EARNINGS CALL: China Huarong in Talks With Other Potential Strategic Investors; Co. Applies for Temporary Exemption of Capital Adequacy Ratio Requirement; Offshore Refinancing Plan Subject to Operational Needs, Recovery of Credit, Regulators’ Assessment

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Management of China Huarong Asset Management, said on an earnings call today, Aug. 30, that Huarong is also in talks with other potential strategic investors, including Chinese and foreign firms, who had shown interests in investing in the company and joining CITIC, China Insurance Investment, China Life, Cinda, Sino-Ocean as its strategic investors. Continue reading for our Asia Core Credit team's reporting that China Huarong Asset Management  is in talks with potential strategic investors and request a trial for access to reporting and analysis of hundreds more stressed, distressed and performing credits. 

The existing strategic investors who have signed framework agreements with Huarong are conducting due diligence and the size of their investments as well as share placement price will be determined later based on asset valuations.

Huarong has also applied to relevant regulators for a temporary grace period for complying with certain capital conditions, especially capital adequacy ratio, which the company has failed to meet so far, according to management.

On the company’s refinancing plan for offshore notes and the potential redemption of perpetual notes, management said it will be determined according to operational needs, recovery of its credit and assessment of the regulators.

Management also disclosed that it had to delay the release of 2020 annual results because of the delay in the disposal of its stake in Huarong Overseas Chinese Asset Management, for which the company had been working with the auditor in submitting relevant documents until August.

As disclosed in the annual report, impairment losses booked in 2020 came from three main areas: risk assets held by Huarong Overseas Chinese Asset Management, current asset risks and impairment loss from certain subsidiaries. Management noted that it had made a plan to resolve the risk asset issues at Huarong Overseas Chinese within the next three to five years.

Despite reporting a significant loss, management highlighted that income from its core business of distressed debt asset management had increased from 60% of total revenue in 2018 to 78.9% in 2020, as the company refocused its attention on the segment. As of the end of June, 2021, approximately 50% of the group’s total assets were related to its distressed debt management segment, and it generated 134% of group’s total earnings before tax, according to the management.

By the end of June, 2021, the company had downsized its exposure in risk assets by more than RMB 100 billion, and at the same time, strengthened quality control in newly launched projects, management said. From 2018 to 2020, the company booked more than RMB 150 billion in provision of impairment loss for acquisition-and-restructuring distressed debt assets, loans and advances to customers, as well as financial assets. The management suggested that the practice will strengthen the company balance sheet in dealing with future risks.

Management also noted that it will continue to downsize non-core businesses. As of the end of 2020, non-financial subsidiaries' total debt instrument assets outstanding totalled RMB 23.426 billion, 2.5% lower than at the end of 2019 while as of today, the company has finished the reorganization of all non-financial subsidiaries. Total non-financial subsidiaries under the group's direct management have decreased from 27 companies to 13.

2020 Impairment Loss

The company attributed the RMB 107.755 impairment loss to overexpanded balance sheet, radical risk appetite, questionable client counterparties, concentrated operation risks, under former Chairman Lai Xiaoming’s management.

From 2014 to 2017, total assets increased by 211.4% to RMB 1,870.26 billion, the number of non-financial subsidiaries has increased to 27 companies from 18 companies, during the same period. The expansion of non-financial subsidiaries was mostly offshore, as out of the 9 new additions, 7 were offshore entities, according to the management.

Among the factors that contributed to the company’s impairment losses, the management guided three reasons: 1) impairment test conducted on the centralized disposal of the existing risk assets including Huarong Overseas Chinese Asset Management’s comprehensive assessment of centralized management of assets which made provisions for credit impairment loss and loss from fair value changes; 2) assessment on the credit impairment loss of current asset risks, resulting from earlier rapid expansions from 2015 to 2017 as well as the current market environment and Covid-19 epidemic; 3) credit impairment loss and loss from fair value changes made by its subsidiaries as underlying assets in asset management plans of relevant financial service subsidiaries were exposed to risks.

According to the 2020 annual report, in 2019, the management has taken measures in respect of organizational structure and management system to improve its management by integrating domestic and overseas non-financial subsidiaries and addressing the risk from disorderly expansion of institutions. Huarong Overseas Chinese, was responsible for managing and vitalizing existing assets as the overseas asset management platform of the group.

Huarong planned to dispose of Huarong Overseas Chinese in 2020 but the transaction failed to materialise due to worsening asset qualities during the outbreak of Covid-19 and market volatility, according to management.

Auditor’s Opinion

Huarong’s management stressed on the call today that the fact that its auditor, Ernst & Young Hua Ming LLP and Ernst & Young, had given an unqualified opinion on the group’s consolidated financial statements for 2020 shows that the auditor agreed with management’s assessment on Huarong’s risk assets.

In its unqualified opinions, the auditor expressed a disclaimer of opinion on the consolidated statement of profit or loss, consolidated comprehensive income statement and consolidated cash flow statement of the group for the year ended Dec. 31, 2020.

The auditor did not express an opinion on the company’s financial performance and consolidated cash flows for the year ended Dec. 31, 2020, because the management at the company was unable to extend the comprehensive review and assessment as well as impairment test to relevant assets in 2019. As a result, the auditor was unable to make reasonable judgement on whether any of the associate gains and losses recognized by the company in 2020 should have been recorded in previous years.

The management noted that there has been significant organizational and personnel changes within the company in the past three years due to risk management practice. In order for the company to be able to release the annual report in time, the company has recorded the impairment losses to the current period, and was not able to provide comprehensive review and assessment, and impairment tests for previous years.

As reported, Huarong needed to provide the relevant audited financial reports by the end of August, in order to avoid triggering an event of default under its offshore senior notes.

Huarong’s capital structure is below.