After the recent hit to the Chinese market, the government was forced to take measures to bring it back on track. Among the actions taken, one measure that stood out was the introduction of loan-to-equity swap.

The measure means that the bank will convert the loan amount due on the party to stock options if they are unable to pay it back. The action was carried out by the Bank of China, when a loan amounting to RMB 2.75 billion was converted into equity. The Huarong Energy, a big shipping company, had outstanding loans to the bank. They weren’t able to pay it back due to the crisis. To solve the matter, the loan was converted into equity and in turn made Bank of China the largest shareholder of the company.

The measure introduced a convenient way of improving the NPL situation of the company. The immediate effect was also positive as the company’s liquidity improved and was a signal for investors to inject in the industry.

It wasn’t only Huarong Energy that was facing the crisis. Other companies too were facing a problem meeting the repayment conditions. One of the famously known cases was of SinoSteel. The new measure seemed to be troublesome to the market because of possible capital implications.

The strategy was later converted into a less capital intensive one. Named loan-to-convertible bond swap, this included capital inflow from the central SASAC. The struggling SinoSteel was going to be the first of the companies to go through the new measure. The key feature of this tool was to improve the financial position of the company without becoming owners immediately and increasing the capital demand.

Loan-to-equity had some drawbacks as it was only increasing the capital needs of the company. However, the loan-to-convertible swap was effective in solving liquidity issues and also the ownership problem. A convertible bond may eat up capital but only at some point in future. The immediate effect was positive and helped companies to operate consistently.

The convertible bond option gave life to the company as it didn’t require any immediate feedback, neither did it implicate the dividend payout. With this option, there was a higher chance of the bond being paid back, even if it was a lower rate of return. The provision would also have been freed as it was going to be a non-performing loan before the swap.

The new scheme to solve the investment issue in the China was quite successful as the companies became profitable in the medium-term without any significant costs. It also gave breathing space to banks as there was an urgency to raise capital.