Perpetual Notes - China's New Way To Hide Debt (Call It Equity)

The legacy of the soon-to-retire PBoC governor, Zhou Xiochuan, will be that in sharp contrast to his western brethren, he warned that China’s credit bubble would burst before the fact. Two weeks ago, Zhou warned during the Party Congress that China’s financial system could be heading for a “Minsky moment” due to high levels of corporate debt and rapidly rising household debt (see here).

“If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a ‘Minsky moment’. That’s what we should particularly defend against.”

Perhaps sensing that nobody in the Middle Kingdom was paying attention, we noted two days ago his lengthy essay published on the PBoC website. It contained another warning that latent risks are accumulating in the Chinese system, including some that are “hidden, complex, contagious and hazardous.” He also highlighted “debt finance disguised as equity” as a concern. Talking of which, there’s a new growth market in the gargantuan Chinese corporate debt market – we are referring to perpetual notes. Are you ready for the clever part about perpetual notes - they are debt but it’s permissible under Chinese accounting regulations to classify them as “equity” - et voila, corporate gearing has fallen. According to Bloomberg.

Under pressure to trim borrowings, China’s companies have found a way to reduce their lofty debt burdens -- even if some of the risk remains. Sales of perpetual notes - long-dated securities that can be listed as equity rather than debt on balance sheets given that in theory they could never mature -- have soared to a record this year as Beijing zeros in on leverage and the threat it poses to the financial system. The bonds are so popular that issuance by non-bank firms has jumped to the equivalent of 433 billion yuan ($65 billion), more than seven times sales by companies in the U.S.


“Chinese issuers love perpetual bonds because they are under great pressure to deleverage,” said Wang Ying, a senior director at Fitch Ratings in Shanghai. “Sophisticated investors should do their homework and shouldn’t be misled by the numbers in accounting books.

Unsurprisingly the state-owned companies have been gorging themselves on perpetuals, accounting for more than 60% of issuance. In the state-owned sector, perpetuals are the perfect source of financing for companies that are unlisted and need to raise financing without damaging their pro-forma gearing level. As Bloomberg notes.

While many state-owned or connected companies are trying to deleverage, actually reducing debt can be tough, says Ivan Chung, head of Greater China credit research at Moody’s Investors Service in Hong Kong. A lot of firms aren’t listed so can’t raise cash by issuing shares.


“By selling perpetual bonds under Chinese account treatment they can present lower debt ratios to SASAC,” Chung said, referring to the State-Owned Assets Supervision and Administration Commission of the State Council.


SASAC generally uses the ratio of total liabilities to total assets to measure the leverage of China’s state-owned enterprises against their performance, according to Christopher Lee, managing director of corporate ratings at S&P Global Ratings. That means perpetuals wouldn’t appear as part of the tally.

Don’t mention the war perpetuals. Bloomberg’s efforts to engage regulators and corporates in a discussion of perpetuals was spectacularly unsuccessful. To wit.

Two calls to SASAC weren’t answered and the body didn’t respond to faxed questions about why perpetual sales were increasing and whether the practice helped SOEs to conceal their true leverage burdens. State firm China Datang Corp. has sold 15 billion yuan of the securities this year, making it the country’s top non-financial issuer. The company also didn’t respond to emailed questions on the sales. Local issuance of perpetual notes only started in 2013, while offshore dollar-denominated perpetuals from China dates back to 2010. The finance ministry didn’t issue the regulation saying accountants can classify the securities as equity until 2014.

Besides facilitating more debt equity to be piled on to China’s debt mountain, there are two further downsides to the rapid growth in perpetuals issuance:

  • Perpetuals are more expensive than plain vanilla debt during the five years following issuance. Bloomberg estimates the average coupon on perpetual notes is 5.83%, about 20 basis points higher than a 5-year note; and
  • The coupon on perpetuals typically rises after 5 years, often by 100-200 basis points or more. Consequently, Chinese corporates need to be in a position to refinance them within that period.

With respect to the latter, Bloomberg notes...

Rating firms sometimes classify perpetuals as debt when assessing Chinese companies’ creditworthiness. Fitch does this if the call date on the note is within five years of issuance and the coupon step-up is 100 basis points or more. S&P does the same if the jump in the coupon is at least 200 basis points. But because of the way they work, perpetuals can pose particular problems for firms facing financial difficulties, said Tan Chang, an analyst at China Chengxin International Credit Rating Co.’s research institute in Beijing.


“If a company faces capital shortages on the call date and can’t redeem the bonds, they must accept a surge in future interest payments,” she said. That “may worsen the company’s financials and increase credit risks.”

…which is reminiscent of adjustable rate mortgages.

