China’s Debt-to-Equity Swap Could be Costly, Says Natixis

Deteriorating corporate revenues since 2011 has transmitted into higher credit risk in the banking sector. Debt-to-equity swap could be the timely rain to deter the problem and buy time, but the cost could be huge, according to research by Natixis.

The debt-to-equity swap led by the National Development and Reform Commission (NDRC) will begin as early as mid- September, says the report, citing the China Securities Journal which quoted authorities.

The first tranche will focus mainly on the big five banks. “No amount or quota has been announced but it seems clear that it will be done case by case with blessing at the highest level, such as the state council,” says Natixis.

The rumor comes almost half a year after the first case (Bank of China converted 100RMBbn loan from Huarong Energy into equity), according to the report.

Costly and no guarantee

With 1 RMB trillion debt-to-equity swap (half of the package dedicated to NPL), the big 5 banks could get a +0.3% boost in Tier 1 capital ratio from the existing 12.3% mainly because of capital release from loan provision.

However, Natixis warns the plan could backfire after 2 years with a risk weight of 1,250%, bringing the Tier 1 capital ratio down to 9.1%, which is a -3.3 percentage point reduction from the current level.

If the plan is used to remove still performing loan, the cost would be a -1.9% reduction of Tier 1 capital ratio per trillion RMB initially and - 4.7% after 2 years, according to Natixis.

“Therefore, the solution is costly and there is no guarantee whether the “recused” corporates could turnaround within 2 years. The only thing that we are sure is banks could sweep part of the non-performing or risky loan under the carpet in exchange of a higher capital ratio for the time being.”

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