It has – so far – been a tale of two credits for Huarong and HNA, two Chinese borrowers which are being forced to slash their asset bases to avoid a liquidity crunch.
At one end of the trading spectrum is HNA, the airline turned global conglomerate whose offshore bonds are trading at highly distressed levels in the run up to two pivotal redemptions in November and December.
At the other end is China Huarong Asset Management, the country’s largest financial asset manager, whose dollar-denominated bonds are still trading close to its peer group, despite mounting evidence of the same cashflow problems afflicting HNA, including debt covenant breaches.
There are multiple ironies about Huarong’s predicament, not least the bad debt manager’s spectacular inability to manage its own debt load. In addition, investment bankers say one of the main reasons it got itself into such a mess is because it repeatedly issued dollar bonds in order to simply plough the proceeds back into the wider Asian high yield bond market.
They add that it then exacerbated the situation by using financial engineering to leverage cash proceeds from its bonds so it would have more money to expand its asset base at a sharper clip. For a couple of years, this issue and re-investment strategy created a virtuous circle of ever tighter new issue spreads for the whole Chinese high yield universe.
“Huarong was a huge investor in China’s offshore high yield bond market,” said one investment banker. “It eclipsed the other three state-owned AMCs by some margin.”
However that process has now gone into reverse, sucking liquidity out of the market and blowing out spreads. Lower-rated borrowers are, consequently, being forced to issue bonds with double-digit coupons to clear the market.
That will also make it much harder for Hong Kong-listed Huarong to refinance its outstanding domestic and international bonds, which amount to $49 billion according to S&P Global Market Intelligence figures.
Owen Gallimore, ANZ’s head of Asian credit strategy and research, told FinanceAsia investors have mounted a very muted response to Huarong’s problems to date because the market is "pricing in explicit sovereign support on the back of Ministry of Finance ownership".
But he points out that there are always significant risks whenever a company is running off its assets, majority government-owned or not. As a result, he believes investors are being far too optimistic about how events might unfold.
“The initial reaction to the managed HNA run-off of offshore assets was similarly complacent,” he commented.
That is certainly no longer the case.
HNA’s $300 million bond due this November is now yielding 42.085% compared to the 8.875% coupon it was priced at last November. At the time, this was considered an eye-popping level for one-year paper.
HNA also has another $250 million bond fall due this December, which is being quoted on a yield-to-worst of 33.38%.
Huarong, meanwhile, has a $700 million 4.75% April 2027 bond, which is now yielding around 5.55%. That is roughly 50bp wide of Cinda’s $700 million 4.4% March 2027 bond.
Huarong is trading at a record wide differential to Cinda, but its yields are still very much within touching distance of it. Fixed income analysts agree that they may not stay that way.
“Headline risk for this company remains very large,” said JP Morgan analyst Matthew Hughart in a recent research report about Huarong entitled “a slow moving tempest".
HUARONG AND HNA: THE DUALITY
Huarong and HNA share far more similarities than differences, not least the former’s status as one of the key financial backers of the latter’s $50 billion two-year global acquisition spree until the central government brought it to an abrupt halt in the summer of 2017.
Today, both are right at the sharp end of the government’s deleveraging campaign across shadow banking (Huarong) and among the country’s rapacious corporate empire builders (HNA).
They have also both been caught up in president Xi Jinping’s efforts to quash corruption.
Huarong’s chairman, Lai Xaomin, was arrested in April for “serious violations of the rules of the law" according to a statement by the Central Commission for Disipline Inspection. Local newspapers believe it will turn out to be the largest corruption case since the People’s Republic of China was founded in 1949.
Local and international newspapers have also widely reported alleged ties between HNA and the country’s former anti-corruption tsar, Wang Qishan. The company has repeatedly denied this and sued the exiled businessman who made the claim.
Most importantly of all are the pairs’ similarly overstretched balance sheets.
HNA has already suffered two repayment problems over the summer, although it attributed its failure to repay an Rmb1 billion 270-day issue by Haikou Meilan to a technical glitch.
“The government is effectively overseeing HNA’s asset divestment process and is back-stopping its liquidity now,” one banker commented.
“But that means HNA can’t move without securing multiple levels of official sign-offs,” the banker added. “It constantly needs to wire money and it only needs one bureaucrat to get out of bed on the wrong side one day for another liquidity event to erupt."
Likewise, the publication of Huarong’s first half results revealed that it has breached certain debt covenants thanks to falling interest coverage ratios. The company said it was seeking a waiver from local banks covering Rmb50 billion ($7.26 billion) of debt.
ANZ’s Gallimore highlights how unstable Huarong’s entire funding model is. “It’s an institution that relies on fragile wholesale and offshore funding,” he explained.
He also noted that the Hong Kong-listed group’s precipitous drop in first half net income (down 95% year-on-year) and covenants breach “indicates that it has invested in assets, which aren’t generating returns".
S&P Global Market Intelligence data shows that Huarong’s asset base expanded 5.86 times from Rmb315 billion ($45.73 billion) in 2012 to Rmb1.85 trillion ($268.3 billion) at the end of June 2018.
Over the same period, long-term debt jumped 16.2 times from Rmb49.9 billion ($7.2 billion) to Rmb803.4 billion ($116.9 billion). Nearly half of that debt is due within one year.
This leaves it with a debt-to-capitalisation ratio 87.8%. Cinda and China Great Wall Asset Management have equally high debt-to-capitalisation ratios of 82.2% and 82.8% according to S&P Global Market Intelligence.
STATE SUPPORT
However, many fixed income analysts believe the government will not let Huarong default because it is too systemically important to the financial system. Some predict it will play an even greater role managing the bad debts arising from the shadow banking clampdown.
The rating agencies also believe the government will provide “extraordinary government support if needed,” resulting in an A3/BBB+ rating. On a stand-alone basis, S&P says Huarong would be rated BB and Moody’s at B1.
Equity investors, on the other hand, fear massive dilution from a potential government-led re-capitalisation. As a result, China Huarong Asset Management’s Hong Kong shares have lost almost two thirds of their value since peaking at HK$4.02 in late January.
On the positive side, HSBC says that the AMCs’ lack of issuance has held prices up. In a recent research report, fixed income analyst Christopher Lee highlights that the four AMCs have collectively issued $4.2 billion so far this year compared to $15.7 billion during 2017.
But he also considers valuations “unattractive due to near-term earnings uncertainty from the de-leveraging of offshore businesses and the substantial amount of bonds outstanding.”
JP Morgan also concludes that, “the impact from the investigation into the former chairman will take longer to quantify than we originally anticipated and will constrain performance in the near-term.”
In the meantime, Huarong has got a new chairman, Wang Zhanfeng, late of the CBIRC’s Guangdong branch. He has been trying to reassure the financial markets by telling reporters that Huarong will shed assets when the timing is right.
So far, he has already laid off most of the asset manager’s international staff and closed down its Hong Kong office according to local investment bankers.
HNA also continues to try to divest assets fast enough to keep ahead of its debt repayments. Its first half results show a 7.4% reduction in assets since December (Rmb1.231 trillion to Rmb1.14 trillion) compared to a 10.7% reduction in total debt (Rmb736.5 billion to Rmb657 billion).
Bankers also report that it is hoping to access the international debt markets to refinance Hainan Airlines $300 million 6.35% bond issue, which falls due in October. The outstanding bonds’ current yield of 22.591%, suggests that if it succeeds, it may well set a new low for offshore bond pricing out of the Asian region.
