Huarong
Doug Noland
New data this week confirm the “global government finance Bubble” is alive and unwell.
In the past, a $660 billion U.S. federal deficit over the course of a year would have been concerning.
In today’s crazy world, it’s now accomplished in a single month.
March’s shortfall compares to the $119 billion deficit posted in March 2020.
Last month pushed the deficit for the first-half of the fiscal year to a frightful $1.71 TN.
For the month, spending of $972 billion was up from the year ago $356 billion, while receipts increased to $268 billion from $237 billion.
Washington borrowed 70 cents of every dollar it spent last month.
About 50% of the $3.41 TN first-half expenditures were debt-financed.
Our federal government is on track for back-to-back years of $3.0 TN plus annual deficits.
The battle of rival global super-borrowers: China’s Aggregate Financing (their measure of broad system credit) jumped $512 billion during March, pushing Q1 growth to $1.569 TN.
Over the past 15 months, China’s Aggregate Financing expanded an unprecedented $6.9 TN – or 17%.
For perspective, this was 50% greater than the preceding 15-month expansion, a period of exceptionally strong credit growth in its own right.
China’s Bank Loans expanded a stronger-than-expected $416 billion in March and $1.17 TN for the first quarter.
First quarter lending was 8% ahead of booming Q1 2020, and 32% above growth from Q1 2019.
China’s total Bank Assets ended 2020 at $49 TN, having expanded $7.9 TN, or 19%, over two years, and $18.5 TN, or 60%, in five years.
Amazingly, Bank Assets have ballooned 10-fold since 2005.
China’s Consumer Loans gained $176 billion in March, 16% ahead of March 2020 growth, and second only to January’s $195 billion.
At $393 billion, record Q1 Consumer Loan growth was more than double Q1 2020’s $185 billion.
Corporate Loans gained $246 billion (down 22% from March ’20), with Q1 growth of $821 billion down 11% y-o-y.
Corporate Bonds expanded $132 billion during the quarter, about 50% below record Q1 2020.
With system Credit growth in overdrive, a booming Chinese economic recovery is neither a surprise nor cause for celebration.
One could argue March’s 34.2% y-o-y surge in Retail Sales, 18.5% annualized Q1 GDP growth, and the strongest monthly apartment price inflation (0.41%) in seven months point to overheating.
With recovery having attained momentum, Beijing has turned more assertive in signaling tougher oversight and a tightening of Credit conditions.
Global markets have been dismissive of the Chinese tightening narrative, convinced a wary Beijing will retreat at the first inkling of systemic stress.
According to IIF data, Chinese debt ended 2020 at a record 329% of GDP.
A spectacular 15-month $7 TN Credit splurge has temporarily masked festering Credit and structural issues.
The upshot is a deranged Credit system increasingly at risk of market instability, blowups and crises of confidence.
China Huarong International Holdings’ Credit default swap (CDS) prices began April at 147 bps and closed last Friday at 436 bps.
In Thursday trading, this CDS price spiked to 1,466.
Some offshore Huarong bond yields spiked to nearly 100%, signaling market fear of imminent default.
Crisis management operations were at full-throttle Friday.
Huarong wired funds for a bond payment due on Sunday.
Chinese regulators, staying mum during the week, Friday announced Huarong’s operations and liquidity management were functioning normally, while requesting banks not withhold lending to the company.
Huarong CDS prices ended the week near 1,000, down from Thursday’s panic but still indicating alarm.
At this point, it’s easy to dismiss Huarong as just another troubled Chinese institution that will be resolved well before it becomes a systemic issue – providing further proof that the great Beijing meritocracy has everything well under control.
I would caution against this Halcyon interpretation.
This week’s Huarong eruption marks a significant escalation in China’s unfolding Credit drama.
Huarong was one of four major “asset management companies” (AMCs) created in the late-nineties to acquire non-performing loans as part of Beijing’s plan to restructure its major (troubled) banking institutions.
As a quasi-government institution, Huarong has enjoyed unlimited access to cheap bank and market finance.
April 14 – Dow Jones (Mike Bird):
“Whenever a Chinese bond market panic begins, similar arguments are rehashed: The blowup is idiosyncratic, deleveraging has generally been going in the right direction and increasing openness to foreign capital presents opportunities for foreign investors.
