China’s very bad bank: within the Huarong debt debacle

It has been 11 weeks since Lai Xiaomin, the man known as the God of Wealth, was executed on a cold Friday morning in the Chinese city of Tianjin.

But its shadow still rests on one of the most dramatic corruption stories to ever come out of China, a story that has now put nerves on the edge of the financial world.

In its center is China Huarong Asset Management Co., the state-owned financial company that Lai dominated until he was caught in a crackdown on corruption by Chinese leader Xi Jinping.

From Hong Kong in London to New York, questions burn. Will the Chinese government keep the $ 23.2 billion Lai asked for in foreign markets or will international bond investors have to swallow losses? Key state-owned companies like Huarong are still too big to fail, as global finances have taken over for a long time – or will these companies be allowed to stumble, like anyone else?

The answers will have huge implications for China and Asian markets. If Huarong does not pay its debts in full, the development would call into question a basic principle of Chinese investment: the government’s alleged support for major state-owned enterprises (SOEs).

“A default on a central state-owned company like Huarong is unprecedented,” said Owen Gallimore, head of credit strategy at banking group Australia and New Zealand. Should it occur, he said, it will mark “a turning point” for the Chinese and Asian credit markets.

No, since the Asian financial crisis of the late 1990s, the issue has not weighed so heavily. Huarong bonds – among the most widely traded SOE debts in the world – recently fell to a record low of about 52 cents on the dollar. It’s not the one-dollar money that is typically associated with troubled companies elsewhere, but it’s virtually unheard of for an SOE.

Fears of a short-term default were allayed Thursday after the company it was said to have prepared funds for the full redemption of a $ 600 million ($ 450 million) offshore bond to mature on April 27th. information.

This is a drop in the ocean and will not eliminate investor concerns. All in all, Huarong owes the holders of domestic and foreign bonds the equivalent of $ 42 billion. According to data collected by Bloomberg, about $ 17.1 billion is to be paid by the end of 2022.

Bad bank

It wasn’t supposed to be that way. Huarong was created after the 1990s of the Asian collapse to avert another crisis, not to provoke one. The idea was to contain a wave of bad loans that threatened Chinese banks. Huarong was to serve as a “bad bank,” a safe deposit of billions in agricultural loans granted to state-owned enterprises.

Along with three other bad banks, Huarong exchanged delinquent debts for stakes in hundreds of large sound companies and, in the process, helped turn around chronic money losers such as China Petroleum & Chemical Corp. giant.

After Lai took over in 2012, Huarong achieved more, betting on investment banking, trusts, real estate and positioning himself as a key player in China’s $ 54 trillion financial industry.

Soon, world banks touched. In 2013, for example, Shane Zhang, co-director of Asia-Pacific investment banking at Morgan Stanley, met with Lai. Zhang said his company was “very optimistic” about Huarong’s future, according to a statement posted on Huarong’s website at the time.

Before Huarong went public in Hong Kong in 2015, it sold a $ 2.4 billion stake to a group of investors such as Warburg Pincus, Goldman Sachs Group Inc. and the sovereign wealth fund of Malaysia. BlackRock Inc. and Vanguard Group also acquired many shares, according to data compiled by Bloomberg. Shares have fallen 67% since their listing.

Lai had no trouble funding his great ambitions. One big reason: everyone thought Beijing would always be behind a key company like Huarong. He borrowed money easily from the offshore market at such low rates of 2.1%. He asked for more loans in the domestic interbank market. Along the way, Lai transformed Huarong into a powerful shadow lender, who extended credit to companies that banks squandered.

The truth was darker. Lai, a senior official of the country’s banking regulator, distributed the loans with little oversight from his board of directors or risk management committee.

A Huarong credit officer said Lai personally fired most of the offshore corporate loans taken out by his division.

The money was also earmarked for projects disguised as parts of China’s drive to build railways, ports and more around the world, the so-called Road and Waist Initiative, according to a bank executive state. Huarong did not immediately answer questions about his loan practices.

Given Lai’s luck, both people spoke on condition of anonymity.

Huarong earned more than half of the 510 billion yuan in distressed debts that Chinese banks withdrew in 2016. At its peak, Lai’s expanding empire had nearly 200 units at home and abroad. He it was boasted in 2017 that Huarong, having gone public on the Hong Kong stock exchange, would soon go public on mainland China as well.

The IPO never happened. Lai was arrested in 2018 and later confessed to several economic crimes on a state television show. He talked about the amount of cash coming into a Beijing apartment he had dubbed “the supermarket.” Authorities said they discovered 200 million yuan there. Expensive real estate, luxury watches, art, gold: Lai’s treasure list continued.

Last January, Lai was found guilty by the Tianjin Intermediate Secondary People’s Court of accepting bribes of $ 277 million between 2008 and 2018. He was sentenced to death three weeks later, a rare use of the death penalty for economic crimes. Some took the execution as a message from Chinese leader Xi Jinping: My repression of corruption will continue.

In Huarong, the bottom has fallen. Net profit fell 95% from 2017 to 2019, to 1.4 billion yuan, and then sank 92% during the first half of 2020. Assets have shrunk by 165 billion yuan.

The company announced on April 1 that it would delay its 2020 results, saying its auditor needed more time. The influential Caixin magazine this week openly speculated about Huarong’s fate, including the possibility of bankruptcy. Their credit prospects were reviewed for a possible downgrade of the three top-rated companies.

According to people familiar with the matter, Huarong has proposed a sweep restructuring. The plan would involve unloading your non-core businesses that are losing money. Huarong is still trying to get an idea of ​​what these companies might be worth. The proposal, which the government should approve, helps explain why the company delayed the 2020 results, citizens said.

Company executives have met with colleagues from state-owned banks to allay their concerns over the past two weeks, a Huarong official said.

The Chinese Ministry of Finance has raised another possibility: to transfer its stake in Huarong to a unit of the nation’s sovereign wealth fund that could then solve the various debt problems. Regulators have held several meetings to discuss the company’s plight, according to people familiar with the matter.

Increased stress

Non-payment of land bonds by Chinese state-owned enterprises hit a record high in 2020

Source: Fitch Ratings; The data for 2021 correspond to the first quarter

In an email response to Bloomberg questions, Huarong said he had “adequate liquidity” and plans to announce the expected release date of earnings for 2020 after consulting with auditors. China’s banking and insurance regulator did not immediately respond to a request for comment on Huarong’s situation.