China's Great Balance Sheet Play
China's debt problems are old news, but several analysts in Asia have been telling me that the world is ignoring the amount of equity that's been added to balance sheets of late. It's true -- if only it were that simple.
A string of share offerings, asset disposals and sales of bonds that convert into equity has pushed the median debt-to-equity ratio of publicly traded Chinese companies to the lowest level in almost a decade, according to data compiled by Bloomberg.
Before you celebrate, however, look a bit more deeply into the numbers. Much of the stuff that has been viewed as equity could be seen as debt, too. Issuance of convertible bonds, which pay fixed coupons and may be transformed into shares at a certain level, increased last year after a pause from a record streak in 2013 and 2014. While those securities sit further down the line for payment if a company is liquidated, they still require regular payments and therefore increase gearing.
Also underlying the improvement are preferred stock or perpetual bonds, which accountants and banks consider equity. Those securities, however, also pay fixed yearly amounts and thus add to gearing. Some varieties have clauses that could force the issuer to redeem them in a few years, just like a normal debt security. And never before have Chinese companies had so much of those out there.
The result has been that the ratio of debt to common equity, a measure that shows what really is left for shareholders after all creditors are paid, remains very high -- even though it has dropped from the peak reached in 2014.
But that measure only considers traditional borrowings. If preferred stock is added to debt and divided by common equity, things look a lot more worrying: There's on average $1.65 in obligations that pay fixed coupons for every $1 of shares in Chinese companies.
So, yes, China's listed companies are aware of their debt problem and are doing something about it. As with many other things in China, though, they're adorning the issue instead of addressing it.
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