Dongbei Steel has been in difficulties for months – from the news of its initial bond defaults last year (see WiC319) through its challenges in agreeing a restructuring with its creditors (see WiC335).
In August there was a resolution (of sorts) with the approval of a bailout plan for the state-owned steelmaker by a court in Dalian. Unsecured creditors owed less than Rmb500,000 ($76,328) will be repaid in full. But larger lenders have been given a choice: recover about a fifth of their loans in cash or sign up for a debt-for-equity swap for the fuller amount.
Some of the bigger creditors aren’t happy, it seems, saying that they have been browbeaten into keeping the company alive. Public officials “forcefully intervened” on the state-owned steelmaker’s behalf, a bankruptcy lawyer complained to Caixin Weekly. “The whole restructuring process can hardly be said to have set a good example,” he complained.
Commentators are asking whether the debt-for-equity programme is sending the right message on the national level as well. A study from the National Development and Reform Commission (NDRC) earlier this summer calculated that banks have already converted more than Rmb1 trillion ($149.2 billion) of corporate debt into shares. Political leaders like Li Keqiang, the Chinese premier, have insisted that companies with little chance of recovery – so-called zombie enterprises – mustn’t get undeserved lifelines. But a clear definition of what constitutes a zombie is lacking, making it easier to skirt the guidance.
When HSBC’s fixed income analysts ran an assessment of the debt-to-equity rescues of 61 companies since the programme began last October, their findings pointed to the limits of the ‘market-driven’ message.
While it’s true that the central government hasn’t been involved in the restructurings in the same way it championed the big bank bailouts of the 1990s, the signs are that the state is still playing the lead role.
Unsurprisingly, public officials have been lobbying loudest for hometown firms in which the local government has a shareholding. HSBC uncovered just one privately-owned company that had benefited in the same way, and this was for one of the smallest bailouts.
Another indicator that the market focus is getting lost is the number of deals being struck in provinces with struggling heavy industries, like Shanxi and Shandong. Coal miners and steelmakers are conspicuous beneficiaries. Some of these firms might have prospects for a broader recovery but some of them probably aren’t worth saving.
Of course, the restructuring plans are good news for the insolvent firms concerned. But the debt swaps aren’t so appealing for the banks being asked to forgive their loans, especially when the equity looks like unconvincing compensation. The settlements will also put pressure on their balance sheets. Typically, banks that swap defaulted loans for equity have to allocate 400% of the value of their stake in capital for the first two years after conversion, and 1,250% after that. While the large majority of swaps are still to be executed, the pipeline of deals is growing, pointing to wider pressure on balance sheets across the sector. China Construction Bank has committed to about half of the Rmb1 trillion of the swaps so far, for instance, for an equivalent of about 8% of its corporate loan book.
In a bid to encourage the banks to do more the banking regulator is allowing them to set up subsidiaries called “execution institutions” to take on the assets. The plan is that the subsidiaries will raise capital by selling bonds and privately-placed loans, and regulators are sweetening the deal by reducing the capital requirements to 200% of the equity.
In return, the banks are required to hold their shares for at least five years, although the government is hoping that other investors can be convinced to put in capital, taking some of the strain off the lenders. So far there have been few takers, however, and analysts predict that the banks will be on the hook if the new units fail. “When other financial institutions and the public who invested in the ‘execution institutions’ bonds or funds want their money back, can banks really avoid trouble?” HSBC analysts ask.
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