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Why China’s Bad Debts Won’t Wash Away Easily
‘Bad bank’ China Huarong’s plan to raise a fresh 1 billion dollars in equity is acknowledgment that the country’s debt situation can’t be easily resolved
By ANJANI TRIVEDI
June 28, 2016 4:39 a.m. ET
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Acknowledgment is the first step toward acceptance. In China, that means realizing that cleaning up the bad debts riddling the financial system will require more than just piling on fresh debt. It will take major doses of equity, too.
China Huarong Asset Management, one of the largest institutions tasked with soaking up the country’s souring loans, said Friday that it plans to raise more than $1 billion in a public offering in Shanghai—less than a year after raising $2.5 billion with an offering in Hong Kong.
Beijing established Huarong and other “bad bank” asset-management companies almost two decades ago to take on a growing bad-debt mountain. They have since morphed into slightly more commercial enterprises, selling themselves as countercyclical plays on China’s again-substantial stock of nonperforming loans. They buy bad debt at a discount to restructure and sell, swap bad debt for equity and securitize assets. They also have other businesses providing the likes of asset-management and brokerage services.
Huarong’s possible Shanghai listing is an acknowledgment that capital will erode faster than had been expected. On the face of it, Huarong seems adequately capitalized. Its capital-adequacy ratio dropped close to the 12.5% regulatory minimum last year, but the Hong Kong offering boosted it to 14.75%, and Jefferies analysts say the Shanghai offering could bolster it by a further 4 to 6 percentage points.
Why so much buffer? Huarong is tasked with taking on aggressive asset growth—averaging 40% over the past three years—so a substantial capital cushion is necessary. And Huarong has been moving away from a wholesale bank-funded model, meaning an increasing portion of its funding comes from debt itself. Earlier this month, for instance, it raised more than $1 billion in debt to fund operations.
Other signs of indigestion are emerging as the scale of China’s bad-loan grows clearer. The asset manager’s distressed assets have risen by more than 40%, but impairments have risen even more, by almost 70%. Huarong’s earnings growth is becoming volatile as impairments on distressed assets and financial assets like bonds rise sharply and returns on these assets fall. Interest margins are shrinking. This means replenishing capital to keep up with asset growth isn't straightforward—and comes at a cost for existing shareholders.
The next step for Huarong will be accepting that gainfully washing away bad debts isn’t so easy.
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