We have to credit (intended) China’s corporate sector with “pushing the envelope” in terms of finding ways to extend its debt binge. Last week we highlighted the debt-laden and corruption-tainted conglomerate, HNA, which issued dollar bonds with less than a year to maturity in order to circumvent restrictions on outbound investment. The only problem was the coupon of 9%. PBoC Governor, Zhou, must be coming to the realisation that nobody is going to listen to him and he might as well trudge off into the sunset and leave China Inc. to its fate. Nobody likes a smart ass anyway.


NiggaPleeze MozartIII Thu, 11/09/2017 - 21:58 Permalink

 Economically perpetual subordinated (even to unsecured creditors) debt is equivalent to perpetual preferred stock (or Trust Preferred Securities), which is quite common in the "West" as well (JP Morgan e.g. has about $26 billion in perpetural preferred ouststanding).Key is how subordinated it is to unsecured (e.g. trade) creditors - the author doesn't say but the rating agencies' rating suggests very subordinated.

In reply to by MozartIII

Citxmech NiggaPleeze Thu, 11/09/2017 - 22:38 Permalink

Another article here mentioned that perpetual bonds is how China is funding their new silk road project.  Interest is paid on the loan, but the principal never gets paid.  F'n stupidest way to fund shit I've ever heard - unless, of course, you think the monetary system under which it was created is on its way out...

In reply to by NiggaPleeze

Laowei Gweilo Citxmech Thu, 11/09/2017 - 23:13 Permalink

a lot of these PBs are not to other Chinese tho... article really should have mentioned that though China via SOE corp bonds (govt too tho) are issuing most of their loans to Africa via PBs it's how the Middle Kingdom is turning Africa into their perpetual fiefdom 'need 1 billion? sure, here you go. no no, u never have to pay back. just make sure you keep sending us the monthly interest -- FOREVER -- and we're good'and they can never ever be redeemed; only way out if Africa fiefdom X becomes rich enough they want unsaddle that debt, then they gotta find a new Africa fiefdom Y to trade it, ensuring the number of African fiefdoms remains constant

In reply to by Citxmech

luckylongshot Brian Fri, 11/10/2017 - 06:00 Permalink

Yet another in a series of articles written by people who do not understand the situation in China and based on the false assumption that China has a Rothschild owned central bank then predict disaster for China. While this ignorance is widespread- a recent report claimed 75% of British MPs still think the British Government issues money in Britain- it is still wrong.China has a public banking system where the Chinese Government has the right to issue money. In the west we have a banking system where the right to issue money is owned by a small group of private bankers. Public banking means the Chinese can convert debt into equity, cancel debt and make loans interest free without any damage occurring to their economy. They even fund their pensions through paying retirees money the Government creates, which is not debt and simply creates demand. Haven’t we had enough of these articles written by poorly informed China doomsayers to stop running them on ZH

In reply to by Brian

holdbuysell Thu, 11/09/2017 - 21:26 Permalink

Yeah, but have they figured out the 'mark to unicorn' method by suspending fair value accounting rules?They get that in place along with this, and they'll be right as rain.

Quivering Lip Thu, 11/09/2017 - 22:55 Permalink

Right out of the Lehman playbook, using loans as equity. If the other FED owners didn't hate Dick Fuld so much and want to "consolidate" Lehman, they might still be around.

Clowns on Acid Thu, 11/09/2017 - 23:20 Permalink

Why shouldn't China do this? The Fed printing money our of thin air has given rise to all sorts of "lets make it seem real" by Gov'ts socialst and communist (China is still a Communist run country politically...but "Capitalist" economonically? ...When has that EVER worked?....Without a massive war?).Nonetheless.... The Fed decison to print / monetize the debt has unleashed immorality and subsequent death notices around the less developed world.Only the "Federal Reserve", a private corporation operating in the USA with their under understood intent, as the World's Reserve currency (established and supported by the Anglo Saxon ethos) could pull off a QE to infinity BS. unethical, immoral, bail out the Bankers completely evil pogram.What is the difference now between the Fed and its paid off / blackmailed accomplices in the Western Banking world and the Central Planning Committe of the new China?  Nothing except that China has a monolithic (enforced) culture....the Fed and their Western CB banking cabal iare attempting to "import" tens of millions of under educated, non Anglo Saxons (from low wage . violent societies) to make up the "numbers" to get Gov't hand outs and ultimately get on the books as debtors (illegal and racist to deny credit to a non Anglo Saxon). To destroy the fiscally prudent Anglo Saxon culture, and replace it with a nervous, low productivity but high net profit. "diverse culture" trhat can be controlled by virtue signalling" debt and high tech miliraty enforcement.Think Zuckerberg and Schmidt. 

Ink Pusher Fri, 11/10/2017 - 07:28 Permalink

The Securitization of Debt and the subsequent re-branding of that debt as an Asset ,is the reason we are in this global shitstorm today. China just finally caught on to the biggest bullshit game in history and is going to play too....