China is battling the latest debt crisis with a company that caused the latest

(Bloomberg) — Three months ago, Chinese authorities rescued the country’s biggest troubled debt manager from a potentially disastrous meltdown.

Now they are making China Huarong Asset Management Co. and its peers a key line of defense for the $54 trillion financial system as defaults in the property sector soar.

In a sign of the growing urgency within Xi Jinping’s government to stabilize the world’s second-largest economy, regulators in recent weeks have asked Huarong and other so-called AMCs to buy real estate assets from struggling developers and to formulate plans to take over or restructure smaller lenders, according to people familiar with the matter.

Authorities are also considering new funding for AMCs, a move that would increase their ability to prevent housing market stress from spilling over to the banking system, the people said, asking not to be identified discussing private information.

The call to action represents a kind of homecoming for Huarong and his state-owned peers, which were designed to help Beijing resolve a financial crisis in the late 1990s.

Huarong’s brush with default last year came after it extended well beyond its original tenure, but the company is still among the most experienced in China in restructuring overdue debt, including in the real estate sector. About 40% of the nation’s banking system assets are directly or indirectly associated with real estate, according to researchers at Citigroup Inc.

“Risks in the real estate sector and among smaller banks are mounting and need to be addressed urgently,” said May Hu, partner in KPMG LLP’s Restructuring Services and Portfolio Solutions Groups.

Huarong, who declined to comment for this story, is among financial institutions in talks with embattled developer Shimao Group Holdings Ltd. on the potential purchase of assets. China Cinda Asset Management Co. is part of a proposed China Evergrande Group restructuring that calls for a group of investors to take over the property giant’s hard-to-sell real estate assets, Bloomberg reported late last month. Last week, China Orient Asset Management Co. won approval to sell up to 10 billion yuan of bonds to help de-risk large property developers.

“Big AMCs are arguably the best or even the only suitable candidate to play a quasi-governmental role in risk resolution,” said Muse Zheng, managing director of Heilongjiang-based Great Financial Asset Management Co. “It’s also a great opportunity for these bad debt managers because they’ve been under a lot of pressure to go back to their core business in recent years. It’s not about short-term profit.

But AMCs’ ability to provide large-scale aid to developers could also be limited by their own liquidity and capital needs, unless there is political support, according to China International Capital Corp.

The four bad debt managers together held nearly 5 trillion yuan ($790 billion) in combined assets and about $62 billion in cash, according to Bloomberg Intelligence. By comparison, the total liabilities of 38 Chinese developers rated BB or lower by Fitch Ratings amounted to $1.3 trillion, excluding opaque debt residing off their balance sheets.

China set up Huarong, Cinda, Orient and China Great Wall Asset Management Co. in the wake of the Asian financial crisis to protect its state-owned banks that were on the verge of insolvency. The four Beijing-based companies borrowed from the central bank and sold special bonds to buy trillions of yuan in bad debt over the 10-year life they were originally given.

Eventually, the companies were able to recover around 20% of the cash from the degraded loans. Once that mission was completed, AMCs expanded into everything from insurance and leasing to brokerage and trust to cheap borrowing in the onshore and offshore markets, and became themselves d important parallel lenders.

Huarong was most aggressive under former President Lai Xiaomin, who was executed for crimes including corruption early last year. Soon after, the company rocked Asian credit markets as it failed to release its annual report on time, ultimately revealing a massive $15.9 billion loss for 2020. As the crisis was eventually averted thanks to a $6.6 billion equity injection from a group of state-backed investors. led by Citic Group, investors remained nervous and divided over the industry’s long-term growth prospects.

Spreads on Huarong’s dollar bonds have widened in recent weeks as investors grow increasingly concerned about the company’s new mandate. The yield spread on Huarong’s 3.375% 2030 note widened by about 40 basis points this month, and its 5.5% 2025 bond widened by 30 basis points.

Citi strategists Dirk Willer and Luis E Costa, who first recommended buying Huarong’s 5.5% dollar bond due 2025 when it was priced at 72 cents on April 15 of the year, have now closed the trade after it returned 49.3% through mid-February.

“Due to the new AMC mandate, we consider this a good time to exit,” Citi analysts wrote. “We await more details on this development and warn that it could mean a higher risk of contagion in the sector if funding restrictions persist.”

Some AMCs returned to the offshore bond market after being cut during the Huarong scare. Cinda priced a $1 billion 5-year bond with a 3.25% coupon rate in January, following a deal on a 4.4% perpetual bond of 1.7 billion dollars last October. Great Wall issued a $300 million 2.875% 5-year bond last November.

China’s economy faces multiple risks in 2022, battling a real estate crisis and the ongoing pandemic. The real estate sector will need at least $140 billion to cover bonds, coupons and fiduciary products maturing this year. In banks, outstanding loans to the real estate sector stood at 51.4 trillion yuan in September, accounting for 27 percent of the country’s total loans and more than any other sector.

Total non-performing loans hit a record 2.85 trillion yuan at the end of December, with urban and rural banks showing the biggest increases. Last year, the central bank designated 422 financial institutions as high-risk entities, most of them small rural banks.

The state of China’s myriad small regional lenders has been a constant concern since mid-2019, when regulators took over a bank in Inner Mongolia – the first such move in two decades – and imposed restrictions. losses to certain creditors.

There have been at least 20 mergers involving smaller banks since 2020, and bad debt managers have played a key role by buying up large amounts of bad debt or providing restructuring advisory services.

Huarong, Cinda and other bad debt managers could help shield banks from the corrosive effects of 126 billion yuan in problem home loans, according to Bloomberg Intelligence estimates.

Andrew Collier, managing director of Orient Capital Research Inc. in Hong Kong, said using AMCs is another shortcut to supporting the economy without adding to the central government’s debt burden.

“Management is afraid of an economic slowdown but is even more concerned about a massive central government stimulus that would lead to an even worse real estate bubble whose collapse would call into question the effectiveness of the Communist Party,” he said. declared.

©2022 Bloomberg LP

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