Chinese investors grapple with financial implications of debt-equity swaps
Replacing ‘normal’ loans with equities would entail a much higher capital charge, analysts warn
The debt relief programme for troubled companies operated by China’s Big Four banks has ballooned from zero to nearly 300 billion yuan within three months, but some suggest it looks more like a black hole, as investors with scant information grapple its financial implications.
Interviews conducted by the South China Morning Post with banking and local government officials, and analysts, provided conflicting views on its worth to the sector.
The government and private companies are enthusiastic as it allows firms to replace their sky-high debt with interest-free equities, effectively reducing their leverage.
However, the sentiment is mixed for banks because on the one hand, such a swap avoids a potentially damaging liquidation that would mean significant losses for creditors, while on the other the newly added equities would put pressure on banks’ capitalisation.
Among the Big Four state-owned banks, China Construction Bank Corp, the nation’s second-largest lender, took the lead with 200 billion yuan worth of debt-for-equity swap agreements. Industrial and Commercial Bank of China, the country’s biggest bank, has signed about 60 billion yuan worth deals so far, while the other two – Bank of China and Agricultural Bank of China – split the rest, public records show.
All the beneficiaries are state-owned enterprises, mostly in the coal, steel and metal sectors that are plagued by overcapacity.
What is intriguing is that few of the loans involved are bad loans on account. Rather, they are “normal” loans that are unlikely to default.
Liao Qiang, an S&P Global Ratings credit analyst, said this had significant implications for bank capitalisation.
“If banks are swapping a non-performing loan for equity investment, there should be less concern about the capital charge because the carry value of the loan normally is only a fraction of its face value after [the loan is done],”Liao said. “But if it is a ‘normal’ loan without any specified loan-loss provisions, it would entail a much higher capital charge after the swap.”
It is impossible to quantify actual capital losses for the time being, given that the size of the swaps and the breakdown between normal loans and non-performing loans was not known, he said.
Adding to the uncertainty is the fact that many of the detailed clauses in each agreement are unavailable to the public.
For example, deeply indebted Yunnan Tin Group secured a 10 billion yuan equity injection in December from CCB Trust and other unspecified investors – in the first debt-for-equity swap deal signed by CCB.
Yunnan Tin committed to buy the shares back within three years if its management failed to meet “expectations”. In terms of pricing, the loans are recognised at their face value to swap with unspecified stocks, but the transactional stock price is not known. Also unknown is how many deals contain buy-back options.
“The buy-back implies that the equity injection is temporary and essentially makes this transaction a three-year refinancing with delayed interest payment … the eventual loss could be bigger if creditor banks provide new money. The banks also face reputation risk if the investment is loss-making,” said a report by Moody’s Investors Service.
Giving creditors a guaranteed return betrayed the central government’s intention to cut corporate debt, but in the absence of certain promises and given a lack of creditors’ involvement in the companies’ management, the deal was not commercially viable for banks, experts said.
CCB, however, is pitching the deals as “innovative financial services”. Board secretary Chen Caihong emphasised in a January briefing that the bank acted as the lead coordinator for fundraising and just contributed part of the capital.
However, he declined to say whether CCB’s on- or off-balance sheet wealth management products had participated.
Banks may only contribute to a portion of the fund with their own capital, but Liao believes lenders cannot transfer the equity investment risks to the wealth management product investors because of implicit credit support the banks provide to those products.
In the case of third parties contributing to the majority of such funds, Liao expects they will most likely be state-owned asset management companies or insurers because private investors are unlikely to participate given the limited returns.
The upside is that surging commodity prices over the past year have erased some of the bailout firms’ losses. The benchmark price of steam coal at Qinghuangdao port has surged 61 per cent over the past year. Of the 17 listed coal firms that have pre-announced 2016 earning, 12 reported profits. The scale of swaps could taper off if commodity prices continue to recover this year.
An official with a provincial asset management company, who requested anonymity, said the “overcapacity shedding” policy was a bonus to major state firms, as was their smaller peers’ capacity that was cut. Coke firms in his province that signed swap deals with CCB in 2016 have reported profits.
Still, these firms were highly indebted, mostly relying on loan rollovers to stay afloat, the official said. “The swap just solved the problem for the time being. The fundamental problem still not addressed is the low efficiency and gigantic social burden carried by state firms,” he said.