Debt-to-equity swaps will remain a focus in 2017
But analysts suggest the benefits for the banks has been limited so far, and are now urge more transparency in the deals being made
Chinese debt-for-equity swap (DES) agreements will remain a key focus this year, following the long-awaited kick-off of the scheme last year.
Since China’s policymakers re-launched the scheme in October to ease the borrowing overhang of struggling firms, and the country’s state-run banks and bad debt managers have rushed to sign deals with big state-owned enterprises.
But analysts suggest the benefits for the banks has been limited so far, and are now urge more transparency in the deals being made.
The last year marked a milestone for the DES deals in China, in an effort to lower corporate debt and the banking system’s bad-debt ratio.
Bank of Communications last week announced it had set up Bocom Asset Management Company for DES business with a registered capital of 10 billion yuan, becoming the latest of China’s “big four” commercial banks to established a dedicated asset management arm for the DES scheme.
Debt-to-equity swaps are programmes to help reduce corporate financial leverage, improve corporate governance and enhance long-term development. They are transactions by which the obligations or debts of a company or individual are exchanged for something of value, usually equity.
During the last quarter of last year, around 20 corporations announced DES agreements with large commercial banks or asset management companies, with total disclosed amounts reaching 242 billion yuan.
“It’s a sizable amount, but still small compared with the total 227 trillion yuan value of the Chinese banking system. We believe more deals are coming,” said Christine Kuo, analyst at rating agency Moody’s.
The market saw an sharp increase in the number of DES schemes set up in December, because banks are eager to grab the best projects, said Sun Binbin, analysts at TF Securities in a research report.
China Construction Bank has become the market leader after launching its first batch of DES cases in October and November, while other banks quickly followed.
On January 14, Construction Bank signed debt-for-equity pacts with three Henan-based coal and steel companies for a combined value of 35 billion yuan, for instance, three days after it signed deals with three energy companies in Shaanxi for a total 50 billion yuan.
“We will continue to see such quick growth for a period of time, but the growth could slow after more of the larger projects are completed,” Sun said.
So far companies seem to have benefitted more from DES deals than the banks, Kuo from Moody’s said, adding the execution of the transactions remains the focus when evaluating the impact of DES deals are having on the banking system.
From the banks’ perspective, they can only benefit when stressed companies become more viable and let banks avoid significant losses, as a result of liquidation of bankrupt borrowers
“But the transparency [of DES deals] has been very poor. In some transactions we have been involved in, we knew the amount, but there was no details on internal pricing structures, of the participants, and so on,” Kuo said.
One of the first deals of 2016 was between Yunnan Tin and China Construction Bank, the former promised converted the shares back into with debt in three years, which makes this transaction a three-year refinancing, with a delayed interest payment.
“Yunnan Tin agreed to distribute 10 per cent of its profit as cash dividends, but it is uncertain how this would improve the deal’s economics for the banks,” according to Kuo.
If lots of DES schemes are made under such temporary structures, even thought the bad-debt ratios come down for a moment, the risk for the banking system may be underestimated, Kuo said
Under current practise, a commercial bank transfers lending from other banks, to its newly established asset management arm, which is in charge of converting the debt into equity holdings.
Social capital from wealth management products, brokers, insurers, and the Social Security Fund have tended to be the major holders of the equities, with the banks themselves holding only small portions.
Local governments, however, do not guarantee returns.
Current DES deals are mainly local state-owned enterprises from cyclical industries such as steel, metal, coal and infrastructure, holding leading market positions in their appropriate industries.
Except for a few cases, such as Sinosteel and Rongsheng Heavy Industries, the converted loans are still performing ones, rather than soured debt.
“It will take time before we see the emergence of DES schemes that really convert bad debt into equity,” Sun said.
The Chinese government aims to lower corporate leverage, but has not raised the requirements when dealing with already non-performing debts of banks, Sun said.