China Debt-for-Equity Swaps Turn Out More Like Debt-for-DebtBy
Shaanxi bond deal shows a new template for SOE workouts
If funding is from debt, it’s not solving the problem: S&P
A key Chinese initiative to rein in the world’s largest corporate-debt load has been a program swapping some loans into equity stakes. As the initiative gets going, however, it’s becoming clear the debt isn’t really going away.
In a late-summer notice, central government officials said that new bonds should be used to finance the swaps, effectively moving the debt off the balance sheets of the original lenders onto those buying the new debt.
The first such deal came last month, according to China Lianhe Credit Rating Co., a domestic rating firm. Shaanxi Coal and Chemical Industry Group Co., a troubled old-line industrial company, was targeted for a debt-for-equity swap. Then the Shaanxi provincial government in northwest China set up an asset-management company to raise new debt to pay off the existing lending that was designated to be swapped for an equity stake.
One criticism of the debt-for-equity initiative, which was launched a year ago, is that it keeps afloat struggling enterprises, leaving excess capacity intact and pulling down productivity. The Shaanxi example shows a further weakness: while the company won’t need to service debt any more, the new asset-management unit will -- without any new source of revenue having been generated.
“If the funding comes from debt, it’s really not solving the issue here because the capital is not permanent capital,” said Christopher Lee, managing director of corporate ratings at S&P Global Ratings in Hong Kong. “In fact, you are adding more debt just to refinance the debt that was going to be swapped.”
Because of potential conflict-of-interest concerns, the original lenders to now-troubled companies aren’t encouraged to swap their own credit for shares. Instead, new entities are raising financing that allows the original creditors to offload those assets. Funding for the deals could come from sources such as private equity or bonds sold by asset-management companies.
In last month’s operation, Shaanxi Financial Asset Management Co. sold 500 million yuan ($76 million) in six-year bonds in a private placement, China Lianhe Credit Rating said in a Sept. 26 report. The asset manager, established in August last year with registered capital of 4.5 billion yuan, has already signed 40 billion yuan of debt-swap agreements with Shaanxi Coal and Chemical, the report said.
The Shaanxi provincial government didn’t respond to an email seeking comment on the deal. It wasn’t immediately clear who the buyers were.
The total value of lending designated to be swapped into equity in China has topped 1 trillion yuan, involving more than 70 companies, according to an official statement in August. Though plenty of deals have been announced, there are major gaps in funding, with institutional investors remaining cautious about the program and banks also reluctant to dive in.
For example, China Construction Bank Co., one of the country’s four biggest lenders, had signed 544.2 billion yuan of swap deals with 41 companies by the end of July, but less than 10 percent of that had been funded, according to the bank.
While it’s still a work in progress, the advantage of the program is that the financial risks stemming from these mainly state-owned enterprises will be diversified, through the participation of private companies and financial institutions along with local authorities, according to advocates including China Lianhe Credit Rating, which gave the Shaanxi bond a top AAA grade.
A bigger question is whether the initiative will end up reducing debt, however. That ultimately depends on the valuation of the equity stakes taken by the financing units involved. If companies turn around and the shares climb, then the units can sell and retire the new debt. If not, then the private sector is saddled with soured SOE obligations.
“The question is whether this will transfer debt from the public sector to the private sector,” said Ivan Chung, head of Greater China credit research at Moody’s Investors Service in Hong Kong. Selling bonds “could be a new direction for the debt-to-equity swap program. But whether it will result in deleveraging in a meaningful way, it will take some time to tell.”