CITIC Securities' 2025 Urban Investment Outlook: Debt Reduction in the Second Half, Moving from Urban Construction to Industry Empowerment.

CITIC SEC released a research report stating that regarding the debt issues of local governments, debt resolution can only solve the expenditure side, while the revenue side of local governments still faces challenges. The traditional land finance model that local governments heavily relied on in the past is expected to not be able to be replicated, and future government development needs to find new paths. For financing platforms, debt resolution is just the first half, while innovative development is the key focus of the second half. As infrastructure development is crucial for local government development in the era of construction, after lightening the load, they should also take on new responsibilities to promote the transformation of local government investment and financing, driving the development of local listed companies and new manufacturing industries. The main points of CITIC SEC are as follows: The main focus of the city investment market from 2023 to 2024 will be on debt resolution, moving from the "package debt resolution" to "hidden debt replacement". In 2023, the package debt resolution work officially started, accompanied by a series of debt resolution policies centered around Document 35, indicating the start of a new round of debt resolution work. Moving into 2024, debt resolution work will move from the "package debt resolution" to "hidden debt replacement". In terms of rhythm, various debt resolution funds will alternate, with debt resolution funds accelerating in the second half of the year. It is estimated that a total of 3.38 trillion yuan of debt resolution funds will be issued throughout the year, including 2 trillion yuan of special bond replacement, 501.8 billion yuan of special refinancing bonds, and 877.8 billion yuan of multi-purpose special bonds. Looking at the distribution of debt resolution funds by region, considering the debt pressure in each region and the size of hidden debts, the three regions of Jiangsu, Guizhou, and Sichuan are expected to receive the largest amount of debt resolution funds in 2024. Under the logic of debt resolution, city investment market financing is significantly tightening, but city investment bonds as scarce high-quality assets are still performing well. Against the backdrop of curbing hidden debts and city investment market financing tightening, as of December 13, 2024, there was a net outflow of about 393.5 billion yuan from the city investment market, with financing levels significantly lower than the average level in previous years. In addition, the net outflow of platforms at the county level with medium to low qualifications was particularly noticeable. Despite this, city investment bonds, as scarce high-quality assets in the context of asset shortage, are still performing well. Overall, city investment swap spreads are trending downward, rising slightly in the third quarter due to financial redemption pressures, then returning to a downward range after the fourth quarter, although there is still room for further decline from the lowest point of the year. In addition, to increase returns, there is a clear preference for longer-duration city investment bonds, with relatively high turnover rates for long-duration credit bonds. Where will the city investment market go in 2025? 1) It is expected that city investment financing will continue to remain tight in 2025. For 2025, it is expected that city investment financing regulatory policies will not be significantly relaxed, so the proportion of new city investment bond issuances for refinancing old debts will remain relatively high. Although there may be a slight improvement in city investment market financing compared to this year, the net financing in 2025 is expected to be -0.1 trillion yuan, continuing to remain tight. 2) It is expected that there will be further promotion of the marketization transformation of city investment platforms. The marketization transformation of city investment platforms is an inevitable path for the future development of city investment and an effective measure to alleviate local government debt pressures from the source. With further implementation of debt resolution funds, it is expected that the number of platforms announcing marketization transformation will also increase. 3) It is expected that the scale of early redemption of city investment bonds will increase in 2025. The purpose of debt resolution is to reduce the debt pressure on platforms, and early redemption is beneficial for platforms to replace high-interest liabilities earlier. With the normalization of debt resolution fund issuance, the scale of early redemption of city investment bonds is expected to increase, mainly focusing on regions where the marketization transformation of city investment is progressing quickly or where platform debt costs are still relatively high. After lightening the load, city investment platforms should also take on the responsibility of promoting local development. The core of debt resolution work is to reduce the debt pressure on local governments. We estimate that considering only the interest payments of city investment bonds, debt resolution can save interest payments of 83.6 billion yuan annually. In addition, high-interest debts previously in the form of bank loans or non-standard debt can also be converted into local government bonds, further reducing interest payment pressures. However, for local government debt issues, debt resolution can only solve the expenditure side. Spending cuts can increase the financial flexibility of local governments, but on the revenue side, local governments still face challenges. The traditional land finance model that they relied on in the past is expected to not be able to be replicated, so future government development needs to find new paths. As the right-hand man of local government development in the era of infrastructure, debt resolution will effectively reduce their own debt burdens. After lightening the load, they should also take on new responsibilities and once again become the driving force for local development. It is expected that city investment bonds will continue to be the most core asset for credit allocation in 2025. Under the main theme of debt replacement, it is expected that the risks in the city investment market in 2025 will be manageable. Furthermore, the supply of industrial bonds is difficult to reverse the trend of asset shortage in the credit market. Therefore, city investment bonds are still expected to be the most core asset for credit allocation in 2025. However, as benchmark interest rates continue to decline, the most important point of contention will be to extract the remaining yield premiums from city investment bonds. 1) There are still regional differences in the yields of city investment bonds, and weak-quality regions should look for high-yield assets. After adjustments in the credit market in the third quarter, regional differences in the yields of city investment bonds have reappeared. Before the final deadline for city investment platform retirement in 2027, the risk of default in the public bond market is low, making yield strategies the preferred choice. Among city investment bonds expiring before June 2027 with yields of 2.5% or higher, only 645.7 billion yuan, accounting for about 11%, recommend continuing to look for high-yield assets in weak-quality regions, focusing on Shandong, Shaanxi, and Sichuan in non-priority provinces and cities. 2) The key point of contention in the city investment market is the yield premium between key time points. The allocation dispute in the city investment market currently centers around the time point of June 2027, with investors differing on the cost-effectiveness of city investment bonds maturing after this time. For 2028, as the concluding year of hidden debt clearance work and with debt resolution funds still landing, we believe that the likelihood of substantial risks in the city investment market before 2028 is still low. Therefore, the key point will be to bet on the yield premiums of city investment bonds maturing within this timeframe, particularly focusing on key provinces and cities for debt resolution, such as Guangxi and Chongqing, as well as non-priority provinces and cities like Shaanxi and Henan. 3) Seizing the opportunity brought by early redemption of city investment bonds. After announcing early redemption, bond valuations generally declined.The early redemption of this urban investment bond can provide certain returns. In addition, the early redemption of urban investment bonds is usually based on face value redemption, with profit potential for some discounted bonds. It is recommended to pay attention to the following types of entities or regions: 1) Urban investment entities or regions that have sufficient funds for debt restructuring; 2) Entities with existing bonds that have significantly higher face interest rates than the market average; 3) Entities with smaller outstanding bond sizes.Risk factors: Unexpected tightening of regulatory policies; Unexpected changes in financing policies for urban investment; Unexpected monetary policy by the central bank; Impact of individual credit events; Slow progress in debt conversion work.