Completed 04 Jun 2018 05:55 PM HKT Disseminated 04 Jun 2018 06:08 PM HKT Asia Pacific Credit Research 04 June 2018

China Local Government Financing Vehicles A rough (and tough) ride ahead given limited transparency, but there are alternatives

The emergence of LGFVs and their growing representation in the USD bond Asia Corporate Research markets continues to catch investor interest. Major policy shifts have raised Varun Ahuja, CFA AC questions as to whether all LGFV can be considered provincial debt, and this is (852) 2800 6038 further underscored by recent onshore defaults, including some SOEs, leading to [email protected] more muted supply and wider spreads for the LGFV sector. In this report, we Tiantian Teng AC present an update on recent policy changes as well as our views on their impact (852) 2800-7024 on the LGFV sector. In an environment where onshore default rates are rising and [email protected] transparency stays low, we remain cautious on the sector as a whole, preferring J.P. Morgan Securities (Asia Pacific) Limited to own stronger SOEs rather than LGFVs. That said, we do make exceptions for a few LGFVs that play strong policy roles (willingness) and backed by stronger provincial governments (capacity). We also believe that while one or a few LGFV defaults would be acceptable to the central government, widespread defaults are unlikely given the larger implications for the financial sector. We initiate coverage of Wuhan Metro and its ‘19s with OW, Neutral on BJSTAT and its ‘20s and ‘25s, on Yanzhou Coal and its perps ‘c20s, '22s with OW with the bonds trading wider than even Indika, which we think does not make complete sense.  The central government would continue to make LGFVs more market- oriented, as part of the ongoing deleveraging drive. Since the budget law revision in 2014, the government has released a number of documentations around LGFV operations and their funding, which we discuss in this note.  Pace of issuance has slowed down in recent times. The issuance of LGFVs USD bonds had increased substantially over 2015-2017 due to onshore issuance policy tightening as well as LGFV’s funding diversification. However, this has slowed drastically in recent months, due to the central government’s tightening policy to address debt overhang problems in the system. In addition, recent onshore defaults have given further apprehension about exposure to the sector, where underlying information flow remains very limited.  Staying cautious on sector and preference for LGFVs with clear policy role only. While LGFVs have risen to be a ‘too big to ignore’ sector in JACI, the lack of information flow and opacity in underlying businesses remain key concerns, especially in the current environment. We would stick to LGFVs with clear strategically important roles and ideally with decent standalone credit profiles.  Having said that, there are certain LGFVs that are quite wide in the 1-2yr duration bucket, which present investors with the conundrum of missing out on better yields if not invested but having a high ‘jump risk’ if any of these LGFVs widen materially due to financial constraints, which are difficult to monitor given inadequate underlying information flow.  Hence, in this note, while we categorize LGFVs based on factors such as policy role, social and economic importance, etc., given that most LGFVs are trading as a ‘group’ in different yield buckets, we would look to take selective exposure in LGFVs through credits in the ‘preferred’ and ‘some comfort’ categories, while for exposure to higher yields, we are more comfortable with the risk-reward and information flow in other China SOEs and HY corporates as presented in this report.

See page 33 for analyst certification and important disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.jpmorganmarkets.com Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Table of Contents Onshore defaults back in focus ...... 3 LGFV policy changes in recent years...... 5 Document No.50 & No.87: weakening the ties between local governments and LGFVs...... 5 Relative value...... 7 Sector strategy and key recommendations ...... 9 Background of LGFVs ...... 16 Categorization of LGFVs...... 18 Technicals: Less negative due to lower supply but investor base still narrow ...... 20 Bond supply should slow going forward ...... 21 Investor base remains narrow as Asia continues to dominate...... 22 Background of Individual LGFVs...... 24

2 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Onshore defaults back in focus

Focus is back on onshore defaults, especially from the weaker government- owned entities, after China Energy Reserve and Chemicals Group (CERCG, not covered) defaulted on the principal repayment of its US$350 million offshore bonds, which triggered a cross-default to all of its outstanding debt.

While the company classifies itself as an SOE in the bond prospectus, there remains a question-mark on the company's actual shareholding structure, as per newswires (e.g. Debtwire and other local news). The company was reportedly ~30% owned by the Beijing Municipal Commission of Commerce, 28% by CNPC through its engineering arm; and ~15% by China Economic Cooperation Center, however, its shareholding structure has since changed based on the company’s latest presentation.

Interestingly, just a few months ago, the company was in news (source: SCMP) to buy a marquee commercial building in Central, Hong Kong, from CK Assets for ~US$5 billion. CERCG is involved in the oil & gas trading, logistics and distribution, etc. segments. In its disclosure announcement post its principal repayment default, it guided that it is unable to make the payment due to tightening conditions in the PRC over the last two years, which restricted its financing channels, including access to bank funding. As per CERCG, it aims to divest some assets to improve its cash flow situation.

Separately, there has been more news on LGFV defaults. Reuters recently reported that a firm controlled by a city government in Inner Mongolia region had failed to pay interest and principals on about RMB4 billion of off balance sheet loans. The article suggested that the firm should be technically in default after missing payments but more information is needed to determine whether it was actually a missing payment or a delayed payment.

Figure 1: Onshore defaults in China (US$ million) 6,000 4,815.0 5,000

4,000 3,547.1

3,000 2,364.7 2,465.1

2,000

750.6 1,000 157.5 0 2016 2017 2018YTD SOE Non-SOE Source: WIND and J.P. Morgan estimates.

Defaults in China, including those from the SOEs, are not something that is entirely new, but have been ongoing for quite some time now. At the time of commodity downturn in 2015-16, there were several credits, mainly in the metals and mining sector, that faced liquidity pressure. While 2016 was a recent high, we think the government will slowly but surely let more companies including some local SOEs default, as long as it does not present a systemic risk to the broader financial sector.

3 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Table 1: List of defaults from Chinese issuers in 2018 SOE or Non- Issuer Province Industry Default date Amt (US$ mm) Coupon SOE CEFC China Energy Co. Shanghai Oil & Gas Non-SOE 21-May-18 315.0 6.00 Sichuan Coal Industry Group Sichuan Metals & Mining SOE 21-May-18 78.7 5.94 Fuguiniao Co. Fujian Consumer Non-SOE 9-May-18 204.7 6.50 Kaidi Ecological and Env. Tech. Co. Hubei Utilities Non-SOE 7-May-18 103.5 6.27 China Security Co. Shanghai TMT Non-SOE 7-May-18 14.4 7.00 Evergreen Holding Group Zhejiang Industrial Non-SOE 24-Apr-18 85.0 7.78 Fuguiniao Co. Fujian Consumer Non-SOE 23-Apr-18 126.0 6.30 Yiyang Group Holdings Heilongjiang Diversified Non-SOE 17-Apr-18 190.6 7.10 Shenwu Env Tech Co. Beijing Industrial Non-SOE 14-Mar-18 70.9 8.00 Dandong Port Group Liaoning Transport Non-SOE 13-Mar-18 141.7 5.67 Dandong Port Group Liaoning Transport Non-SOE 12-Mar-18 157.5 6.00 China City Construction Beijing Infrastructure Non-SOE 1-Mar-18 283.5 3.97 Yiyang Group Holdings Heilongjiang Diversified Non-SOE 28-Feb-18 118.9 7.10 Dalian Machine Tool Group Corp Liaoning Industrial Non-SOE 7-Feb-18 78.7 7.80 Dandong Port Group Liaoning Transport Non-SOE 29-Jan-18 315.0 5.50 Yiyang Group Holdings Heilongjiang Diversified Non-SOE 27-Jan-18 32.9 7.10 Dandong Port Group Liaoning Transport Non-SOE 15-Jan-18 78.7 7.60 Dalian Machine Tool Group Corp Liaoning Industrial Non-SOE 15-Jan-18 63.0 7.00 Sichuan Coal Industry Group Sichuan M&M SOE 9-Jan-18 78.7 7.70 Source: WIND, Bloomberg and J.P. Morgan estimates.

Similarly, some LGFVs default(s) are possible, but a widespread phenomenon would be too disruptive. We believe that while the probability of one / a few LGFV defaults exists, the Chinese government is unlikely to allow multiple / large-scale defaults from the sector. This is because the scenario could trigger substantial damage, not just in the respective region especially if the LGFVs execute an important socio-economic role, but also in the broader financial markets. This could further lead to material increases in the cost of funding and impact credit availability. Hence, we still expect most of the LGFVs to be supported to remain solvent although there is a real possibility, in our view, for the government to accept a few defaults as an example to balance discipline in financial markets with moral hazard problems.

We also think that as time passes with some defaults occurring each year, market participants will start factoring in as well as reacting to defaults in a much more rational manner rather than a kneejerk reaction. Ultimately, this ‘soft transition’ from a market that had seen almost no defaults before 2014 to one where a default is seen as a ‘normal’ probability in the markets is also what the government is trying to achieve in the current period.

4 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] LGFV policy changes in recent years

Since the budget law revision in 2014, the government has taken further steps to tighten policies on local government funding and LGFVs’ borrowing activities. Government authorities released Article No. 43 in 2014 and Article No. 4 in 2016 to separate the financing function of LGFVs from local governments and to prevent LGFVs from using land pledges to obtain financing. Higher-tier local governments were only allowed to issue bonds directly but not through LGFVs or enterprises. The authorities also introduced the bond swap program to refinance legacy LGFV debts – basically it is a practice to swap LGFV debts into lower-yielding munis so that interest on these products can be effectively reduced. The government thereafter introduced several more regulatory measures, including: 1) Document No. 50 (May-2017), which reinforces the policy goal of Article No. 43 to prohibit local government off-budget borrowing, 2) Document No. 87 (June- 2017), which prohibits illegal financing behavior in purchasing certain services of LGFVs by local governments. The most recent development was in April 2018, the Ministry of Finance (MoF) released Notice 23 to regulate state-owned bank lending activities, particularly to LGFVs. Notice 23: curbing financing sources to LGFVs Notice 23 was released by the Ministry of Finance in April, mainly towards state-owned bank lending activities and targets, among which LGFVs were included. The Notice guided that banks should not aggressively lend to local governments for new projects, investment funds or PPP projects. It is consistent with the central government’s deleveraging campaign by curbing several expansionary infrastructure projects to prevent further leverage build-up in the financial system. This policy update (Notice 23) also pointed out that when state-owned financial institutions serve as underwriters, they must assess the issuers’ ability to repay and are not allowed to indicate implicit or direct local government support. Stricter underwriting standards should make funding availability somewhat tighter for several LGFVs, from banks or capital markets.

Document No.50 & No.87: weakening the ties between local governments and LGFVs Document No.50 was jointly issued by the Ministry of Finance, the Development and Reform Commission, the central bank and the Ministry of Justice and Securities and banking regulators. It carries the same policy agenda as of Article No. 43, but stresses more on prohibiting any implicit government guarantee on LGFV financing. It prohibits local governments from raising debt via PPP projects, pledging future land sales into LGFVs or executing land sales to repay debt. The document pointed out that local governments should swap their existing debt with more transparent muni-bonds, with the additional purpose of lowering funding costs. Local governments are urged to more thoroughly inspect financing activities and regularly disclose their government debt information. On the other hand, LGFVs are obliged to declare a lack of local government guarantee in writing if they plan to raise onshore debt. Lastly, a cross-department supervisory mechanism was proposed as well, having both fiscal and financial ministries and commissions to co-operatively supervise and oversee local governments’ financing activities, LGFVs debt and financial institutions’ lending activities.

5 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Document No. 87 was released right after Document No. 50 by the Ministry of Finance, for the main purpose of further regulating local government illegal financing activities. The document prohibits local government from financing projects through certain asset and/or service purchase routes, effectively reducing sources of LGFVs revenues that were previously generated directly from local governments.

