Founder of Antler Capital

Stanley Tsai, CFA

Thematic (Sector/Industry)

In the spirit of the long-awaited UEFA Euro 2020, we present our inaugural "China Financials: Silver Linings Playbook", which summarizes our views on the names that are best positioned to navigate an environment of progressively slower credit growth, tighter liquidity and rising defaults. 
Our screen consists of 100+ stocks in the A/H share universe, as well as a select number of international / non-traditional names that have significant exposures to China's financial system. We have a preference for larger-cap and liquid names, which are then filtered by our opinions on their fundamentals, value, momentum and recent trading volumes. We also try to make our selections versatile and less vulnerable to single-factor movements.
Each player's position on the pitch and the team formation itself convey incremental information about our thoughts on the sector's performance over a three to six-month horizon. To the extent possible, we intend to update our ideas on a periodic basis. This provides a feedback loop with our other ongoing research on the industry.
However, our team selections are not investment recommendations. Instead, they are meant to give structure to our analysis. The playbook allows us to articulate our views on the sector in a timely, concise manner. Our objective is to ensure we don't throw the baby out with the bathwater as sentiments on the sector remain bleak.
With that out of the way, the following is our starting XI. We will dive deeper into our rationale for our selections in the remainder of this insight (Exhibit 1).
<table class="table table-striped">
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<td style="width: 726.047px;">Exhibit 1: China Financials | Silver Linings Playbook</td>
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<td style="width: 726.047px;">
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/213/768/original/image_768460236451623962508577.png?1623962508" class="editor-image img-responsive" data-smartkarma-image-id="213768"></figure>

Source: Our analysis
</td>
</tr>
</tbody>
</table>
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In the spirit of the long-awaited UEFA Euro 2020, we present our inaugural "China Financials: Silver Linings Playbook", which summarizes our views on the names that are best positioned to navigate an environment of progressively slower credit growth, tighter liquidity and rising defaults. 
Our screen consists of 100+ stocks in the A/H share universe, as well as a select number of international / non-traditional names that have significant exposures to China's financial system. We have a preference for larger-cap and liquid names, which are then filtered by our opinions on their fundamentals, value, momentum and recent trading volumes. We also try to make our selections versatile and less vulnerable to single-factor movements.
Each player's position on the pitch and the team formation itself convey incremental information about our thoughts on the sector's performance over a three to six-month horizon. To the extent possible, we intend to update our ideas on a periodic basis. This provides a feedback loop with our other ongoing research on the industry.
However, our team selections are not investment recommendations. Instead, they are meant to give structure to our analysis. The playbook allows us to articulate our views on the sector in a timely, concise manner. Our objective is to ensure we don't throw the baby out with the bathwater as sentiments on the sector remain bleak.
With that out of the way, the following is our starting XI. We will dive deeper into our rationale for our selections in the remainder of this insight (Exhibit 1).



Exhibit 1: China Financials | Silver Linings Playbook





Source: Our analysis




Related Insights
China Macro: Consumers Remain on the Sidelines, as Their Home Equity Grows 
Glut and Famine: We Might See Snow in China This Summer 
China Macro: PPI Peaks, while CPI Eases Tightening Fears 
China Macro: Exports Disappoint, but It's Still Early in the Game 
Glut and Famine: China's Monetary Conditions a Notch Tighter in May 
ICBC: The Bond Identity | A Zero-Growth Dividend Discount Story 
BOC Aviation (2588 HK): The Stars Don't Look Bigger, but They Do Look Brighter

China Financials: Silver Linings Playbook

Silver Point

Thomas J. Monaco

Independent Insight Provider

Silver Point is a boutique research firm that focuses on the broader financial services sector, with a particular focus on troubled institutions globally. 

