Govt Credit Guarantee Not Worth Much When Govt Can't Pay Bills

Here's a new twist: a local government cannot pay a construction company for government work, which causes the construction company to default on its bonds, which causes investors to ask the credit guarantee firm to step in. Except in this case, the credit guarantee firm is funded by the same government.

April 2015, FT: Chinese bond defaults test Beijing appetite for market discipline

Separately this week, financial magazine Caixin reported that a local government-owned financing vehicle in the famous ghost city of Ordos, in Inner Mongolia, was unwilling to honour a guarantee it provided to Rmb200m in bonds sold by a highway construction company in 2013.

Ordos-based Sunry Group, which builds roads and bridges for local governments, lacked funds to honour redemption obligations on bonds issued by a subsidiary that are due on April 18, the magazine reported.

The bonds carry a guarantee from Erdos Dongsheng City Construction Development Investment Group, a financing platform that the Ordos government — like thousands of Chinese localities around China over the last decade — established in order to skirt a ban on direct borrowing by local governments.

Ordos has the most famous ghost city in all of China. It blew up years ago now, due to the drop in resource prices, which led to a dip in the local economy and an end to the real estate/credit bubble.

July 2015, Bloomberg: What to Buy Amid China’s Stock Slump? LGFV Bonds, Survey Shows

“LGFV bonds still have implicit guarantees from local governments and we won’t likely see them default this year or next year,” said Cheng Peng, head of investments at Beijing-based Genial Flow Asset Management Co. “They’re safe and have high yields. Judging from the vantage of both risk and return, they’re the best to invest in.”

...“The government seems to be adjusting its policy on LGFVs,” said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shanghai. “Under pressure to stabilize growth, the government has shifted from limiting local governments’ leverage to again allowing them to increase it.”

Surprise surprise, Erdos Dongsheng City Construction Development Investment Group is now in arbitration for failing to honor the guarantee.

"Before April 18, the local government coordination to prepare about 60 million funds to repay debt, and promised the government will be in a month or so, to solve this problem." One investor told reporters, upfront funds After the local government initially "did not meet the conditions of payment, accounting for projects is too slow," on the grounds, we will continue to pay back the passage of time.

More than six months later, to honor the work under difficult circumstances substantial progress, investors will bond issuer Inner Mongolia Hengda Road Development Company Limited (hereinafter referred to as "Hengda Road"), and two secured party, Inner Mongolia, New Earth Construction Group Co., Ltd. (hereinafter referred to as the "New Earth Group") and Dongsheng City voted together to resort to arbitration, the investor now has received confirmation of the China International Economic and Trade Arbitration Commission.

The government needs time because it is out of money:

Its disclosure, for projects between government departments and between New Earth Group, currently unified and coordinated by the municipal government, "we are urging, but the city government will take some time to coordinate, but also more difficult to finance municipal government this year."

New Earth（新大地 in Chinese）borrows money with a credit guarantee from the local government, in order to carry out construction for the local government. The local government is out of cash and can't pay New Earth for their work, so in turn New Earth can't pay the bond holders, who ask for the credit guarantee to kick in, which comes from the local government.

The local government has urged New Earth to sell some equipment to raise money, but there's no market because the Inner Mongolian economy has cratered:

The local government urged New Earth to raise funds through asset backed borrowing or sale of assets and other means.

Sun Ping, chairman of the New Earth told 21st Century Business Herald reporter, confirmed that "more than 100 million," the total project arrears. He also said that New Earth is ready to sell assets through low-cost, as well as the debt exchange with other companies, etc., to raise funds, to deal with "12 Mongolian Hengda" funding gap.

But he also said that in Inner Mongolia, "there is no market price" for assets, to raise funds in this way takes time. But he said the sale of assets funding program details not be disclosed.

Don't worry says an analysts, the odds of the government allowing a default here is very small:

"As concerns the whole of local government debt replacement forward, the market for the city to vote bonds are gradually reduced." Analysts say Beijing a brokerage analyst told this reporter, the city voted sued Dongsheng case, or lead to market City Investment platform credit questioned, and then spread to the whole city to vote bonds, causing yields overall upward.

"But given the tough first half regulators zero tolerance for corporate bonds, '12 Dongsheng debt 'probability of default is still small." The brokerage analyst adds.

21st CBH: 东胜城投因“12蒙恒达” 担保违约涉诉