This report does not constitute a rating action.
Key Takeaways
- China's LGFVs would need to nearly triple their EBITDA over three years just to bring leverage down to that of commercial state-owned enterprises.
- While some first movers have managed to strengthen their financial profiles, many of these development-oriented entities will struggle to balance business expansion with debt control.
- Investors may gradually become more discerning on fundamental credit risks for LGFVs as well as "former LGFVs." In the latter case, a new status may not come with meaningful changes to their credit profiles.
LGFVs in China may have finally tamed their debt growth. The next step will be to run their operations along commercial lines, without relying on subsidies or other supports from their local-government owners. S&P Global Ratings believes this goal could be much harder.
Chinese authorities have drawn a line in the sand for thousands of local government financing vehicles, or LGFVs, to transform into market-oriented state-owned enterprises by mid-2027. This could be a tall order. By our calculations, LGFVs would need to increase EBITDA at an annual rate of 40% over three years just to bring leverage (debt to EBITDA) in line with other SOEs.
We think LGFVs in wealthier locales and with fiscally stronger governments will be better positioned to become profitable or take convincing steps toward commercialization. Those that fail to genuinely transition could face higher risk premiums in the market. Indeed, some of these companies may seek to declare they are no longer LGFVs, what’s commonly called "delisting as LGFVs," to signal their transition progress and to broaden new funding access. A new status, however, may not come with meaningful changes in their credit risks.
The LGFV Debt Problem And The 2027 Deadline
LGFVs have traditionally executed policy and development directives, and their important roles have allowed them to raise a lot of debt despite their poor track records on profits. They've focused chiefly on infrastructure construction, zone development, utilities and transportation.
As a group, LGFVs are among China's biggest borrowers, with over Chinese renminbi (RMB) 35 trillion in outstanding domestic bonds according to Wind, a data provider.
Last year the government stepped in with a RMB10 trillion debt swap program to boost the sector's transition to commercial SOEs (see "LGFV Brief: China's RMB10 Trillion Debt-Swap Scheme Is A Good Start," Nov. 13, 2024). This program swaps out "hidden debt" obligations--those that are deemed as effectively off-budget spending by local government owners.
While the debt swaps continue, LGFVs are eagerly applying to "delist"—i.e., removal from the list of government financing platforms. Whereas in the past being an LGFV helped entities get funding, current policy controls could make it hard for them to raise new funds.
However, a change of status is merely the start of a journey to become fully commercialized. It won't be an easy feat in general, especially within the deadline.
A Tough Equation
LGFVs are becoming less reliant on debt. The sector's debt rose by just 3.4% in 2024, a record low after years of rampant increase. And they have been paying down more than issuing bonds as a whole so far this year, with a net repayment of about RMB210 billion in the first five months. The government's measures have substantially alleviated the immediate liquidity pressure of many entities and the resolution of hidden debt is well underway.
But that's just one side of the equation. To genuinely transition into more self-sustaining entities, LGFVs will also need to boost their cash inflows and profitability.
By the mid-2027 deadline, these policy- and development-oriented entities should no longer carry any financing function for the government. Likewise, their debt should no longer benefit from expectations of implicit repayment guarantee by their government owners.
Business Shift Doesn't Have To Fully Break Policy Links
LGFVs have choices as they shift to more commercially oriented business lines. This may involve investing into industrial or manufacturing activities, renewable energy, financial services, and rental and leasing operations.
Others may enhance the efficiency of their original businesses to focus on projects with more visible return structures. They can also extend into related services; for example, by moving into property management or other cash flow-generating services related to their assets.
Many entities may continue to pursue policy-driven or government-directed projects, even after their transitions. But this time around with clearer and more market-based terms.
Leverage won't improve without actual earnings
One way to gauge the financial improvement that LGFVs need for meaningful deleveraging would be to measure the gap in credit metrics of LGFVs to other commercial SOEs. This is not a high bar because commercial SOEs themselves overall do not have strong metrics and are highly leveraged overall. But it would be a start.
Even after clearing "hidden debt" from their books, LGFVs still bear a large amount of corporate debt (see graphic 1). This debt is to be serviced by their market-based operations.
Graphic 1
To improve debt-servicing ability comparable to with today's levels for commercial SOEs, LGFVs would need a substantial jump in earnings:
- For example, if their debt-to-EBITDA ratio is to meet the level of commercial SOEs, LGFVs will need to grow their EBITDA by 40% each year until 2027, effectively nearly tripling their 2024 EBITDA by then.
- Interest coverage improvement may look more feasible with an 15% rise in EBITDA each year to reach a compounded 52% growth over the period to be able to match up with the commercial SOE average. (see charts 1 and 2)
Chart 1
Chart 2
Our estimates assume average annual debt growth can hold at around 3% and without any hike in rates, which should be attainable given the current policy controls and low funding cost environment. However, significant earning jumps generally require hikes in investment as well. As a comparison, LGFVs managed to double their EBITDA size over the five years during 2018 to 2023. But their debt balance also doubled while achieving that.
