China Fuels Speculation Debt-for-Equity Swaps Starting Soon

Updated on
  • State Council statement seen as signaling trial will go ahead
  • Swaps may be tool for tackling build-up of leverage, bad debt

China’s cabinet fueled speculation that the nation is pressing ahead with debt-to-equity swaps that would give lenders stakes in some companies as part of tackling a build-up in corporate leverage and bad loans.

A brief reference in a statement on Monday to letting financial institutions hold stakes in companies in a trial indicated that the swaps are coming soon, according to China Merchants Securities Co. analyst Ma Kunpeng.

Caixin magazine reported that the State Council was signaling the start of the program, citing an unidentified person close to the authorities.

Large lenders have previously expressed some wariness, with China Construction Bank Corp. Chairman Wang Hongzhang saying in March that he wouldn’t want to see a plan that simply converted “bad debt into bad equity.”

The potential for debt-to-equity swaps was highlighted by Premier Li Keqiang in March, who said such arrangements could cut companies’ levels of leverage. International Monetary Fund staff are among those to have warned that such a move could backfire by supporting debt-laden “zombie” companies that should be allowed to fail. In deals in India, lenders have been lumbered with assets from deodorant makers to steel mills.

Beyond Rescue

In an article in May on China’s debt challenges, the People’s Daily, a Communist Party mouthpiece, said that zombie companies beyond salvage should be allowed to fail because their debt-to-equity swaps could be costly and self-deceiving. The report cited an unnamed “authoritative person.”

Last Friday, China’s banking regulator told banks to step up risk controls and safeguard financial stability as it reported that the official bad-loan ratio had climbed to 1.81 percent, the highest since 2009. Analysts doing their own calculations come up with much higher estimates.

Some troubled companies will be keen to strike deals. In one example of a business that is trying to restructure, regional authorities of Liaoning province are lobbying the central government to let Dongbei Special Steel Group swap 70 percent of its financial debt into equity, people familiar with the matter said. Liaoning officials didn’t immediately reply to faxed inquiries, and a call to the steelmaker went unanswered.

Dongbei Special Steel has defaulted multiple times on bonds this year and its chairman, Yang Hua, was found dead by hanging in March.