Huarong posts $15.9 billion loss as leverage reaches 1,333 times

(Bloomberg) — China Huarong Asset Management Co.’s long-delayed 2020 results showed a record loss, with leverage of 1333 times and capital buffers well below the legal minimum, highlighting the difficult task for the bad debt manager recently secured a government bailout.

Huarong reported a loss of 102.9 billion yuan ($15.9 billion) for the full year, pushing equity capital down nearly 85%, the company said in a filing on Sunday in Hong Kong. The company recorded 107.8 billion yuan in impairment charges and suffered a 12.5 billion yuan loss on financial assets. Although it returned to a profit of 158 million yuan in the first half of this year, Huarong’s key capital level was well below regulatory requirements in June.

After five months of turmoil since it postponed its earnings report in March, China’s largest bad debt manager secured a bailout package from some of the country’s largest financial companies this month. Its plight had become the biggest test in decades as to whether Beijing would still protect state-owned companies from market forces, amid renewed pressure from President Xi Jinping to curb debt growth as bankruptcies hit records.

A review of assets and risks last year “had a significant impact on company results and is a hard lesson to be learned in the company’s development history,” Chairman Wang Zhanfeng said in the report. “What’s gone is gone, but go for what’s to come. We will learn from the lesson and regard it as valuable experience and the desire to move forward.”

The company said on Sunday it plans to divest non-core subsidiaries in the “near future” to increase internally generated fund inflows and replenish capital. It gave no further details about its rescue plan in the report.

The company said that by taking steps, including asset sales and a capital increase, it can guarantee operations for the next 12 months.

State investors, including Citic Group, China Insurance Investment Co. and China Life Asset Management Co., agreed on Aug. 18 to put fresh capital into Huarong. The company is set to receive $7.7 billion as part of an overhaul plan that will shift control from the Treasury Department to Citic, though details are still being finalized and could change, people familiar with the matter have said.

Huarong has $238 billion in various liabilities – including more than $20 billion in offshore bonds – and has been closely watched by investors around the world. The company’s loans amounted to 782 billion yuan as of June 30, of which the loans maturing within one year were 578 billion yuan. It warned that the significant decline in operating performance and its financial condition could lead to immediate repayment of about 17.9 billion yuan.

Huarong’s solvency ratio fell to 4.16% at the end of last year and stood at 6.32% on June 30. Chinese regulators require a minimum of 12.5% ​​for asset managers of bad loans and a core tier 1 ratio of at least 9%. The leverage ratio, calculated as interest-bearing debt to equity, decreased from 1,333 to 37.1 as of June 30. That is still four times higher than the level at the end of 2019 and compared to 6.8 times at major rival China Cinda Asset Management Co.

Huarong’s auditor, Ernst & Young, also made a reservation on the company’s 2020 income and cash flow statements, as it was unable to obtain “sufficient appropriate audit evidence” to determine whether any of the associated gains and losses recognized by Huarong in 2020 should have been recorded in previous years.

Moody’s Investors Service last week cut Huarong’s credit rating to Baa2, two levels above junk, and awaited a possible further cut, citing a deterioration in capital and profitability. The projected loss for 2020 “may lead to failure to meet minimum regulatory requirements for capital adequacy and leverage, and indicates that the company cannot continue its operations without government support.”

The company’s shares, which will remain suspended from trading, are down 67% since their debut. Before going public in 2015, it was backed by heavyweights including Warburg Pincus and Goldman Sachs Group Inc.

Huarong has been effectively frozen out of the bond market since the second quarter, even though the company has paid off its debts on time and reached an agreement with state-owned banks to ensure it can meet its obligations until at least the end of August. The company assured investors this month that it has no plans to restructure its debt and is preparing for future bond payments.

While Chinese state-owned enterprise defaults have become more frequent in recent years, none of the borrowers who have missed out on payments is as systemically important as Huarong. Aside from its close ties to China’s central government and its complex web of connections with other financial institutions, Huarong is also one of the country’s largest issuers of offshore bonds, holding portfolios from Hong Kong to London and New York.

If Huarong were to lose its investment-grade credit rating, 56% of surveyed fund managers holding its dollar bonds would be forced to sell, according to an Aug. 17 report from the Bank of America.

Huarong, together with Cinda, China Great Wall Asset Management Co. and China Orient Asset Management Co. founded to buy bad loans from banks in the wake of the Asian financial crisis, when decades of government-led loans to state-owned companies had disappeared. China’s largest lenders are on the brink of insolvency.

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

(Updates to leverage ratio comparison with Cinda in the ninth paragraph.)

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