Chinese economic policymakers are caught between a rock and a hard place as they try to piece together a rescue plan for embattled bad-asset manager China Huarong Asset Management.
On the one hand, they want to adhere to the market-based principle that investors should bear part of the burden. But on the other, policymakers are trying to avoid saddling those investors with a cost that would hurt future investments in China.
Because of Huarong’s many connections to other financial institutions, analysts agree that the situation needs to be resolved, and soon, to avoid significant contagion effects on the domestic and international financial systems. The question is what form that resolution will take, and how much government support will factor in the plan.
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Authorities are unprepared to let Huarong fail, as doing so would raise questions about the financial health of other state-owned asset management companies while putting the broader economy at risk, according to analysts.
Given Huarong’s aggressive asset expansion through problematic merger and acquisition transactions overseas, it no longer fixes problems but has become the problem itself, said Larry Hu, chief China economist at Macquarie Group, noting that Huarong’s total assets surged six-fold in the five years to 2017.
But Huarong does not represent a “Minsky moment” – the onset of a market collapse brought on by reckless speculative activity – and the overall risk to China’s financial system remains low because the market still holds a strong belief in Beijing’s seemingly unlimited capacity to step in as the lender of last resort, Hu said.
Huarong has a balance sheet of more than 1.7 trillion yuan (US$261.5 billion), three times bigger than that of Baoshang Bank, which was taken over by the government in 2019 when it went belly-up amid a rash of speculative lending.
But financial markets remain nervous about the outlook for China’s US dollar bond market, given that there are few details about Huarong’s overall financial health or about how it will be put back on a firm footing.
Set up as one of the country’s four state-owned Asset Management Companies in 1999 to dispose of non-performing loans for the big four state-owned banks before their listings on stock exchanges, Huarong serves a key role in supporting Chinese commercial banks’ ability to extend credit to the wider economy by buying up their bad assets, providing them with cash for further lending. Its majority stakeholder is the Ministry of Finance.
“This is not over as long as there is no official information released on what the actual problem is,” said Zhang Ning, senior China economist at UBS Global Research. “Until now, [Huarong] still has not said if it will default or have a corporate restructuring plan.”
Judging from the current situation, the operating conditions of these financial asset management companies are stable
Xiao Yuanqi, China Banking and Insurance Regulatory Commission
Panic in Asia’s credit markets and a sell-off in Chinese offshore dollar bonds in the past two weeks were triggered by Huarong’s failure to publish its annual results pending a “relevant transaction”. With local media reporting a looming debt restructuring in which bondholders would be hit by painful losses, the price of Huarong’s offshore bonds slumped by as much as 30 per cent.
At the weekend, Chinese regulators tried to soothe investor worries over Huarong and reduce the risk of market contagion, but uncertainty about the extent of Beijing’s support for the nation’s biggest distressed debt manager continues to linger.
“Judging from the current situation, the operating conditions of these financial asset management companies are stable,” Xiao Yuanqi, vice-chairman of the China Banking and Insurance Regulatory Commission, said at a briefing on Friday in response to a question on Huarong’s situation. “Rest assured, the key operating indicators and regulatory indicators are within a reasonable range.”
Huarong Securities also said at the weekend that it had fully repaid its 2.5 billion yuan (US$384.5 million) worth of subordinated bonds that were due on April 18, according to the firm’s Weibo account, adding that it had fully met its redemption obligations on various bonds as scheduled, with no debt-default situation occurring.
Huarong has also prepared sufficient funds for the full repayment of a S$600 million (US$452 million) offshore note due on April 27, the official Shanghai Securities News reported.
Following the official comments, Huarong bonds have been paring losses in recent days, bouncing back from record lows. However, prices remain well below last months’ levels as worries persist. Prices of Huarong credit default swaps – financial derivatives that act as insurance policies against default – eased on Friday from their peak on April 15 but remained well above levels seen in March, indicating continued worries about the company’s future.
How much Beijing will support Huarong in its current troubles is the key question for financial markets.
“Given the opaque nature of distressed asset holdings for these [asset management companies], a pullback of state support could threaten their credit access and liquidity positions,” said Chang Wei-liang, currency and credit macro strategist at DBS Bank. “The failure of a large financial institution such as Huarong runs the risk of fanning financial turmoil, due to a large exposure to Huarong across many financial institutions.”
As the financial health of state-backed firms continues to deteriorate due to the shock from the coronavirus and the US-China trade war, Beijing has been signalling that it will tolerate defaults on bonds issued by some state-owned enterprises (SOEs) to curb faith in the notion that SOEs carry an implicit government guarantee.
China’s top five defaulters made up 54 per cent of onshore bond defaults in 2020, showing that repayment pressure is being driven by larger but fewer firms, of which many are SOEs since local governments, which used to provide implicit guarantees, have been breaking away from the practice, said Alicia Garcia-Herrero, chief economist for Asia-Pacific at Natixis.
Huarong’s situation is a test of the extent of Beijing’s willingness to resolve repayment difficulties with debtholders using a market-driven approach as part of a potential debt restructuring, instead of relying fully on government support measures.
Under its former chairman, Lai Xiaomin, Huarong expanded beyond its original mandate of managing soured debt – branching out into securities trading, trusts and other investment products.
Lai was executed in January after being found guilty of bribery, corruption and bigamy charges. Lai was accused of accepting US$277 million worth of bribes when he was party secretary and Huarong’s chairman between 2008 and 2018.
China’s Ministry of Finance is considering transferring its ownership stake in Huarong to Central Huijin Investment, a sovereign wealth fund, Bloomberg News reported, citing a person familiar with the matter.
“On the one hand, they are keen to reduce a moral hazard by forcing investors to take a haircut – thereby teaching them the hard way that even state-controlled institutions such as Huarong do not enjoy blanket government guarantees,” said Wei He, China economist at Gavekal. “On the other, they want to prevent any disorderly knock-on effects in the domestic financial system and to limit the damage to confidence in China’s offshore market.”
China’s onshore corporate bond market has stayed calm so far, with the difference in the price of Huarong bonds remaining low compared with similar issues. But the issue is with Huarong’s so-called Keepwell provisions that enable China’s banks and non-bank finance companies to access foreign currency financing in the global bond markets.
Essentially, a Keepwell provision is a pledge, not a guarantee, to keep an offshore subsidiary that issues the bonds solvent in the event of distress. The immediate risk is that Huarong’s offshore issuance vehicles may not be supported in any restructuring, Hank Calenti, credit analyst at research firm CreditContinuum, wrote in a note published by online research network Smartkarma.
Not supporting [Huarong’s offshore issuance vehicles] could all but eliminate China Inc’s access to the global bond markets
Hank Calenti, CreditContinuum
“Not supporting these securities could all but eliminate China Inc’s access to the global bond markets,” Calenti said.
China Huarong International Holdings, the key offshore financing arm of China Huarong Asset Management, said in a statement on Tuesday that it returned to profitability in the first quarter and would be focusing on cutting risk exposure and ensuring liquidity.
International investors may be required to bear a somewhat bigger loss in any restructuring to remind them that the Keepwell arrangements backing offshore bonds have no formal validity, Gavekal’s He said.
After some initial harsh rhetoric, the People’s Bank of China eventually took over Baoshang to prevent contagion and imposed an average haircut of around 10 per cent on large institutional investors. It is probable that the Huarong haircut will be on a similar scale, He argued
“Nevertheless, the haircut will not be so big that it inflicts longer-term damage on investor confidence in the market,” He said.
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