Asia Ex Japan

Equity Bottom-Up

China Huarong Asset Management / Equity Bottom-Up

*Legacy Risks Strangling China Huarong: The issue appears to be China Huarong Asset Management’s (Huarong) legacy exposure associated with the misdeeds of its former Chairman, which still need to be addressed. Since our last note, Huarong still continues to teeter on the edge of insolvency and ongoing silence from Beijing has materially impacted funding costs. Huarong has until August 2021 to finally release its 2020 financial statements; and *Too Big Too Fail:  None of what is occurring should come as a surprise given mainland China's rapidly increasing debt position since the financial crisis - along with the same at its SOEs which are perceived to be too-big-to-fail and wield enormous political clout. A funding backstop from state-owned banks has been ordered by the China Banking and Insurance Regulatory Commission (CBIRC), and the mainland Chinese government is likely to again blink and make good on Huarong's significant debt obligations. Distressed investors should consider picking away at Huarong’s debt; we’ll believe it when see Beijing imposing losses on investors in SOEs.

*Legacy Risks Strangling China Huarong: The issue appears to be China Huarong Asset Management’s (Huarong) legacy exposure associated with the misdeeds of its former Chairman, which still need to be addressed. Since our last note, Huarong still continues to teeter on the edge of insolvency and ongoing silence from Beijing has materially impacted funding costs. Huarong has until August 2021 to finally release its 2020 financial statements; and *Too Big Too Fail:  None of what is occurring should come as a surprise given mainland China's rapidly increasing debt position since the financial crisis - along with the same at its SOEs which are perceived to be too-big-to-fail and wield enormous political clout. A funding backstop from state-owned banks has been ordered by the China Banking and Insurance Regulatory Commission (CBIRC), and the mainland Chinese government is likely to again blink and make good on Huarong's significant debt obligations. Distressed investors should consider picking away at Huarong’s debt; we’ll believe it when see Beijing imposing losses on investors in SOEs.

China Huarong Asset Management – Silence Is Golden

Independent Asian Credit Research, Bondcritic

Warut Promboon

Independent Asian Credit Research

Asian Fixed Income/Frontier Market Research

Bondcritic

Bondcritic, established in 2009, is designed to be an independent credit research voice that helps investors gain insights and unbiased analyses on Asian fixed income market. Our mission is to discover deep-value Asian high-yield and distressed bonds with a bottom-up approach, together with the help of our proprietary ESG (Environmental, Social Development, and Governance) model. At the same time, we focus on bringing investment cases of unrated and unloved issuers to the general public.

Credit

We highlighted <a href="https://www.smartkarma.com/entities/china-huarong-asset-management-26375cc4-728e-4f75-b058-64298b10f256" target="_blank" data-smartkarma-citation="entities:28089:1" rel="noopener">China Huarong Asset Management (HUAZ CH)</a> (Huarong) in our debut  “The Chinese Credit Chronicle (CCC)” last month on Huarong’s annual report delay. The subsequent events have stabilized Huarong’s HRINTH complex somewhat before the market fears Huarong’s debt could be restructured.
The rating downgrades by Fitch and Moody’s are less of an issue, in our view, as they are simply actions to catch up with what the market fears. Huarong’s story is less flamboyant than the HNA Group Limited (HNA) and yet it highlights the very same problem with HNA in terms of a lack of transparency and implicit support by the Chinese government. Both were eventually rescued by state-owned Chinese banks and both could be restructured down the road.
At the end of the day, we believe Huarong has been viewed as a quasi-sovereign credit and even rating agencies have been being caught by surprise as the market doubts support from the Chinese government will be certain. For Huarong, we still believe government support can be expected, but we believe the dust has not settled yet on the liabilities (and losses) that Huarong may have in store for bondholders. As a result, we cannot recommend buying Huarong’s HRINTH complex.
In a greater context, the risk we see here is that the rating agencies may revamp their methodologies to assess Chinese government-related entities (GREs). The adjustment could result in a wholesale downgrade of those GREs which are spread negative, not just for the Chinese GREs, but also other Chinese credits with implicit support from the central and local Chinese governments. We note that Chinese issuers have come a long way in terms of corporate governance improvement but transparency remains one of the key reasons why developed market USD bonds trade much tighter than Chinese USD bonds with the same rating, and this Huarong saga is a reminder that the spread will not narrow anytime in the near future.

