Chinese government becoming less dependent on bank financing

Borrowing from corporates increased surged 125% to RMB1,114b.

According to Barclays,  China's National Audit Office (NAO) conducted an audit of 36 local governments in 15 provinces, 3 municipalities and 18 prefecture cities between November 2012 and February 2013. It is the second time that the NAO has reviewed local government debt. The last time was in May 2011.

Here's more from Barclays:

While the entities being audited in this round: 1) only accounted for 2-6% of the total entities involved in the last round; and 2) have a stronger financial position, as they only involve provincial-level governments and capital city/city districts in those provinces, we believe the audited results and data could partly reflect the current financial position of local governments and add transparency to banking system risk exposure to local government debts.

Total government debts at end-2012 increased by 13% compared to end-2010

Total local government debts of the 36 local governments increased to RMB3,848bn, +RMB441bn or 13% from end-2010, including RMB1,844bn directly liability (48% of total debts), RMB908bn guaranteed by local governments (24%) and RMB1,096bn other government related borrowings (28%).

Local government financial vehicles (LGFVs) remained major borrowing entities. Total LGFV loans was RMB1,757bn, +23% (or RMB323bn) from end-2010, and accounted for 46% of the total local government debts.

While the local governments repaid RMB1,332bn, or 39% of the debts borrowed before 2010, net borrowing in 2011 and 2012 was RMB631bn (accounting for 16% of the outstanding debt balance at end-2012) and RMB1,142bn (30%), respectively, indicating that some local governments could use new borrowing to roll over their old debts. In fact, the NAO highlighted in the report that five local governments had a debt rollover ratio higher than 20%, with the highest at 67.7%.

More dependent on non-bank financing

While bank loans remained the major financing sources (accounting for 78% of the total debts), the local governments have been looking for bond issuance and borrowing from corporates and individuals as their funding sources.

Bond financing increased by RMB153bn, or 62%, from end-2010, due to: 1) rapid development of the bond market; 2) regulatory control on LGFV loans; and 3) the lower funding cost of bond issuance, in our view.

Borrowing from corporates and individuals also increased substantially to RMB1,114bn, +RMB 131bn or 125% from end-2012, and accounted for 6% of the total debts. We believe it was mainly due to the development of trust loans and entrusted loans.

Local governments strengthened efforts to reduce borrowing risks; financial condition and repayment ability remain challenging

The NAO said, in the past two years, local governments have: 1) set up RMB90.8bn debt provisioning (2.4% of the total debts); 2) reduced high-risk debts that existed prior to 2010; 3) strengthened the management of new debt-raising and cash flow uses; and 4) further rectified LGFVs' debts through restructuring and capital injection.

At end-2012, 31 out of 36 local governments had established RMB91.8bn provision, accounting for 2.4% of the total debts of RMB3,848bn. 24 of 13 local governments reported a lower debt ratio/debt service ratio than in 2010. Overdue ratios of debt guaranteed by local government or contingent liability and other debt local government that may need to be repaid, were 0.59% and 0.75%, +16ppt and +48ppt from end-2010.

Registered capital of the 223 LGFVs being audited increased 11% from end-2010 through restructuring and capital injection. Their overall liabilities to assets declined 4.16ppt from end-2010. Total income and profit increased 53% and 13.7%, respectively, from 2010.

However, the NAO also highlighted that some LGFVs have poor asset quality and weak repayment ability. In 2012, 31 LGFVs (14% of the total LGFVs being audited) reported net loss and income of 151 LGFVs (68%) was not enough to repay their debt principal and interest.