Jiangsu converts high-cost debt into much more affordable notes

Jiangsu province has fired the first shot in China's 1.77 trillion yuan ($285 billion) annual local government bond sales program by selling securities at a yield only slightly above that of sovereign bonds, after an initial hitch a month ago.

The province issued 52.2 billion yuan of municipal bonds on Monday, including securities to be swapped for existing debt and new general notes.

Three-year securities were sold at 2.94 percent, five-year securities at 3.12 percent and seven-year and 10-year paper at 3.41 percent, according to the ChinaBond website.

The rates are close to the lower end of the reference range, and just one basis point above the Treasury rate, enabling the province to convert its previous high-cost liability into much more affordable notes.

The sale was closely watched by China's financial market as a barometer of the 1 trillion yuan of debt swaps and 771.4 billion yuan of municipal notes set to be issued this year. Premier Li Keqiang is trying to build a transparent municipal bond system to rein in local borrowing while maintaining infrastructure investment to help an economy growing at the slowest pace since 2009.

The debt-for-bond swap plan, intended to alleviate pressure on the servicing of local government debt, hit a hiccup on April 23 when Jiangsu's initial 64.8 billion yuan issuance plan was delayed because of a failure to agree on a price with the banks. The delay prompted market concerns over whether other regional governments could successfully sell their bonds. A landmark document, jointly issued by the Ministry of Finance, the People's Bank of China and the China Securities Regulatory Commission on May 8, transformed the dynamics.

At the center of the plan is a requirement that banks have to accept a minimum amount of bond placements, as defined by their pro rata share of an issuing local government's total debt to be swapped.

In response to apparent concerns over the cost to local governments of issuing the bonds, the document stipulated that interest on the new securities cannot exceed the Treasury rate for the same tenure by more than 30 percent.

The stipulation, though criticized by some observers as going against the "market-oriented" principle, ensured the low rate of Jiangsu's bonds. The bonds were sold on the open market instead of by private placement, but the auction was held under the strict guidance of the authorities.

"The result did not surprise me," said Sun Binbin, an analyst at China Merchant Securities. "The restrictions, including a 15 percent float ceiling above average Treasury rate in the five-day period before auction, ensured it was sold near the sovereign rate."

Commercial banks were initially reluctant to swap the bonds, as earlier loans to local governments had interest rates of between 7 and 8 percent.

It remains unclear whether other provinces will be able to match Jiangsu's price. Thirty-six regional and city governments have been asked to complete the 1 trillion yuan sale before August 31, and the Xinjiang Uygur autonomous region is set to sell 5.9 billion yuan of bonds on Thursday.