China has big task to curb leverage

It’s become a stock phrase: “China is deleveraging.” That, however, does not mean the threat from excess liabilities is not real. The identification of a network of companies connected to asset manager Huarong and Minsheng Bank by activist David Webb shows what regulators worry about. As much as $1bn of market value was wiped from the Huarong listed holdings as a result of the announcement.

Huarong is one of four state-owned groups founded in 1999 to bail out China’s top banks. The former benefit from preferred access to portfolios of nonperforming loans. Huarong bought up more than half of the nonperforming loans in 2017, according to S&P Global, and has since aggressively pushed into offshore investment banking. Partly as a result, Huarong’s total assets have tripled to ¥1.8-trillion ($260bn) in the past four years, only about half in its distressed asset management unit. The ratio of its debt to equity rose from four to seven. Beijing’s efforts to curb the offshore investments Huarong kept bankrolling has hurt it. Its chair, Lai Xiaomin, was arrested earlier in 2018 and stripped of party membership.

The network of companies allegedly includes 26 groups connected to each other by loans as well as personal relations. Such links must make it difficult to maintain centralised risk control. The real risk is that if one member of the network defaults, it leads to payment problems across the web of holdings.

Understandably, Huarong’s market value has declined by nearly two-thirds since its late January peak. It could get worse. A similar network was discovered by Webb in March 2017. One of those companies, Amco United, has lost more than 90% of its worth since then.

Beijing is right to crack down on excessive leverage, but the problem is pervasive. Given what Huarong was set up to do restructure bad debts China’s regulators have a very big task ahead. /London, October 22.