China Makes Big Move In Debt-To-Equity SWAPs

Debt-to-equity SWAPs in debt-ridden China are flourishing to unprecedented levels, a Natixis report shows, one of several reports on the topic. While the system for exchanging debt for equity is running at “full speed,” there remain issues, namely “it is not perfect,” the report opined, Natixis report.

Dramatic growth in Chinese debt-to-equity SWAPs

There has been a decided shift in China. The unelected regime at one point decried western-style SWAPs and excessive bank leverage – both financial and political. That attitude changed and gained momentum after the 2008 financial crisis, and China has engaged in various forms of financial engineering

For debt to equity SWAPs, the growth has been a recent phenomenon, the Natexis report points out. In the third quarter of 2016, for instance, there were only 30 Trillion (RMB) in debt to equity SWAPs. That number swelled to 203 trillion (RMB) in the fourth quarter and today stands at 238 trillion (RMB).

The more than seven times increase in debt to equity SWAPs have two primary characteristics: they are relatively industry specific and they are done with one goal in mind: clean up dirty bank balance sheets.

“Corporates can turn loans into equity, which in turn lower the liability-to-asset ratio,” research analyst Alicia Garcia Herrero wrote in an April 7 report. “Banks can also dispose of their loans but it is hard to assess what they obtain in exchange.”

Coal and steel primary users, but watch over-leveraged construction and transport industries to increase usage

Currently, the industries exchanging their debt for equity in the company are primarily found in the coal and steel industries, which are the primary forces driving the move, according to the report titled “Debt-to-Equity SWAPs Continue At Full Speed With Deferred Consequences.”

Coal is currently the leading industry, accounting for 32% of all Chinese corporate debt-to-equity SWAPs transactions. Steel, accounting for 14% exposure, is a distant second. Most Chinese industries account for a single digit percentage of such financial engineering, but that could change.