 "For China banks, swapping stock for debt is a stopgap")
A new approach to managing China's corporate debt burden may offer temporary relief for banks but spell further difficulties for the country's economy: Having deeply troubled companies use stock to pay overdue loans.
Early evidence of the strategy emerged late on Thursday, when a heavily indebted Chinese shipbuilder disclosed that it would issue equity to its creditors, instead of repaying $2.17 billion in bank loans. If Chinese companies were to broadly adopt the approach for their debt issues, banks could temporarily shore up their balance sheets by replacing troubled loans with shares that have at least some value. But accepting stakes in highly indebted companies is likely to make banks even more reluctant to shut them down.
And that could mean China will be stuck with enormous overcapacity in industrial sectors including shipbuilding, steel and cement, hampering economic growth for years to come. "The program amounts to a sleight of hand that beautifies bank balance sheets but hardly comes to grips with the basic problems of bad loans, distorted incentives in the banking and state enterprise systems, and weak financial regulation," said Eswar S Prasad, an economist at Cornell University who used to lead the China division at the International Monetary Fund. "This is a classic case of putting lipstick on a pig. Bank balance sheets may look prettier but nothing fundamental changes."
This latest strategy has some advantages. It would allow companies to cut their debt loads. In doing so, they could potentially improve their credit profiles, borrow more from banks, and keep their businesses running. It also makes banks' loan books appear healthier, since they can reduce the amount of past-due loans. Financial markets have been fixated on Chinese banks' portfolios of so-called nonperforming loans. And halting the recent expansion of these loans has become a high priority for Chinese bank executives.
While repaying loans with shares might seem a quick solution to China's enormous debt overhang, it could make the problems more pernicious.
In effect, it is just another way for troubled Chinese companies to put off making hard choices, like laying off employees or closing operations. Rather, businesses can continue to limp along, even when their underlying operations are not making money and customer demand has evaporated.
Such problems have been at the root of China's economic issues, as many state-owned enterprises, or SOEs, and private companies have continued to roll over the debt and keep their operations going. The government has supported the tactic, in an effort to avert mass layoffs and maintain social stability. The new approach is "in a nutshell, very bad news for SOE reform and, more specifically, for the solvency of Chinese banks," said Alicia Garcia Herrero, the chief economist for Asia at Natixis, a French investment bank. At this point, it is unclear how widespread this strategy has become among Chinese companies. The shipbuilder, China Huarong Energy Company Limited, had to disclose the move only because it is listed on the Hong Kong stock market. Mainland companies not listed overseas do not face the same stringent rules.
Two finance specialists with ties to China regulators say the government is working on a broader plan to allow troubled firms to repay loans with shares instead of cash. Officials at the People's Bank of China and the China Banking Regulatory Commission could not be reached for comment.
Zhou Xiaochuan, the central bank's governor, and three of his deputies are scheduled to hold a news conference on Saturday morning in Beijing, near the session of the National People's Congress. The debt issue is core to the debate over where China's economy is headed. China avoided most of the ill effects of the global financial crisis by ordering the state-controlled banking system to engineer a major increase in the money supply. Those banks channeled huge loans to companies and to government construction projects. While the stimulus helped stoke growth, the country's debt burden ballooned.
Overall debt in China was equal to slightly more than one year's economic output as recently as 2008. It now stands at 2.5 years' economic output - above levels considered dangerous in other countries. The debt is still rising, and most of it is owed by companies. The stock-for-debt strategy speaks to the underlying trouble at many companies.
China Huarong Energy is one of dozens of Chinese shipbuilders in financial distress as prices worldwide for new ships have halved in the past two years. It is a similar story for steel makers, cement makers and many other businesses in heavy industry. China Huarong Energy has been a dismal performer on the Hong Kong stock market. Its shares have tumbled even more steeply than broad mainland Chinese stock indexes, falling 83 per cent since late April 2015.
The stock-for-debt swap is taking shape as Hong Kong financiers say that China's bad debt problem has worsened appreciably in recent weeks. The problem, they said in recent interviews, is that more companies are stopping payments on their loans from mainland Chinese banks with the country's economy continuing to slow. That has begun to produce ripples in China's financial system. Desperate borrowers have pledged in recent weeks to pay several percentage points in extra interest to borrow in Hong Kong, after finding that banks and other financial institutions on the mainland were reluctant to lend.
HSBC warned on Thursday that allowing borrowers to pay in shares was a limited solution to bad debt problems. International bank standards on capital assign a large penalty to holdings of shares, meaning banks must hold extra money against the stock.
But China's five biggest banks have somewhat more capital than the standards require. So they may be able to swap some loans for shares without falling below the required minimums for capital, but are unlikely to resolve large portions of their portfolios of troubled loans through this method.
"We think it is unlikely to be of significant scale given there are limited ways of replenishing" capital once it has been allocated to offset equity holdings, HSBC said in a research note.
©2016 The New York Times News Service