Early Movers Show What Works Best
In our view, transitions work best if LGFVs stick to fields in which they have experience and access. These mainly are urban infrastructure and utilities, and land and property development and operations, including industrial parks and commercial zones, (see "China LGFVs' Bigger Housing Role: Risk Control Matters," March 26, 2024).
Shanghai Municipal Investment (Group) Corp. (SMIG; unrated) is an example of a company that transitioned its business and significantly improved its financial profile. The company, established as one of the earliest LGFVs in China, has transitioned into a state-owned asset operator with fee-driven income from utilities and roads (see chart 3). Its current reliance on ongoing subsidies from government is relatively low, at less than 10% of its EBITDA on average.
Chart 3
SMIG generates cash flows from operating a diverse portfolio of state-owned assets while continuing to invest in policy-driven projects. It also reined in its pace to control debt and leverage (see chart 4). After halving its debt to EBITDA ratio to 10.8x from 20.8x over two years from 2015-2017, the company's debt growth trend has largely tracked its EBITDA growth.
Chart 4
Transitions That Help Them To Stand On Their Own
To successfully transition, LGFVs will strike a balance between pursuing commercial businesses and enhancing earnings, while controlling down debt. Their already weak stand-alone financial profiles make this challenge even harder.
Meanwhile, if they don't manage to retain their policy roles and linkages with their governments, government support may weaken on an ongoing basis or even at times of distress. Whereas, if these entities continue to carry out their roles for important public services, even if while they expand their commercialized activities, government support will likely be stable.
We think their access to financing could be increasingly subject to financiers' screening of return of projects rather than purely on their government linkages alone (see "China Brief: LGFVs Face Credit Differentiation As Transition Deadline Looms," Oct. 17, 2024).
The twist: Access to new funding may not prevent problems from growing
In our view, access to new debt could be a double-edged sword. Liquidity can be replenished temporarily, and immediate stress may be improved. But if earnings don't increase, their already very high leverage could deteriorate further, and refinancing pressure will come back to bite.
Even if the companies manage to rein in debt growth, leverage ratios are still rising for most LGFVs. This includes those farther along in the commercialization process, based on the assessment of Dealing Matrix International (DMI), a financial data provider (see chart 5). Although the most commercialized entities have the least leverage, it doesn’t mean that they have turned the tide in their leverage levels.
Chart 5
Some entities may rush to delist as LGFVs simply due to administrative orders or to bypass financing restrictions (see chart 6). There are also benefits to delisting if the firms fulfill all three criteria aimed at limiting the extent of their dependence on the government from asset, revenue and profitability perspectives (see table 1). These entities should be able to seek normalized funding and issue corporate bonds.
Chart 6
Table 1
Shaoxing case study on 'delisted' LGFVs
As a case study, we looked at four Shaoxing companies that delisted as LGFVs in late 2024. These were one of the first since the new directives were announced. However, their overall ability to service debt did not improve (see chart 7). The sum of their gross interest was nearly 7x their total EBITDA in 2024 due to continuous cash drains from their operating and investment activities.
Chart 7
Less Direct Fiscal Support; More Differentiation Ahead
We don't expect mid-2027 to be a hard stop. We believe a surge in defaults would be counterproductive. Struggling entities may see more debt restructuring to buy more time or be reorganized into other larger and more successful SOEs. Support in extraordinary situations will also come in the form of policies.
On the other hand, we also don't expect a return to borrowing binges. Government directives thus far have been set to de-risk the sector and to avoid any large systemic disruptions and to stop LGFVs from playing quasi-government funding roles.
Local governments will maintain oversight of their SOEs including those that have transitioned from LGFVs. Indeed, the governments have specific responsibility to continue monitoring these entities for at least one year post-transition. These checks should help avoid new debt risk flaring up.
Entities that become more self-sufficient will likely get better funding access and for this reason, among others, credit-quality differentiation will likely accelerate for this sector.
Related Research
- LGFV Brief: China's RMB10 Trillion Debt-Swap Scheme Is A Good Start, Nov. 13, 2024
- China Brief: LGFVs Face Credit Differentiation As Transition Deadline Looms, Oct. 17, 2024
- China LGFVs' Bigger Housing Role: Risk Control Matters, March 26, 2024
| Primary Contact: | Christopher Yip, Hong Kong 852-2533-3593; christopher.yip@spglobal.com |
| Secondary Contacts: | Wenyin Huang, Singapore 65-6216-1052; Wenyin.Huang@spglobal.com |
| Lawrence Lu, CFA, Hong Kong 85225333517; lawrence.lu@spglobal.com | |
| Research Assistant: | Harry Yuan, Hong Kong 852-25333567; harry.yuan@spglobal.com |
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