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Perpetuals Skirt Effort to Curb $14 Trillion Debt: China Credit

Chinese companies are selling a record number of bonds that can be booked as equity this year, sidestepping Premier Li Keqiang’s bid to reduce the world’s biggest corporate debt load.

Ten firms have issued perpetual notes that pay higher yields in exchange for having no set maturity date, up from eight last year and two in 2010 when such securities debuted in the nation, Bloomberg-compiled data show. China Railway Construction Corp. led offerings with $800 million of 3.95 percent securities last month. The coupon exceeds the 3.5 percent on its 2023 debentures issued in 2013.

Total Chinese corporate debt topped that of the U.S. last year to reach $14.2 trillion, Standard & Poor’s estimates, and the number of publicly traded firms with liabilities double equity rose 64 percent since the financial crisis. Chinese perpetuals account for 34 percent of Asia-Pacific issuance of the securities this year from 16 percent in 2013. Rating companies have warned of the burdens of step-ups in issuers' debt servicing costs.

“Perpetual bonds have become such a big market lately because of the high liability ratios,” said Tracy YH Chen, a partner in the accounting and consulting-services division of PriceWaterhouseCoopers in Beijing. “From a technical perspective, issuers aren’t doing anything wrong, they’re just taking advantage of the accounting standards.”

‘Rising Vulnerabilities’

The International Monetary Fund said last month that China’s reliance on credit and investment has created “rising vulnerabilities” in the world’s second-largest economy. Overall company debt jumped to about 110 percent of gross domestic product in 2013 from an average 92 percent in 2003 to 2007, the Washington-based lender said in a report.

All of the perpetual bonds sold by Chinese corporates this year include options giving the issuer the right to buy back the securities after a certain number of years. If they don’t, the coupons increase. Railway Construction has its first call opportunity in five years. If it doesn’t pay off the notes then the coupon rises to 7.251 percentage points over five-year Treasuries.

“If it has an onerous step up it is the equivalent of debt,” said Benjamin Cryer, a Singapore-based Asia credit analyst in the fixed-income group at Franklin Templeton Investments, commenting on undated securities in general. Franklin Templeton had clients in more than 150 countries as of Dec. 31.

Accounting Debate

While internationally accepted accounting standards allow perpetuals to be entered as equity on balance sheets, investors should consider them as debt unless the company lacks a strong incentive to pay off the bonds at the first call date, according to Fitch Ratings Ltd.

Many borrowers selling the securities do so to keep the obligations from showing up as debt, a tactic that helps meet bank-loan rules, said Kalai Pillay, the Singapore-based head of Asia-Pacific industrial ratings at Fitch.

So long as bonds have no legal maturity and a clause allowing the company to defer coupon payments, they’re accounted as equity under International Accounting Standards 32, which has been adopted by Chinese regulators and is used by almost all countries in Asia, according to PwC’s Chen.

Five out of the seven listed Chinese companies that have sold perpetuals this year had negative cash flow in 2013, Bloomberg-compiled data show.

Railway Construction

China Railway Construction, which has built more than half of all railways in the nation, had negative cash from operations of 15.7 billion yuan ($2.6 billion) as of Dec. 31, according to Bloomberg-compiled data.

The rail builder didn’t immediately respond to an e-mailed request for comment via an external public relations company.

Concerns have mounted that financial strains could spread after the country’s first onshore bond default in March when Shanghai Chaori Solar Energy Science & Technology Co. missed part of an interest payment. Data released this week showed China’s broadest measure of new credit plunged to the lowest since the global financial crisis at 273.1 billion yuan in July, compared with the 1.5 trillion yuan median estimate of economists. The readings flashed warnings on growth that investors bet will spur policy makers to expand stimulus.

Mounting expectations for such easing have helped send the yield on AAA rated Chinese corporate notes due in ten years down 62 basis points this year to 5.69 percent as of Aug. 14. Similar-maturity government securities yield 4.21 percent.

Step-Up Clauses

All the other undated securities sold by Chinese companies this year have coupons that increase if not called and exceed the average yield for top-rated corporate notes due in ten years.

Aluminum Corporation of China Ltd., the nation’s biggest producer of the metal, raised $400 million selling 6.25 percent perpetuals in April. The notes, sold to investors at par, traded at 101.657 cents on the dollar Aug. 14, Bloomberg-compiled prices show.

“A likely reason for Chalco selling perpetuals is to comply with accounting and regulatory requirements,” said Anthony Leung, a credit research analyst in Hong Kong at Nomura Holdings Inc.

Chalco Chief Financial Officer Weizhi Xie didn’t respond to requests for comment via both phone and e-mail.

Beijing-based Chalco’s net debt rose to 75 percent of its total capital as of Dec. 31, from 72 percent in 2012, according to its annual report.

Yanzhou Coal Mining Co., a state-owned enterprise based in the northern province of Shandong, sold 7.2 percent undated notes in May. The coupon increases to 11.82 percentage points more than two-year Treasuries after a call option in 2016. The yield premium on the securities at issuance was 682.9 basis points, exceeding the 485 basis points on its 2022 dollar notes at that time.

If perpetuals were to help companies access funds at lower costs, that would be a good reason to use them, according to Franklin Templeton’s Cryer. Issuing them to manage debt ratios would be the “wrong reason,” he said.

“My concern is that more companies fall into the latter category rather than the former,” Cryer said.

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