New regulator appointees signaling deleveraging policy continuity The central government shuffled several key positions in the country’s top regulatory authorities and expanded the scope of responsibility of such authorities. The 13th National People’s Congress noted that more responsibilities will be carried by the National Audit Office (NAO) and proposed to reform the previously separated national and local taxation system by integrating the offices at and below the provincial level. One of the areas specifically targets local and regional governments through enforcement of stricter investigation of potential LGFV financing using PPP projects.

These policy changes over the last several months, as well as slowly but surely allowing a greater number of onshore defaults or debt-equity restructurings for even some SOEs, aim to adjust the market’s expectations on implicit government support for LGFVs as well as SOEs, in our view.

6 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Relative value

The China LGFV sector has typically moved on macro-headlines emerging from China around policy changes with regards to the sector. After a decent performance in 2017 where the sector outperformed China IG by ~10bps, the sector has underperformed quite materially in 2018ytd, with a sharp and most prominent widening happening in May-2018.

We attribute much of this widening to an increasing number of headlines emerging from China, around ever-tightening policy changes on their funding sources as well as increasing news of onshore defaults in the sector and more broadly, in the weaker China SOE space. This should not be surprising given that the government has been talking about higher tolerance for SOE/LGFV defaults for quite some time now and that investors should not consider all debt issued by these entities as being government guaranteed obligations.

Figure 2: LGFV IG vs China IG Z-spread 300 50 280 40 260 30 240 20 220 10 200 0 180 -10 160 140 -20 120 -30 100 -40

Spread (RHS) JACI LGFV Z-spread JACI CN IG Z-spread

Note: Prices as of May 28, 2018; Source: Bloomberg, J.P. Morgan.

As a sector recommendation, we have been advocating an UW on LGFVs for long time, given the lack of comfort from several of the LGFVs’ weak standalone credit quality as well as opacity in their most of their underlying businesses. LGFVs typically operate provincial and municipal level government projects, and the transparency of their businesses is low and the scope of financial reporting is limited. However, the size of the LGFV sector as a part of the JACI universe is not negligible, and we think that especially benchmarked investors could start looking at adding some of the credits within this space, which we think have less scope of widening given multiple factors such as policy role importance, stable credit profile etc. We also note that several LGFVs that have underperformed in the recent widening are especially from lower rated provinces and mainly involved in the infrastructure construction business. Also, LGFVs with strong / clear policy roles (metro operators, holdco companies like Beijing State Assets) are ones which are least affected as well, to no surprise to us.

7 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Figure 3: Spread performance of LGFVs since Apr 28, 2018

HRINT '19 137 SXROBR '19 59 DFINVH '19 42 QDCCIZ '25 32 CQNANA '21 31 GXCMIN '19 28 YUNMET '19 26 CCUDIH '20 25 YUNAEN '19 25 QHINVG '20 24 XZETDZ '19 20 GSHIAV '19 19 YUNINV '19 18 CHADEC '19 18 CHDXCH '21 17 CQNANA '26 16 TJNCON '19 14 NJYZSO '27 14 QDCCIZ '22 14 QDCCIZ '20 13 QDCCIZ '20 13 NJYZSO '22 13 XIHUI '19 13 CONSON '20 11 CQNANA '19 10 CDCOMM '27 10 WHMTR '19 9 ZHHFGR '20 8 BINHCO '20 6 BJSTAT '20 3 BJSTAT '20 3 CQLGST '21 3 NMHIGH '20 3 YWSOAO '20 3 BEIJII '20 3 CSPLIN '19 3 JNXCCC '21 3 TRTHK '21 3 ZZCITY '19 2 YUNAEN '19 2 TRTHK '19 2 XANCON '19 2 BEIJII '19 1 BJSTAT '25 (6) -20 0 20 40 60 80 100 120 140 160

Note: Prices as of May 28, 2018; Source: Bloomberg and J.P. Morgan estimates.

8 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Sector strategy and key recommendations

With LGFVs growing large enough to be a sub-sector in JACI, while too big to ignore, jump-risk stays high, given the lack of information flow. Hence, we think it makes sense to stick to LGFVs with defined/strategically important roles and ideally having decent standalone credit profiles.

Amongst the LGFVs that we screened, given that most LGFVs are trading as a “group” in different yield buckets, we would look to take selective exposure in LGFVs through credits in the first two categories for each yield bucket. For exposure to higher yields, we are more comfortable with the risk-reward and information flow in other China SOEs and HY corporates as presented in this report.

We think those in the regional infra and construction sectors are more at risk compared to say metro operators, public utility services (water treatment etc.) with existing operations or some investment holdco companies that function as a key government arm. While utility and toll-road companies have high earnings visibility, they are also at some risk of reduced uplifts in ratings for them as well as they are more likely to be commercial-like entities (rather than policy) in practice.

Table 2: Summary of recommendations for LGFVs and selected SOEs and corporates

Bond Bond Amt (US$ Entity Issue Structure rating mm) Ratings Z-sprd M. Dur YTW Guangzhou Metro GUAMET 3.375% '20 Keepwell N 200 Baa1/-/A 106 2.4 3.8% Tianjin Rail Transit TRTHK 2.875% '21 Keepwell N 300 Baa1/-/A 115 2.8 3.9% Tianjin Rail Transit TRTHK 2.5% '19 Keepwell N 200 Baa1/-/A 71 0.9 3.2% Beijing Infrastructure Investment BEIJII 3.625% '19 Keepwell N 300 A2/A/A+ 28 0.8 2.7% Beijing Infrastructure Investment BEIJII 3.25% '20 Keepwell OW 300 A2/A/A+ 76 1.6 3.4% Wuhan Metro Group WHMTR 2.375% '19 sr. unsec OW 290 -/-/A 126 1.4 3.8% Beijing State-Owned Asset Mgmt BJSTAT 3% '20 Keepwell N 300 A3/A-/A 93 1.9 3.6% Beijing State-Owned Asset Mgmt BJSTAT 4.125% '25 Keepwell N 700 A3/A-/A 145 6.0 4.3% Tianjin Binhai New Area Cons & Inv BINHCO 4% '20 sr. unsec UW 500 Baa1/BBB+/A- 167 2.0 4.3% Qingdao City Construction Inv Grp QDCCIZ 5.95% '25 Keepwell UW 300 -/BBB-/BBB+ 243 5.4 5.2% Qingdao City Construction Inv Grp QDCCIZ 4.75% '20 Keepwell N 500 -/BBB-/BBB+ 223 1.6 4.5% Hanrui Overseas Investment Co Ltd HRINT 4.9% '19 Keepwell UW 490 -/-/BB+ 1197 1.0 14.5% Jiangsu NewHeadLine NHLHK 6.25 '19 Keepwell UW 300 -/BB-/BB+ 1327 0.5 15.7% Oriental Capital Co Ltd DFINVH '19 Keepwell NC 300 -/-/BB+ 452 1.4 7.2% ChemChina HAOHUA 4.125% '21s sr. unsec OW 1000 -/BBB/A- 117 2.6 3.9% ChemChina HAOHUA 3.5% '22s sr. unsec OW 1500 -/BBB/A- 146 3.7 4.3% Yanzhou Coal YZCOAL Perp 'c20 sr. unsec OW 500 Ba3/BB/B+ 330 1.7 6.1% Yanzhou Coal YZCOAL 5.73% ‘22 sr. unsec OW 228 Ba3/BB/B+ 407 3.4 7.0% Baoshan Iron & Steel BAORES 3.875% '20s Keepwell OW 500 Baa2/BBB/A 102 1.6 3.7% Sino-Ocean Land SINOCE 4.625% '19s sr. unsec OW 500 Baa3/-/BBB- 124 1.1 3.8% Shanghai Construction SHCONS 3.75% '20s sr. unsec NC 400 Baa2/BBB-/BBB+ 97 2.0 3.7% China Hua Neng Group HUANEN 3.6% c'22s Keepwell OW 500 -/-/- 340 3.7 6.3% Aluminum Corp of China CHALUM 4% '21s Keepwell OW 800 -/-/- 246 2.9 5.3% Central China CENCHI 6.875% '20s sr. unsec OW 386 B1/-/BB- 485 2.1 7.5% Fantasia Holdings FTHDGR 7.25% '19s sr. unsec NC 300 B3/-/- 577 0.6 8.0% ChemChina HAOHUA Perp 'c22 sr. unsec OW 600 Baa2/-/BBB+ 222 3.6 5.3% Power China CHPWCN Perp 'c19 sr. unsec OW 500 Baa1/-/- 128 1.3 4.0% MCC Holding CHMETL Perp 'c21 sr. unsec NC 500 Baa1/-/- 209 2.7 4.9% China Minmetal Corp. MINMET Perp 'c21 sr. unsec OW 400 Baa1/-/- 226 2.7 5.1% China Railway Construction RLCONS Perp 'c19 sr. unsec OW 800 A3/-/- 118 1.1 3.9% Power China CHPWCN Perp 'c22 sr. unsec NC 500 Baa1/-/BBB+ 230 3.6 5.2% Aluminum Corp of China CHALUM Perp 'c21 Keepwell N 500 -/-/BBB 232 3.1 5.2% FWD Ltd FWDINS Perp 'c22 AT1 NC 250 Ba2/-/BB+ 372 3.1 7.0% Nanyang Commercial Bank NANYAN Perp 'c22 AT1 OW 1200 Ba2/-/- 377 3.5 6.0% China Cinda Asset Management CCAMCL Perp 'c21 AT1 OW 3200 B1/-/- 403 2.9 6.1% ICBC ICBCAS Perp 'c21 AT1 OW 1000 Ba1/-/- 315 2.8 5.8% Note: Prices as of May 28, 2018; Source: J.P. Morgan, Moody’s, S&P, Fitch and Bloomberg.

9 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Clearly, there are certain LGFVs that are quite wide in the 1-2yr duration bucket which presents investors a conundrum of missing out on better yields if not invested but having a high “jump risk” if any of these LGFVs widen materially due to financial constraints, which are difficult to monitor given inadequate underlying information flow. Based on the sector overview, our strategy for LGFVs is as following:

 As we have discussed in our prior reports as well, taking exposure in some LGFVs with very definite policy-role and/or with high cash visibility such as metro operators, toll road operators etc. would be better than infrastructure construction companies, especially if the latter have largely under-construction projects. We think tighter financial conditions, limited earnings visibility and overall social impact will likely be lowest for them. Hence, most at risk to underperform in this environment.

 In terms of tenor, shorted-dated notes (preferably 1-3 years) remain preferable vs. their longer end notes given LGFV curves are not steep enough in an already volatile sector with limited information flow. We believe this sector’s bond curve should be steeper as policy environment and regulations are still evolving for the sector and hence uncertainty is relatively higher.

 We would also look for similar yielding China SOEs / corps as proxies to this space (especially in 2-3yr duration) as we think this would enable investors to earn similar carry but with better ability to monitor risk. We do note that except for credits where tight liquidity conditions have already started pricing in concerns on the specific credits, most LGFVs are still at least quoted at similar levels to the SOEs whose bonds are more liquid and investor base more diverse, both by investor type and geographically.

