Despite the focus on Chinese banks and local governments, it is important to note just how stressed the entire corporate sector is in China. Additionally, Chinese firms are turning to real tricks to keep from collapsing. Let me give you a couple of examples.
Ever heard of a perpetual bond? There are many ways to structure a perpetual bond, but it basically is a debt that is never repaid but receives a yearly interest payment. Companies are interested in issuing perpetual bonds because it a hybrid with some of the characteristics of debt in that it requires a fixed yearly payment and some characteristics of equity, given certain structuring factors, such as a continual use of capital. The primary reason companies are interested in issuing perpetual bonds is this: in international capital markets, perpetual bonds can in some cases be treated for financial purposes as equity. One enterprising Chinese company has seen the opportunity to lower its debt to equity ratio by converting some of its outstanding bonds to perpetual bonds. Given an average debt to equity ratio for non-financial Chinese companies above 100%, don’t be surprised if other Chinese companies start exploring the perpetual bond or unique ways to lower their debt burden.
Probably the best example of Chinese public-private financial gluttony is the steel industry. Just how obscene is the credit orgy in steel? According to this article citing the Beijing Economic Observer, steel companies made “2.2 billion yuan (US$356.7 million)” in profits but had “3 trillion yuan (US$486.4 billion) in total liabilities as of June”. Let me put that in perspective. If you borrowed the same amount of money and put the money in a savings account earning 2% annually, over the same amount of time you would have earned $4.9 billion or roughly $4.5 billion more than the entire steel industry of China.
Closing out our Chinese corporate hall of shame today is China Southern Airlines. Incurring an operating loss of 114 million yuan was transformed by a 1.5 billion rmb currency bet into a net profit of 344 million rmb. Needless to say, airlines that make their money as hedge fund managers quickly exit the airline industry to focus on currency trading.