China’s Huarong posts record $16bn loss in long overdue annual report

China Huarong Asset Management reported a record loss as leverage hit 1,333 times in 2020 in a long overdue annual report, just a little more than a week after it secured a government-orchestrated bailout to keep it from the precipice.

Huarong reported a 102.9-billion yuan ($15.9bn) loss for all of 2020, slashing its shareholder equity by nearly 85%, the firm said in a filing on Sunday in Hong Kong. The bad loan manager booked 107.8-billion yuan in impairments and suffered a 12.5-billion yuan loss on financial assets. While it returned to a profit of 158-million yuan in the first half this year, Huarong’s key capital level was far below regulatory requirements in June.

After five months of turmoil since it delayed its earnings report in March, China’s biggest bad debt manager secured a rescue package in August  from some of the nation’s biggest financial firms. Its plight had become the biggest test in decades of whether Beijing would still shield state-owned firms from market forces amid a renewed push by President Xi Jinping to rein in debt growth as defaults have hit records. 

A review of assets and risks in 2020 “had a significant impact on the operating results and is a harsh lesson to be learnt in the development history of the company”, chair  Wang Zhanfeng said in the report. “What is gone is gone, but go for what to come. We will learn from the lesson and take it as valuable experience and the desire to move forward.”

The firm said on Sunday that it plans to dispose of subsidiaries with noncore business activities in the “near future” to increase internally generated fund inflows and to replenish capital. It didn’t give any further details on its rescue plan in the report.

The company said by implementing measures including asset sales and a capital boost it can ensure operations for the next 12 months.  

State-owned investors including Citic Group, China Insurance Investment   and China Life Asset Management   on August 18 agreed to put fresh capital in Huarong. The firm would receive $7.7bn as part of an overhaul plan with control shifting to Citic from the finance ministry, though details were still being finalised and could change, people familiar with the matter have said. 

Huarong has $238bn in different liabilities — including more than $20bn of offshore bonds — and has drawn close scrutiny from investors across the world. The company’s borrowings amounted to 782-billion yuan in June 30, of which those coming due within one year amounted to 578-billion yuan. It warned that the significant decline in operating performance and its financial condition may trigger immediate repayment of about 17.9-billion yuan.

Capital adequacy ratio

Huarong’s capital adequacy ratio was 6.32% in June 30, falling from 13.2% at the end of June 2020. Chinese regulators demand a minimum 12.5% for bad loan asset managers, and at least a 9% core tier-1 ratio.  

Moody’s Investors Service last week cut Huarong’s credit rating and put it on watch for a potential further downgrade, citing deterioration of its capital and profitability. The projected 2020 loss “could result in a failure to comply with the minimum regulatory requirements on capital adequacy and leverage, and indicate that the company cannot sustain its operation without support arranged by the government”.

The firm’s shares, which will remain suspended from trading, have slid 67% since their debut. Before it wen public in 2015, it was backed by heavyweights including Warburg Pincus and Goldman Sachs Group. 

Huarong has been effectively frozen out of the bond market since the second quarter, even as the company has been servicing its debt on time and reached agreements with state-owned banks to ensure it can meet obligations through at least the end of August. The firm assured investors this month that it has no plan to restructure its debt and has made preparations for future bond payments.

While defaults at state-owned Chinese companies have become more common in recent years, none of the borrowers that missed payments have been as systemically important as Huarong. Aside from its close link to China’s central government and complex web of connections to other financial institutions, Huarong is also one of the country’s biggest issuers of offshore bonds that sit in portfolios from Hong Kong to London and New York.

If Huarong lost its investment-grade credit rating, 56% of surveyed fund managers that hold its dollar bonds would be forced to sell, according to a Bank of America report dated August 17. 

Huarong, together with China Cinda Asset Management, China Great Wall Asset Management   and China Orient Asset Management, was created to buy bad loans from banks in the aftermath of the Asian financial crisis, when decades of government-directed lending to state companies had left China’s biggest lenders on the brink of insolvency.

The bad-debt firms later expanded beyond their original mandate, creating a labyrinth of subsidiaries to engage in other financial businesses and borrow billions from the bond market. Huarong was the most aggressive of the four under former chair  Lai Xiaomin, who was executed in January for crimes including bribery.

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