But this time around, the upheaval is particularly large and sudden.
China Huarong Asset Management failed to publish its 2020 earnings in late March, saying it needed more time to complete a transaction.
The company is a behemoth, with a total debt load of $162.34 billion as of the middle of last year, according to Capital IQ.
The situation also has a certain undeniable irony: The firm began life as one of four large bad banks designed to clean up the country’s financial sector in the late 1990s.
It has since become a broader financial holding company.”
Best I can tell, the various Huarong entities have assets of about $260 billion, with total debt between $162 billion and $209 billion (per Nikkei Asia’s Narayanan Somasundaram).
Huarong has $44 billion of outstanding bonds, of which about half were issued off-shore (foreign currency denominated) and half due within a year.
Huarong’s former CEO was executed in January for, among other things, accepting $277 million in bribes.
With its implicit backing from Beijing (and associated top bond ratings), Huarong borrowed crazily and expanded into myriad businesses.
It appears the company has struggled with most endeavors, including its core debt restructuring operations.
The company recently delayed financial reporting until the completion of its own restructuring.
Clearly, Beijing is mighty perturbed with the whole Huarong fiasco.
Beyond its now exterminated ex-CEO, Chinese officials point blame to bond investors having thrown money at Huarong without regard to shady management or a reckless business strategy.
This is a widespread issue.
With Huarong – and the system more generally – Beijing has a newfound determination to push back against moral hazard risk.
April 14 – Bloomberg (Richard Frost):
“Market turmoil surrounding China Huarong Asset Management Co. intensified on Wednesday as investors interpreted government silence on the embattled firm as a lack of official support.
The Communist Party has yet to comment on the distressed-debt manager, which is controlled by the finance ministry, even as concern about a potential restructuring sent its dollar bonds plunging to distressed levels.
China’s State Council, the country’s top administrative body, instead reinforced the idea that struggling state-backed companies shouldn’t rely on government support.
In a statement late Tuesday, the State Council urged local government financing vehicles to restructure or enter liquidation if they can’t repay their debts.
While it’s unclear if the comments were meant to send a veiled message about China Huarong, they added to the perception that the government is taking a tough stance on reining in risks to the financial system.”
I’ll assume at least PBOC officials are familiar with the U.S. GSE debacle, where implicit government guarantees were fundamental to a prolonged period of ill-advised leveraging, worsening market distortions, Credit and asset Bubbles, economic maladjustment and, in the end, the worst U.S. financial and economic crises in decades.
Moral hazard has traditionally played an integral role in financial booms.
It became momentous during this age of unfettered market-based finance.
Beijing made a catastrophic mistake in waiting this long to address implied Beijing guarantees for the AMCs, the banking system, and the entire Chinese Credit apparatus more generally.
April 13 – Bloomberg:
“Chinese authorities want failing local government financing vehicles to restructure or go bust if they can’t repay their debts, suggesting the state-linked sector is closer to seeing its first defaults on publicly traded bonds.
The LGFVs should ‘implement bankruptcy proceedings or liquidation in accordance with the law if they lose their ability to pay,’ according to… the State Council -- or China’s cabinet...
Local governments should not rely on LGFVs to finance their activities, the statement said, and LGFVs are banned from accepting documents offering guarantees from local officials or departments.
The statement may further undermine investor faith in implicit support for state-backed companies as doubts over bad-debt manager China Huarong Asset Management Co.’s future continue to roil credit markets.”
How serious is Beijing about reining in government guarantees and moral hazard more generally?
Clearly, they belatedly recognize some of the dangers associated with market distortions, resource misallocation and structural impairment.
They’re surely also quite apprehensive with the scope of central government obligations that will be required after a deeply impaired financial system forces Beijing into massive bailouts and recapitalizations.
An analyst appearing on Bloomberg Asia Television stated Chinese banks have lent “Trillions” to the AMCs, essentially providing the funds necessary to offload the banks’ non-performing assets.
This conveniently gets sour loans off the banking system’s books, though problems are allowed to fester on the AMC's balance sheets (reminiscent of how the U.S. savings & loan industry mushroomed from a few billion dollar problem to a several hundred billion fiasco).
