When the former chair of China’s biggest manager of distressed debt was executed in January, the focus had been on the Rmb1.8bn ($280m) of bribes he had been found guilty of taking.
The amount misappropriated by Huarong Asset Management’s Lai Xiaomin, whose crimes included abusing the power to allocate credit and bigamy, was the highest since the founding of the People’s Republic of China in 1949, according to the judge that presided over the case.
But investors’ attention has now turned to a number many times bigger: the $22bn of dollar-denominated bonds owed by the state-owned company.
A sell-off in Huarong’s bonds, which was triggered by the group’s failure to release its financial results at the end of March, has become a test case for a longstanding conviction that Beijing will always bail out state-backed companies that borrow on international markets.
“Regulators have to decide who they’re going to help and how, and while they’re deciding, western investors are reacting with shock and horror, because it looks all of a sudden like a company owned 61 per cent by the Ministry of Finance is being hung out to dry,” said Andrew Collier, managing director of Orient Capital Research.
Assets held by Huarong as of June 2020
The prices of some of Huarong’s bonds maturing in 2022 plunged to as low as 67 cents on the dollar last week. They partially recovered on Tuesday after the Chinese regulator said at the end of last week that Huarong’s operations were “normal”, according to local media.
The company’s securities arm said via social media platform WeChat that it had repaid an onshore bond due over the weekend. Big western investors including BlackRock have invested in the company’s offshore bonds, according to Bloomberg data.
More volatility came on Tuesday evening in Asia, when prices of Huarong dollar bonds fell after US-based research firm Reorg Research reported that Chinese regulators were considering a restructuring, citing sources familiar with the matter.
Huarong International, the unit that issues or guarantees most of the group’s offshore debt, said the same day it had returned to profit in the first quarter in a statement posted on WeChat.
The gyrations indicated the importance that markets place on the Chinese government’s stance toward Huarong. The company did not respond to requests for comment.
The group is one of several big distressed asset management companies in China founded to clean up the banking system following the Asian financial crisis in the late 1990s. It has since grown into a sprawling conglomerate with Rmb1.7tn in assets as of last June, after expanding aggressively into areas including property and investment banking.
The company has said its failure to release its financial results was required so it could complete a transaction, without specifying further details. That has tapped into a wider uncertainty surrounding the quality of Huarong’s assets and the business activities of its former chair.
Caixin, a respected Chinese business publication, reported around the time of Lai’s execution that his 100 properties in southern China were distributed to his former wife and mistresses. According to state media, Lai had deposited Rmb300m in a bank account nominally belonging to his mother and stashed tonnes of cash at his home in Beijing.
Chengxin Credit, a mainland Chinese rating agency, last week warned over the business’s declining profitability and high debt, though it maintained a triple A rating. Western rating agencies have stuck with investment grade scores on Huarong but have issued similar warnings over its outlook or placed it on review for downgrade. S&P said this month that there was a “high likelihood” the company would benefit from government support.
The sell-off “serves as a reminder that a state-owned enterprise being a shareholder doesn’t mean you are taking sovereign risk”, said Michel Lowy, chief executive at SC Lowy, a distressed debt investor with a small position in Huarong bonds. “It’s a few steps removed from that.”
Fears over the health of Huarong have been compounded by uncertainty over the assets it holds. “We are trying to do due diligence to try to understand what were the assets that were acquired and what is their true value,” Lowy added.
The concerns extended beyond Huarong. China Orient Asset Management, another manager of bad loans, said last week that it was more difficult to dispose of non-performing assets in 2020 because of coronavirus.
“What no one seems to be talking about is that the other AMCs [asset management companies] may be in trouble,” said Collier. “We just don’t know . . . there’s not any transparency.”
Media reports of a potential restructuring at Huarong have added to investor concerns.
“Any losses on Huarong bond instruments will not only impact the company itself but rock the foundations of proactive state support by the Chinese government on which the dollar bond valuation of Chinese financial institutions and other state-owned entities are built,” said research firm CreditSights in a note in April, though it added losses were unlikely.
Beijing’s response to Huarong will probably take into account much more than the quality of the asset manager’s balance sheet, analysts believed.
The debacle at Huarong “could have negative repercussions on how buying bonds in Asia is perceived globally”, said Lowy. “The level of scrutiny by investors may be higher,” he added, “and it should be.”
Additional reporting by Sherry Fei Ju in Beijing