Despite an increase in new issuance in the primary market, the widened spread of onshore local government financing vehicle (LGFVs) bonds in the secondary market reflects concerns among onshore bond investors.

According to China Chengxin International Credit Rating, as of Q1, China's LGFVs have issued 645 new onshore bonds with a total amount of 569.8 billion yuan, up 103% from same period last year. Net financing amount hit 200.7 billion yuan. However, in the secondary market, the credit spread of AAA、AA+、AA、AA- rated onshore LGFV bonds widened by 2bps, 3bps, 8bps and 4bps respectively, per Industrial Securities. In Q1, the average credit spread of onshore LGFV bonds was 268 bps.

China's central bank issued a new asset management regulation in April prohibiting the implicit guarantee of return of asset management products from banks. The new regulation reflects China's determination to clamp down on the shadow banking sector and is likely to impact issuers' access to funding.

According to S&P Global Ratings, China's regulators are making it harder for heavily indebted municipalities and provinces to borrow through LGFVs. "The Chinese government's financial deleveraging campaign has led banks to unwind the off-balance-sheet funding that some companies have relied on to finance aggressive business expansion in the past several years," said S&P Global Ratings credit analyst Christopher Lee.

China has seen several onshore bond defaults so far in 2018, many relating to private companies reliant on shadow banking. Wind data shows that as of 11 May 2018, 20 issues from 10 issuers have defaulted. The issuers include China City Construction Holding Group Company, Dan Dong Port and Kaidi Ecological And Environmental Technology. "Most of the defaulting entities have deteriorating credit profiles and the type of highly leveraged capital structures that compound losses," said Lee.

2017 was a record high for offshore bond issuance from Chinese issuers. Yet in 2018, the interest rate hike in the US lifted offshore financing costs, deterring many low-quality issuers from tapping the US dollar offshore market.

The other constraint for offshore bond issuance is the weakening "China bid", where large Chinese issuers issue dollar bonds at low cost and invest in high yield Chinese offshore bonds. Per S&P, abundant liquidity pushed down bond yields for Chinese companies. The bid is weakening because of higher funding costs and derisking.