China Huarong girds against upstarts

Huarong chairman Lai Xiaomin tells FinanceAsia that the country's largest asset manager faces tougher competition from new market entrants.
Lai Xiaomin
Lai Xiaomin

China Huarong Asset Management, the country’s largest asset management company, is set to face stiffer competition from new market participants as the nation’s financial industry evolves into a more complex structure, chairman Lai Xiaomin told FinanceAsia.

China’s four largest asset management companies have long enjoyed total domination in the industry due to their close ties with the central government and policy banks, which allows them to secure bank funding at lower rates and gets them access to proprietary deals from collateralised loans to distressed property assets.

This advantageous scenario is however changing with the Chinese authority opening up the asset management industry as part of its economic reform to increase competition and efficiency.

“Greater competition will come mainly from newly established local asset management companies as the central government delegates more responsibility to provincial and local governments,” China Huarong chairman Lai Xiaomin said in an emailed statement to FinanceAsia.

Lai’s experience from his 11 years with People’s Bank of China and another six years with the China Banking Regulatory Commission will no doubt help the firm navigate these more competitive waters.
He was appointed president of China Huarong Asset Management in 2009, and subsequently promoted as chairman of the distressed debt manager in 2012.

As China Huarong enters into final preparation for a public listing in Hong Kong, investors are bound to take into consideration the intense competition to access the company’s growth prospects.

By the end of this year China is expected to open its eleventh local asset management company in the northern province of Shanxi. At the moment six asset management companies are in operation in the provinces of Jiangsu, Zhejiang, Anhui, Guangdong, Fujian, and Liaoning, while four others operate at the municipal level in Beijing, Shanghai, Tianjin, and Chongqing.

The measures are part of a wider economic reform to tackle rising bad debts in local financial institutions as the country continues rapid urbanization.

Challenging market
Competition appears to have already affected China Cinda Asset Management, the first mainland Chinese asset management company to list in Hong Kong. It reported slower net profit growth of 21.2% last year compared to 31.7% in 2013 and 30.8% in 2012.


Non-asset management companies are also trying to share a slice in the pie by introducing financial products that cater to the needs of retail investors or small and medium-sized enterprises.

“In the next few years we will see more participation from private banks, trust companies, securities firms and insurance companies in the asset management business,” Lai added. “The introduction of internet finance has made it easier for them to make inroads into sectors that have been traditionally dominated by the big asset managers.”

To make things worse, the plunge in Chinese stock markets since June has already caused China Huarong to slightly delay its listing plans to October.

Lai did not comment on the timetable for the IPO.

To help it fend off the expected stiff competition, China Huarong is hoping to improve profitability and efficiency through introducing private capital from its long-awaited Hong Kong listing by the end of the year.

Since Chinese president Xi Jinping assumed office in November 2012, his government has put reform of state-owned companies top of the agenda. Privatisation and introduction of mixed ownership in state-owned companies are aimed at improving return on assets and stimulate private investment.

Prospective investors will be sensitive towards China Huarong’s valuation, among other things, because it lacks the first mover advantage to list, said one person familiar with the company.
“When China Cinda listed two years ago investors flocked into buying because it was the first distressed debt business to go public. They were not very concerned about the price,” the person said. “Now investors will have an option when evaluating interest in China Huarong.”

China Huarong’s private round of funding in August 2014 saw eight international and domestic strategic investors - China Life Group, Citic Securities, CICC, COFCO, Fosun International, Goldman Sachs, Khazanah Nasional and Warburg Pincus - took a 20.6% stake for a total consideration of Rmb14.5 billion ($2.4 billion).

As a result the finance ministry’s shareholding was reduced from 98.1% to 77.5%.

Stabilisation machine
As part of former Chinese Premier Zhu Rongji’s economic policies, China Huarong was one of the four bad debt managers set up to purchase distressed assets from the so-called Big Four banks prior to their listing.

Since then the bad debt manager has played a key policy role in maintaining China’s financial stability. It has also acted as a liquidator for the government when managing distressed institutions that might impact financial stability.

Investors will be reassured that Beijing-based China Huarong will continue to enjoy a unique market position due to the Ministry of Finance’s majority ownership and that it does not maintain a high cash position on its balance sheet but instead keeps multiple bank lines to meet liquidity requirements.

The company is expected to continue its policy role as a market-stabilising institution, although that role has diminished compared with when it was first established.

While the government’s shareholding is set to fall further as the company forges ahead with its IPO in Hong Kong later this year, there will be a stronger push for improved efficiency and profitability from new shareholders, said a banker familiar with the situation.

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More broadly the distressed asset management industry in China is in a catch-22 scenario, which potential investors need to take into consideration.

Established in 1999 after the Asian financial crisis, China Huarong Asset Management could never have reached its current scale without being lifted by the country’s whirlwind economic growth.
Between 1999 and 2014, China’s gross domestic product grew at a compound annual growth rate of 13.91%.  As a result the nation that ranked seventh in size became the world’s second-largest economy is less than a decade and a half.

In just three of those years, between 2012 and 2014 when Chinese GDP grew by almost a third, the country’s largest asset management company saw its total assets grow nearly 1.5 times.

However distressed debt management – the core business that accounted for 56.1% of China Huarong’s income last year – is often a countercyclical business that benefits from economic weakness. When times are hard it is easier to find distressed assets; distressed debt managers can lower their sourcing costs due to a larger supply of distressed assets at lower prices.

Official data show the Chinese economy still expanded at an annual rate of 7% in both the first and second quarters of this year, in keeping with government attempts to manage the slowdown and wean the economy off its investment- and export-dependence. But other evidence suggests the slowdown could be more severe.

So the debate now is whether China’s economic slowdown will create more opportunities or risks for distressed asset managers.

Analysts believe it will create ample business opportunities for China Huarong to acquire distressed assets. But as China Huarong aggressively expands its asset portfolio, so the risk of getting lower quality assets increases, which will subsequently increase the group’s default rates and put pressure on its liquidity profile.

“China Huarong’s rapid asset growth over the past few years could bring some uncertainty to the group’s credit quality in the event of an economic downturn, particularly if the downturn is worse than the company expected at the time of purchase of the distressed asset,” Harry Hu, an associate director for financial institutions rating at S&P, said in a research note in July.

A banker familiar with the company said China’s slowdown means distressed debt managers will have to put more effort into managing the quality of their assets.

“When the Chinese economy grew steadily in the past few years it was not difficult for China Huarong to operate because many of the debtors can pay off their debt,” the banker said. “As a result China Huarong can easily restructure the distressed assets and sell them to make profits.”

But as China enters a phase of slower economic growth, the pressure on the debt serving capabilities of the distressed companies under China Huarong’s portfolio will increase, Moody’s said in a July research report.

That is particularly true when it is considered that China Huarong has a large share of distressed assets in the property sector, where a prolonged boom appears to have run its course. The asset manager could face substantial credit risk if there is a major correction in China’s property markets, reducing the recovery prospects on its property-related exposures, Moody’s said.

Additional reporting by Julie Zhu

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