10 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Figure 4: China LGFV relative value vs. China IG and HY (BBB-rated SOEs and corporates in green and LGFVs in blue)

8% yield to worst

CENCHI '20

FTHDGR '19 7% XZETDZ '19 SXROBR '19 CCAMCL Perp 'c21 YZCOAL '22

FWDINS Perp 'c22 NANYAN Perp 'c22

6% YZCOAL Perp 'c20 ICBCAS Perp 'c21 DFINVH '19

CHPWCN Perp 'c22 CDCOMM '27 NMHIGH '20 CHALUM '21 QDCCIZ '25 CQNANA '26 CHALUM Perp 'c21 NJYZSO '27 YUNMET '19 HAOHUA Perp 'c22 ORIEAS Perp 'c22 5% YUNINV '19 YUNAEN '19 MINMET Perp 'c21 CHMETL Perp 'c21 QDCCIZ '22 SINOCE '24 CSPLIN '19 CHDXCH '21 CHADEC '19 QDCCIZ '20 CONSON '20 JNXCCC '21 NJYZSO '22 YUNAEN '19 CCUDIH '20 CQLGST '21 HUANEN '22 QDCCIZ '20 YWSOAO '20 CQNANA '21 ZZCITY '19 ZHHFGR '20 HAOHUA '23 GSHIAV '19 BINHCO '20 HAOHUA '22 BJSTAT '25 XIHUI '19 GXCMIN '19 CHITRA '24 XANCON '19 CHIOLI '23 CQNANA '19 CHPWCN Perp 'c19 SUNOTG '23 4% HAOHUA '21 RLCONS Perp 'c19 TRTHK '21 CHIOLI '22 TJNCON '19 SHCONS '20 COSL '22 WHMTR '19 GUAMET '20 SINOCE '19 CMHI '20 CMHI '22 CHRAIL '23 BAORES '20 MINMET '20 CHITRA '19 BJSTAT '20 BEIJII '20 CHIOLI '20 TRTHK '19 3%

BEIJII '19 CHIOLI '19 CRHZCH '19

M. Dur 2% 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0

Note: Prices as of May 28, 2018; Source: J.P. Morgan, Bloomberg.

Select LGFVs with strong policy role As we see from the chart above, most of the LGFVs trade in a ‘group’:  Within LGFVs, we are comfortable with bonds from Beijing State, Wuhan Metro, Guangzhou Metro, etc. in the 3-3.5% bucket for 1-2yr average life. We also place higher comfort for them over the infrastructure construction companies with similar yields such as BINHCO, QDCCIZ etc.

 We initiate with N on Beijing State-Owned Asset Management (BJSTAT) ‘20s and ‘25s. We recognize the high policy importance of BJSTAT for Beijing municipal government to incubate investments in key industries as well as managing stakes in key financial institutions. But our Neutral recommendation on the 20s is on the valuation basis, which we believe is fair but not particularly attractive as it is trading ~20bp higher than its closest peer BEIJII ‘20s which is one notch higher in credit rating. We also recommend N on the 25s due to fair valuation, and the longer duration indicates relatively limited policy visibility.

11 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]  We initiate with OW on Wuhan Metro (WHMTR) '19s. On a relative basis, we think the bonds look slightly attractive at only marginally inside Tianjin Railway ‘21s (NC), which has the same credit rating but ~2 years shorter duration. Wuhan Metro is also the sole metro operator in a first-tier city in China, with a strategic business positioning that we have bit more comfort with.

 Looking at strategic relationships with the provincial government is key when selecting LGFVs. For example, we would have bit more comfort with Tianjin Binhai (BINHCO) over say Xihui Haiwai (NC), Qingdao Conson or Yunnan Metropolitan (YUNMET, NC). While all are in infrastructure construction business, BINHCO is the sole government investment and financing arm for an area which gets regular grants from central government as well. In addition, Tianjin has relatively stronger provincial level local government finances.

 We reiterate that these recommendations are for investors looking to invest within LGFVs only as they are nevertheless still trading somewhat close to some of the mid-tier SOEs such as China Merchant Holdings (CMHI), ChemChina, Minmetals, Power China, China Railway Constructions (CRCC), etc. for which we would still have relative preference.

Upside catalysts for Wuhan Metro include higher-than-expected government capital grants and subsidies. Downside risks include weaker economic performance and higher indebtedness of the municipality, which may affect government support for WHMTR.

Upside catalysts for Beijing State-owned Asset Mgmt include diversification of investments and resulting generation of portfolio value. Downside risks include underperformance of investment portfolio and weakening of Beijing municipal government’s willingness to support.

Several SOE alternatives in the 4-5% range We note that there are several LGFVs with 1-3 year duration that are yielding in the 4-5% range, which should seem attractive for an IG investor, in our view. Typically, investors buy bonds in this tenor for their stability rather than capital appreciation given the short tenor (even 100bp spread compression implies only 1-1.5pts here).

With this in mind, we think investing in strong SOEs even if that means going for the callable part of the capital structure (perpetuals with high step-up), should better qualify for the above yields vs low volatility requirements as mentioned above. We note from the chart above that there are several such alternatives that investors could look at.

For example, we think the following China SOE and corporate bonds are some alternatives we think offer similar yields while information transparency around business and outlook is much clearer and easier to monitor:

12 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]  China Railway Construction perps ‘c19s: At 4%ytc for 2019 call date, the bonds are senior unsecured in ranking and issued from A3/A- rated issuer which is one of the largest railway infrastructure construction in China. While the company is ~55% owned by central SASAC and is listed in Shanghai and Hong Kong, we think the partial ownership is more due to bringing financial discipline through listing and management appointment and operations etc. remain closely monitored by central government through the wholly owned China Railway Construction Corp, parent company of CRCC. The perps have 5% step-up if not called, hence a steep incentive to do so given the coupon will reset to ~10%.

 ChemChina ‘21s: ChemChina is China’s largest chemical company and third largest globally. As a key company in specialty chemicals, crop protection and agro-chemicals sector, we think the company has a strategic position in a sensitive sector for the government given the importance of food safety and self-sufficiency for the country. In our view, this strategic importance has further increased for the wholly central-SASAC owned entity which also directly guarantees the bonds, post-acquisition of Syngenta and this support is also evidenced from the US$43 billion acquisition which has completed in the middle of an otherwise, “deleveraging focused year” by the Chinese government. The bonds offer ~4%ytm as well, similar to the weaker LGFVs of 2020-21 maturities but in our view, the former has much better earnings visibility, closer government ownership structure and clear and high strategic support.

 Minmetals 4.45% perps 'c21s: We also think the perps from China Minmetals Group callable in 2021s (5.2%ytc) are a decent alternative for investors looking to invest in core China SOEs but yielding over 5%, as compared to the weaker LGFVs at similar levels and duration. The SOE is again wholly central-SASAC owned and was designated as the only State- owned Asset Investment Platform in the M&M industry and hence in our view, further increased in its strategic importance. Even from a bottom-up perspective, the credit should be deleveraging especially with commodity prices rebounding and the company’s key project in Peru (Las Bambas) operational. The bonds are rated Baa1, have 400bp step-up if not called and hence in our view, have high likelihood of being called.

The 6-7% club – not without risk but risk-reward wise better, in our view Clearly, bonds yielding over 6% for 1-2 year average life are not without higher risks or some broad concerns. However, we think the following bonds offer a much better risk-reward vs. some of the lower quality & rated LGFVs in the sense that they can still be more effectively monitored.

Also, these LGFVs are typically from lower rated (weaker credit profile) provinces and typically in infrastructure construction businesses. Consequently, either directly or through the province, these credits are quite dependent on the property sector themselves. Hence, we think it makes some sense to present some HY China property credits as a decent alternative to consider, where we are bit more comfortable with standalone business profile from default-probability perspective.

13 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]  Yanzhou Coal perp ‘c20s and ‘22s: We initiate coverage on Yanzhou Coal, its 5.75% perps ‘c20s and ‘22s with OW. The perps have a 400bp step-up (to T3+830bp) if not called in Apr-2020 and are senior unsecured in ranking. The outlook for coal prices is relatively better and along with continued cost control in both China and Australian operations, the company has reduced leverage to ~3.4x as of Dec-17 but we expect this number to stay broadly similar on higher capex in next 1-2 years. Yanzhou is 55% owned by Shandong government’s wholly owned Yankuang Group and is the main profit contributor to the SOE. While not a strong standalone credit, we think the company still provides much better earnings visibility, has decent operations at standalone level and being listed, investors would should be able to monitor the company closely. Hence, we think the bonds are a decent alternative to the higher yielding LGFVs in 2-3yr duration bucket. We would also recommend YZCOAL perps ‘c20s over QDCCIZ ‘20s (also Shandong province LGFV) with the former trading ~140-150bps wider to call date. Separately, we think Yanzhou ‘22s look cheap at 7% which is wider than its peers such as Indika ‘22s (also pure coal credit). We also note that in the lows of coal cycle in 2015, Yanzhou was actually buying back its 2022 bonds at around 90cents, even as other commodity credits’ bonds fell to below 50cents.

Key upside catalysts are higher coal prices, reduced capex and asset sales, while key downside risks are a decline in coal prices, higher-than-expected costs of production, aggressive capex etc.

 NANYAN and CCAMCL AT1s (covered by Matthew Hughart): We think the AT1s from these financial institutions offer decent yields for the risks and though there is some call risk from them, we think it is still low. For CCAMCL, Matthew writes in his recent note published May 3rd: “Offered at a yield to 2021 call of 6.6%, a variety of comparisons highlight the value, whether it is vs. AT1 peers, vs. senior bonds, or relative to the company's Hong Kong subsidiary: we conclude that the yield supports a more positive view.” Also, while supply remains a concern, it has been quite slow this year, which we believe is either is a reflection of increasing pressure to manage leverage and stick to core businesses, although it may also suggest a pick-up in the rest of the year.  Central China 6.875% ‘20s (covered by Daniel Fan): We would recommend this as an alternative only against the highest yielding LGFVs which are HY rated (by Fitch only) despite getting the uplifts due to provincial government ownership and hence having a very weak standalone profile. Also, as mentioned above, since these LGFVs are, either directly or through the province, quite dependent on the property sector themselves it makes some sense to present some HY China property credits. The company has a good track record in project execution, maintains strong liquidity and conservative financial management. Capitaland is a strategic partner, which should ease some concern over the less transparent JV projects. Key downside risks are concentration in Henan and low transparency at JV level. Further catalyst is the expansion of its asset-light project management business.

14 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]  Golden Eagle ‘23s: Not an ideal comp but to again exemplify our rationale, the bonds trade about flat to some of the weaker LGFVs of this duration. While the risks would be relatively high in both cases, we draw bit more comfort from holding Golden Eagle at this time, given its likely bottoming out of retail sales cycle, clear asset coverage in multiple of net debt etc. Hence, “jump-risk” of spreads much more mitigated and investors would have better ability to monitor the investment. Please refer to our last published coverage report for key risks on the above alternatives presented.

15 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] LGFVs: A quick recap

Background of LGFVs LGFVs have special roles in supporting regional economic development but also constitute a major portion of local government liabilities. Local government funding vehicles (LGFVs) are a sub-group of SOEs in China, typically founded for financing infrastructure and other regional development projects and usually do not operate for profits. They rose to prominence in the 1990s to largely fund local governments’ new projects. Over time though, their number grew materially with the strategic role of keeping up with infrastructure spending to meet regional economic growth targets. Since the 2000s, the LGFV debt market has grown at an even faster pace given the policy support on boosting regional economies by investing extensively in infrastructure and social welfare projects.

Table 3: Total debt as % of net assets vs LGFV outstanding amount as % of net assets (USD bn) As of 2018YTD Total debt Total LGFV amount outstanding Total net asset 648 22 2,610 Total net asset 24.8% 0.8% 100.0% Source: WIND. J.P. Morgan estimates.

At the same time though, mounting debt and high leverage carried by LGFVs have led to concerns of overleveraging which has typically been off-balance sheet so far. While onshore bank and bond markets have been traditional sources of funding, in recent years, a large number of LGFVs have tapped the offshore bond market as well. As the LGFVs usually operate social welfare or infrastructure projects which do not generate constant and immediate cash flows, government support for their operations becomes even more critical.

