China revives debt-to-equity swaps

Beijing aims to curb its increasing debt level with programme introduced during the country’s banking crisis in the 1990s.

China Construction Bank has completed a 2.3 billion yuan ($344 million; €306 million) debt-to-equity swap through its nonperforming corporate loans portfolio, as the country kick-starts the revival of its conversion programme in an attempt to tackle underperforming loans held by banks.

Under the terms of the transaction, CCB received 700 million yuan in equity from borrowers, including wholesalers and manufacturers of machinery and electronic equipment, according to a report by Nikkei.

“There is now clear policy to support debt-to-equity swaps and this is going to be an attractive restructuring option for Chinese banks. It would allow banks to avoid making immediate bad debt provisions and to participate in the turnaround of the customer's business in sectors which they believe would recover in the medium term,” said Howard Lam, partner at law firm Latham & Watkins.

“From the debtors’ perspective, it would allow them to adjust to a more sustainable capital structure. It would also be attractive to distressed investors who is looking to benefit from the equity upside in a turnaround.”

CCB had 181.9 billion yuan in NPLs on its books at the end of June, up nearly 10 percent from the end of 2015.

A few days before CCB’s swap, the government approved Sinosteel’s swap of 27 billion yuan of its debt into equity convertible bonds, according to China’s financial publisher Caixin.

As part of the plan, a subsidiary will be set up to handle the conversions and the Chinese central government body responsible for managing state-owned assets, will inject 10 billion yuan of capital.

The debt-to-equity swap has been a long-discussed strategy to solve the issue of growing corporate debt and NPLs held by banks in China. The total for China’s big four state-owned banks, which includes CCB, stands at 746.5 billion yuan.

“The impact [from a private investor’s view] is limited as these type of arrangements will largely be for SOEs. For NPLs, our focus is on private co-related loans,” said Eddie Hui, managing director of private equity firm PAG. But Hui pointed out that this could be an interesting opportunity, as the banks might need to sell the stakes after the swap.

Most players say that it is too early to tell how big an opportunity this conversion programme could become. Details released so far by the regulator are still sketchy and it is unclear how this mechanism could potentially help banks deal with their NPL stock.