Huarong Is a Big Bad Mess and Bailing It Out Won’t Be Pretty

How do you clean up a mess created by the clean-up crew? That’s what Beijing is contending with as one of its largest liquidators of bad debt — established to mop up China’s $43 trillion banking system — has gone out and created a shambles of its own.

At the center of the ongoing bondholder nightmare is China Huarong Asset Management Co., the nation’s largest distressed asset manager, which sits on 1.73 trillion yuan ($263 billion) of assets and is majority-owned by the Ministry of Finance. Lai Xiaomin, the institution’s top executive until 2018, was sentenced to death for bribery and bigamy and executed in January.

Huarong is now mired in a mess of issues resulting from Lai’s investments and spending. On March 31, the company said its auditor needed more time before financials are released. There is also speculation about potential restructuring. The news sent Huarong bonds tumbling. On Tuesday, yields on some of the company’s dollar bonds rose to as high as 23%.

Who will be left holding the bag if Chinese regulators let more state-backed institutions like Huarong fail? The fate of its offshore unit, a key entity, hangs in the balance along with $22 billion of dollar bonds outstanding. A restructuring with deep haircuts for everyone who enabled Huarong’s bad behavior should be expected at this point.

It wasn’t supposed to play out this way.

Over two decades ago, in the aftermath of the Asian financial crisis, Beijing set up a quartet of large asset management companies, or AMCs, to reform and relieve its banking system of toxic debt generated by inefficient state-owned companies and the country’s leverage-fueled growth. These institutions had a clear job: keep lenders’ books neat and tidy. They vacuum up bad loans from banks and then restructure, securitize or service the soured debt. In addition, they run asset and investment management services.  

In the middle of last year, the big four AMCs — Huarong, China Cinda Asset Management Co., China Orient Asset Management Co. and China Great Wall Asset Management Co. — held 5 trillion yuan of assets and accounted for $49 billion of offshore debt, 369 billion yuan of onshore financial bonds outstanding and another 192 billion yuan of asset-backed securities, according to Goldman Sachs Group Inc. estimates based on reported results. As of October, they had more than a 90% market share in the distressed asset industry. They have raised billions of dollars of capital to help absorb the unending influx of souring debt and have played an expanding role in rescuing and restructuring a slew of failed small banks over the last year and a half. 

Huarong’s crisis was brought on by Lai’s profligate investments. However, over time, all four of the national state-owned asset managers became deeply intertwined with China’s gargantuan financial system. They are funded by the banks they are responsible for cleaning up and enjoy extended credit lines from large lenders.  Meanwhile, Beijing has created more asset management companies and expanded their ability to make markets for bad debt.  

Lai’s indiscretions put the spotlight on Huarong’s peers that were expanding well beyond managing distressed debt and into full-fledged financial services, dabbling in brokerages and trust companies. Regulators reined them in and the likes of Cinda have started reverting to their core operations. In 2020, regulators were planning to set up a holding company to oversee the AMCs as a way to ring-fence the finance ministry from more risks. In the government’s eyes, Huarong and the AMCs must not become a problem along with the toxic debt they were supposed to dissolve.

Huarong’s systemic importance and state-backed majority ownership may have given bondholders a sense of security. However, there will be consequences for its tangled relationships. Beijing is furious about the current mess. If there is one thing the last two years of rumbles in the Chinese financial system have made clear, it is that regulators aren’t going to give any support to obvious bad actors; neither are they likely to provide any real clarity to investors. They will do as they will — on an ad-hoc basis, plugging holes and finding ways to save China’s banks — one way or another.

When a restructuring does happen, the interests of China’s lenders — likely to be among the largest — will take precedence as will those of domestic investors. Unless offshore bondholders have some recourse to mainland assets or connections to help them jump the queue, they may find a big empty bag on their hands.

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

Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia. She previously worked for the Wall Street Journal.

©2021 Bloomberg L.P.

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