Image source: Lei Kesi for China Daily
The HKEX-listed China Huarong Asset Management (“China Huarong”) failed to publish its 2020 annual result before the 31 March deadline, causing investors to be concerned about its credit health. Subsequently, the price of its bonds across the curve plunged.
Huarong is one of the Ministry of Finance owned Asset Management Companies (AMCs) (about 60% stake), which has a superior background compared to previous distressed SOEs cases such as Tewoo Group and Yongcheng Coal. However, the financial profile of the Group is not quite healthy, and some of its subsidiaries, including Huarong International, Huarong Finance leasing and Huarong Securities, are currently facing serious asset quality problem.
One point to note is, Huarong International and Huarong Finance leasing are the issuers or guarantors of all Huarong Group’s offshore bonds, but these two companies only account for 10.8% and 7.8% of the Group’s assets respectively. China Huarong provides only keepwell deeds, which has no legally binding effects, and the creditors cannot directly claim against the keepwell provider. This scenario is similar to the previous Peking Founder Group default event, where the company refused to recognize this part of debts during their restructuring process.
For Huarong International, the largest issuer of offshore bonds, the total outstanding amount of USD bonds has already accounted for over 80% of its book assets, reflecting that the company has already suffered significant loss over the previous years. Its solvency is apparently much weaker than its parent, China Huarong.
At this juncture, we are unable to determine whether the Ministry of Finance will decide to hand over its stakes on China Huarong to Central Huijin Investment. The central government has reiterated several times this year that they will not be rescuing regional SOEs from their distressed debt holes. While China Huarong has a stronger background, if the government does not step in by offering a bailout to Huarong Group, the Group may still enter a restructuring process even if the ownership is transferred.
Once the Group enters a restructuring process, the uncertainty becomes much higher and there may be several kinds of proposal to reduce the debts, which will likely result in a haircut for the bonds and other debt instruments.
The Group said they are preparing liquidity to repay the upcoming short-term maturities, which may be true, but its sustainability is really in doubt. We think that retail bond investors should not be counting on any government assistance while investing in a bond (especially the long-term bond). Apart from the high unpredictability, even if the recovery rate is higher than the current price, it usually takes a long time to realize the gain, and the process could be extremely complicated.
Currently the negative sentiment released by this event has already spread to the entire Chinese credit market, not just Local Government Financing Vehicles (LGFVs) and SOEs. We saw the price of real estate bonds decline significantly over the last few days. However, we think the development and outcome of China Huarong’s event will continuously affect the public sectors, but not other private sectors. Those AMCs and other heavily indebted LGFVs will be facing greater risks in the future once the market confidence declines and they are unable to refinance anymore, and we expect that there will be more default cases to come.
From our perspective, many of these SOEs are actually non-profitable, highly leveraged along with a huge balance sheet, non-listed (lack of transparency in financial information), do not have liquid assets that can be converted into cash quickly, and the company’s management may lack motivation to turn the company profitable since they are usually appointed or hired (as the owner is the government). Therefore, we do not hold positive views towards them.
When it comes to the corporate bond market (including private enterprises) as a whole, we actually do not see a high systematic risk. We think the impact is temporary to other sectors and that there are more appealing investment opportunities out there.
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