Why China's planned railway operation restructuring is a boon for banks

Chinese banks hold a large portion of the RMB759 billion of bonds.

According to Moody's, China’s State Council announced it would abolish the Ministry of Railway (MOR), transferring the former ministry’s railway supervisory function to the Ministry of Transport and its railway transportation business to a new entity, China Railway Corporation (CRC). The State Council also confirmed that public support to the sector will continue.

Here's more from Moody's:

This development is credit positive for Chinese banks, which hold a large portion of the RMB759 billion of bonds that the MOR issued and whose exposure to the former ministry totals more than RMB1.3 trillion (or 2% of banking system loans).

We expect the CRC to continue to benefit from strong public support, but to have stronger corporate governance and more funding channels than its predecessor. This will improve its credit quality, which will benefit its key creditor banks.

These banks include China Development Bank, China Construction Bank Corporation, Industrial & Commercial Bank of China Ltd., Agricultural Bank of China Ltd. and Bank of China Limited.

The announcement removes uncertainty regarding the new government’s agenda to support railway operators, particularly the RMB2.7 trillion of liabilities as of the end of September 2012 that the CRC will inherit from the MOR.

The State Council confirmed with its announcement that current government policies on financing railway operations will remain in place. Railway construction bonds will continue to be government supported, and railway operators will continue to enjoy preferential tax treatment and exemptions from dividend upstream requirements.

This support is important considering the MOR’s poor financial standing and its lack of a viable business model. The MOR had a leverage ratio of 61.8% as of September 2012 and had incurred a loss of RMB8.5 billion in the first nine months of 2012.

Given its massive workforce and the social effects of the MOR’s plan to increase fares, MOR’s restructuring into a corporate entity capable of conducting large-scale external financings on its own will, like other central state-owned enterprises, take years.

We also think CRC will require additional measures to clean up its balance sheet. However, the fact that CRC continues to have explicit government support is a key factor sustaining its credit.

Beyond public support, we also expect the reform, which aims to more clearly separate the policy roles and commercial aspects of China’s railway operation, to improve the CRC’s credit quality as a standalone railway operator through stronger transparency, governance and oversight.
We expect CRC to remain reliant on bank loans for funding.

We also acknowledge that it will take time for CRC to transform itself into a full-fledged business entity. However, the restructuring of the former Ministry of Power and Ministry of Coal suggest that some of CRC’s profitable operations and projects could gain access to broader funding channels such as equity investments, thereby reducing its dependence on bank loans and the concentration risk that poses to banks.