The executives of Huarong Asset Management could not hide from the Chinese authorities. A corruption investigation by the state financier in April 2018 resulted in executives and business partners scattering abroad, only to be grouped together in an international magnet. A casino tycoon with close ties to Huarong has been captured in Cambodia. Its former chairman, Lai Xiaomin, was killed in January for what a Chinese court called outrageous financial crimes and bigamy. Until recently, the company was much better at hiding its debt and covering up losses. Huarong, who had assets of 1.7 trillion yuan (US $ 262 billion) in June, is believed to have lent some of China’s riskiest borrowers with devotion. Three years after regulators began rooting out the chaos of previous management, risks are shifting to global markets.
The first sign of trouble came when the company didn’t release its 2020 financial statements by March 31. The delay was attributed to a “relevant transaction” that the auditors needed more time to assess. Then, CaixinA financial publication reported that a major restructuring was being discussed that would push bond prices to record lows. In mid-April, the debt was trading at junk prices (although government support meant that the investment grade rating was maintained). Regulators held mother for weeks and panic spilled over into other state-owned securities before declaring on April 16 that Huarong had sufficient liquidity. This has allayed some concerns about the $ 22 billion offshore bond held by global investors. On April 20, Huarong’s offshore finance unit attempted to further ease worries and said it was back to profitability in the first quarter.
However, the specter of restructuring or default in a group in which the Treasury has a nearly 60% stake continues to rock the markets. Larry Hu of Macquarie, an investment bank, noted this the turbulence in Huarong is “likely to be the start of a series of credit events in 2021”.
The concerns are justified. Huarong, one of four distressed asset management companies (AMCs), is one of the most powerful financial institutions in China. The groups were formed in the late 1990s to deal with bad debts of 1.3 trillion yuan from the country’s four largest commercial banks China’s banking system continued to produce mounds of blind credit (as of June, Huarong alone had 841 billion yuan in distressed assets). Originally designed for mining when the first toxic asset cache was drafted or liquidated, the AMCs have instead become sprawling conglomerates, both within China and Hong Kong. Under Mr. Lai’s leadership, Huarong transformed into an investment bank with dozens of subsidiaries doing everything from real estate and securities brokerage to insurance to high-yield cross-border loans. Much of its losses are believed to be related to loans given to companies that have since gone bankrupt.
The AMC business model was very controversial. Instead of just buying acidic debt from commercial banks, they began borrowing at low interest rates from banks and then lending distressed funds at high cost at high cost. A recent paper by Ben Charoenwong of the National University of Singapore and others concludes that AMCs hide banks’ bad assets from regulators, often selling them on at inflated prices to investors who borrow heavily from the same banks. These and other bad practices have resulted in a distressed commercial bank lending rate that could be two to four times higher than the officially reported 1.84%, or 2.7 trillion yuan at the end of 2020. Additionally, China’s banks have largely done so, for the most part, Andrew Collier of Orient Capital Research notes that the AMCs have been recapitalized through bond purchases.
Civil servants are becoming more and more comfortable with outages at state-owned companies. The failure of Yongcheng Coal late last year was a clear signal that even important regional state-owned companies could fail. But Huarong presents Beijing with a much bigger and more systemic challenge. The restructuring proposal has already begun to change the way investors view the most powerful financial institutions in the country. Centrally controlled state-owned companies have long been considered too big and important to fail, and are therefore seen as prime targets for investment. Any change in this sense of security would force global investors to rethink their investments in China.
According to Ming Tan of S&P Global, a rating agency, regulators are treading “a very fine line” between financial stability and moral hazard. You must weigh the potential for major financial instability if an institution the size of Huarong collapses against the effects of rescuing a ruthless conglomerate along with global investors. You may also have learned that bad assets, however well disguised, cannot be hidden forever.
A version of this article was published online on April 20, 2021.
This article appeared in the Finance & Economics section of the print edition under the heading “Righting Huarong”.