China Huarong Gets State-Led Bailout After Record 2020 Loss

(Bloomberg) -- Government-backed investors will recapitalize China Huarong Asset Management Co. after the bad-debt manager posted a record $15.9 billion loss, ending months of speculation over whether Beijing would deem the troubled financial giant too big to fail.

The rescue package unveiled on Wednesday, while thin on official details, suggests President Xi Jinping’s government is for now unwilling to allow a default by one of China’s most systemically important state-owned companies. It’s likely to boost short-term confidence in China’s $12 trillion credit market, even as it raises concerns about the longer-term dangers of a financial system where implicit government guarantees have enabled years of reckless borrowing.

State-owned investors including Citic Group, China Insurance Investment Co. and China Life Asset Management Co. will replenish Huarong’s capital, the nation’s biggest bad-loan manager said in an exchange filing Wednesday. Huarong said it has no plan to restructure its debt, reiterating that it’s made preparations for future bond payments.

The statement confirmed a Bloomberg report that Huarong was poised to receive fresh capital as part of an overhaul plan, according to people familiar with the matter, who put the amount being discussed at about 50 billion yuan ($7.7 billion). Control of the company would shift to Citic, the people had said, though details were still being finalized and could change.

The overhaul marks the government’s first major attempt to resolve a crisis at Huarong that has roiled the world’s second-largest credit market since April. The financial giant’s plight has become the biggest test in decades of Chinese authorities’ willingness to support troubled state-owned borrowers amid a record wave of defaults.

“This is clearly a good signal that SOE support is still firmly in place when financial stability is at risk,” said Kamil Amin, a credit strategist at UBS Group AG, referring to state-owned enterprises. “For financial systemically important issuers, I think the notion of being too big to fail holds more than for property developers, for example.” 

Concerns have been swirling among investors over Huarong’s financial health and the lack of clarity on government support after the company delayed its earnings release. In separate exchange filings on Wednesday, Huarong reported a preliminary 2020 loss of 102.9 billion yuan and said the board will approve the results for last year as well as interim 2021 results on Aug. 28.

China Huarong’s dollar bonds are rallying Thursday morning to their highest levels since mid-April. The firm’s Huarong’s 4.5% perpetual note rose 5.8 cents on the dollar to 96.5 cents, Bloomberg-compiled data show. That’s up from a low of 50 cents in May. Dollar bond spreads in China’s broader investment-grade market tightened by about 1 basis point, according to credit traders.

The details of the government’s ultimate decision on Huarong will be scrutinized by investors for its broader implications. The effort to help the company make good on its $242 billion of liabilities -- including about $21 billion of offshore bonds -- would neutralize a potential systemic risk to China’s financial system and make it easier for other state-owned borrowers to tap the credit market.

At the same time, authorities may be wary of providing unconditional support. That would likely undermine Xi’s campaign to curb reckless borrowing, much of which has been enabled by implicit government guarantees. When asked about Huarong last month, a spokesperson for China’s banking regulator said the government addresses problems at risky companies with “market-oriented” solutions.

Some analysts have warned that rescuing troubled companies will only delay China’s reckoning with its record corporate debt pile, making it more painful when a crisis inevitably strikes.

“Overall we think it’s credit positive for investors, particularly those holding bonds with near-term maturities. From a cash-flow perspective, the company will potentially refinance the bank loans it has taken to pay off the bonds maturing this year with proceeds from asset sales,” said Amin of UBS. “Longer term, the company will need to show itself as stable and well-capitalized for investors to regain confidence and consider investing in new issues.”

If the potential strategic investment is implemented, it will replenish Huarong’s capital, consolidate its foundation for sustainable operations, and ensure it meets regulatory requirements, the firm said on Wednesday.

Huarong shares will remain suspended. The stock has tumbled 67% since its 2015 listing. 

Citic Ltd. said in an exchange filing on Wednesday that Citic Group will become a substantial shareholder of Huarong, without giving more details.

What Bloomberg Intelligence Says...

“In order to avoid contagion for other Chinese SOEs, the government and Citic could choose to avoid haircuts for Huarong bondholders and ask shareholders to bear losses, as has been done in previous bailouts in China.”

--Dan Wang, credit analyst

Huarong’s fate has been a subject of intense speculation since it missed a deadline to report results at the end of March. That stoked concern the company might be headed for a landmark default, sending its bonds to record lows.

While missed payments at state-owned Chinese companies have become more common in recent years, none of the defaulters have been as systemically important as Huarong. In addition to its close link to China’s central government and complex web of connections to other financial institutions, Huarong is also one of the country’s biggest issuers of offshore bonds that sit in portfolios from Hong Kong to London and New York.

Huarong has so far repaid all its bonds on time and said last month it would redeem a $500 million perpetual note in September, helping to boost market confidence. The company has also reached agreements with state-owned banks to ensure it can meet obligations through at least the end of August, Bloomberg reported in May.

Investors have remained jittery because both Huarong and regulators have stayed quiet about the state of the company’s finances and restructuring plans. Huarong’s dollar bonds due January 2025 trade at about 88 cents on the dollar, implying an unusually high risk of default for an investment-grade issuer.

Whether or not the capital injection plan comes to fruition, Huarong’s balance sheet is poised to shrink over time, people familiar with the matter said. The company is planning to sell nearly all its local units outside of the core distressed-debt business, Bloomberg reported in June.

Huarong, together with China Cinda Asset Management Co., China Great Wall Asset Management Co. and China Orient Asset Management Co., was created to buy bad loans from banks in the aftermath of the late 1990s Asian financial crisis, when decades of government-directed lending to state companies had left China’s biggest lenders on the brink of insolvency.

The bad-debt firms later expanded beyond their original mandate, creating a labyrinth of subsidiaries to engage in other financial businesses and borrow billions from the bond market. Huarong was the most aggressive of the four under former Chairman Lai Xiaomin, who was executed in January for crimes including bribery.

Established in 1979 to help pilot Deng Xiaoping’s economic reforms, Citic Group is a ministerial level financial conglomerate directly overseen by China’s State Council. That means it sits above Huarong in the nation’s complex hierarchy of government ministries and state-owned enterprises. Citic Group last year appointed former People’s Bank of China Deputy Governor Zhu Hexin as its chairman.

Citic Ltd., the group’s main listed arm, has about HK$9.7 trillion ($1.25 trillion) of assets and holds stakes in firms including China Citic Bank Corp. and Citic Securities Co.

©2021 Bloomberg L.P.

With assistance from Bloomberg