The Politics of Chinese Credit Risk
“To exactly solve the problem of corruption, we must hit both flies and tigers.” - Xi Jinping
In December this past year, Chinese lender Citic Bancorp warned that the high-flying conglomerate, the HNA Group, was having trouble paying its considerable short-term debts. After building a $40 billion pile of investments around the world largely funded with debt, HNA seems to have reached the end of its ability to grow further, both in financial and political terms. Western investors and banks have recently begun wondering whether the Chinese government will come to the rescue.
HNA symbolizes China’s schizophrenic approach to economic growth: an on-again, off-again roller coaster which reflects the changing political priorities of the country’s communist leaders. Whereas in 2016 China’s leaders allowed and even encouraged Chinese investments offshore, both by companies and individuals, since last summer the situation has changed. President Xi Jinping is reasserting the government’s control over the economy. And perhaps the highest priority for China’s rulers is reining in the overheated financial sector symbolized by firms like HNA.
Think of HNA Group as a Chinese version of Softbank, but with considerably less transparency and more debt leverage. The firm exploded onto the global financial scene several years ago, acquiring New Zealand’s largest financial services firm and stakes in companies such as Hilton and Deutsche Bank. It ostentatiously hung its name on office buildings in major world financial centers. HNA created its own aircraft leasing company, Avolon, to compete with global banks in this lucrative financial market. Incredibly, it even acquired SkyBridge Capital from hedge fund manager Anthony Scaramucci before he briefly joined the Trump administration last summer.
The public face of HNA is Adam Tan, who is identified as its chief executive officer and co-founder. The company’s ownership and corporate structure remains shrouded in mystery, however, causing investors increasing disquiet. To fuel its growth, HNA aggressively leveraged existing assets to fund the purchase of new ones, the Financial Times reported last summer, a process known in Chinese as “a snake swallowing an elephant.”
Ratings agency S&P has cut the company’s debt rating deep into junk territory, causing some analysts to predict that the firm will eventually default. There has been talk of asset sales to deleverage and pay down debt. But the key question is whether the founders of HNA, which started off as a regional airline, have lost the political support of China’s leaders.
“There has been a lot of commentary focusing on the notion that China is deleveraging,” notes Leland Miller, CEO of China Beige Book. “China is not deleveraging right now, at least in terms of where it really counts, the corporate sector. What is happening is a crackdown on certain shadow products across the financial sector. The government is clamping down on instruments it thinks are running amok, such as wealth management products, trust products, negotiable certificates of deposits, and others.”
Miller notes that he expects there to be some high profile defaults in China during the coming months. It is critical that Beijing sends the message that people can and will lose money when they invest blindly into the shadow banking system, he notes. “They have to eviscerate the idea that the Great Chinese Government Backstop continues to remain in place.”
Many foreign investors and corporate managers find it convenient to believe that firms like HNA are private companies that are similar to their western counterparts. But in fact, all businesses in China are ultimately subordinate to the Chinese Communist Party (CCP) and Xi Jinping. Last summer, Chinese regulators began restricting liquidity to acquisitive Chinese firms, Reuters reports, ordering a group of lenders to assess exposure to some of the more aggressive dealmakers. These include HNA, the property-to-film conglomerate Dalian Wanda and Anbang Insurance Group.
Foreigners also like to believe that the party will support companies such as HNA when they get into financial trouble, but in fact the decision of whether to bail out an insolvent bank or company is ultimately political. HNA’s roots are also political, as a June 2017 feature article in the Financial Times makes clear, but this could ultimately lead to the firm’s undoing.