Huarong’s woes pose dilemmas for Beijing

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Will China bail out a giant financial octopus or teach reckless actors a lesson?


The executives of Huarong Asset Management could not hide from the Chinese authorities. A public financier corruption investigation in April 2018 sent senior executives and business partners overseas, to be rounded up in an international pickup. A casino mogul with close ties to Huarong has been captured in Cambodia. Its former president, Lai Xiaomin, was put to death in January for what a Chinese court has called blatant financial crimes and bigamy. Until recently, the company has proven to be much better at hiding its debt and hiding its losses. Huarong, who in June had 1.7 trillion yuan ($ 262 billion) in assets, is said to have loaned out to some of China’s riskiest borrowers. Three years after regulators began removing the mess left by his previous management, the risks are spilling over into global markets.

The first sign of trouble came when the company failed to release its financial statements for 2020 by the March 31 deadline. He attributed the delay to a “relevant transaction” that the auditors needed more time to assess. Then, Caixin, a financial publication, said a major restructuring was under discussion, pushing its bond prices down to historically low levels. By mid-April, its debt securities were trading at undesirable prices (although its government support kept it holding its investment grade rating). Regulators were silent for weeks, allowing panic to spread to other state-owned securities, before declaring on April 16 that Huarong had sufficient liquidity. This allayed some concerns about the $ 22 billion in offshore bonds held by global investors. On April 20, Huarong’s offshore finance unit sought to ease concerns further, saying it had returned to profit in the first quarter.

However, the specter of the restructuring or the failure of a group in which the Ministry of Finance holds nearly 60% continues to shake the markets. Larry Hu of Macquarie, an investment bank, noted that the turmoil in Huarong is “likely to be the start of a series of credit events in 2021.”

The concerns are justified. Huarong, one of four struggling asset management companies (AMCs), is among China’s most powerful financial institutions. Created in the late 1990s to process 1.3 trillion yuan in bad debt from the country’s four largest commercial banks, the groups flourished as China’s banking system continued to produce mounds of delinquent credit (in June, Huarong alone held 841 billion yuan in distress). assets). Originally designed to be liquidated during the development or liquidation of the first cache of toxic assets, AMCs have instead grown into vast conglomerates, both in China and Hong Kong. Under Mr. Lai’s leadership, Huarong has grown into an investment bank with dozens of subsidiaries doing everything from real estate and securities brokerage to insurance and high-yield cross-border lending. Many of its losses are believed to be linked to loans made to companies that have since gone bankrupt.

AMC’s business model has been very controversial. Instead of just buying bitter debt from commercial banks, they started borrowing at low rates from banks and then lending high-cost last resort funds to struggling businesses. A recent article by Ben Charoenwong of the National University of Singapore and others concludes that AMCs aim to hide bad bank assets from regulators and often resell them at inflated prices to investors who borrow heavily from the same banks. banks. This and other bad practices have led to a non-performing loan rate for commercial banks that could be two to four times higher than the officially declared 1.84% or 2.7 billion yuan at the end of 2020. In addition, Chinese banks have largely recapitalized AMCs through bond purchases, notes Andrew Collier of Orient Capital Research.

Civil servants are increasingly comfortable with defaults in public enterprises. Late last year, Yongcheng Coal’s default sent a clear signal that even large regional state-owned enterprises could be allowed to go bankrupt. But Huarong presents a much bigger and more systemic challenge for Beijing. The suggestion of restructuring has already started to reshape the way investors view the country’s most powerful financial institutions. Public enterprises under central control have long been considered too large and too important to fail, and therefore considered prime targets for investment. Any change in this sense of security would force global investors to rethink the way they invest in China.

Regulators “are walking a very fine line” between financial stability and moral hazard, says Ming Tan of S&P Global, a rating agency. They must weigh the potential for great financial instability if an institution the size of Huarong collapses, against the effects of a reckless conglomerate bailout with global investors. They may also have learned that bad assets, no matter how well disguised, cannot stay hidden forever.



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