We highlighted China Huarong Asset Management (HUAZ CH) (Huarong) in our debut  “The Chinese Credit Chronicle (CCC)” last month on Huarong’s annual report delay. The subsequent events have stabilized Huarong’s HRINTH complex somewhat before the market fears Huarong’s debt could be restructured.
The rating downgrades by Fitch and Moody’s are less of an issue, in our view, as they are simply actions to catch up with what the market fears. Huarong’s story is less flamboyant than the HNA Group Limited (HNA) and yet it highlights the very same problem with HNA in terms of a lack of transparency and implicit support by the Chinese government. Both were eventually rescued by state-owned Chinese banks and both could be restructured down the road.
At the end of the day, we believe Huarong has been viewed as a quasi-sovereign credit and even rating agencies have been being caught by surprise as the market doubts support from the Chinese government will be certain. For Huarong, we still believe government support can be expected, but we believe the dust has not settled yet on the liabilities (and losses) that Huarong may have in store for bondholders. As a result, we cannot recommend buying Huarong’s HRINTH complex.
In a greater context, the risk we see here is that the rating agencies may revamp their methodologies to assess Chinese government-related entities (GREs). The adjustment could result in a wholesale downgrade of those GREs which are spread negative, not just for the Chinese GREs, but also other Chinese credits with implicit support from the central and local Chinese governments. We note that Chinese issuers have come a long way in terms of corporate governance improvement but transparency remains one of the key reasons why developed market USD bonds trade much tighter than Chinese USD bonds with the same rating, and this Huarong saga is a reminder that the spread will not narrow anytime in the near future.

*Already On Edge:  Again in mainland China, there have been rumblings of another credit default over the past several days. The CBIRC disclosed that China Huarong Asset Management (2799.HK) [Huarong] is actively working with its auditor to complete its annual report. The issue appears to be Huarong’s legacy exposure associated with the misdeeds of its former Chairman, which still need to be addressed post-removal in 2018; and *Another Audit Delay: Huarong is delaying its 2020 earnings results beyond the April 30, 2021 deadline, which, in our view, only exacerbates concerns over a potential Huarong default. Ironic, given that Huarong was supposed to help mainland China clean up its bad debt mess. This further delay will not help bond liquidity which already appears to have disappeared. Contagion risk remains a real threat as bondholders likely sell other holdings.

*Already On Edge:  Again in mainland China, there have been rumblings of another credit default over the past several days. The CBIRC disclosed that China Huarong Asset Management (2799.HK) [Huarong] is actively working with its auditor to complete its annual report. The issue appears to be Huarong’s legacy exposure associated with the misdeeds of its former Chairman, which still need to be addressed post-removal in 2018; and *Another Audit Delay: Huarong is delaying its 2020 earnings results beyond the April 30, 2021 deadline, which, in our view, only exacerbates concerns over a potential Huarong default. Ironic, given that Huarong was supposed to help mainland China clean up its bad debt mess. This further delay will not help bond liquidity which already appears to have disappeared. Contagion risk remains a real threat as bondholders likely sell other holdings.

