China’s very bad bank: inside Huarong debt debacle

It’s been 11 weeks since Lai Xiaomin, the man once known as the God of wealth, was executed on a cold Friday morning in the Chinese city of Tianjin.

But his shadow still hangs over one of the most dramatic corruption stories ever to come out of China – a story that has now sparked nerves in the financial world.

In the middle is China Huarong Asset Management Co., the state-owned financial company that Lai hired until he became entangled in a comprehensive crackdown on corruption by China’s leader Xi Jinping.

From Hong Kong to London to New York, questions burn. Will the Chinese government stand behind the $ 23.2 billion Lai has borrowed in overseas markets – or will international bond investors have to swallow losses? Are major state-owned enterprises like Huarong still too big to fail, as global finances have long assumed – or will these enterprises be allowed to stumble, just like anyone else?

The answers have major implications for China and markets in Asia. Had Huarong not repaid his debt in full, the development would have cast doubt on a core principle of Chinese investment: the supposed support of the government for major state-owned enterprises, or SOEs.

“A default at a central state-owned enterprise like Huarong is unprecedented,” said Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group. If it were to take place, it would be a ‘watershed moment’ for Chinese and Asian credit markets.

Not since the financial crisis in Asia in the late 1990s has the case weighed so heavily. Huarong bonds – among the globally most held SOE debt – recently fell to a record low of about 52 cents on the dollar. This is not the penny on a dollar that is normally associated with companies that are deep in trouble, but it is virtually unheard of for an SOE.

Fears of short-term default eased to the company on Thursday he is said to have prepared funds for the full repayment of a foreign bond of S $ 600 million ($ 450 million) payable on April 27. information.

It is a drop in the ocean and will not remove investors’ worries about it. By all accounts, Huarong’s domestic and foreign mortgage holders are equivalent to $ 42 billion. About $ 17.1 billion of that is payable by the end of 2022, according to Bloomberg data.

Bad bank

It did not have to be that way. Huarong was created in the wake of the Asian collapse of the 1990s to prevent another crisis and not cause one. The idea was to contain a heavy wave of bad loans threatening Chinese banks. Huarong would serve as a ‘bad bank’, a safe haven for the billions secured by loans to state-owned enterprises.

Along with three other bad banks, Huarong swapped criminal debt for interests in hundreds of large state-owned enterprises, helping in the process to recover chronic money losses such as the giant China Petroleum & Chemical Corp.

After Lai took over in 2012, Huarong gained more support by pursuing investment banking services, trusts, real estate and positioning itself as a major player in China’s $ 54 trillion financial industry.

Before long, global banks came knocking. In 2013, for example, Shane Zhang, co-head of investment banking services in Asia and the Pacific at Morgan Stanley, met with Lai. According to Zhang, his company is “very optimistic” about the future of Huarong, according to a statement posted on Huarong’s website at the time.

Before Huarong went public in Hong Kong in 2015, he sold a $ 2.4 billion stake to a group of investors, including Warburg Pincus, Goldman Sachs Group Inc., and Malaysia’s sovereign wealth fund. BlackRock Inc. and Vanguard Group also acquired a lot of inventory, according to data compiled by Bloomberg. The stock has collapsed 67% since its listing.

Lai had no trouble financing his big ambitions. A big reason: Everyone thought that Beijing would always stand behind an important company like Huarong. It easily borrowed money in the foreign market at a rate of as low as 2.1%. It borrowed even more in the domestic interbank market. Along the way, Lai Huarong transformed into a powerful shadow lender, issuing credit to companies that turned down banks.

The truth was darker. Lai, a former senior official at the bank’s bank regulator, disbursed loans with little supervision from his board or risk management committee.

One Huarong credit official said Lai personally called the shots on most foreign corporate loans endorsed by her division.

Money has also flowed into projects disguised as parts of China’s pressure to build railways, ports and more around the world – the so-called Belt and Road Initiative, according to a state bank executive. Huarong did not immediately respond to questions about his lending practices.

Given Lai’s fate, both people talked about the condition of anonymity.

Huarong has collected more than half of the 510 billion yuan in emergency debt sold by Chinese banks in 2016. Lai’s vast empire had nearly 200 units domestically and abroad. He boasted in 2017 that Huarong, after reaching the Hong Kong Stock Exchange, would soon appear on mainland China as well.

The IPO never took place. Lai was arrested in 2018 and subsequently pleaded guilty to a series of economic crimes in a state television program. He spoke of the cargo of cash sent to a Beijing apartment he called “the supermarket”. Authorities said they discovered 200 million yuan there. Expensive real estate, luxury watches, art, gold – the list of Lai’s treasure kept going.

This past January, Lai was was convicted by the Secondary Interim People’s Court in Tianjin of accepting bribes of $ 277 million between 2008 and 2018. He was killed three weeks later – a rare use of the death penalty for economic crimes. Some accepted the execution as a message from China’s leader, Xi Jinping: my suppression of corruption will continue.

At Huarong, the bottom fell out. Net income fell by 95% from 2017 to 2019, to 1.4 billion yuan, and then fell by 92% in the first half of 2020. Assets shrank by 165 billion yuan.

The company announced on April 1 that it would delay its results for 2020, saying its auditor needed more time. The influential Caixin magazine this week openly speculated about Huarong’s fate, including the possibility of bankruptcy. Its credit outlook has been rated by all three top rating agencies for a possible downgrade.

According to people familiar with the matter, Huarong suggested a cattle restructuring. The plan involves downloading non-core businesses that are losing money. Huarong is still getting a grip on what the businesses are worth. The proposal, which the government will have to approve, helps explain why the company has delayed its 2020 results.

Huarong officials have been meeting with peers at state-owned banks for the past two weeks to allay their concerns.

The Chinese Ministry of Finance has argued another possibility: the transfer of its stake in Huarong to a unit of the country’s sovereign wealth fund which could then solve the various debt problems. According to people familiar with the matter, regulators have held several meetings to discuss the state of the business.

Rising tension

The default of the country’s mortgage by China’s state-owned enterprises reached a record in 2020

Source: Fitch Ratings; 2021 data are for the first quarter

In an email response to Bloomberg’s questions, Huarong said he had “sufficient liquidity” and planned to announce the expected date of his 2020 revenue release after consulting auditors. The Chinese banking and insurance regulator did not immediately respond to a request for comment on Huarong’s situation.