Il presente contenuto è destinato a investitori professionali ai sensi della direttiva MiFID.
by Marcus Weston, Fixed Income Senior Portfolio Manager, JK Capital Management Ltd., a La Française group-member company
In 1999, following the Asian Financial Crisis, the Chinese government created four nationally owned asset management companies (AMCs), namely China Huarong AMC, China Cinda AMC, China Great Wall AMC and China Orient AMC, to focus on managing distressed debt accumulated in state owned banks. These entities which were each attached to one of the “Big-4” Chinese banks were initially mandated to acquire and rehabilitate non-performing loans in the Chinese financial system leaving their affiliated banks to focus on their core deposit taking and lending role. This “bad bank” model has been seen successfully applied across the world in both developed and emerging countries and has proved to be extremely effective as a policy of economic risk management.
China Huarong Asset Management Corporation was incorporated in November 1999 under the Ministry of Finance (MoF). In 2000 it began to purchase Non-Performing Loans (NPL) of Industrial and Commercial Bank of China (ICBC). In 2014, the government introduced strategic investors as shareholders of the company and listed China Huarong AMC on the Hong Kong stock exchange in 2015 although, to this day, the China MoF has maintained a majority ownership and policy control of the entity (63% shareholding).
As a result of the economic boom after the 2008 financial crisis, NPL growth in China remained relatively contained while other parts of the domestic financial economy such as shadow banking, private equity and tradable securities markets have seen explosive growth. China’s AMC have therefore seen an opportunity and indeed a need to diversify their mandate beyond the core distressed debt management role to maintain growth. No entity has been more aggressive in this trend than China Huarong which has used inexpensive funding in the domestic and international bond markets to rapidly grow its balance sheet. In 2014 just ahead of its listing, the company’s balance sheet total assets stood at RMB600bn, in mid-2020 that number had grown to RMB1.7trn.
For the most part, the market has remained relatively unconcerned by this growth. The general market assumption that a 60% MoF-controlled financial institution with a central policy role would always enjoy state backing underpinned its investment grade rating. It allowed the company to raise over USD14bn worth of bonds in the dollar bond market alone in recent years. Even a fraud scandal related to Huarong’s Chairman in 2018 has done little to significantly affect market appetite for Huarong bonds. Its aggressive nature has seen the Huarong curve trade wider than other AMCs. As such it has long been thought of as a cheap way to hold China Quasi-Sovereign risk.
However, sentiment seems to be changing. As we have previously mentioned on several occasions in our commentaries, in recent years the government has been explicitly trying to change market assumptions about the domestic SOE sector. Specifically, the government wants investors to understand that all government entities would not enjoy a central bailout if they got into financial difficulties. Historically, it was assumed that non-strategic entities held by local governments would be the only ones impacted by reduced support. However, after the surprise default of some central government owned issuers in 2020 including university issuers owned by the Ministry of Education, the market started to realise that the line in the sand had moved. The concept of strategic importance to the economy has become less clear cut.
On April 1, 2021, China Huarong surprised the market by announcing that its FY20 results would be delayed. Its shares were, and still are suspended as a result. The reason given for the delay is that the auditors need more time to assess a financial transaction that is still being finalised. Given the unusual nature of such a delay, particularly given that Huarong is one of the largest financial institutions of China, this has led to a large amount of rumours and speculation, mostly surrounding a potential restructuring of the company. It is no secret that Chinese policy makers would like to rein in the risk-taking expansion of Huarong and to consolidate its business back to its core distressed debt management roots. Apart from some anonymous “insider” reports, there have been no official announcements of an impending restructuring, let alone what form it would take. The information vacuum has understandably created a huge amount of volatility in Huarong bonds with the curve falling between 20-40pts since the start of the month. The Investment Grade (IG) nature of the issuer and the existence of leveraged positions in the securities have no doubt added to this volatility. Given the widely held distribution of the bonds, this has had a significant impact on China IG market sentiment in April, with related names such as other AMCs and Chinese financial issuers trading weaker throughout the month.
What is really behind the Huarong suspension is still unclear. In our view it would not be surprising if the company did announce some major assets write-downs in their balance sheet considering the volatile economic environment. Similarly, we would not be surprised if the company did announce some form of business restructuring to refocus its operations back to its core strengths. Does this imply Huarong really faces the prospect of central government abandonment and a massive write down of its dollar bonds curve? At this stage we see this as unlikely. As much as a “too big to fail’ moniker in China is less powerful than it used to be, the government has bailed out financial institutions that are much less strategically important to the economy over the past few years. We believe the pragmatic policymakers in China are aware of the economic and reputational damage a failure of an entity as large and important as Huarong would have. Nevertheless, until the government or the company comes out with a clarification on the issue, the sector will continue to trade with significant volatility and we maintain a defensive positioning on Chinese SOE’s in the near term.
Note that JKC Asia Bond 2023 fund has no exposure to the AMC sector. We would wait for a lot more clarity on the situation before we would consider picking up investment opportunities in the segment.