China Huarong Asset Management  - This Can’t Be Good

Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Uncertainty at <a href="https://www.smartkarma.com/entities/china-huarong-asset-manageme" target="_blank" data-smartkarma-citation="entities:28089:1" rel="noopener">China Huarong Asset Management (HUAZ CH)</a>, China’s largest distressed debt manager is causing ripples throughout Asia’s credit markets. More broadly, China’s <a href="https://www.smartkarma.com/entities/tencent-holdings-ltd" target="_blank" data-smartkarma-citation="entities:26:1" rel="noopener">Tencent Holdings (700 HK)</a> cancelled a US$4 billion bond sale due to market conditions. Specifically, Huarong contagion steepened the credit curve of China’s other asset management companies (AMCs).
At issue here are the Keepwell provisions which enable China’s banks, and non-bank finance companies to access foreign currency financing in the global bond markets. Essentially, a Keepwell provision is a pledge, not a guaranty, to keep an offshore subsidiary which issues the bonds solvent in the event of distress.
The immediate risk is that Huarong’s offshore issuance vehicles are not supported in any restructuring. Orphaning the Keepwell provisions would destroy an important component of AMC funding. The damage here would extend beyond AMCs to other non-bank finance companies, including leasing companies and other entities owned by China’s banks. Not supporting these securities could all but eliminate China Inc.’s access to the global bond markets.
Concurrently, price action in the bond market suggests concern with the long-term viability of the AMC model rather than jump to default risk. We are not convinced this is appropriate and recommend Overweighting other AMC bonds.
Although the former top executive was put to death, Huarong bondholders need not be. Nonetheless, the walk to the gallows can be harrowing and uncertainty is high. There is likely more than meets the eye in this story. It is conceivable that we never see a 2020 year-end report for this state-owned enterprise. Therefore, having a strong conviction on Huarong means undertaking a leap of faith. As such, we suggest a way to trade Huarong  such that downside is limited; however, our preference is to trade the contagion.

Uncertainty at China Huarong Asset Management (HUAZ CH), China’s largest distressed debt manager is causing ripples throughout Asia’s credit markets. More broadly, China’s Tencent Holdings (700 HK) cancelled a US$4 billion bond sale due to market conditions. Specifically, Huarong contagion steepened the credit curve of China’s other asset management companies (AMCs).
At issue here are the Keepwell provisions which enable China’s banks, and non-bank finance companies to access foreign currency financing in the global bond markets. Essentially, a Keepwell provision is a pledge, not a guaranty, to keep an offshore subsidiary which issues the bonds solvent in the event of distress.
The immediate risk is that Huarong’s offshore issuance vehicles are not supported in any restructuring. Orphaning the Keepwell provisions would destroy an important component of AMC funding. The damage here would extend beyond AMCs to other non-bank finance companies, including leasing companies and other entities owned by China’s banks. Not supporting these securities could all but eliminate China Inc.’s access to the global bond markets.
Concurrently, price action in the bond market suggests concern with the long-term viability of the AMC model rather than jump to default risk. We are not convinced this is appropriate and recommend Overweighting other AMC bonds.
Although the former top executive was put to death, Huarong bondholders need not be. Nonetheless, the walk to the gallows can be harrowing and uncertainty is high. There is likely more than meets the eye in this story. It is conceivable that we never see a 2020 year-end report for this state-owned enterprise. Therefore, having a strong conviction on Huarong means undertaking a leap of faith. As such, we suggest a way to trade Huarong  such that downside is limited; however, our preference is to trade the contagion.

China Huarong: Contagion Creates Opportunity

China

China Cinda Asset Management Company Ltd. provides asset management services. The Company invests, disposes, and manages non-performing assets and equity. China Cinda Asset Management also provides consulting, investment, financial, and risk management services to individuals and businesses.

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China Cinda Asset Management (1359 HK)

China Financials: Silver Linings Playbook

Our Silver Linings Playbook outlines our views on the China financials names that are most likely to remain resilient in the face of macro...

Stanley Tsai, CFA

China Huarong Asset Management – Silence Is Golden

CHINA HUARONG: Huarong's legacy exposure associated with the misdeeds of its former Chairman have caused to Huarong to teeter. Beijing is likely to...

Thomas J. Monaco

China Huarong: No Confidence Motion

China Huarong could be the first domino to fall on the confidence on the implicit support by the Chinese government. Rating agencies' scramble to...

Bondcritic

China Huarong Asset Management - This Can’t Be Good

CHINA HUARONG ASSET MANAGEMENT: Huarong is delaying its 2020 earnings results beyond the April 30, 2021 deadline, which, in our view, only...

Thomas J. Monaco

China Huarong: Contagion Creates Opportunity

Trade the contagion from China Huarong uncertainty. Although the former top executive was put to death, bondholders need not be. However, having a...

Hank Calenti, CFA

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