Huarong, Evergrande Bond Slump Tests Too-Big-to-Fail Belief

A bond selloff in two of China’s most prolific debt issuers is widening concern over contagion risks in the country’s $862 billion dollar bond market.

Bonds of China Evergrande Group, Asia’s largest seller of junk-rated dollar debt, have slumped in recent weeks amid a barrage of negative news. That’s added to the sense of unease created by China Huarong Asset Management Co., one of the biggest issuers of investment-grade securities, as the company’s failure to release financial results sparked speculation about a potential debt restructuring. Both firms have about $21 billion of dollar bonds.

While China’s credit market is no stranger to bouts of volatility, the fresh wave is challenging long-held assumptions that the state would bail out investors in the country’s biggest firms. The government has offered little in the way of public support for Huarong as it seeks to balance maintaining financial stability and reducing moral hazard. Regulators have instructed Evergrande’s major creditors to conduct a fresh round of stress tests on their exposure to the firm, people familiar with the matter have said.

“We now have both the giants of China investment-grade and China high-yield dollar bond markets causing major losses for investors,” said Owen Gallimore, head of trading strategy at Australia & New Zealand Banking Group. “Similar to Huarong, you will find the high-yielding and liquid Evergrande bonds in portfolios in most parts of the world.”

Huarong, Evergrande Bond Slump Tests Too-Big-to-Fail Belief

Concern over Huarong’s future is already spilling over into peers. China Cinda Asset Management Co. and China Orient Asset Management Co. have told the banking regulator they’re concerned about losing access to offshore funding due to turmoil around Huarong, Bloomberg News reported last week.

On Wednesday, authorities said a former Orient executive is under official investigation on suspicion of corruption. Hu Xiaogang, now a vice president at Great Wall Asset Management Co., is being probed on suspicion of “severe disciplinary and law violation,” according to a statement by the Communist Party’s anti-corruption watchdog.

Huarong’s longer-dated dollar bonds are still trading well below par with the note due 2025 at 75.4 cents on the dollar and the 4.5% perpetual bond at 70.4 cents.

Evergrande’s dollar note due 2025 fell 0.3 cents to 73.1 cents, Bloomberg-compiled prices show, on pace for its lowest close since October. Its shares sank as much as 7.6% on Wednesday in Hong Kong as a HK$336 million ($43 million) buyback earlier in the week failed to arrest the slump. The stock has tumbled about 60% from a peak last July.

The slump in Evergrande’s shares and bonds is highlighting the growing pressure on Chinese developers as Beijing tightens the screws on leverage in the property sector. The company remained in breach of all official metrics for reducing debt levels -- known as the “three red lines” -- at the end of last year. Evergrande is trying to roughly halve its borrowings over the next two years.

The developer’s selloff worsened last week after Caixin Media’s WeNews reported the banking regulator is examining more than 100 billion yuan ($15.7 billion) of transactions between Evergrande and Shengjing Bank. Shengjing holds large amounts of bonds issued by Evergrande, WeNews said. Evergrande is the bank’s biggest shareholder.

Evergrande said on Monday that its business with Shengjing Bank is in line with laws. Evergrande and its subsidiaries have $1.5 billion in bonds due this year and another $7.4 billion next year, according to data compiled by Bloomberg.

Short interest in Evergrande shares has climbed 2 percentage points since late May to 8.6% of free float, according to IHS Markit Ltd. data as of Monday. Billionaire founder Hui Ka Yan owns more than 70% of Evergrande’s outstanding shares, according to data compiled by Bloomberg.

Both Huarong and Evergrande have been headaches for authorities for some time. In 2018, Huarong’s then chairman Lai Xiaomin was arrested as a corruption scandal engulfed the company, before being executed this year on charges including bribery. Also in 2018, the People’s Bank of China named Evergrande along with HNA Group, Tomorrow Holding Co. and Fosun International Ltd. as businesses that might pose systemic risks to the country’s financial system.

©2021 Bloomberg L.P.

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