Table 4: Selected provinces LGFV outstanding vs. GDP data LGFV total outstanding 2017 nominal GDP (USD 2017 real GDP growth (USDmm) bn) rate Beijing 1600 414.5 6.7% Chongqing 1500 288.7 9.3% Gansu 500 113.7 3.6% Guangdong 500 1330.6 7.5% Guangxi 300 301.9 7.3% Hubei 290 540.7 7.8% Hunan 900 512.1 8.0% Inner Mongolia 400 238.4 4.0% Jiangsu 1890 1271.7 7.2% Jilin 400 226.3 5.3% Qinghai 300 39.1 7.3% Shaanxi 500 324.2 8.0% Shandong 2300 1075.9 7.4% Shanxi 365 221.7 7.0% Sichuan 600 547.5 8.1% Tianjin 1500 275.3 3.6% Yunnan 1410 244.7 9.5% Zhejiang 500 766.4 7.8% Source: National Bureau of Statistics of China, WIND, J.P. Morgan estimates.

16 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Figure 5: Selected provinces LGFV outstanding vs. GDP data 4000 10% 3500 9% 8% 3000 7% 2500 6% 2000 5% 1500 4% 3% 1000 2% 500 1% 0 0% i i i i i g a n n g u n g n n x x x i i e i g u g l l j s a n n a n a a i g n n i b s n n o n i h n o n o u n J j n a a q u g a i g a g a i d u d h n i a a h j n g e H n n c g n u G u H i h i T e a n S o i B n a Y h o S S G J Q a h M h Z

u S r C G e n n I

LGFV total outstanding (USDmm) Nominal GDP (USD bn) Real GDP growth rate 2017

Source: National Bureau of Statistics of China, WIND, J.P. Morgan estimates.

Fundamental analysis framework

We use a top-down approach to assess LGFVs and our selection criterion is therefore more weighted towards its local government strength and its policy role. Standalone credit profile of LGFVs is included as well but with relatively less weight. We take the following listed factors into consideration when we assess individual LGFVs:

1) Strength of the government: We think that how developed and the resulting financial ability of local government is one of the critical factors to be taken into consideration. LGFVs commonly have weak standalone credit profiles, so which provincial or municipal government that is linked to them becomes important. Although the central government has enforced strict rules on the separation of government involvement in LGFV operations and debt financing, we think that the linkage between the two will stay at least for now, but will gradually towards to a much lesser extent. Also, among different levels of governments, we think that provincial governments are usually stronger than municipal or district level governments. In terms of the strength of shareholder structure, we prefer those that are directly owned by central SASACs.

2) Willingness of government support: We would consider lowering weight on this factor eventually given the ongoing reform to eliminate government implicit support for LGFVs. However, in the near term, we still include it as an important part to be considered. Currently, the majority of the existing LGFVs run social and public mandates and projects for their respective local governments and carry policy mandate. In our view, this factor plays a differentiated role for LGFVs that operate on a policy basis versus for commercial purpose, with the former receiving more government support.

17 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] 3) Standalone credit profile: Given the current trend of policy tightening, we do recognize that LGFVs standalone profiles will become more important for assessment going forward as government guarantee is prohibited. But for now, we think that the above factors will still be dominating in our analysis while the standalone profile plays a relatively smaller role.

For more details on the framework, please see our report dated Aug 3, 2016.

Categorization of LGFVs

We determine categorization of the LGFVs based on the following factors, of which the first two should determine the government’s willingness to support, while the latter two will determine the ability.

 Strategic or policy role they play  Economic importance in terms of scale and contribution to provincial economy  Standalone fundamentals (relatively less important, in our view)  Provincial government’s financials (ability to support)

Based on the above four factors, we classify the LGFVs into four broad categories –

 Preferred: LGFVs with a clear and defined strategic / policy role within the province that owns the credit. The LGFV should manage socially important projects, are typically sole vehicles to operate in their sector/segment and largely operational. Hence, any liquidity pressure disrupting smooth operations would have large socio-economic impact. Underlying operations would be strong but financials may not be, more due to government-mandated reasons (ticket price controls, regulated-tariffs). We believe the above factors would most likely ensure that the government would support through either equity infusion, asset sales or subsidy contribution would remain even in stressed periods. Also, we note that these LGFVs are usually from top-tier provinces/cities in China.

 Some comfort: LGFVs with a defined strategic role and again have a dominant, if not a monopolistic position in that sector within the province, even though the operations may be in relatively less strategic sectors. The province should typically be relatively strong as well. If not the above, then they would operate projects that are typically more profitable, such as highway and toll roads business and hence are generally strong at a standalone level. This also means they are subject to less government support as they operate relatively more commercial projects but being fundamentally strong, the likelihood of requiring parental support would also be limited.

 Opportunistic: LGFVs with lesser certain or no material policy role, in a less strategic sector such as mining, infrastructure construction and property development etc. but has a dominant or major market share in the sector / segment it operates in. Also, the province would typically be in the tier 2 or 3 range. The reason this is labeled as opportunistic is while there would be limited social impact in a stressed situation and hence less certain of support in the medium term depending on government’s priority projects. However, since the LGFV would be one of the very few companies implementing the projects for the province, support in near term at least should be there.

18 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]  Uncertain: The LGFVs in this category typically manage cyclical projects which have low to medium socio-economic impact in the near to medium term and without much visibility in its recurring cash flows. Also, several of these credits would have large scale greenfield projects that could keep funding requirement high and hence have most uncertainty in terms of sustained liquidity. Most of them would be from weaker provinces/cities and the operations tend to concentrate in certain area/region. Many infrastructure construction businesses fall into this category, which usually have volatile cash flows due to the nature of the business.

Table 5: Summary of LGFV categorization Preferred Some comfort Opportunistic Uncertain / Negative Policy/strategic role √ ↔ X X Dominant market position √ √ √ ↔ Standalone credit profile X ↔ ↔ X Provincial strength ↔ √ ↔ ↔ LGFVs Beijing Infrastructure Tianjin Binhai Yunnan Investment Group Hanrui Overseas Investment Beijing State-owned AM Tianjin Infrastructure Yunnan Energy Investment Huai'an Development Holdings Wuhan Metro Qingdao City Construction Yunnan Metropolitan Xuzhou Eco Tech Dev Zone Tianjin Railway Transit Chang Development Int’l Nanjing Yang Zi State-owned Changsha Pilot Investment Guangzhou Metro Xi'an Municipal Infrastructure Jinan West City Investment Gansu Prov. Highway Aviation Xihui Haiwai Investment Chongqing Nan'an Urban Qingdao Conson Development Zhuzhou City Construction Guangxi Comm. Inv. Group Yiwu State-Owned Capital Shanxi Road & Bridge Constr. Qinghai Provincial Invt Group Oriental Capital Company Changde Urban Construction

Inner Mongolia HG Highway Chongqing W. Modern Logistics Chengdu Comm. Investment Chengdu Xingcheng Zhuhai Huafa Group Hanrui Overseas Investment Huai'an Development Holdings Xuzhou Eco Tech Dev Zone Changsha Pilot Investment Notes: √ means is a required factor in the credit, X implies the factor is typically not present for the credit. ↔ means the factor could be present but to a lesser degree, in a credit in this sector. Source: Moody’s, S&P, Fitch, Company reports, J.P. Morgan.

19 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Technicals: Less negative due to lower supply but investor base still narrow

LGFV bonds’ representation in JACI has increased sharply over the years. LGFVs as a portion of the JACI index have grown over time. As of April-2018, LGFV market capitalization as a component of the JACI grew 17% from 2017 year- end, totaling around US$21 billion and now represent about 2.4% of the JACI, hence similar to China IG property, Korea or Singapore IG corporates while being bigger than India and Indonesian HY corporate segments.

Figure 6: LGFV as % of JACI 3.0%

2.5% 2.4% 2.1% 2.0% 2.0%

1.5% 1.5%

1.0%

0.5% 0.3%

0.0% 2014 2015 2016 2017 2018YTD

Source: Bloomberg, Bond Radar, J.P. Morgan estimates.

LGFV US$ issuance reached its peak level of US$10.7 billion in 2016 after gradually increasing the measure since 2013. The previously heavy LGFV issuance could be attributed to regional economic stimulus packages usually in the form of infrastructure and PPP projects, relatively lower offshore yields as well as “reputation factor” of being able to access the offshore bond markets.

Rising interest rates in offshore markets could have played a role as well. While onshore rates were rising for most of 2017, USD yields for Chinese issuers including LGFVs had been fairly stable during the period. But after accounting for cross currency swap rates, effective yields of USD bonds in CNY terms were still relatively more attractive. Hence on the demand side, we saw continued participation from investors (largely Chinese investors who had set up offshore offices) looking for USD assets and had prior investment experience / exposure to the credits in the onshore markets.

20 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Bond supply should slow going forward Figure 7: Onshore LGFV bond issuances Figure 8: Offshore LGFV issuances US$ in billions US$ in billions 400 379 12 10.7 312 291 290 10 300 8 6.6 170 200 153 145 6 3.4 4 100 1.6 1.4 2 0 - 2012 2013 2014 2015 2016 2017 2018 2014 2015 2016 2017 Apr-18 Onshore LGFV issuance Offshore LGFV issuance

Source: WIND and J.P. Morgan. Source: Bloomberg, Bond Radar, J.P. Morgan.

LGFV offshore issuance dropped in 2017 after experiencing consecutive growth since 2014, as the central government started addressing local indebtedness issues, total amount of LGFV offshore issuance started to decline. This was not surprising and can be partly explained by China’s policy shift to eliminate local governments’ role in both LGFV financing and operations.

Figure 9: Yield basis between China AAA-rated 5yr bonds and JACI China IG corporates

7.5 160 Basis China corporate bond AAA 5-year ytm JACI China IG ytw 140 6.5 120

5.5 100 80

4.5 60

40 3.5 20

2.5 0 May-14 Nov-14 May-15 Nov-15 May-16 Nov-16 May-17 Nov-17 May-18

Source: WIND, Bloomberg and J.P. Morgan.

Also, the basis between onshore/offshore yields has narrowed again in recent months in addition to the USD appreciating vs most EM countries including CNY. Further, Chinese investors who we think has been the dominant buyers of these bonds have been noticeably cautious in adding exposure to the sector in the recent months. Last but not least, as mentioned in the policy update section above, the government is tightening the underwriting standards whereby state-owned financial institutions should not indicate implicit or direct local government support by reporting local government financials. Implemented in a stringent manner, we believe tighter standards should impose more challenges for LGFVs to tap for more funding going forward and should also imply lower overall supply in the USD bond markets.

21 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected] Investor base remains narrow as Asia continues to dominate The trend of investors in Asia being the most active buyers continues. In the past year, Asian investors (in which we think Chinese investors who have had existing investment experience with LGFVs in the onshore markets) continued to dominate the buying activities of offshore LGFV bonds.

While we did see some allocation increase to European investors in 2017, we attribute this more to allocating some weight to a sector that is reaching a reasonable representation scale. We also think the inclination has been more towards better quality / rated LGFVs rather than a wide comfort in taking substantial exposure into the space. Net-net, we think that regional investors in Asia would still hold most of the LGFVs outstanding.

The above argument can be further exemplified by looking at the investor type, who participated in the LGFV new issuances. Asset managers (48%) and banks (29%) are still the two largest types of investors. Again, we believe the banks involved are largely offshore branches of the Chinese banks who have existing relationship or exposure with the LGFVs even in the onshore markets while asset managers would include JACI-benchmarked investors who had to increasingly participate in some of the LGFVs as it became a material enough part of the index. Interestingly, private bank investors took only 9% of the otherwise “yieldy” LGFV new issuances.

