China: Debt-to-equity swaps continue to flourish - Natixis

Alicia Garcia Herrero, Chief Economist at Natixis, points out that D/E swaps in China continue to flourish, growing 27% from last quarter to 303 RMB billion in Q2 2017, equivalent to 7% of stressed loans.

Key Quotes

“The scale and pace of D/E swaps do not only signal that the Chinese government is increasingly determined to clean up the banking sector, but also the direction. D/E swaps are indeed instrumental in sharing the risk burden with non-bank financial institutions and, at least partially, to households.”

“We expect D/E swaps to continue in similar pace in the most leveraged sectors (coal and steel) and expand further to utilities, materials and transportations. The financial health of corporates with D/E swaps should improve due to a lower interest burden, at least in short run. For a longer term perspective, we remain cautious on China’s corporate health due to the still high and growing leverage with weaker repayment ability and less sustainable debt structure.”

“It should be noted that D/E swaps has so far been used to clean up SOEs, of which they need it more than private companies according to our analysis in Natixis China Corporate Monitor 2017. In fact, we find a higher proportion of zombie SOEs (defined as companies with an EBITDA-to-interest expense ratio below one) than the private ones. Still some companies in the private world (especially real estate) do not have the privilege on accessing D/E swaps, so their relative situation has only worsened since the giant clean-up started.”