Should You Buy the China Huarong Dip? Look Before You Leap
(Bloomberg Opinion) -- Is a great buying opportunity at hand? China Huarong Asset Management Co., majority-owned by the Ministry of Finance, is in the middle of a massive selloff of $22 billion in offshore bonds. The country’s largest distressed-debt manager has investment-grade credit ratings and is now priced like the mainland’s high-yield real estate developers.
In the past, investors who swept in during times of trouble went on to reap handsome rewards. Last September, when a letter warning of cash crunches purportedly circulated from China Evergrande Group, the property company’s bonds were slammed, even though it quickly put out a filing saying the rumors of its reorganization were fabricated. But those who bought the dip are probably smiling right now, because the bonds rebounded after Evergrande shored up its balance sheet via equity raises and debt-to-equity swaps.
Is Huarong going to be another gift from heaven?
Bargain hunters must tread carefully. China Huarong International Holdings Ltd., which guaranteed most of the bonds, is in a much more dire financial condition than Evergrande. Without help from its Beijing-based parent, the offshore subsidiary will have trouble repaying its bonds this year.
As of last June — the latest financials available — Huarong International sat on HK$16.9 billion ($2.2 billion) of cash. It has $3.8 billion in bonds that will be redeemed this year. The offshore subsidiary doesn’t seem to generate much cash flow at all. In 2019, finance costs alone came in at HK$9.4 billion, against HK$9.5 billion in revenue from interest and investment income. The picture is not any prettier in the first-half of 2020.
On paper, Huarong’s parent has the cash to pay off the overseas investors. But does it want to? Take a look at Huarong’s organization structure. The parent is not a guarantor on any of these bonds. The so-called keepwell deed it provided for the bonds is nothing more than a gentleman’s agreement that China’s courts have provided little consistency in upholding. Huarong does not have a complex cross-holdings structure. In the event of a significant restructuring, its international division can easily be spun off to fend for itself.
Here’s the simple math: As of June, Huarong’s parent sat on 1.6 trillion yuan ($240 billion) of debt; meanwhile, one-third of its 1.7 trillion yuan of assets are the result of former boss Lai Xiaomin’s rogue, non-core investments, which are overdue for substantial write-downs. Among the liabilities, about half are loans from banks and other financial institutions, roughly another 20% are bonds and notes issued by Huarong International and other subsidiaries. Who will be left holding the bag? Will Beijing’s regulators protect the overseas dollar bond investors who in part enabled Lai’s bad financial behavior in Hong Kong? Or will they back up China’s banks — whose distressed loans Huarong was supposed to resolve in the first place?
After I published my column Monday, some offshore investors pushed back, arguing that Huarong is a central state-owned enterprise and its bonds are secure. Indeed, after a record year of SOE defaults, the market consensus in 2021 appeared to be that Beijing would keep central SOEs intact while allowing regional ones to go bust.
Let’s be clear. China has a sprawling bureaucracy that can go strictly by the book. In this case, central SOEs are business entities administered by what’s called the State-owned Assets Supervision and Administration Commission. SASAC — along with the Ministry of Finance — reports to the State Council, the highest government authority chaired by China’s premier. Currently, the commission administers 97 central SOEs: Huarong is not one of them.
Caixin, an influential financial media outlet in China, reported on April 1 that Huarong had submitted a “significant” restructuring and recapitalization plan for approval by its major shareholders and authorities, which, as of June, included the Ministry of Finance with a 57% stake. After capital injections, that ownership may well fall below 50%. On Tuesday, Bloomberg News reported that the ministry is considering transferring its stake to Central Huijin Investment Ltd. — a unit of the sovereign fund China Investment Corp. — that invests in domestic state-owned financial institutions. The ministry acquired all of Huijin’s shares in 2007, but its board of directors is accountable to the State Council. In short, while the Ministry of Finance ultimately is responsible for Huarong, it appears to be distancing itself from the troubled asset manager in the government bureaucracy.
The tide is turning. S&P Global Ratings recently put Huarong, which has a BBB+ rating, on a negative credit watch. Meanwhile it revised the outlook for Evergrande, which has a B+ rating, to stable. On Tuesday, Moody’s Investors Service joined the party, placing Huarong under review for a downgrade.
When Evergrande was sold off last fall, its $4.7 billion bond due in June 2025 at least offered 8.75% coupon rate paid semi-annually, giving investors some consolation. The same can’t be said of Huarong, whose $1.5 billion perpetual bond only provides 4.5% interest. Having little access to capital markets onshore, Evergrande always needed dollar bond investors and was willing to keep them happy with higher rates. Huarong the parent does not depend on them. If it’s expedient, it can cut off its offshore arm.
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.
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