Figure 10: Asia investors were the dominant buyers of LGFVs bonds Figure 11: Asset managers and banks are the largest buyers, with limited participation by European and U.S. accounts followed by insurance/pension funds 2%

100% 9% 12% 80%

60% 82% 86% 90% 96% 29% 40%

20% 48% 19% 12% 10% 4% 0% 0% 0% 0% 2% 2014 2015 2016 2017 Insurance / pension funds Bank Asset managers Private bank & Retail US Europe Asia Others

Source: Bloomberg, Bond Radar, J.P. Morgan. Source: Bloomberg, Bond Radar, J.P. Morgan.

The overall trend of investors by region and by type has not seen major changes over time, as the financial opaqueness of LGFVs and their weak standalone credit profiles are inherently less compelling for offshore investors with limited information flow to track the investments.

22 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Table 6: China LGFV offshore USD issuance summary Issuer Ticker Issue date Amt Maturity Province* Municipality Coupon Mdy S&P Fitch Onshore Bj State-Owned Ast Hk Co BJSTAT 5/26/2015 300 5/26/2020 Beijing Beijing 3% A3 A- A AAA Bj State-Owned Ast Hk Co BJSTAT 5/26/2015 700 5/26/2025 Beijing Beijing 4.13% A3 A- A AAA Eastern Creation Invest BEIJII 3/20/2014 300 3/20/2019 Beijing Beijing 3.63% A2 A A+ AAA Eastern Creation Ii Inve BEIJII 11/20/2014 300 1/20/2020 Beijing Beijing 3.25% A2 A A+ AAA Zhaohai Investment Bvi BINHCO 7/23/2015 500 7/23/2020 Tianjin Tianjin 4% Baa1 BBB+ A- AAA Nanjing Yang Zi State-Ow NJYZSO 12/5/2017 300 12/5/2022 Jiangsu Nanjing 3.63% Baa1 BBB+ A- AAA Nanjing Yang Zi State-Ow NJYZSO 12/5/2017 200 12/5/2027 Jiangsu Nanjing 4.50% Baa1 BBB+ A- AAA Rail Transit Intl Invst TRTHK 5/13/2016 200 5/13/2019 Tianjin Tianjin 2.50% Baa1 - A AAA Chang Development Int CCUDIH 1/20/2017 400 1/20/2020 Jilin Changchun 3.63% Baa1 - - AAA Gz Mtr Fin Bvi GUAMET 12/3/2015 200 12/3/2020 Guangdong Guangzhou 3.38% Baa1 - A AAA Rail Transit Intl Invst TRTHK 5/13/2016 300 5/13/2021 Tianjin Tianjin 2.88% Baa1 - A AAA Chongqing Nanan Con Dev CQNANA 7/19/2016 300 7/19/2019 Chongqing Chongqing 2.88% - BBB+ BBB+ AA+ Chongqing Nanan Con Dev CQNANA 7/19/2016 500 7/19/2021 Chongqing Chongqing 3.63% - BBB+ BBB+ AA+ Chongqing Nanan Con Dev CQNANA 8/17/2016 200 8/17/2026 Chongqing Chongqing 4.50% - BBB+ BBB+ AA+ Gansu Highway Aviation GSHIAV 11/18/2016 500 11/18/2019 Gansu N/A 3% - BBB- BBB- *+ AAA Changsha Pilot Inv Hld CSPLIN 12/2/2016 350 12/2/2019 Hunan Changsha 3.10% - BBB- BBB- AA+ Hongkong Intl Qingdao QDCCIZ 2/12/2015 500 2/12/2020 Shandong Qingdao 4.75% - BBB- BBB+ AAA Jinan West City Invt JNXCCC 10/11/2016 300 10/11/2021 Shandong Jinan 3.13% - BBB- BBB AAA Hongkong Intl Qingdao QDCCIZ 2/12/2015 300 2/12/2025 Shandong Qingdao 5.95% - BBB- BBB+ AAA Xihui Haiwai I Invst XIHUI 6/27/2016 300 6/27/2019 Jiangsu Wuxi 3.25% - BBB BBB+ N/A Haitian Bvi Int Invst CONSON 12/12/2017 400 12/12/2020 Shandong Qingdao 3.88% - BBB BBB+ AAA Zhuzhou City Constructio ZZCITY 10/19/2016 300 10/19/2019 Hunan Zhuzhou 2.98% Baa3 - BBB- AA+ Guangxi Comm Invest Gr GXCMIN 11/3/2016 300 11/4/2019 Guangxi N/A 3% Baa3 - BBB AA+ Chouzhou Intl Inv Ltd YWSOAO 12/5/2017 500 12/5/2020 Zhejiang Yiwu 4% Baa3 - BBB AA+ Shanxi Road&Brdg Contr SXROBR 11/4/2016 365 11/4/2019 Shanxi N/A 4.85% - BB- - AAA Qinghai Invest Group QHINVG 2/22/2017 300 2/22/2020 Qinghai N/A 7.25% - BB- - AA Tianjin City Constructio TJNCON 6/15/2016 500 6/15/2019 Tianjin Tianjin 2.75% - A- A AAA Yunnan Inv Hldings Group YUNINV 4/1/2016 300 4/1/2019 Yunnan N/A 3.38% - - BBB+ AAA Yunnan Energy Invst Fin YUNAEN 4/26/2016 300 4/26/2019 Yunnan N/A 3% - - BBB AAA Xz Eco Tech Dev Zone Int XZETDZ 6/16/2016 300 6/16/2019 Jiangsu Xuzhou 4.50% - - BB+ *- AA Hanrui Overseas Invst HRINT 6/28/2016 490 6/28/2019 Jiangsu Zhenjiang 4.90% - - BB+ *- AA+ Caiyun Intl Investment YUNMET 7/12/2016 500 7/12/2019 Yunnan N/A 3.13% - - BBB+ AAA Xian Construction Invest XANCON 9/13/2016 500 9/13/2019 Shaanxi Xi'an 2.80% - - BBB N/A Wuhan Metro WHMTR 11/8/2016 290 11/8/2019 Hubei Wuhan 2.38% - - A AAA Oriental Capital Co Ltd DFINVH 11/22/2016 300 11/22/2019 Jiangsu Yancheng 5.15% - - BB+ *- AA Yunnan Energy Inst Ovr YUNAEN 12/13/2016 310 12/13/2019 Yunnan N/A 3.50% - - BBB AAA Changde City Cons Inv CHADEC 12/15/2016 250 12/15/2019 Hunan Changde 3.70% - - BBB- AAA Huaxing Investment Holdi ZHHFGR 1/26/2017 300 1/26/2020 Guangdong Zhuhai 3.50% - - BBB AA+ Inner Mongolia Highway C NMHIGH 12/5/2017 400 12/4/2020 Inn. Mong. N/A 4.38% - - BBB- *- AA+ Hongkong Intl Qingdao QDCCIZ 12/4/2017 300 12/4/2020 Shandong Qingdao 3.75% - - BBB+ AAA Cq Logistics Deve Cons CQLGST 9/6/2016 500 9/6/2021 Chongqing Chongqing 3.25% - - BBB AA+ Chengdu Xingcheng Inv CHDXCH 11/29/2016 300 11/29/2021 Sichuan Chengdu 3.25% - - BBB+ AA+ Hongkong Intl Qingdao QDCCIZ 12/4/2017 500 12/4/2022 Shandong Qingdao 4.25% - - BBB+ AAA Chengdu Comm Invst Group CDCOMM 12/13/2017 300 12/13/2027 Sichuan Chengdu 4.75% - - BBB+ AAA Source: Bloomberg, Bond Radar, J.P. Morgan. *Beijing, Tianjing, Chongqing are provincial-level municipalities

23 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Background of Individual LGFVs Table 7: Background of LGFVs Tianjin Infrastructure Bond issuer Beijing Infra Inv Construction Tianjin Railway Transit Tianjin Binhai Ticker BEIJII '19s, '20s TJNCON '19 TRTHK '19, TRTHK '21 BINHCO '20s Bond structure Keepwell Guarantee Keepwell Keepwell Ranking Senior unsecured Senior unsecured Senior unsecured Senior unsecured Bond ratings A2/A/A+ -/A-/A A3/-/A Baa1e/BBB+/A- Issuer rating A1/A+/A+ -/A-/A A2/-/A A3/A-/A- Standalone rtgs baa2/bb- bb- ba3/-/BB b2/b+ Notches 4/8 6 6-7 7-8 Govt ownership 100% 100% 100% 100% Shareholder structure 100% owned by Beijing municipal 100% owned by Tianjin Municipal 86% owned by Tianjin 100% owned by Tianjin SASAC, government Government Infrastructure Const.& Invt and directly supervised by district-level 14% Binhai govt owned by Tianjin TEDA Investment Holdings, which is wholly owned by the SASAC of Tianjin Municipal Government Main business and Construction, investment, Transportation E&C projects in Mandated by Tianjin govt to Various infrastructure including market position financing and operation of the Tianjin, operates over construct, own 70% of road network in the New subway system in Beijing, 86% of city’s toll roads; holds and operate rail transportation Area, railways, tunnels, and operates 15 out of 18 of Beijing's 86.34% of Tianjin Railway; assets; also holds Tianjin govt's bridges, etc., also engaged in urban transit system; primary land dominant player in Tianjin's water minority investments in national water treatment, waste disposal, and property development along treatment market through listed rail lines and engages in primary land dev, social housing, rail lines sub Tianjin Capital Environmental metro-related businesses, civil projects, materials trading, Protection Group, which supplies including infrastructure financial service, etc. 60% of water to Tianjin construction, property development and leasing along its metro lines Shareholder strength Beijing as the capital has high Tianjin is relatively strong among Parent Tianjin Infrastructure Tianjin is relatively strong among political and economic provincial-level local govts, per Construction & Investment is provincial-level local govts, per prominence, though credit/GDP is capita GDP was highest in China largest non-financial SOE under capita GDP was highest in China much higher than national for 2014, GDP growth is higher Tianjin for 2014, GDP growth is higher average at 349% than average at 9.4% for 2015, than average at 9.4% for 2015, land sale reliance low, fiscal land sale reliance low, fiscal deficit/GDP moderate, though deficit/GDP moderate, though Debt/GDP higher than average at Debt/GDP higher than average at 188% 188% Linkage and Very High (RMB15.5bn annual High (sole platform for developing High(sole builder and operator of High (strong oversight, sole govt importance to parent grants 2013-2035, execute Beijing and operating infrastructure urban rail transport in the central investment and financing platform govt's urban rail policy, subsidy to projects in central urban area, area of Tianjin; No less than for Binhai New Area development, cover operating loss from low strong govt control and oversight. RMB10bn/year grant 2015 grant totaled RMB1bn for 2012- fare) RMB77bn allocated for 2012- onwards, on-going fare subsidies 2014, cash injections RMB10.6bn 2015, RMB20bn capital injection from Tianjin govt) 2006-2012, land injections, letter expected for 2016, 25% of debt of support for financing) accounted as government related debt in 2015, per S&P.) Strategic / Policy role Very-high (key public High (Sole platform for developing Very high (the sole builder and High (sole govt investment and transportation provider of capital and operating infrastructure operator of urban rail transport in financing platform for Binhai New city, high likelihood of central govt projects in central urban area, the central area of Tianjin, a Area development, part of national stepping in if needed) important role in executing the municipality directly owned by the goal of integrating Beijing, Tianjin, national strategy of integrating central govt; metro projects are Hebei, high-tech and free-trade Beijing-Tianjin-Hebei provinces, approved by the central zone, component of 'one-belt one- policy role of key subs including government) road', grant from central govt) metro, water treatment, etc.) Economic importance High (any disruption of metro Very High (the company is the High (any disruption of metro High (the New Area contributed would likely to severely impact the largest non-financial SOE by would likely to severely impact the 56%/30% of GDP and govt local economy) assets under Tianjin) local economy) revenue of Tianjin, TBCI is one of the largest SOEs for Tianjin) Index eligibility JACI JACI JACI JACI

Source: Moody's, S&P and Fitch, J.P. Morgan.

