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China credit systemic risks. A thread. Before I start I would like to make sure everyone acknowledges and understands that China credit worries have been lingering for a long time now and there has been lots of legacy and excess leverage. But even for China this is big
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China debt build-up since the GFC is something for the economy manuals, and definitely ranks as one of the largest in recent history. Rapid credit growth clearly creates heightened financial sector risks. Makes it more difficult to balance those risks with the need to
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Maintain regular positive credit impulses. This massive re-leveraging has created a significant bad debt problem. The consequences of the debt build-up has occupied policy makers ever since with repeated crisis. Banks, Construction, State Enterprises....some defaulted already
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As stock and flow of debt continues to be problematic, there is no easy fix. But the need to tackle the leverage is preventing more ample liquidity injections. So what’s new and why does it matter? The entity at the center today is Huarong, a AMC
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AMCs were born in the late 90s as a child of the banking crisis, with an aim to hold the system’s bad debt. Huarong is one of 4 national ones (Cinda the biggest) and there are many more regional ones. Over the years these morphed into distressed debt conglomerates.
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They were also allowed to convert into joint-stock companies. So, they listed and sold many euro$ bonds some through keepwell structures. Let’s pause for a sec and summarize all the risks involved.
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1- these vehicles were bad loans structure at inception and morphed into distressed credit and non-bank financial to struggling corporates, including property, so the quality of the books is a reflection of their mandate.
2- the massive increase in leverage
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2- the massive increase in leverage
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and the subsequent change in their mandate generated massive growth in assets. They are huge.
3- their liabilities match the size of their assets. All 4 AMC have something like $ 50 bn in offshore bonds. That’s > 5% of total Chinese offshore. On top of their onshore and ABS
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3- their liabilities match the size of their assets. All 4 AMC have something like $ 50 bn in offshore bonds. That’s > 5% of total Chinese offshore. On top of their onshore and ABS
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Here is the outstanding maturities of Huarong, Great Wall and Cinda. What you can see clearly, is that Huarong problems are related to a wall of maturities this year. Great Wall is next year’s play. Cinda more spread-out.
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This debt structure explains the current panic over Huarong, only there is much more to it. Stock has been suspended since end of March after a 2018 investigation found it’s Chairman Lai guilty of graft. He was sentenced to death and executed end of January 2021.
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4- These entity’s core credit risk is trash but many funds have loaded-up on their offshore and onshore bonds. (Should I name Blackrock?) Why? Because agency’s ratings are not in sync with the underlying core credit risk based on tte assumption of implicit gvt support.
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It’s hard to quantify this rating uplift but credit traders I trust put it at 4 to 7 notches on average. As an illustration Moody’s Feb 20 report on AMC clearly classifies them as « financial stabilizers » hence with implicit gvt support.
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5- it’s all good and well until some of the offshore bonds of Huarong sell-off from parity to 90c then to the low 70c in a few days. Losses have been massive across banks and EM Credit portfolios that relied on Moody’s verbose rating.
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6- All this is just the top of the iceberg. In reality these 4 and their regional clones are non-bank liquidity providers to corporates (usually in distressed sector like construction) and local gvt for off-budget debt management. Who and how much is anyone’s guess.
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7- How committed is the MOF to maintain it’s support to AMCs? For one, they have been allowing state enterprises to default this year. For two, these AMCs have steered away from their original mandate and became conglomerates.
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Estimates of non-core are >40% of revenues on average for the 4 big ones. So it is unclear if a restructuring is not on the cards.
8- And surprise surprise, Huarong failed to publish it’s preliminary result by the March 31 deadline
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8- And surprise surprise, Huarong failed to publish it’s preliminary result by the March 31 deadline
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which probably means that a restructuring IS actually happening. Haircut anyone?
9- With over RMB 5 tn of assets, crap assets, these are systematic players connected through liquidity support provisions to the rest of the financial system, especially it’s weakest parts.
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9- With over RMB 5 tn of assets, crap assets, these are systematic players connected through liquidity support provisions to the rest of the financial system, especially it’s weakest parts.
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10- the funding part is no less alarming as they rely for more than half their funding on wholesale markets and bond issuance. So they depend on the financial system and support it back.
11- the minute Huarong flared, contagion spread
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11- the minute Huarong flared, contagion spread
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Property names saw significant selling pressure while China IG and HY also squeezed lower.
Conclusion: The size of the maturities makes this one of the largest credit events in Asia of late and the signs of Huarong restructuring + haircut are spooking everyone.
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Conclusion: The size of the maturities makes this one of the largest credit events in Asia of late and the signs of Huarong restructuring + haircut are spooking everyone.
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