Huarong’s core distressed business remains of significance; considerations as to offshore “keepwell” structure are not quite the same as other cases.

China’s offshore corporate credit market has been clouded by a potential restructuring of Huarong AMC, the country’s largest state-owned distressed debt manager, after the company failed to file its annual earnings on March 31. Huarong offshore bonds generally have seen significant volatility over the past several weeks.

Huarong, which is 57% owned by the Ministry of Finance, has been in “exploration and recovery” mode since 2018, after its ex-chairman was arrested for corruption. While recent results are underwhelming, Huarong’s core distressed segment continues to deliver stable earnings, helping to absorb impairment from non-core segments related to the ex-chairman’s trades. The core business of Huarong retains strong policy importance in supporting the real economy amid expectations of rising system non-performing loans. An additional matter relates to the potentially large balance of bad assets under Huarong’s non-core units, which grew aggressively during the reign of the ex-chairman. The timing and pace of resolution on these bad assets should be well controlled under the supervision of regulators and management, with good intentions to assist Huarong’s core business to continue its policy mandate in the long run.

Huarong dollar-denominated offshore bonds have an intricate issuance structure, which is supported by a “keepwell” deed from the onshore parent. Enforceability of similar structures has faced high legal hurdles in recent China corporate defaults. However, compared to some previous defaults, we expect Huarong AMC to remain a going concern to perform the keepwell’s undertakings, which is different from insolvent parents in other keepwell enforcement cases. Deliberately breaching a purportedly binding document would set a very negative precedent that would create widespread uncertainty as to the legality of many non-restrictive covenants across the Chinese market.

At a broader level, regulators have multiple tools to avoid an unorderly default of large financial institutions. An outright default of Huarong would create significant volatility in the Chinese USD market—it would be the largest Chinese corporate default in history. In addition to impacting overall default rates and a range of institutions, such a default would likely cause investors and lenders to reevaluate government support for all SOEs going forward, and lead to a permanent debt repricing for both offshore and onshore markets.

Given those potential ramifications, we believe that the authorities will attempt to manage this situation; thus a “hard landing” scenario appears highly unlikely. We continue to find attractive investment opportunities throughout the Chinese markets, with differentiation in ownership structure and policy importance remaining key inputs in our credit assessments in SOEs on top of traditional credit analysis.