24 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Table 8: Background of LGFVs (continued) Yunnan Energy Investment Bond issuer Yunnan Metropolitan Chongqing Nan'an Urban Yunnan Investment Group Overseas Finance Company Construction Investment Group Construction & Development Ticker YUNINV '19 YUNAEN '19s YUNMET '19 CQNANA '19, CQNANA '21 Issued directly by Chongqing Bond structure Nan'an Urban Construction & Directly issued by YIG Keepwell Guarantee Development Ranking Senior unsecured Senior unsecured Senior unsecured Senior unsecured Bond ratings -/-/BBB+ -/-/BBB -/-/BBB+ -/BBB+/BBB+ Issuer ratings -/-/BBB+ -/-/BBB -/-/BBB+ -/BBB+/BBB+ Standalone rtgs -/-/B -/-/B- NA -/B/- Notches 6 7 NA 7 Govt. ownership 100% 100% 100% 100% Shareholder structure 100% owned by Yunnan YEIG is indirectly 94.71% owned 100% ultimately owned by 90% owned by Chongqing Nan'an provincial gov't and ultimately controlled by the Yunnan Province gov't; 3.8% District Department of Finance; Yunnan SASAC directly owned by Yunnan 10% owned by China Construction Engineering Group; Development Bank, which is govt plans to transfer 40% of 100% govt-owned shareholding to Yunnan Shengyi Investment Co Main business and Provincial investment holdco with The company engages in the Commercial property, urban Construction and financing market position diversified industries via subs, investment and management of development (convention for urban infrastructure and land including hydro, railway, finance, energy, natural gas, and coal centres), sole partner with govt development (80% tourism, infrastructure and social energy businesses worldwide. with land reserve function, water revenue);supply-chain finance to projects. Yunnan Energy The company is also involved in treatment, tourism infrastructure, other SOEs and SMEs in the Investment is largest sub and the investment and management healthcare, etc. electronics information industry contributes majority of gross of energy and energy related profits to YIG industries Shareholder strength Yunnan is western province with Yunnan is western province with Yunnan is western province with Chongqing is one of the four relatively low GDP and per capital relatively low GDP and per capital relatively low GDP and per capital central govt directly owned GDP, govt debt/GDP is above GDP, govt debt/GDP is above GDP, govt debt/GDP is above municipalities and its GRP per average at 48%, fiscal average at 48%, fiscal average at 48%, fiscal capital growth ranking 10th in deficit/GDP also slightly higher deficit/GDP also slightly higher deficit/GDP also slightly higher China, though with higher-than- than average; it has fiscal transfer than average; it has fiscal transfer than average; it has fiscal transfer average credit/GDP of 178%; of RMB291bn from central gov't of RMB291bn from central gov't of RMB291bn from central gov't Nan'an District is one of the main downtown districts of Chongqing with 8th GDP rank among districts Linkage and High - YIG is the largest High - Sole energy platform; High- Sole provincial-level Med-High - amongst the importance to parent investment holding platform under hydropower is the key focus of platform for large infrastructure important SOEs in Nan'an for Yunnan provincial govt, engaged energy development for the development; financing and investing in key in diversified industries including province, ranks 2nd among manages large-scale urban infrastructure projects and land high policy role industries e.g. Chinese provinces in terms of infrastructure, social housing development, and funding local hydro, infrastructure, railway.) hydro resources. projects and the province’s SOEs and SMEs. Tourism resources.

Strategic / Policy role High – Key investment holding High - Assigned the role of Medium - Some businesses have High - Executes the government's platform, holds key energy mandated provincial SOE to important policy role, e.g. urban urbanization plan for the subsidiary YUNAEN and railway develop the province's natural- and tourism infrastructure, water Chongqing Nan'an district sub Yunnan Provincial Railway. gas market and power-distribution treatment land reserve, Strategic role could decline if key grid, holds some of province’s healthcare subs are deconsolidated hydro power assets Economic importance High - holding important subs Medium-high - Largest SOE in Medium - Decent profit Medium - constrained by such as Yunnan Energy province by assets but role of contribution from urban city/district-level operation Investment energy security is bit weaker development, tourism, and water relative to others treatment Index eligibility JACI JACI JACI JACI Source: Moody's, S&P and Fitch, J.P. Morgan.

25 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Table 9: Background of LGFVs (continued)

Bond issuer Guangzhou Metro Hanrui Overseas Investment Huai'an Development Holdings Xuzhou Eco Tech Dev Zone Ticker GUAMET '20s HRINT '19 HUAHK '19 XZETDZ '19 Bond structure Keepwell + RMB SBLC Keepwell Keepwell Guarantee Ranking Senior unsecured Senior unsecured Senior unsecured Senior unsecured Bond ratings A3/-/A -/-/BB+ -/-/BB+ -/-/BB+ Issuer ratings) A2/-/A -/-/BB+ -/-/BB+ -/-/BB+ Standalone rtgs baa1 NA NA NA Notches 2 NA NA NA Govt. ownership 100% 100% 100% 100% Main business and Construct and operate Hanrui is responsible for urban Urban and infrastructure The company has been market position Guangzhou's metro system, 45% development and social welfare development in the technology designated to develop large- market share in passenger in the zone through construction development and economic zone scale urban infrastructure transport sector of Guangzhou; of projects in Xuzhou Economic also property dev along metro infrastructure and social housing Technology Zone, provide lines, consultancy for metro ancillary services operations across China, renting and promote investment in the underground advertising and zone other commercial space Shareholder 100% owned by Guangzhou 100% owned by Zhenjiang 100% owned by Huai'an 100% owned by Xuzhou structure SASAC, one of four first-tier SASAC municipality Municipal Government cities in China

Shareholder Guangzhou is Guangdong Zhenjiang has relatively low GDP Huai'an municipality of Jiangsu Xuzhou municipality of Jiangsu strength province’s capital, amongst the and per capita GDP in Jiangsu Province; Jiangsu has relatively Province; Xuzhou has relatively highest in credit quality provinces (rank 10th out of 13). Jiangsu has healthy GDP size and growth, high GDP and per capita GDP in with high GDP and fiscal relatively healthy GDP size and etc. though credit/GDP at 141%; Jiangsu (rank 5th out of 13) revenue, per capita GDP, healthy growth, and fiscal status, though Huai'an has relatively low GDP fiscal balance, and moderate credit/GDP at 141%; and per capita GDP in Jiangsu debt/GDP (rank 11th out of 13) Linkage and High, one of four quasi-public High (only gov't-linked entity in High (the sole investment and High (strong government control importance to welfare enterprises under the the Zhenjiang New Zone to financing platform in the and oversight, on-going subsidy parent Guangzhou SASAC, Guangzhou promote economic development municipal government's flagship and injections, policy role of Municipal govt commits at least of Zhenjiang; govt support via economic and technology infrastructure construction in the RMB10bn/year for capex and capital injections, subsidies and development zone, on-going zone) interest expenses, over 80% payment of related interest capital injections and subsidies) debts were reported as govt debt expense and rebate of land in 2014 development cost, etc.)

Strategic / Policy Very High, executes local Medium (only gov't-linked entity Medium (the company has been Medium (one of the urban role government's urban transit in the Zhenjiang New Zone to designated to develop large- development companies in policy, one of the largest mass promote economic development scale urban infrastructure Xuzhou Municipality and is the transit enterprises in China of Zhenjiang) projects in the zone) sole investment and financing platform in the municipal government's flagship economic and technology development zone)

Economic High (any disruption to metro Medium (constrained by small Medium (constrained by small Medium (constrained by small importance services would likely result in size and city/district-level size and city/district-level size and city/district-level severe negative effects on local operation) operation) operation) economy) Index eligibility JACI JACI JACI JACI

Source: Moody's, S&P and Fitch, J.P. Morgan.

26 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Table 10: Background of LGFVs (continued) Gansu Provincial Highway Bond issuer Beijing State-owned Asset Nanjing Yang Zi State-owned Chang Development Aviation Tourism Investment Management Co. Investment Group International Limited Group Co. Ticker BJSTAT '20s, '25s NJYZSO '22s, '27s CCUDIH '20s GSHIAV '19s

Bond structure Keepwell Directly issued by NYSI Guaranteed by CCDG Directly issued by GHAT Ranking Senior unsecured Senior unsecured Senior unsecured Senior unsecured Bond ratings A3/A-/A Baa1/BBB+/A- Baa1/-/- -/BBB-/BBB- Issuer ratings) A2/A/A Baa1/BBB+/A- Baa1/-/- -/BBB-/BBB- Standalone rtgs Baa3/BB/- B1/B/- Baa3/-/- /BB+/B- Notches 4/6 6-7 2 1/6 Govt ownership 100% 100% 100% 100% Shareholder 100% owned by Beijing SASAC 100% owned by Nanjing 100% owned by Changchun 100% owned by Gansu SASAC structure Municipal Government through SASAC Dept of Jiangbei New Area Administrative Committee Main business and Investment holdco involved in Responsible for public The company develops key The Company builds and market position financial services, environmental construction works including infrastructure projects, including operates toll-road projects, protection, modern manufacturing infrastructure, public housing and land-development to building tourism and financial services and technology, culture, tourism primary land development, affordable public housing and etc. etc. diverse businesses. Has industrial park management and providing water supply and clear mandate from government being the utilities provider in the sewage treatment for its role within these sectors new area

Shareholder Beijing as the capital has high Nanjing is the capital and semi- Changchun is the capital and the Gansu is a province in northwest strength political and economic provincial level city of Jiangsu largest city of Jilin Province, an China, and has relatively small prominence, though credit/GDP is province, and has one of the upper tier province itself. GDP which ranks 23rd out of 31 much higher than national higher GDPs per capita among Changchun is an important mainland China provinces. In the average at 349% semi-provincial cities and stable industrial base with a focus on central government's 13th Five- economic growth; Nanjing's GDP automobile sector, has GRP Year Plan for 2016-2020, Gansu per capita ranks 3 out of 13 in growth rate of 8% for 1H17 amid aims to position as China's Jiangsu province economic rebalancing and a western transportation hub national revitalization program Linkage and High - BSAM supports Beijing's High - Flagship LGFV platform High - CCDG is Changchun’s High - Sole road infra developer importance to economic development, and with clear policy role to develop largest SOE, key utility company the province and also manages parent undertakes political and social Jiangbei New Area in Nanjing for government and monopoly and operates key scenic areas responsibilities; received over and redevelopment program in position in water and sewage on behalf of the provincial RMB11 billion in equity infusion Nanjing city. One of largest treatment in the city. Receives government; increasingly from government and mandated LGFV in Nanjing. regular government grants. important as the province to execute several high profile becomes a key part of China's govt projects including Olympics) the Belt and Road initiative) Strategic / Policy Very High - policy goals and run a Medium - Jiangbei New Area is High – The credit is present in Medium - transportation role portfolio including healthcare, the only state-level new area in strategic public utilities which infrastructure construction technology, property Jiangsu. Social role currently is serve an essential social role. business is not critically strategic development, finance, sports and bit limited as developing new Policy role for companies in this although they typically have high manufacturing etc., holds stakes area. sector with dominant market earnings visibility. in key Beijing financial institutions share becomes critical Economic High - runs key industrials Medium - The new area is High - Largest local SOE and Medium - one of largest LGFV in importance projects, supports urban expected to be the main growth hence decent economic province, this is however offset development and manages engine for Nanjing but only in importance by ~30x net leverage and hence assets in industries of Beijing medium to long term high state dependence

Index eligibility JACI JACI JACI JACI Source: S&P, Moody's, Fitch, J.P. Morgan.

