Debt-to-equity swaps clean up China banks: But is all as it seems?

HONG KONG - Chinese banks seem to have made meaningful progress in the resolution of problem loans, says the French banking group Natixis in a research report. The aggregate amount of announced debt-to-equity (D/E) swaps has reached RMB1,048 billion, amounting to 1.1% of total loans at end-2017. “We expect banks to see an improvement, with corresponding relief on overall asset quality/profitability, but only if the announced deals are implemented for real,” Natixis says.

“In fact, only 15.7% of the total announced D/E swaps are actually happening. We believe the guideline issued in January 2018 clearly aims at facilitating funding and accelerating the implementation of D/E swaps.

“It will now be easier for private equity funds to participate, and banks will be allowed to reinvest their funding from wealth management products into D/E swaps.”  

Natixis says D/E swaps would be great for banks for a very simple reason. Banks can stay out of the picture once the D/E swaps are carried out. And banks retain only 4% of the total amount distributed based on the financial information of the D/E swaps.

“Most of the proportion is not even being held by banks directly but is indeed being disposed through their own asset management companies (AMCs),” Natixis says

“Our analysis shows AMCs (excluding those set up by banks), insurance companies and State-owned funds, are the three most important players, accounting for 34%, 30% and 27% respectively.

Natixis adds, however, that banks’ limited exposure on the surface looks much bigger when digging into who the key shareholders of such “Sstate-owned funds” are.

“In fact, 44% of the total registered capital in two of the largest State-owned funds participating in D/E swaps is in the hands of State-owned banks, especially the supposedly low-risk Postal Saving Bank of China, with the rest of shareholders being cash-rich State-owned enterprises (SOEs).

“This literally means that problem loans are being relabelled outside of the loan book and reallocated both inside and outside the banking system.

“The difference for banks, though, is massive, as even the part they own through their participation in State-owned funds is not as expensive since it does not consolidate. In other words, the regulatory burden of holding bad assets (both in terms of capital and provisioning) is lifted.”

In a nutshell, says Natixis, D/E swaps are helping banks offload stressed assets to the rest of the financial sector, or to financial investors, at a very low cost.

“Banks should indeed benefit from the Chinese Government’s “matryoshka” approach to the clean-up of banks with D/E swaps. A lovely restructuring solution for bank but probably less so for the rest of final investors.”  www.natixis.com (ATI).