To contain the fallout from the Asian financial crisis two decades ago, Beijing created a group of bad banks and bundled them with the country’s most toxic debts. But with deepening distress in China’s property sector threatening to trigger wider economic turmoil, these troubled banks are now scrambling to help.
The problem is that the balance sheets of China’s “Big Four” asset management firms—China Cinda Asset Management, China Huarong Asset Management, China Great Wall Asset Management and China Orient Asset Management—have swelled so much that the its capacity is restricted.
The groups are “financial monsters,” said Chen Long, a partner at Beijing-based consultancy Plenum. “I wouldn’t count on them to play a major role” in addressing the housing crisis, he added.
While the world’s most indebted developer, China Evergrande, has been in the spotlight in the country’s spiraling property crisis, the stress on bad banks reveals Beijing’s challenge in mobilizing bailout options.
It also underscores the impact of President Xi Jinping’s deleveraging campaign, which has destabilized heavily indebted developers, and underscores the risks facing asset managers from a housing crisis that are needed to help relieve
Created in the 1990s, the bad banks expanded far beyond their mandate, becoming financial conglomerates fueled by debt from domestic and foreign investors. Huarong, the largest manager of bad debt, was bailed out in 2021 after delaying for months the disclosure of a $16 billion loss.
A debt restructuring for Great Wall is now expected after the company delayed the publication of its 2021 annual report to June, another sign of weakness in the sector, even as its services become more important to to the health of the world’s second largest economy.
Huarong’s troubles spooked investors in China’s dollar bond market in April 2021, prompting global rating agencies to downgrade and issue warnings.
Although trading recovered after the bailout announcement, investors are sensitive to the health of China’s AMCs. They sold bonds again in July after the Great Wall missed a reporting deadline. Huarong’s $37 million 4.25 percent perpetual bond fell from 91 to 75 cents on the dollar in July before recovering to around 79 cents in August.
Together, the bad banks have about 5 billion Rmb ($740 billion) in total assets and have settled 400 billion Rmb of bad debt in the housing market by 2021, a fifth of the total, according to a Bank of China estimate International.
In the People’s Bank of China’s latest bid to rein in growing discontent over unfinished apartments, including a growing mortgage boycott, central bankers are seeking to mobilize state bank loans from a 200 billion Rmb financing fund for stalled property developments .
AMCs have been included in bailout discussions with central bankers and housing regulators since Evergrande defaulted on its debt last year, according to bank and AMC executives.
Orient and Great Wall raised bonds of Rmb10 billion each in March to “resolve the risk of quality real estate projects and bail out the sector’s aggravating debt,” according to bond prospectuses.
Cinda placed one executive on Evergrande’s board and another on its risk resolution committee to help with its restructuring proposal, which is now delayed after missing a self-imposed July 31 deadline . Struggling developers such as Sunac China Holdings and Fantasia Holdings are also in active talks. to the AMCs on possible rescue plans. City-level rescue funds have also been set up with the help of AMCs.
But the scale of AMCs’ funding is expected to be selective and cautious, said David Yin, vice president and senior credit director at Moody’s Investors Service, as they already have heavy exposure to real estate developers.
The groups are inextricably linked to the housing crisis, said Xiaoxi Zhang, a China financial analyst at Gavekal Dragonomics, a Beijing-based research group.
AMCs are “substantial creditors” of real estate developers, with the sector accounting for between 25% and 42% of total debt assets.
“The ongoing defaults by developers indicate that the effects of the property slump on financial institutions are still increasing,” Zhang said in a recent report. “Regulators have pushed AMCs to reduce their exposure to property, but it remains the largest sector in their portfolios,” he added.
Huarong and Great Wall are the most exposed to the real estate sector due to their heavy reliance on debt assets to generate income, compared to Cinda and Orient, according to Zhang.
However, even Cinda issued a profit warning on July 26 that its six-month profits will fall by 30 to 35 percent as “certain financial assets measured at amortized cost that the company has they are under greater pressure.” In May, Moody’s downgraded Cinda’s Hong Kong unit, citing “increased risks arising from the company’s large real estate exposure.”
Smaller AMCs that only operate in Chinese provinces are expected to bear more responsibility in this round of real estate bailouts because of their close ties to local governments, analysts said.
A manager of a smaller regional AMC in Jiangxi, a province in southeast China, said some local asset managers could contribute to the recovery by investing in bonds linked to unfinished housing projects.
He described this as a “fast in and out” approach, with the aim of the homes being “delivered in around six months”.
A second option to consider is for AMCs to form consortia with new developers or third-party construction groups to take over and restructure the projects, eventually ousting the current developers. But those deals would be thorny and could take two to three years to complete.
“They generally face challenges of their own,” Moody’s Yin said of bad banks. “With the limited capital base and persistent pressure on asset qualities, it is not very realistic for them to invest heavily in real estate and, as trade-oriented entities, they are not strongly motivated to support distressed real estate projects in the lower tier cities.”