27 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Table 11: Background of LGFVs (continued)

Changsha Pilot Investment Jinan West City Investment & Xihui Haiwai Investment Qingdao Conson Development Bond issuer Holding Co. Development Group Holdings Co. Group Co.

Ticker CSPLIN '19s JNXCCC '21s XIHUI '19s CONSON '20s Directly issued by Changsha Bond structure Pilot Directly issued by JWC Keepwell Guaranteed by Qingdao Conson Ranking Senior unsecured Senior unsecured Senior unsecured Senior unsecured Bond ratings -/BBB-/BBB- -/BBB-/BBB -/BBB/BBB+ -/BBB/BBB+ Issuer ratings) -/BBB-/BBB- -/BBB-/BBB -/BBB/BBB+ -/BBB/BBB+ Standalone rtgs /BB-/- /B/- /B/- /B/B Notches 3 5 6 6/7 Govt. ownership 100% 100% 100% 100% Shareholder 100% owned by Changsha 100% owned by Jinan SASAC 100% owned by Wuxi Municipal 100% owned by Qingdao structure SASAC Government Municipal Government

Main business and Primarily involved in land and Largely in infrastructure Wuxi Construction engages in Provides financial investment market position property development urban construction projects, housing property development and services including securities, development projects etc. Also construction, municipal management activities. asset management, small loans, provides financing services but infrastructure construction, Mandated by government to guarantees, and equity land development is majority of tourism development, leasing develop roads, bridges, sewage industries. Also invests in real revenues. and property management, hotel treatment plants etc. estate, infrastructure management, and oil business construction, tourism, hotels

Shareholder Changsha is the capital and most Jinan is the provincial capital of Wuxi is a city in Jiangsu Qingdao municipality is a semi- strength populous city of Hunan province; Shandong, the third largest province, which has relatively provincial-level city, located in Changsha has healthy GDP economy in terms of gross healthy GDP size and growth China's Shandong Province. growth and strong fiscal income, regional product (GRP). The and is one of the strongest Qingdao's GRP ranks 12th out of supported by diversified and well- municipal economy is largely economic regions in terms of the country's over 300 cities. The developed industries driven by tertiary industries such GRP municipality has a healthy fiscal as tourism and logistics performance and diversified socio-economic profile

Linkage and High - major local government High (Was largest SOE, now the High (The keepwell provider High (the government flagship importance to financing vehicle in Hunan key subsidiary of the largest (Wuxi Construction) is wholly investment entity and is also parent Xiangjiang New Area that carries SOE, integration of JWC with the owned by Wuxi government and Qingdao's major primary land out the government's strategic municipal budget; strategic reports to Wuxi Department of developer and financial service development plans for the area) importance of JWC's public- Finance; it has received platform) sector business to the CNY18bn in capital injection municipality) since establishment)

Strategic / Policy Low - Business limited to Medium - Businesses in less Medium - WCDI is Wuxi's major Medium - The company is wholly role property development in critical sectors and has limited urban public infrastructure owned by the government and Xiangjiang New District. Hence, geographical scale but large development and investment develops the municipality's public not a very strategic role in our current operations which platform and plays an important infrastructure and has been view although it has exclusive increase social importance. role in implementing Wuxi's assigned a number of important development rights. blueprint of urban development urban infrastructure projects, including Qingdao Jiaozhou Bay Tunnel) Economic Low (constrained by the High - Largest LGFV group in Medium - Majority of assets are Medium - Second largest of three importance concentration of business in a Jinan by assets after government projects and funding platforms for Qingdao small area in Changsha). Also, reorganization along with its receives financing plan etc. government. Standalone profile govt reimburses full development parents JNUCG). Very weak needs provincial government is weak though. Also Qingdao costs and 60% of profits so standalone financials, though approval first government has bit weaker dependence is high provincial credit profile Index eligibility JACI JACI JACI JACI Source: Moody's, S&P and Fitch, J.P. Morgan.

28 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Table 12: Background of LGFVs (continued) Zhuzhou City Construction Guangxi Communications Yiwu State-Owned Capital Shanxi Road & Bridge Bond issuer Development Group Investment Group Co. Operation Co Construction Group Ticker ZZCITY '19s GXCMIN '19s YWSOAO '20s SXROBR '19s Bond structure Directly issued by ZCCD Directly issued by GCI Guaranteed by YWSCOC Directly issued by SRBC Ranking Senior unsecured Senior unsecured Senior unsecured Senior unsecured Bond ratings Baa3/-/BBB- Baa3/-/BBB Baa3/-/BBB -/BB-/- Issuer ratings) Baa3/-/BBB- Baa3/-/BBB Baa3/-/BBB -/BB-/- Standalone rtgs B1/-/B B1/-/- Ba3/-/- -/B/- Notches 4/5 4 3 2 Govt. ownership 100% 100% 100% 100% Shareholder 100% owned by Zhuzhou 100% owned by Guangxi SASAC 100% owned by Yiwu SASAC 100% owned by Shanxi SASAC structure Municipal Government Main business and Essential public services where it The company engages in the Primarily real estate The company provides a market position has monopoly position in most construction, operation, development. It also operates in comprehensive selection of sectors it is present in, including maintenance and toll collection of market management, services related to the water supply and sewage roads and facilities. It is also merchandising, passenger investment, construction, and treatment plants, city gas involved in the investment and transportation, warehousing and operation of expressways distribution, public transport etc. management of real estate; and logistics, water, infrastructure, financial industry, logistic, hotel service, exhibition and resource development, road, advertising, and other business energy, municipal infrastructure, segments and construction projects Shareholder Zhuzhou City is Hunan’s second Guangxi is the only provincial Yiwu is a county-level local and Shanxi province is located in strength largest city and part of the government in the China Western regional government (LRG) North China and it is less ChangZhuTan Golden Triangle; Development plan with a region, known for commodity developed due to geographic Zhuzhou continues to report coastline and seaports, making it trading incl. wholesale markets. limits in its participation in trade. stable budget performance and a key import-export gate for west Economic strength was ranked Industries in Shanxi is centered benefits from a diversified socio- China. It also benefits from 6th out of over 2,800 county-level around heavy industries such as economic profile. Its GRP per favorable central government LRGs in China, per an affiliate of coal and chemical production capita remains above that of policies, including ASEAN–China the China Ministry of Industry Hunan Province and national avg Free Trade Area and Information Linkage and High – implements mainly non High - GCI is responsible for High - YWSCOC is the sole Medium – An important (not sole) importance to commercially viable and public operating around 70% of the toll platform in Yiwu and toll road developer and operator parent utility projects; largest SOE in roads within Guangxi Province consolidates its major state Shanxi. It has a policy role and Zhuzhou city, almost 50% of its owned operational assets. social responsibility to provide an assets. Sectors such as infrastructure essential public good in Shanxi construction, water supply, property redevelopment etc.

Strategic / Policy High - primary vehicle in urban High - sole SOE for developing High - infrastructure construction, Low - Toll road financing and role planning, infra and construction the province’s expressways for a resettlement housing, water highway bridge construction etc). Receives financial support landlocked province in SW supply, sewage treatment, food business is bit more commercial from got budget allocation China. GCI is responsible for reserves and forest preservation; in our view and hence not as through regular grants and cash operating around 70% of the toll also designated to operate state- critical as businesses of some infusion. Most of debt reclassified roads within Guangxi, owned assets, including other LGFVs here. as govt debt in 2014’s debt swap contributing largely to the land wholesale trading marts, public program. connectivity of the region transportation and an inland port Economic High - ZCCD is the primary High (one of the largest SOEs in Medium- Main arm to provide Medium - a market leader in importance investment and financing vehicle Guangxi by assets and the sole Yiwu's public-sector services and provincial toll road and highway of Zhuzhou City, largest SOE SOE in Guangxi that is receive monetary and non- construction, having its strong accounting for 50% of its responsible for developing the monetary support from Yiwu track record of handling 70% of Zhuzhou SASAC’s assets province's expressway network) Municipal Government Shanxi’s toll road projects Index eligibility JACI JACI JACI JACI Source: Moody's, S&P and Fitch, J.P. Morgan

29 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Table 13: Background of LGFVs (continued) Xi'an Municipal Infrastructure Qinghai Provincial Investment Oriental Capital Company Bond issuer Construction Investment Wuhan Metro Group Group Limited Group Corp. Ticker QHINVG '20s XANCON '19s WHMTR '19s DFINVH '19s Bond structure Directly issued by QPIG Directly issued by XICI Directly issued by WMG Keepwell Ranking Senior unsecured Senior unsecured Senior unsecured Senior unsecured Bond ratings -/BB-/- -/-/BBB A3/-/A -/-/BB+ Issuer ratings) -/BB-/- -/-/BBB A3/-/A -/-/BB+ Standalone rtgs -/B-/- NA Ba3/-/- -/-/B Notches 3 NA 6 4 Govt. ownership 100% 100% 100% 100% Shareholder Qinghai SAAC & Western Mining 100% owned by Xi'an Municipal 100% owned by Wuhan SASAC 100% owned by Yancheng structure Group own 69.3% of QPIG. Government Municipal Government Main business and The company operates as an The company is a utility The company constructs, The company offers market position integrated aluminum producer, company, selling piped natural operates, and manages rail infrastructure and housing 1.45mtpa capacity. Also has gas to residential and non- transit. It is also involved in land construction services. Also 1.2GW power plant. Bu high cost residential users; constructs reserve, property development, manages parks and commercial of production, not fully integrated. natural gas pipelines and resource management, and real estate operations, property facilities; and constructs and financing activities leasing, protection of housing operates gas stations. construction, O&M of infrastructure and municipal utilities projects

Shareholder Qinghai province is a tier-1 local Xi'an is the capital of Shaanxi Wuhan ranks amongst the top-10 Yancheng is ranked 7th out of 13 strength government under China's Province and the largest city Chinese cities by GRP; has cities by GRP, in Jiangsu. administrative within the province in terms of strong fiscal performance, a division hierarchy; its economic population and economy; GRP of diversified socioeconomic profile profile is relatively weak (rank Xi'an made up 33% of the and a strategic location as being 18th among 31 provincial province's and it was well above in central China economies in GDP per capita) national growth in the past few years Linkage and Low – The company is a Medium - Dominates the markets High – Is registered as local SOE High – Yancheng Oriental is importance to relatively small aluminum for gas, heat, public under Chinese company law. largest LGFV in the city for infra parent producer with management transportation in Xi'an and city’s Sole metro operator and & property development etc. Also appointed by govt but should be budget integrates the company’s executes urban transportation has the Sino-Korea Industrial a small company for the province financials. Had its debt replaced policy. Park, established under a Sino- given its scale. Is not very by government debt in debt-swap Korea FTA. profitable too. program in 2016

Strategic / Policy Low –aluminum production is not Low - leading distributor of piped Very High – As sole metro Medium – involved in infra and role in a sensitive or strategically gas in Xi'an, a business which we operator in Wuhan, it is one of development projects and hence important sector, in our view. think can be easily replicated by the core SOEs in Wuhan, in our is a somewhat strategic LGFV private players and hence is not view. Managed appointed by but the sector is more of medium too strategic in nature government, strong oversight strategic importance in our view and receives regular capital injections from govt Economic Low - small scale of operation, Medium – Xi’an’s largest public High (any disruption of metro Low – With 60% of revenues are importance limited product and geographic sector entity and the primary would likely to severely impact generated by govt itself, diversity, not very profitable and public service provider in Xi'an, the local economy) economic importance seems low. hence limited contribution to controls ~75% of supply, ~30% of Receives capital injections from province gas stations, 70% of public government though, very weak transportation financials Index eligibility JACI JACI JACI JACI Source: Moody's, S&P and Fitch, J.P. Morgan.

