Speculation about the future of Huarong, the state-linked bad debt manager at the heart of the latest Chinese credit scare, is really speculation about policy and politics.
I elaborated in “The Huarong Message,” and the point was underscored Wednesday when reports indicated Beijing may be set to transfer some 100 billion yuan of assets from Huarong’s unprofitable operations to the PBoC.
Obviously, such a move would be a boon to Huarong’s balance sheet, but more importantly, the prospective transfer sends a message to markets that the Party is not, in fact, prepared to allow a systemically important entity to undergo some manner of potentially destabilizing credit event.
These were just preliminary plans, but they built on previous reporting that telegraphed a similar message. Although Beijing is certainly keen to dispel the notion that all state-linked firms enjoy an unconditional guarantee, the Party isn’t just going to wake up one day and tell the market to have at it when it comes to pricing in credit risk for critical SOEs and pseudo-SOEs. I’m not sure why anyone would have believed that in the first place.
On Tuesday, Huarong’s international unit (the subject of extreme investor consternation) insisted it was profitable in Q1. China Huarong International is responsible (in one way or another) for some $22 billion in dollar bonds, and it’s probably not a stretch to describe some offshore bondholders as terrified. It’s conceivable they could incur losses irrespective of the resolution mechanism under discussion in Beijing.
In addition to the possible transfer of assets to the PBoC, other ideas include transferring the Finance Ministry’s stake in Huarong to Huijin, which operates within the sovereign wealth fund and is overseen directly by the State Council.
Asia CDS snapped as much as 7bps tighter Wednesday after Bloomberg reported the PBoC plans which, again, weren’t finalized. Huarong’s dollar bonds gained in tandem.
Moral hazard concerns aside, I’d simply reiterate the points made here earlier this week. For those still unfamiliar with the story, Bloomberg summarized (for the thousandth time in two weeks) the scope of Huarong’s operations and the reason it matters for investors seeking to get a read on the evolution of the Party’s thinking vis-à-vis SOE guarantees. “With nearly 1.6 trillion yuan of liabilities and a vast web of connections with other financial institutions, Huarong is among China’s most systemically important companies outside the nation’s state-owned banks,” the article linked above said, adding that “it’s also majority-owned by China’s finance ministry, making it a closely watched barometer of the government’s willingness to backstop debt of troubled state-owned enterprises.”
In the simplest possible terms, you don’t need to be a ratings agency or a credit analyst or even a market participant to suggest it’s inconceivable that Beijing would allow such an entity to experience a catastrophic credit event, irrespective of how irritated Xi clearly was with management (he had the chairman executed in January).
Letting SOEs with ties to regional governments miss some payments in an effort to demonstrate something about Beijing’s commitment to market “reforms” is one thing. Permitting a systemically important bad debt manager that’s partially owned by the Finance Ministry to collapse wouldn’t just be out of character for China, it would probably be inadvisable for even the most committed capitalist nations. (The US government didn’t just say: “Oh well, Fannie and Freddie, you’re on your own now, here’s a fifth of Jack and a loaded revolver. Good luck!”)
None of this means a restructuring is off the table for Huarong International. And I don’t mean to suggest that the last few weeks haven’t been harrowing for bondholders. But for the vast majority of market participants, it’s highly unlikely that this is going to matter.
If I’m wrong, I’m wrong. It wouldn’t be the first time. Just the second.