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(Bloomberg) -- Reports of a looming restructuring at one of China’s largest bad-debt managers are prompting bondholders to ponder scenarios that not long ago would have been inconceivable.
After China Huarong Asset Management Co. joined dozens of Hong Kong-listed firms in failing to publish its 2020 earnings by the March 31 deadline, Caixin attributed the delay to plans for a significant financial restructuring. With few other specifics to go on, investors have so far taken the news negatively, despite efforts by Huarong to rebuff the concerns.
The company’s $300 million 3.375% bond due May 2022 now yields 14.3% -- a 12 percentage-point increase since the report was published -- putting it firmly in the ranks of junk. Five-year credit default swaps for one of its units more than doubled to 492.4 basis points in the period, the highest on record, according to Bloomberg-compiled data. This is a serious -- and rare -- deterioration in sentiment toward a state-owned enterprise that plays a key part of the nation’s financial markets.
It’s understandable that some investors have decided to quit. SOEs are no longer granted immunity from market forces as President Xi Jinping revives an old campaign to reduce leverage in the financial system. Huarong has governance issues it is trying to address. Its former chairman was put to death earlier this year for bribery after a trial notable for its swiftness and severity.
But restructuring and reform need not result in pain for bondholders. The following are some of outcomes analysts are considering:
No haircut, no Huarong International firesale: China Huarong and regulators agree the company can revive profitability without needing to force losses on bondholders. In this scenario, authorities approve a plan where the company offloads non-core and loss-making units but retains Huarong International -- the offshore unit that issues or guarantees most of its dollar bonds but is considered non-core by analysts.
The parent company currently intends to keep Huarong International without changing its ownership structure or restructuring its debt, people familiar with the matter said last week. Analysts at HSBC Holdings Plc had earlier said “the possibility of debt restructuring at the Huarong International level cannot be ruled out completely.”
Other candidates for sale include Huarong Securities, Huarong Leasing and Huarong Trust, according to Nicholas Yap, a credit analyst at Nomura International (HK) Ltd. China will probably prefer to honor keepwell provisions for key state-owned enterprises like Huarong, Yap wrote last week, as not doing so undermines their validity.
Thu Ha Chow, a portfolio manager at Loomis Sayles Investments Asia in Singapore, says authorities could introduce some strategic investors or look for new capital to help recapitalize the non-core businesses. Still, she says even a partial separation “would be complex.”
A quick resolution: China Huarong gets its annual report audited and published quickly, and the shares resume trading in Hong Kong. Chinese authorities could also affirm their support for the company by injecting capital or allowing state banks to grant new lending to the company. A statement along the lines of “any credit event of such a financial institution like China Huarong AMC is not acceptable from a policy perspective” would be good news, HSBC credit analysts wrote in an April 8 report.
Owen Gallimore, head of trading strategy at Australia & New Zealand Banking Group, says this scenario has the lowest probability and recommends an underweight position in the bonds. Even if the government does help Huarong, the risk-reward is unattractive.
Lengthy negotiations with regulators. This would imply no annual report, a prolonged stock suspension, lack of clarity for bondholders and a scenario where “banks and investors continue to cut lines” for fear of a significant haircut, according to Gallimore. Investors would price in an eventual restructuring and holders of offshore bonds would suffer. China Huarong and its subsidiaries may also struggle to refinance upcoming local and offshore debt as borrowing costs rise.
“With large refinancing risk coming due, it is important that Huarong gives clarity to the situation,” said Thu Ha Chow.
The lack of clarity could result in “real liquidity problems” for Huarong International given its “hefty” maturities, according to HSBC’s Shiwen Ding and Keith Chan.
(Updates prices in third paragraph, adds investor voice to ninth and 13th paragraphs)
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