The Bloomberg guest analyst suggested actual Chinese bank non-performing assets could be 15 to 20% of assets (versus about 2% reported) – which implies a problem approaching $10 TN.
And with Bank Loans expanding an unprecedented $4.2 TN over the past 15 months, it’s a fair bet the problem loan issue is poised to get a lot worse.
It’s worth repeating the “Terminal Phase” Bubble Dynamic, whereby a rapid rise of Credit of deteriorating quality ensures a parabolic surge in systemic risk.
Such a spectacular Credit boom is vulnerable to waning growth momentum.
Arguably, the ongoing wild Credit inflation rests on the market premise Beijing support underpins the entire system.
As such, China’s now colossal shadowy Credit apparatus collapses without confidence in Beijing’s implicit and explicit backing.
The entire edifice has become “too big to fail” – which markets have viewed in nothing but the most positive light.
There’s troubled Huarong and the other vulnerable state-owned AMCs.
The solvency of China’s fragile multi-Trillion “small” banking sector has been an issue.
Solvency is also a concern for a few Trillion dollars of local government financing vehicles (LGFV) and other local government debt.
A tremendous amount is riding on Beijing’s shoulders.
Many believe the “great financial crisis” could have been avoided if only Lehman Brothers had been bailed out.
Ben Bernanke and others are convinced the Great Depression was the result of a negligent Federal Reserve failing to print sufficient money to recapitalize the banking system.
Dr. Bernanke’s flawed doctrine unleashed the greatest runaway global monetary inflation in history.
Especially after 2006 “Terminal Phase” excess (including $1 TN of subprime mortgage derivatives), there were literally Trillions of debt securities whose market prices had completely detached from underlying fundamentals and values.
Crisis was unavoidable.
A Lehman bailout would have only prolonged “Terminal” excess.
A post-1929 crash bank recapitalization would not have averted the Great Depression.
An historic decade-plus Credit boom had created deep financial and economic structural maladjustment.
Enormous amounts of speculative leverage had accumulated over a prolonged cycle, with a parabolic rise following Benjamin Strong’s infamous 1927 stock market “coup de whisky.”
The critical policy blunders were made accommodating the boom.
Ebullient markets are today much too complacent.
Credit crises tend to advance at a glacial pace – until something suddenly triggers an avalanche.
China’s resurgent boom applies added pressure on Beijing.
Chinese officials would prefer to see some modicum of market discipline in China’s $18 TN bond market, along with a slowdown in lending.
Reminiscent of the Fed in the late-twenties, Beijing would today hope to promote Credit flows to productive uses, while restraining non-productive and speculative Credit.
But when Credit expands at such a feverish pace late in the boom cycle, resulting Monetary Disorder ensures liquidity flows in overabundance to inflating speculative Bubbles and uneconomic endeavors.
The system turns dysfunctional, and it becomes impossible to effectively manage the confluence of destabilizing financial flows, and the system’s progressive addiction to ever-increasing quantities of Credit.
Chinese Credit has been growing at a blistering pace, and Beijing has so far done little more than talk of cautious tightening measures.
Yet we’re already witnessing a major blow-up.
It’s worth noting CDS prices for the other AMC’s jumped this week.
China Orient Asset Management CDS surged 20 to (at least a one-year high) 136 bps, with a two-week jump of 36 bps.
According to ANZ research, China's high-yield corporate spreads widened 44 bps this week, with China investment-grade 29 bps wider.
Asia's high-yield widened 26 bps, with investment-grade 16 bps wider.
Interestingly, even China’s sovereign CDS traded above 45 mid-week, up from 38 to begin the week to the high since October.
This is how I would expect a Credit crisis to commence in China.
Focus turns to implicit Beijing guarantees.
Marginal borrowers lose access to cheap borrowings.
Debt at the “periphery” begins to lose its perceived moneyness.
Foreign investors in the crosshairs.
Risk aversion and de-leveraging begin to gain some momentum.
Financial conditions tighten.
All eyes on the Haurong and the AMCs. But pay attention as well to the small banking sector and the local government financing vehicles.
But these are likely just the tip of the iceberg.
Many things have surprised me over the course of this extraordinary cycle.
That confidence has been sustained in Chinese Credit in the face of historic Bubble excess is at the top of the list.
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