent trend of a 40bps premium which helped to draw investors towards the end of last year.
The “40 bps” price guidance kick off in August 2018, when the Ministry of Finance required that local government bond yields be at least 40 basis points above the average value of Chinese treasuries for the past five days, in order to maintain price levels amidst a dense cluster of issues.
According to Ming Ming (明明), chief fixed-income analyst at CITIC Securities, the downward adjustment of rates is in consonance with the broad trend of marketisation, while the recent intense popularity of local government bonds means there is no longer any need to maintain excessively high spreads.
“The requirement of a yield of ‘at least 40bps’ in 2018 was based on the prevailing environment for local government bond issuance, yet recently the local government bond market has been on fire, with many banks making a mad dash for them.
“It’s quite a good outcome for the market to independently determine the market rate based on conditions in the issuance region…this will make market supply and demand more balanced.”
Local government bond issues in 2019 had proven to be intensely popular prior to the rate adjustment, particularly with non-bank financial institutions, with Ming Ming imputing their popularity to rising risk aversion.
“2018 was a major year for credit risk shocks, and the risk avoidance awareness of various types of financial institutions is intensifying,” said Ming.
“They are all looking for low-risk assets, and their aversion to risk is greater than their hunt for returns. The higher pledge rates and low risk of local government bonds makes them especially popular in this environment.”
Henan, Hebei, Shandong, Fujian and Tianjin all saw issues that were oversubscribed by more than 40-fold, while the three-year “19 Yunnan Bond 01” (19云南债01) issued on 28 January was oversubscribed a record 70.98 fold.
Economist Deng Haiqing (邓海清) said that in terms of actual risk Chinese investors perceive local government bonds and Chinese sovereign bonds as being the same, with the only distinguishing feature being the returns they provide.
Given current risk weighted indices as well as bank capital adequacy ratios, the capital premium should not be valued at 40bps in Deng’s opinion, and provides an opportunity for risk-free arbitrage.