China's Largest Conglomerate Is On The Verge Of Bankruptcy

On December 8, we lamented how every few days we return to the subject of systemic risk in China related to its big four highly-indebted conglomerates, HNA, Anbang, Evergrande and Dalian Wanda. We also noted how our chief source of concern had become HNA, after it issued a bond with less than one year to maturity with the extortionately high coupon of 9%, not longer after S&P downgraded HNA’s credit rating from B+ to B, five levels below investment grade. The reason for our continuing focus on HNA is its $28bn of short-term debt which matures before the end of next June, much of it accumulated during a $40 billion binge of acquisition-driven growth which saw it become a major shareholder in Deutsche Bank, Hilton Worldwide and others.

We have repeatedly discussed  how despite being one of China’s largest conglomerates, HNA has been shut out of stock and bond markets as lenders worry about its outsized debt load, forcing the company to pledge some of its core holdings as collateral for short-term loans, as the Wall Street Journal  reported last month. And yet, even as the company resorted to loaning out shares and entering into arcane derivative financing agreements to finance its debt-service payments, it quickly found out that traditional avenues of financing are disappearing or becoming too costly

We also noted how HNA business units had suffered further credit downgrades and been forced into cancelling bond issues. For example, Hainan Airlines cancelled a 1 billion yuan ($151.2 billion) issue of perpetual bonds to repay maturing debt, HNA Investment Group (hotels and real estate) cancelled a 5.22 billion yuan ($790 million) issue and S&P cut the long-term credit rating of HNA’s Swissport Group Sarl to b-, six levels below investment grade, citing concerns about its parent.

Two weeks later  we followed up with another piece on this giant Chinese conglomerate, noting that while almost everything we read about HNA is “shady”, one thing is certain, HNA’s financial position is far from being “stable”, as the company asserts. Indeed, all the evidence points to it becoming more unstable, although its extremely opaque “private” ownership structure, which prompted Bloomberg to call it “The Mysterious Chinese Company Worrying The World”, makes it even harder to analyze.

This was confirmed by China's Citic Bank which said a unit of HNA Group is having difficulty repaying certain short-term debts, just over a week after the Chinese conglomerate said it won’t default in the coming year. HNA Aviation Group has had trouble paying bankers’ acceptances - debt instruments that mature in the short term - and Citic Bank is working with HNA Group to try to resolve the situation, the Chinese lender said in a statement sent exclusively to Bloomberg News. The group has several bonds and loans from multiple banks maturing at similar times, causing a “temporary liquidity” issue, Citic Bank said.

All this followed earlier reports that first Bank of America  and then HSBC had advised their banks to stop transactions with HNA and pitching new business due to the conglomerate's "debt levels and ownership structure."

As we concluded one month ago, "We see it as a major “red flag” when fee-hunting banks – Bank of America in July and HSBC earlier this month – warn their bankers not to pitch for new business with a company that’s been on a $40 billion acquisition spree since 2016."

Just a few days later, and with memories of 2016's dramatic plunge in Deutsche Bank shares still fresh, its fellow shareholders that it is a “long-term investor” in Germany’s largest bank.  The comment was, of course, self-serving: Though it has purchased downside protection to protect against a large drop in DB’s shares, a substantial decline in the company’s valuation could be the straw that pushes the conglomerate into bankruptcy, and potentially triggers China’s "Minsky moment." It could also unleash another liquidation panic in Deutsche Bank shares if other shareholders become convinced that HNA is looking to sell its $4 billion worth of DB shares (roughly a 10% stake) and try to frontrun it. 

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With all this in mind (and there is much, much,  much  more), fast forward to today when the crisis surrounding HNA Group deepened after it emerged in the latest twist, that the giant Chinese company’s ability to repay its debt will face a potential shortfall of at least 15 billion yuan ($2.4 billion) in the first quarter, according  to Bloomberg.

In a continuation of the financial warnings passed around quietly behind the scenes by HNA, the sprawling conglomerate warned major creditors about its financial status in a meeting in Hainan last week, though it also said that the pressure will probably ease in the second quarter as the group steps up asset disposals, according to Bloomberg sources.

While this latest news illustrates the extent of HNA’s liquidity challenges - none of which will come as a surprise to readers who have been following this long-running fiasco - as well as the urgency behind it after the conglomerate spent tens of billions of dollars on debt-fueled investments to transform a little known airline into one of China’s biggest business behemoths, the scale of the funding gap will likely deepen concerns about the viability of the group, which owns stakes in everything from Deutsche Bank AG to Hilton Worldwide Holdings, as it faces scrutiny worldwide from regulators and investors.

As for HNA's assurance that its asset sales will accelerate, the desperation behind that statement is by now obvious to all: "It’s not going to be easy to sell assets in such a short time to cover the shortfall so the decisions made by banks will be crucial in the coming weeks," said Linus Yip, Hong Kong-based strategist with First Shanghai Securities Ltd. "HNA can only hope that banks will grant it new funds."

The private warnings come at a time when the company has repeatedly said that it’s in good financial condition and that its debts are manageable. Just last month we reported that board director Zhao Quan said that any tightness in funds would be temporary and that the group wouldn’t default on any borrowings in the coming year.

Meanwhile, fears of a systemic crisis are growing: as Bloomberg cautions, HNA has become massive. The company had $190 billion of assets - more than at American Express - as of June, held nearly $30 billion of shareholdings and owned an estimated $14 billion in real estate properties worldwide.

But recently, the company has mostly stood out for its debts as concerns about its ability to repay loans and bonds have driven up its borrowing costs.

And the punchline: HNA is now effectively insolvent as its earnings can’t even cover its interest expenses, which according to data compiled by Bloomberg, have soared to levels topping those of any non-financial Chinese company. This is why the company is now a systemic threat to the entire Chinese economy. Meanwhile, its cash and earnings also fall short of the $29 billion in short-term debt that the company faces.

Which brings us to the bottom line: HNA has about 65 billion yuan in debt coming due during the first quarter, and it is facing a 15 billion yuan shortfall to cover just this quarter's obligations.

In other words, if HNA fails - and the government does not bail it out - the Chinese dominos will start falling. HNA’s overall debt totals about 1 trillion yuan, with China Development Bank being the group’s biggest creditor, according to the people. That’s 56% higher than the 637.5 billion yuan in short- and long-term debt the company disclosed as having as of November.

And the biggest surprise in the Bloomberg report: HNA's creditors are already starting to organize ahead of what may be one of the world's messiest bankruptcies.

HNA’s mounting liquidity woes have prompted some major lenders to consider banding together to form a committee that could exert more pressure on HNA, the people said. HNA creditors have yet to decide whether to form a creditor committee, the people said. Forming a committee is a popular strategy that creditors in China use when dealing with a borrower facing substantial difficulties. Such an arrangement may give creditors more influence in the group’s strategic decisions, including asset sales.

It also would mean that, for all intents and purposes, China's largest conglomerate is effectively bankrupt, which is bad news for the company's dozens of creditors, which include China Development Bank, Export-Import Bank of China, Bank of China Ltd., Agricultural Bank of China Ltd., Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Bank of Communications Co. and Shanghai Pudong Development Bank Co.

HNA met with those eight banks in Hainan last month to discuss ways of providing credit support in 2018.

There is still hope that the local Chinese government will bail the company out: the Hainan provincial government, which called the meeting, expressed its support for HNA, Bloomberg's sources said, although should China proceed with a bailout of this magnitude it would demonstrate to the world that Xi Jinping's reform agenda which includes deleveraging and allowing insolvent corporations to fail, has been nothing but smoke and mirrors.