Eleven weeks have passed 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 lingers over one of the most dramatic corruption stories ever to come out of China – a story that has now set the nerves around the financial world.
Photographer: Anthony Kwan / Bloomberg
It is in its center China Huarong Asset Management Co., the state-owned financial company Lai led until it was caught in a crackdown on corruption by Chinese leader Xi Jinping.
From Hong Kong to London to New York, the questions burn. Will the Chinese government stand behind the $ 23.2 billion Lai has lent it to overseas markets – or will international bond investors have to swallow losses? Key state-owned enterprises like Huarong are still too big to fail because global finances have long been assumed – or will these companies be left to fend for themselves, just like anyone else?
The answers will have huge implications for China and Asian markets. If Huarong does not pay its debts in full, the development would call into question a central principle of Chinese investment: alleged government support for major state-owned enterprises or state-owned enterprises.
“A shortage at a central state-owned company like Huarong is unprecedented,” said Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group. If one happens, he said, it will mark “an important moment” for the credit markets in China and Asia.
Not since the Asian financial crisis of the late 1990s has the problem weighed so heavily. Huarong bonds – among the world’s largest holders of SOE debt – have recently fallen to a record 52 cents a dollar. There is no money on a dollar normally associated with deeply troubled companies elsewhere, but it is virtually unheard of for an SOE.
Fears of a short-term default calmed down on Thursday after the company He is said to have prepared funds for the full repayment of an offshore bond of $ 600 million ($ 450 million), due on April 27. information.
This is a drop in the ocean and will not eliminate investor concerns. However, Huarong owes the equivalent of $ 42 billion to bondholders in the country and abroad. About $ 17.1 billion of it will fall by the end of 2022, according to data compiled by Bloomberg.
Bad Bank
It didn’t have to be that way. Huarong was created following the collapse of Asia in the 1990s to avoid another crisis, not to provoke a crisis. The idea was to contain a growing wave of non-performing loans threatening Chinese banks. Huarong was to serve as a “bad bank,” a safe deposit for billions of loans to state-owned companies.
Together with three other bad banks, Huarong exchanged delinquent debts with stakes in hundreds of large enterprises and, in the process, contributed to the return of chronic money losers such as the giant China Petroleum & Chemical Corp.
After Lai took over in 2012, Huarong reached several, pushing into banking, trust, real estate and positioning himself as a key player in China’s $ 54 trillion financial industry.
In a short time, global banks beat. In 2013, for example, Shane Zhang, co-head of Asia-Pacific investments at Morgan Stanley, met with Lai. Zhang said his company is “very optimistic” about Huarong’s future, according to a statement posted on Huarong’s website at the time.
Before Huarong went public in Hong Kong in 2015, it sold a $ 2.4 billion stake to a group of investors, including Warburg Pincus, Goldman Sachs Group Inc. BlackRock Inc. and Vanguard Group also bought a lot of shares, according to data compiled by Bloomberg. The stock has collapsed by 67% since its listing.
Lai had no problem financing his great ambitions. One important reason: everyone believed that Beijing would always be behind a key company like Huarong. It easily borrowed money on the offshore market at rates of up to 2.1%. It borrowed even more on the domestic interbank market. Along the way, Lai turned Huarong into a powerful shadow loan, extending credit to companies that banks rejected.
The truth was darker. Lai, a former senior official at the nation’s banking regulator, lent loans with little oversight from his board or risk management committee.
A Huarong credit officer said Lai had personally appealed most of the offshore corporate loans subscribed by his division.
The money also came in projects disguised as part of China’s effort 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 answer questions about his lending practices.
Given Lai’s fate, both people spoke on condition of anonymity.
Huarong acquired more than half of the 510 billion yuan in disposed-off debt ceded by Chinese banks in 2016. At its peak, Lai’s expanded empire had nearly 200 units at home and abroad. He boasted in 2017 that Huarong, which reached the Hong Kong Stock Exchange, will soon become public in mainland China as well.
The IPO never happened. Lai was arrested in 2018 and later confessed to a series of economic crimes in a state TV show. He talked about the cash loads going to an apartment in Beijing that he had called the “supermarket.” Authorities said they discovered 200 million yuan there. Expensive real estate, luxury watches, art, gold – Lai’s treasure list worked.
Last January, Lai was found guilty by the Tianjin People’s Intermediate Secondary Court for accepting a $ 277 million bribe between 2008 and 2018. He was sentenced to death three weeks later – a rare use of the death penalty for economic crimes. Some took the execution as a message from China’s leader Xi Jinping: my crackdown on corruption will continue.
At Huarong, the bottom fell. Net income decreased by 95% from 2017 to 2019, to 1.4 billion yuan, then decreased by 92% in the first half of 2020. Assets decreased by 165 billion yuan.
The company announced on April 1 that it will delay the 2020 results, saying its auditor needs more time. Caixin’s influential magazine this week has openly speculated about Huarong’s fate, including the possibility of bankruptcy. Its credit outlook has been examined for a potential downgrade by all three rating firms.
According to people familiar with the matter, Huarong proposed a sweep reorganization. The plan would involve unloading his lost non-core business. Huarong is still trying to figure out what those businesses might be worth. The proposal, which the government should approve, helps explain why the company delayed the 2020 results, people said.
The company’s executives met with colleagues at state-owned banks to allay concerns over the past two weeks, a Huarong official said.
The Chinese Ministry of Finance has raised another possibility: the transfer of its action in Huarong to a unit of the nation’s sovereign wealth fund that could then solve the assorted debt problems. Regulators have held several meetings to discuss the company’s difficult situation, according to people familiar with the matter.
Growing stress
The implications of the onshore bonds of state-owned firms in China reached a record high in 2020
Source: Fitch Ratings; The data for 2021 are for the first quarter
In an e-mail response to Bloomberg’s questions, Huarong said he has “adequate liquidity” and intends to announce the expected launch date for 2020 after consulting with auditors. The Chinese banking and insurance regulator did not immediately respond to a request for comment on Huarong’s situation.
News that the company intends to repay a banknote due this month helped bonds return to record lows on Thursday. It’s not just about the cost of financing, said Thu Ha Chow, portfolio manager at Loomis Sayles Investments Asia in Singapore. For Huarong to have market access, it will need a “clear and definitive commitment” from the Chinese finance ministry on offshore debt or the clarity of a restructuring, she said.
One thing is for sure: Huarong is part of a much bigger problem in China. State-owned enterprises are taking on the equivalent of $ 4.1 billion in debt, and an increasing number are struggling to keep up with creditors. In total, commercial enterprises dropped a record 79.5 billion yuan of local bonds in 2020, raising the share of onshore payment bankruptcies to 57% from just 8.5% a year earlier, according to Fitch Ratings . The figure rose to 72% in the first quarter of 2021.
The shock waves in Huarong and these wider debt problems began to reverberate only with Chinese financing. The dismantling of all or part of the old Lai empire would show that Beijing is willing to accept short-term pain in order to instil financial discipline in state-owned enterprises.
The irony is that Huarong had to fix China’s big debt problem, not cause a new one.
“Allowing a state financial institution that has taken on the task of solving China’s financial system problems to fail is the worst way to deal with the risks,” Feng Jianlin, chief analyst in Beijing, told the FOST research institute. . “The authorities must take into account the massive effects of the risk of dispersal.”
– With the assistance of Charlie Zhu, Jun Luo, Zheng Li, Dingmin Zhang, Evelyn Yu, Rebecca Choong Wilkins and Tongjian Dong
(Updates with Loomis Sayles comment in the final section)