Why Didn’t Wall Street See Archegos and China Huarong Coming?


Wall Street can be a well-oiled machine, selling, recommending and facilitating the trading of securities with armies of prime brokers and capital markets bankers. But every so often, something ugly rears its head. And we ask: How did we even get here? Was someone asleep at the wheel? 

It’s baffling how Bill Hwang of Archegos Capital Management LP built a staggering $100 billion portfolio with just $20 billion net worth. Why did elite banks give someone with a history of margin calls and fines and bans by securities watchdogs, so much leverage in the first place? Now, Credit Suisse Group AG, one of the lenders, has to soak up $4.7 billion in losses. If it wasn’t for ViacomCBS Inc.’s sudden sale of new shares that resulted in an enormous margin call, the Hwang time-bomb could still have been ticking.

And right now, all eyes are on a contagious dollar bond rout spurred by China Huarong Asset Management Co., once impeccably investment grade and secure in the public eye because it is majority-owned by the Ministry of Finance. With its high ratings, Huarong’s issues could have been collateralized for up to 90% of their market value, enabling holders to buy even more assets elsewhere. But that’s history. It failed to report its 2020 financials on time, and with $22 billion in dollar bonds outstanding, the country’s largest distressed asset manager has become distressed itself. Media reports of restructuring have contributed to market anxiety not just in Asia but everywhere money flows. 

You can almost imagine what’s happening behind the closed doors (or virtual equivalents) of financial houses: Rating agencies wondering if they should cut Huarong’s grade now before the asset manager actually delays bond repayments  — a move that could affect their own reputations. Prime brokers and repo traders are more than likely debating if they should slash these bonds’ loan-to-value ratio or if they should tighten financing for bond fund clients as well. Meanwhile, fund managers, who had bought Huarong for its investment grade, are now questioning the infallibility of China’s large state-owned enterprises — and kicking themselves over their own gullibility.

The Big Three rating agencies have already put Huarong on a negative credit watch — a prelude to a possible downgrade. Talks of margin calls swirled —  how else do you explain the selloff of high-yield bonds issued by real estate developers, a completely different category? Was it spillover? Investors raising cash to cover a Huarong bet? There’s definitely long fund panic selling: Huarong is now offering higher yield than China Evergrande Group, the nation’s most indebted developer. 

Granted, just like Bill Hwang’s family office, China’s SOEs are opaque entities. But there have been plenty of ominous signals. Wall Street’s credit analysts are reacting too little, too late. And some aren’t reacting yet even though Huarong’s dollar bonds have been slowly sliding down since April 1, when Caixin, an influential financial news outlet in China, reported the delay in the annual report was due to a significant financial restructuring. The asset manager and its 1.7 trillion yuan ($260 billion) of investments needed “a big bath,” wrote Caixin, alluding to substantial write-downs. Over the weekend, the magazine followed up with a harshly worded Chinese-language editorial, headlined “Holes Won’t Disappear on Their Own”, with a subtitle “How Can Huarong Be Destroyed and Restored?”

Still, credit analysts at the big banks seemed unperturbed, even bullish. In an April 11 note, Goldman Sachs Group Inc. assured its clients that the four state-owned distressed debt asset managers enjoyed “strong government support.” After Bloomberg News reported Tuesday that the finance ministry was considering transferring its Huarong stakes to a sovereign wealth fund, Nomura Holdings Inc. said it there was still a 70% probability that most of Huarong’s senior and subordinated debt “should ultimately be made whole.” 

Some, including this columnist, see this potential stake transfer as the Ministry of Finance distancing itself from Huarong. If you believe in “strong government support,” I’ve got fairy tales to tell you. Indeed, hard reality is hitting Huarong’s bond prices as investors finally brush aside the sell-side commentary. The 4.25% perpetual bond was seeing bids at only 57 cents on the dollar Wednesday.

These bonds are guaranteed by Huarong’s cash-strapped Hong Kong-based subsidiary, China Huarong International Holdings Ltd. — not the Beijing-headquartered parent. The offshore unit held $2.2 billion cash as of June, but has $3.8 billion in bonds to be redeemed this year. 

Why Didn’t Wall Street See Archegos and China Huarong Coming?

In the event of a default, the recovery rate could be alarmingly low. As of June, loans to fellow subsidiaries ballooned to roughly half of Huarong International’s HK$198 billion ($25.5 billion) of assets, up from 22% in 2018. Some of these loans are not due until 2047. Yet, according to the company’s latest prospectus, they are considered “low risk” and therefore “no reconciliation of loss allowance has been prepared.” In other words, at Huarong International, there was no impairment charge to HK$99.5 billion worth of loans. It’s something that most reputable auditors would have frowned at. 

Meanwhile, financial assets at fair value through profit or loss — relatively easier to offload compared to related party loans —  fell to HK$29.6 billion last June, down HK$32 billion from 2018. Roughly 46%, or HK$13.8 billion, were level 3 assets, whose valuations were “not based on observable market data,” according to the prospectus.

If no one bothers to read the footnotes, we’ll eventually go deaf from all the alarm bells ringing.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

©2021 Bloomberg L.P.

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