The dread and uncertainty over the fate of China's largest legacy bad bank, Huarong Group, is over and the outcome is as most had expected: another state bailout.
This morning, after a four-month saga that had sparked speculation over the fate of the nation’s largest bad bank and roiled Asian credit markets, China Huarong Asset Management revealed a record loss for last year and also said said the badly undercapitalized conglomerate would issue new shares to a consortium of strategic investors led by Citic Group, which is owned by the Chinese government and which has $1.25 trillion of assets with stakes in firms including China Citic Bank Corp. and Citic Securities.
Earlier in the day, Bloomberg reported that Huarong would receive about 50 billion yuan ($7.7 billion) of fresh capital as part of an overhaul plan that would shift control of the embattled company to state-owned conglomerate Citic Group. The number is roughly half of the $15 billion number thrown around back in April.
Huarong said a group of state-owned investors including Citic, China Insurance Investment and China Life Asset Management will "replenish" the capital (an "investment" sounds so much better than a "bail out" especially in China which has been posturing so hard that it will be far more selective which companies it rescues and/or nationalizes) of the troubled firm by buying new shares, according to a filing to the Hong Kong stock exchange. In separate statements, Huarong reported a giant loss of 102.9 billion yuan ($15.9 billion) for 2020 after initially delaying its results, and said the board will approve the results for last year as well as interim 2021 results on Aug. 28.
Rumors of the bailout helped push Huarong bond higher by 6 points to 92 cents on the dollar earlier today, the highest level since April. We expect more upside tomorrow when markets digest the news.
The bailout 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.
As Bloomberg adds, existing Huarong shareholders will likely see the value of their stakes plunge as the company recognizes losses on non-performing assets. This would include the likes of Warburg Pincus and Goldman Sachs, which were among a group of investors that bought a $2.4 billion stake in Huarong before it went public in 2015.
Ahead of the news, concerns have been swirling among investors over Huarong’s financial health and the lack of clarity on government support after the long delay in earnings. As Bloomberg notes, Beijing’s silence over the future of a company that’s majority owned by the Finance Ministry has stoked debate over whether state-backed firms are no longer granted immunity from market forces as President Xi Jinping has revived an old campaign to reduce leverage in the financial system. Persistent concerns about Huarong's fate had led to recurring selling in China's bond market, and were one of the reasons why bonds of Evergrande are now trading at all time 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. Citic faces $4 billion in maturing bonds this year which the new capital should be sufficient to cover.
Despite the euphoric burst higher earlier in the day, the implications for Huarong bondholders are less straightforward. While the capital injection would help shore up Huarong’s balance sheet, the stake transfer to Citic would leave the company one step removed from government control -- a change that may unnerve some creditors Bloomberg notes. Huarong plans to continue honoring local and offshore debt obligations, but its ability to do so over the longer term will depend on how much cash it can raise from asset disposals. Huarong aims to raise about 50 billion yuan from asset sales.