Lenders push to reduce companies' high leverage by taking ownership stakes

China's biggest banks are accelerating their debt-for-equity program to offload distressed debts and help reduce high corporate leverage.

The country's five big lenders pledged in their annual earnings reports to continue to push the debt-for-equity program - one of the country's solutions to reduce the corporate debt burden and contain the risk of corporate credit defaults, which is threatening the financial system.

Zhao Huan, president of Agricultural Bank of China, says his bank will make "substantial progress" in swapping debt for equity this year with more than 20 deals in the pipeline.

The bank has signed contracts with eight companies for debt-for-equity swaps and the total value of the program has reached 70 billion yuan ($10.2 billion; 9.5 billion euros; 8.1 billion), according to Zhao.

A debt-for-equity swap allows creditors to cancel some or all debt in exchange for an ownership stake in the business.

In October, Beijing backed the program, which allows the bank debts of struggling enterprises to be exchanged for shares, as the authorities moved to resolve increasing worries about China's swelling pile of corporate debt.

The State Council approved the debt-for-equity swaps following a policy debate, as part of a broader effort to cut back corporate indebtedness in the world's second-largest economy.

Agricultural Bank of China said in its earnings report that it has also established an asset management company with an initial investment of 10 billion yuan. That move is pending regulatory approval.

Similarly, Wang Zuji, president of China Construction Bank, says his bank saw the value of its debt-for-equity business reach 300 billion yuan in the first quarter.

Wang says the bank would continue to provide solutions for its clients through the debt-for-equity program to help them reduce their leverage and improve their debt structure.

The bank signed debt-for-equity contracts worth 20 billion yuan with Lu'an Group Co and Shanxi Jincheng Anthracite Mining Group Co, two state-owned coal miners.

Setting up asset management entities has been a solution for the big banks to deal with the new debt-for-equity business in a market-driven approach.

While some believe the debt-for-equity program could help improve the quality of bank assets, some analysts warned about potential risks, as there has been a lack of commercial rules and market mechanisms for the new business.

"Some of these transactions might not be commercially driven, might not involve a true transfer of risk or may simply shift that risk to other parts of the financial system, without any write-down," analysts at Fitch Ratings Inc said in a research note.

Zeng Gang, director of banking research at the Chinese Academy of Social Sciences' Institute of Finance and Banking, says allowing banks to set up asset management entities would offer them more market incentives to handle the debt-for-equity business.

"More banks will be licensed to set up their own asset management companies, which will not only help reduce bad loans but also allow them to profit from the business," Zeng says.

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(China Daily European Weekly 04/07/2017 page29)