Corporate hybrids reach China
* Guodian set to issue first equity-eligible perpetual bond
* New structure comes as debt-to equity ratios balloon
* Deal may set template for other companies
By Carrie Hong
HONG KONG, Aug 30 (IFR) - Companies in China are looking to a new way to reduce their leverage - at least on paper - just as analysts step up calls for the world's second-largest economy to reduce its debt burden.
Shanghai-listed Guodian Power Development is preparing an offering of Rmb1bn (US$163m) in perpetual medium-term notes that looks set to become the first corporate hybrid in China's domestic capital markets. The landmark paper is expected to qualify as equity for accounting purposes, helping Guodian reduce its leverage ratio.
The transaction could set a template for hybrid capital in China, where many companies are grappling with rising debt-to-equity ratios and banks are under pressure to rein in the use of their balance sheets.
According to the IMF's Global Financial Stability Report, issued in April, the average debt-to-equity ratio of Chinese non-financial companies has risen more than 30 percentage points since 2007 and now stands above the key 100% level.
"For a balanced panel of some 900 listed companies, the median ratio of earnings to interest expenditure fell to 2.4 by mid-2012, down from 4.4 nine years earlier," the report said, highlighting how Chinese companies are spending more to service debt.
Guodian is a good example. The company and its subsidiaries are regular visitors to the bond market, having amassed outstanding debt of Rmb38.9bn and a debt-to-equity ratio of 73%.
"The company's debt keeps increasing and the liquidity declining every year. Its debt structure needs to be improved," said local rating agency Dagong.
Under International Financial Reporting Standards, perpetual bonds count as equity as long as they do not have a set maturity and the call is an option of the issuer.
While that is commonplace in the international markets, perpetual bonds are unprecedented in China.
"The deal will count 100% as equity for Guodian (for accounting purposes). This is totally new and we are still doing preparation work in order to promote the deal to more investors," said a source close to the offering.
Guodian is not the first corporate issuer to try its hand at a perpetual note in China. China Merchants Group cancelled a potential Rmb1bn perpetual medium-term note earlier this year, as it found the coupon that investors demanded too high.
The deal had looked set to break a taboo in the local market, since China's company law bars the issuance of bonds without fixed maturities.
However, perpetual notes can be issued under medium-term note format, thanks to a loophole in the regulations of the National Association of Financial Market Institutional Investors.
The regulator states that "medium-term notes are debt-funding tools for non-financial institutions to issue in the inter-bank market, but are not called 'bonds'." In defining perpetuals as medium-term notes, rather than bonds, issuers may be able to put out corporate hybrids without violating current laws.
According to a prospectus IFR obtained, Guodian's planned perpetual medium-term note will come with call options to allow the company to redeem the paper from the sixth year and every five years thereafter, with a step-up at the first call date.
The coupon for the first five years will be determined through bookbuilding. At the first call date, the coupon will reset to the initial spread over the prevailing five-year government bond, plus an additional 300bp.
Agricultural Bank of China will be the bookrunner and lead manager on the deal, while CICC will be a joint lead. Dagong has rated both the deal and the issuer AAA.
Although it still requires the approval of the National Association of Financial Market Institutional Investors, sources have confirmed that leads have been promoting the offering to investors and roadshows are being arranged.
Once it happens, more can be expected to follow. (Reporting By Carrie Hong; Editing by Christopher Langner and Steve Garton)
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