30 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Table 14: Background of LGFVs (continued) Qingdao City Construction Changde Urban Construction Inner Mongolia High-Grade Bond issuer Zhuhai Huafa Group Investment Group Investment Group Co. Highway Ticker QDCCIZ '20s, '22s, '25s CHADEC '19s ZHHFGR '20s NMHIGH '20s Bond structure Keepwell+USD SBLC Directly issued by CUCI Guaranteed by Zhuhai Huafa Directly issued by IMHCD Ranking Senior unsecured Senior unsecured Senior unsecured Senior unsecured Bond ratings -/-/BBB+ -/-/BBB- -/-/BBB -/-/BBB- Issuer ratings) -/-/BBB+ -/-/BBB- -/-/BBB -/-/BBB- Standalone rtgs NA -/-/B NA NA Notches NA 5 NA NA Govt. ownership 100% 100% 100% 100% Shareholder 100% owned by Qingdao 100% owned by Changde 100% owned by Zhuhai SASAC 100% owned by Inner Mongolia structure Municipal Government SASAC Autonomous Region Government Main business and The company engages in the Urban and affordable housing The company engages in urban The company engages in the market position construction and development of construction, infra, land operations, real estate operation and management of urban and rural projects. The consolidation and development, development and trade logistics highways in the region, also company is also involved in the upstream and downstream etc. The company’s operations finances key road construction municipal engineering; civil air industry chain management as include urban renewal projects projects on behalf of the defense development and well as construction of roads, and infrastructure facilities, port government operation; and real estate bridges, and parks etc. investments and construction of development and management housing projects; and real estate and asset management activities comprise residential businesses, as well as provides and affordable housing funds for foreign investment development etc. Shareholder Qingdao is Shandong’s largest Changde is the third-largest Zhuhai municipality has average Inner Mongolia is positioned as strength city, has solid budgetary economy in Hunan province in budgetary financials but is a strong industrial hub in performance, decent fiscal terms of GRP and ranks among relatively small in size. Also, northern China, mining (coal, iron flexibility due to its special status the first quartile of all China's there are contingent liabilities ore, rare earth) are key that grants it provincial-level prefecture-level cities. Changde's from its state-owned entities, per resources along with wind economic management authority GRP growth outperformed the Fitch which could increase energy. Ranked 16th out of 31 provincial and national average, leverage provinces while its budgetary performance improved over the years Linkage and High - QCCI is the 2nd largest Medium – Primary land Medium – Not sole player but High – Sole SOE responsible for importance to SOE in Qingdao, plays an developer in and around the city. plays an important role in development of the region’s parent important role in implementing Implements the city’s blueprint implementing urban development highway network. Company the infra construction, property plans for urban planning and projects. Also owns majority of operates key regional highways, development, waste water muni development Zhuhai Financial Inv - a key roads and as financing vehicle management, tourism, financial holdco for other SOE for road construction services. subsidiaries.

Strategic / Policy Medium - QCCI serves as a key Low – While a key player in land Low-Medium – One of the (not Medium – Similar to Shanxi role urban infrastructure investment development, we see the scope sole) developers of new projects Road, operating key highways company for Qingdao as bit more limited compared to limits the scope of policy role but and roads is not very critical from Municipality and carries out other LGFVs that we discuss investment arm for ownership in social role perspective. state-owned asset management. here other FIs and industrials Nevertheless, is a sole SOE While has some public utility increases is slightly doing this and hence policy role businesses, primary business is is not low as well more commercial in nature Economic Medium – Asset size as % of Medium – Since it is the Medium – While receives Medium - Total highways are importance total assets is relatively low government arm for urban subsidies from govt, it is mainly ~40% of all the region’s highways compared to the core LGFVs construction, main profit to support upfront capex. Also, as of mid-2017. Weak credit contribution could be coming authorized to conduct primary metrics (net leverage of 12-14x) from govt projects itself land sales to external customers. though. Index eligibility JACI JACI JACI JACI Source: Moody's, S&P and Fitch, J.P. Morgan.

31 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

Table 15: Background of LGFVs (continued) Chongqing Western Modern Chengdu Xingcheng Chengdu Communications Bond issuer Logistics Industry Zone Investment Group Investment Group Ticker CQLGST '21s CHDXCH '21s CDCOMM '27s Bond structure Directly issued by CQWL Directly issued by CXIG Directly issued by CCIC Ranking Senior unsecured Senior unsecured Senior unsecured Bond ratings -/-/BBB -/-/BBB+ -/-/BBB+ Issuer ratings) -/-/BBB -/-/BBB+ -/-/BBB+ Standalone rtgs -/-/B -/-/B -/-/B Notches 6 7 7 Govt. ownership 100% 100% 100% Shareholder 100% owned by Chongqing 100% owned by Chengdu 100% owned by Chengdu structure Shapingba District SASAC SASAC SASAC Main business and The company provides land The company engages in the The company engages in market position development and construction operation and management of investment, construction, services. The Company operates highways in the region, also operation, and administration of logistics park development and finances key transportation highways and traffic projects and infrastructure construction, as related projects for the it also engages in fuel sales, real well as land reserve and government. estate development, property consolidation businesses management, rental, design, production, publishing, advertising, energy, and transportation business Shareholder Chongqing is one of the four Chengdu is Sichuan Province’s Chengdu is Sichuan Province’s strength central govt directly owned capital, is one of the six large capital, is one of the six large municipalities and its GRP cities designated as National cities designated as National growth was the fastest in China Central Cities to take the lead in Central Cities to take the lead in among all the provincial-level balancing national development. balancing national development. local governments, while its GRP Chengdu was ranked 8/333 Chengdu was ranked 8/333 per capita was ranked 10th municipalities by GRP, in 2016. municipalities by GRP, in 2016. Linkage and Medium - CQWL is the sole Medium – Primary (not sole) High – Sole SOE responsible for importance to developer and operator of platform for land, city infra and development of the region’s toll- parent Chongqing Logistics City, a affordable housing development. road network, also invested in national logistics hub under Credit’s debt integrated with the railways and Tianfu Int’l airport OBOR and Yangtze River government’s local debt on behalf of the government. Economic Belt initiatives. Receives grants and project subsidies and was part of govt’s debt-swap program Strategic / Policy Low – While it is the sole Medium – While a key player in Medium – Similar to Shanxi Road role developer, the underlying assets infrastructure and property and Inner Mongolia Highway, are not as critical as public utility development segment, we see operating toll-roads is not as assets and hence has limited the scope as bit more limited strategic as public utility in our social role, in our view. compared to other LGFVs that view, but investing in other Eventually though, this could be we discuss here transportation projects on govt’s medium as operations increase behalf improves the social role in scale somewhat. Economic Low – While receiving subsidies, Medium – financials Medium – Has some integration importance financials is not consolidated with consolidated, but majority of with the city’s budget and govt budget. Majority of revenues revenues from government. Part receives grants but overall scale sourced from city itself of debt-swap program not too material Index eligibility JACI JACI JACI

Source: Moody's, S&P and Fitch, J.P. Morgan.

32 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

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 Market Maker/ Liquidity Provider: J.P. Morgan Securities plc and/or an affiliate is a market maker and/or liquidity provider in securities issued by Yanzhou Coal, Wuhan Metro Group.  Market Maker/ Liquidity Provider (Hong Kong): J.P. Morgan Securities (Asia Pacific) Limited and/or J.P. Morgan Broking (Hong Kong) Limited and/or an affiliate is a market maker and/or liquidity provider in the securities of Yanzhou Coal and/or warrants or options thereon, which are listed or traded on The Stock Exchange of Hong Kong Limited.  Client: J.P. Morgan currently has, or had within the past 12 months, the following entity(ies) as clients: Yanzhou Coal.  Client/Investment Banking: J.P. Morgan currently has, or had within the past 12 months, the following entity(ies) as investment banking clients: Yanzhou Coal.  Client/Non-Investment Banking, Securities-Related: J.P. Morgan currently has, or had within the past 12 months, the following entity(ies) as clients, and the services provided were non-investment-banking, securities-related: Yanzhou Coal.  Investment Banking (past 12 months): J.P. Morgan received in the past 12 months compensation for investment banking services from Yanzhou Coal.  Investment Banking (next 3 months): J.P. Morgan expects to receive, or intends to seek, compensation for investment banking services in the next three months from Yanzhou Coal.  Non-Investment Banking Compensation: J.P. Morgan has received compensation in the past 12 months for products or services other than investment banking from Yanzhou Coal.  Other Significant Financial Interests: J.P. Morgan owns a position of 1 million USD or more in the debt securities of Yanzhou Coal, Wuhan Metro Group, Beijing State-Owned Assets Management. Company-Specific Disclosures: Important disclosures, including price charts and credit opinion history tables, are available for compendium reports and all J.P. Morgan–covered companies by visiting https://www.jpmm.com/research/disclosures, calling 1-800-477- 0406, or e-mailing [email protected] with your request. J.P. Morgan’s Strategy, Technical, and Quantitative Research teams may screen companies not covered by J.P. Morgan. For important disclosures for these companies, please call 1-800-477- 0406 or e-mail [email protected].

Yanzhou Coal - J.P. Morgan Credit Opinion History Date Action Rating/Designation Ticker/ISIN Issuer 06 May 16 Upgrade Neutral YZCOAL Issuer 08 Jul 16 Upgrade Overweight YZCOAL Issuer 14 Oct 16 Downgrade Neutral YZCOAL Issuer 24 Jan 17 Withdrawn Not Rated YZCOAL 4.461% '17 11 Sep 15 Downgrade Underweight USY97279AA45 4.461% '17 30 Sep 15 Upgrade Neutral USY97279AA45 4.461% '17 08 Jul 16 Upgrade Overweight USY97279AA45 4.461% '17 14 Oct 16 Downgrade Neutral USY97279AA45 4.461% '17 12 Jan 17 Terminate Not Covered USY97279AA45 5.730% '22 17 Nov 15 Upgrade Neutral USY97279AB28 5.730% '22 24 Jan 17 Withdrawn Not Rated USY97279AB28 7.200% Perps 19 Nov 15 Upgrade Overweight XS1070575953 7.200% Perps 24 Mar 16 Downgrade Neutral XS1070575953 7.200% Perps 16 Sep 16 Terminate Not Covered XS1070575953

*Indicates representative/primary bond/instrument.

33 Varun Ahuja, CFA Asia Pacific Credit Research (852) 2800 6038 04 June 2018 [email protected]

Tiantian Teng (852) 2800-7024 [email protected]

The table(s) above show the recommendation changes made by J.P. Morgan Credit Research Analysts in the subject company and/or instruments over the past three years (or, if no recommendation changes were made during that period, the most recent change). Notes: Effective April 11, 2016, J.P. Morgan changed its Credit Research Ratings System. Please see the Explanation of Credit Research Ratings below for the new definitions. The previous rating system no longer should be relied upon. For the history prior to April 11, 2016, please call 1-800-447-0406 or e-mail [email protected]. Explanation of Credit Research Valuation Methodology, Ratings and Risk to Ratings: J.P. Morgan uses a bond-level rating system that incorporates valuations (relative value) and our fundamental view on the security. Our fundamental credit view of an issuer is based on the company's underlying credit trends, overall creditworthiness and our opinion on whether the issuer will be able to service its debt obligations when they become due and payable. We analyze, among other things, the company's cash flow capacity and trends and standard credit ratios, such as gross and net leverage, interest coverage and liquidity ratios. We also analyze profitability, capitalization and asset quality, among other variables, when assessing financials. Analysts also rate the issuer, based on the rating of the benchmark or representative security. Unless we specify a different recommendation for the company’s individual securities, an issuer recommendation applies to all of the bonds at the same level of the issuer’s capital structure. This report also sets out within it the material underlying assumptions used.

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Tiantian Teng (852) 2800-7024 [email protected]

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