Ex-Huarong Asset Head Cautions on `Painful' Debt-to-Equity Swap

  • Objectives of swaps can be contradictory, Yang Kaisheng says
  • China may approve 1 trillion yuan of swaps this month

Yang Kaisheng, who led China Huarong Asset Management Co. in conducting China’s first swaps of bad debt to equity in the late 1990s, has issued a warning on government plans to revive the exchanges, describing them as a “painful” process that should only be used when there is no other choice.

The objectives of the conversions -- currently being considered by authorities as a way to reduce corporate leverage and mounting bad loans at the nation’s banks -- can be contradictory to each other, Yang wrote in an opinion piece published in the 21st Century Business Herald on Wednesday.

While the swaps may lower bad-loan ratios, lenders may need to set aside more capital to account for the resulting equity holdings, compromising their financial strength, said Yang, who is currently an adviser to the China Banking Regulatory Commission. Debtors give up their control of the company, while creditors lose their rights to debt claims and there’s no guarantee on the return of equity, he wrote.

The discussion of debt-equity swaps comes as policymakers scramble for ways to cut the highest levels of bad loans held by banks in a decade. Premier Li Keqiang floated the idea at last month’s National People’s Congress, and a person with knowledge of the matter said this week China may approve as soon as this month a plan allowing banks to convert as much as 1 trillion yuan ($154 billion) of soured debt into equity.

“The debt-to-equity swap is a painful process to both creditors and debtors,” Yang said. “Creditors and debtors need to be aware that this is only done when there’s no alternative so every party should keep a cautious attitude.”

Face Value

Yang joined Huarong Asset in 1999 as its president, when it was created along with three other taxpayer-funded asset-management firms to buy about 1.4 trillion yuan of bad loans from banks. The soured debt was bought at face value, thereby protecting lenders from losses and relieving state-owned enterprises of their debt burdens. The four asset managers swapped 580 companies’ debt worth 405 billion yuan into equity as directed by the government.

Almost two decades later, the managers are still holding some of the stock acquired through those swaps. Huarong alone converted 281 state-owned enterprises’ debt into equity in 1999, and still held stakes in 196 of them by the end of June 2015, according to Haitong Securities Co.

Boao Forum

Most of those stakes are unwanted or hard to deal with, Yang said, adding that it’s very important to decide targets qualified for the swap. While the debtor no longer needs to pay interest after the swap, it needs to pay dividends to shareholders, which continues to add pressure, according to Yang, who has also served as president of Industrial & Commercial Bank of China Ltd.

If banks use their own units for the arrangement, it’s no different from converting bad loans into bad investments immediately, he said, echoing a comment made at last month’s Boao Forum by China Construction Bank Corp. Chairman Wang Hongzhang. Bank of China Ltd. Chairman Tian Guoli said at the same forum that it’s “hard to evaluate” how effective the swaps will be, as so much has changed in China since the 1990s.

Yang also urged the government to amend China’s commercial banking law and allow banks to become holders of preference shares in the debtor companies, so that they can continue to receive fixed dividends and retain their seniority in claims.

— With assistance by Jun Luo

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