More Chinese firms unveil debt swaps as Beijing struggles to reduce leverage

China Construction Bank Corp (CCB), the nations' second-largest lender by assets, has been reported in two deals to help big, debt-laden state companies in as many days, and other Big Four banks are expected to follow soon.

Chinese companies sit on $18 trillion in debt, equivalent to about 169 percent of gross domestic product (GDP), according to the most recent figures from the Bank for International Settlements. Most of it is held by state-owned firms.

Construction Bank will conduct a debt-to-equity swap with Yunnan Tin Group, the world's biggest tin producer and exporter, to cut its debt and financing costs, the official Xinhua News Agency reported on Wednesday.

Separately, the bank on Tuesday announced the launch of a 24 billion yuan ($3.60 billion) debt restructuring fund to help struggling Wuhan Iron and Steel Group Corp.

Although the statement from CCB did not specify the planned operations of the fund, official media reported that the debt reduction would be accomplished primarily through debt-to-equity swaps.

CCB will give Yunnan Tin 2.35 billion yuan next week in its first round of investment to swap some high-interest debt, Xinhua reported, without spelling out further details of the deal.

The guidelines for debt-to-equity swaps, mooted as one solution to China's growing corporate debt overhang, have been in development for months.

However, some senior bankers and analysts have been outspoken critics of the idea, saying it risks saddling banks with ownership stakes in weak companies which Beijing sees as too big or too sensitive to fail, rather than addressing the root causes of repayment problems.

In a news briefing on Monday apparently intended to assuage such concerns, a high-level official warned the swaps are not a "free lunch" for troubled companies, adding that loss-making "zombie" firms are strictly forbidden from such exchanges, which will be used mainly to help high-quality firms that face temporary difficulties.

The government will take a multi-pronged approach to cutting company debt, including encouraging mergers and acquisitions, bankruptcies, debt-to-equity swaps and debt securitization, according to the guidelines issued by the State Council, China's cabinet.

State-owned metals trading giant Sinosteel was the first firm to receive approval for a debt-to-equity swap this year, according to online financial magazine Caixin, later confirmed by one of Sinosteel's subsidiaries.

As China's corporate debt burden reaches levels that International Monetary Fund economists say sharply raises the risk of a financial crisis, top officials have increasingly urged struggling firms to "deleverage" – borrow less and pay off existing debt quicker.

Less leverage almost always means slower economic growth in the short run, however, a prospect China's leaders will be loathe to accept as they spend ever more to hit official targets.

MODELS OR MESS?

Analysts said the plans announced this week could serve as models for future debt restructurings, but stressed that success would ultimately depend on the ability of the firms themselves to use healthier balance sheets to improve their competitiveness.

"Unlike the previous candidates under a debt-for-equity swap pilot, (Wuhan Iron and Steel) is a company with a relatively secure financial outlook. The firm is in the process of merging with Baosteel and the newly-formed giant will likely become the second-largest steel company globally," wrote analysts at consultancy NSBO Research in a Wednesday note.

"Approximately 17 billion yuan will be used for the debt-equity swap, leaving at least 7 billion yuan in capital to invest in other projects in order to diversify risk. Since both creditor and debtor alike are involved, social investors could have an interest in injecting further capital."

Yunnan Tin controls more than 10 percent of the world's tin resources and accounts for more than 45 percent of China's tin products market. But its debt level is nearly 30 percentage points higher than the industry average, according to Xinhua.

The total scale of CCB and Yunnan Tin's agreement could be worth nearly 10 billion yuan, and it is expected to lower the firm's debt-to-asset ratio by 15 percentage points.

A third refinancing agreement involving China First Heavy Industries has also been approved by regulators, according to a disclosure to the Shanghai Stock Exchange on Wednesday.

China First Heavy said it has received approval to pay off debts through a private 1.55 billion yuan A-share equity placement by its parent China First Heavy Industries (Group) Co Ltd.

($1 = 6.6685 Chinese yuan renminbi)

(Reporting By Shu Zhang, Matthew Miller and Nathaniel Taplin; Editing by Amrutha Gayathri and Kim Coghill)