China’s Very Bad Bank: Inside the Huarong Debt Debacle

Photographer: Anthony Kwan/Bloomberg

It’s been 11 weeks since Lai Xiaomin, the man once known as the God of Wealth, was executed on a cold Friday morning in the Chinese city of Tianjin.

But his shadow still hangs over one of the most dramatic corruption stories ever to come out of China – a tale that has now set nerves on edge around the financial world.

At its center is China Huarong Asset Management Co., the state financial company that Lai lorded over until getting ensnared in a sweeping crackdown on corruption by China’s leader, Xi Jinping.

From Hong Kong to London to New York, questions burn. Will the Chinese government stand behind $23.2 billion that Lai borrowed on overseas markets — or will international bond investors have to swallow losses? Are key state-owned enterprises like Huarong still too big to fail, as global finance has long assumed – or will these companies be allowed to stumble, just like anyone else?

The answers will have huge implications for China and markets across Asia. Should Huarong fail to pay back its debts in full, the development would cast doubt over a core tenet of Chinese investment: the assumed government backing for important state-owned enterprises, or SOEs.

“A default at a central state-owned company like Huarong is unprecedented,” said Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group. Should one occur, he said, it would mark “a watershed moment” for Chinese and Asian credit markets.

Not since the Asian financial crisis of the late 1990s has the issue weighed so heavily. Huarong bonds — among the most widely held SOE debt worldwide — recently fell to a record low of about 52 cents on the dollar. That’s not the pennies on a dollar normally associated with deeply troubled companies elsewhere, but it’s practically unheard of for an SOE.

Time is short. All told, Huarong owes bondholders at home and abroad the equivalent of $42 billion. Some $17.1 billion of that falls due by the end of 2022, according to Bloomberg-compiled data.

It wasn’t supposed to be this way. Huarong was created in the aftermath of the ‘90s Asian collapse to avert another crisis, not cause one. The idea was to contain a swelling wave of bad loans threatening Chinese banks. Huarong was to serve as a “bad bank,” a safe repository for the billions in souring loans made to state companies.

Along with three other bad banks, Huarong swapped delinquent debts for stakes in hundreds of big SOEs and, in the process, helped turn around chronic money-losers like the giant China Petroleum & Chemical Corp.

After Lai took over in 2012, Huarong reached for more, pushing into investment banking, trusts, real estate and positioning itself as a key player in China’s $54 trillion financial industry.

Before long, global banks came knocking. In 2013, for instance, Shane Zhang, co-head of Asia-Pacific investment banking at Morgan Stanley, met with Lai. Zhang said his company was “very optimistic” about the future of Huarong, according to a statement posted on Huarong’s website at the time.

Before Huarong went public in Hong Kong in 2015, it sold a $2.4 billion stake to a group of investors including Warburg Pincus, Goldman Sachs Group Inc., and Malaysia’s sovereign wealth fund. BlackRock Inc. and Vanguard Group acquired lots of stock too, according to data compiled by Bloomberg. The stock has collapsed 67% since its listing.

Lai had no trouble financing his grand ambitions. A big reason: Everyone thought Beijing would always stand behind a key company like Huarong. It easily borrowed money in the offshore market at rates as low as 2.1%. It borrowed still more in the domestic…