China’s Very Bad Bank: Inside the Huarong Debt Debacle

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

Keynote speakers at the Boao Forum for Asia Financial Cooperation Conference

Photographer: Anthony Kwan / Bloomberg

Central China Huarong Asset Management Co., the state-owned financial company Lai ruled until he became entangled in a sweeping crackdown on corruption by the Chinese leader, Xi Jinping.

From Hong Kong to London to New York, questions are burning. Will the Chinese government back the $ 23.2 billion Lai has borrowed in foreign markets – or will international bond investors have to absorb the losses? Are major state-owned companies like Huarong still too big to fail, as global finance has long assumed – or should these companies stumble like anyone else?

The answers will have huge implications for China and markets in Asia. Should Huarong fail to repay its debts in full, the development would cast doubt on a core tenet of Chinese investment: supposed government support for major state-owned or state-owned enterprises.

“A default at a central state-owned company like Huarong is unprecedented,” said Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group. Should one happen, he said, it would be a “turning point” for the Chinese and Asian credit markets.

Since the Asian financial crisis of the late 1990s, the issue has not weighed so heavily. Huarong bonds – one of the most widespread government debt in the world – have recently fallen to a low of about 52 cents on the dollar. That’s not the pennies on a dollar normally associated with big trouble businesses elsewhere, but it’s practically unheard of for a state-owned company.

Fears of short-term bankruptcy eased after the company on Thursday allegedly prepared funds for the full repayment of an S $ 600 million ($ 450 million) offshore bond due April 27. Huarong plans to pay by the due date, according to a person familiar with the matter, who asked not to be named on private information.

That is a drop in the ocean and will not allay investors’ concerns. All told, Huarong owes bondholders at home and abroad the equivalent of $ 42 billion. According to data compiled by Bloomberg, about $ 17.1 billion of that will have to be paid by the end of 2022.

Bad bank

It shouldn’t have been like that. Huarong was founded in the aftermath of the Asian collapse of the 1990s to stave off a new crisis, not cause one. The idea was to stem a swelling wave of bad loans threatening Chinese banks. Huarong would serve as a “bad bank,” a safe depository for billions of souring loans to state-owned companies.

Along with three other bad banks, Huarong traded overdue debt for stakes in hundreds of large state-owned companies, helping chronic money losers like the giant China Petroleum & Chemical Corp.

After Lai took over in 2012, Huarong reached out for more, delving into investment banking, trusts, real estate and positioning itself as a major player in China’s $ 54 trillion financial sector.

It didn’t take long for the global banks to knock. For example, in 2013, Shane Zhang, co-head of Asia-Pacific investment banking at Morgan Stanley, met with Lai. Zhang said his company was “very optimistic” about Huarong’s future, according to a statement posted on Huarong’s website at the time.

Before going public in Hong Kong in 2015, Huarong sold a $ 2.4 billion stake to a group of investors including Warburg Pincus, Goldman Sachs Group Inc. and the sovereign wealth fund of Malaysia. BlackRock Inc. and Vanguard Group have also acquired many shares, according to data collected by Bloomberg. The stock has plunged 67% since listing.

Lai had no trouble financing his grand ambitions. An important reason: everyone thought that Beijing would always stand behind an important company like Huarong. It easily borrowed money in the offshore market at rates as low as 2.1%. It borrowed even more in the domestic interbank market. Gradually, Lai Huarong turned into a powerful shadow lender, providing credit to companies that had turned down banks.

The truth was darker. Lai, a former senior official with the country’s bank regulator, made loans under little oversight from his board of directors or risk management committee.

A Huarong loan officer said Lai was personally in charge of most of the offshore corporate loans underwritten by her division.

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

Given Lai’s fate, both people spoke on condition of anonymity.

Huarong absorbed more than half of the 510 billion yuan in distressed debt divested by Chinese banks in 2016. At its peak, Lai’s vast empire numbered nearly 200 units at home and abroad. He boasted in 2017 that after hitting the Hong Kong stock exchange, Huarong would soon go public in mainland China as well.

The IPO never happened. Lai was arrested in 2018 and subsequently confessed to a series of economic crimes on a state television program. He was talking about huge loads of cash ending up in an apartment in Beijing he called “the grocery store.” Authorities said they discovered 200 million yuan there. Expensive real estate, luxury watches, art, gold – the list of Lai’s treasure went on and on.

Last January was Lai Found guilty by the Secondary Intermediate People’s Court in Tianjin for accepting $ 277 million in bribes between 2008 and 2018. He was put to death three weeks later – a rare use of the death penalty for economic crimes. Some perceive the execution as a message from the Chinese leader, Xi Jinping: my crackdown on corruption will continue.

The bottom has fallen out at Huarong. Net income plummeted 95% to 1.4 billion yuan from 2017 to 2019, then declined 92% in the first half of 2020. Assets shriveled by 165 billion yuan.

The company announced on April 1 that it would postpone its 2020 results as the accountant needed more time. Influential magazine Caixin openly speculated this week on Huarong’s fate, including the possibility of bankruptcy. The credit outlook was assessed by all three top rating firms for possible downgrading.

According to people familiar with the case, Huarong has suggested a swipe restructuring. The plan means relieving its money-losing, non-core activities. Huarong is still trying to get a grip on what those companies could be worth. The proposal, which the government should approve, helps explain why the company has slowed its results for 2020, the people said.

Company executives have been meeting with colleagues from state-owned banks over the past two weeks to address their concerns, a Huarong official said.

The Chinese Ministry of Finance has brought in another one possibility: transfer its stake in Huarong to a unit of the nation’s sovereign wealth fund, which could then resolve its various debt problems. Regulators have called several meetings to discuss the company’s plight, according to people familiar with the matter.

Increasing stress

The bankruptcy of onshore bonds by Chinese state-owned companies hit a record high in 2020

Source: Fitch Ratings; The data for 2021 refers to the first quarter


In an email response to inquiries from Bloomberg, Huarong said it has “sufficient liquidity” and plans to disclose the expected earnings release date for 2020 after consulting auditors. The Chinese banking and insurance regulator did not immediately respond to a request for comment on Huarong’s situation.

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