Are these Conglomerates the Black Swan in China?
Bank of America suddenly pulled back from doing business with HNA Group, a privately held Chinese conglomerate that has been on the forefront of highly leveraged, opaque Chinese conglomerates out on a mind-boggling debt-funded acquisition binge around the world.
“We simply don’t know what we don’t know, and are not prepared to take the risk,” Bank of America president for Asia Pacific, Matthew Koder, wrote in an internal email, dated June 28 that was leaked to The New York Times. “Given the importance of maintaining rigorous client selection standards, we have decided not to be involved with transactions with the HNA Group at this point in time.”
So Bank of America is getting scared and won’t do business with HNA. It’s walking away from a lucrative customer that has been generating piles of fees and interest income for the banks. The Times:
On one side of business, banks have helped HNA buy companies by arranging what is called collateralized financing. That has entailed allowing HNA to borrow money against the shares of the company that it is acquiring.
Big banks have also received large paydays for advising on HNA’s acquisitions. HNA and its affiliates overseas have paid an estimated $100 million in fees to banks advising on mergers and acquisitions since 2016….
HNA’s most recent mega deal in the US was its $2.2-billion purchase in May of the 45-story office tower at 245 Park Avenue, the sixth largest transaction ever in Manhattan. At $1,282 per square foot, the price was also among the highest ever paid for this type of asset.
Most of HNA’s funding for this deal came from loans by state-owned banks in China that have extended HNA a $60 billion line of credit for those kinds of deals. But it also borrowed $508 million from JPMorgan Chase, Natixis, Deutsche Bank, Barclays, and Societe Generale.
This has been the trick: a lot of borrowing from Chinese state-owned banks mixed with some borrowing from US and European banks. And it worked: Since the beginning of 2016, HNA has done over 30 acquisitions, including:
- The $6.5 billion 25% stake in Hilton Hotels.
- Raising its stake in Deutsche Bank to 9.99%, now under scrutiny by the ECB; the deal was done with a $2.6 billion loan mostly from UBS.
- The $6 billion acquisition of Ingram Micro in California, the world’s largest IT distributor. The deal received US government approval.
- The $2.77 billion acquisition of Swissport, the world´s largest airport ground and cargo handling company.
- The $10 billion acquisition of CIT Group’s aircraft-leasing business, which was added to HNA’s Avolon Holdings to create the world’s third-largest aircraft rental fleet.
On all these deals, US and European banks extracted fees and interest. And on all these deals, their lawyers and auditors examined HNA, The Times pointed out: “Yet, questions persist as to whether the banks have the proper due diligence and risk control processes for dealing with Chinese companies.”
BofA had been discussing lending arrangements with HNA for future transactions, “according to a person with direct knowledge” of the matter. And it was one of several banks trying to help HNA sell at least one of its operations to the public. But now, BofA has walked away.
Among the reasons BofA listed in the email for refusing to get involved in any transaction with HNA:
- Opaque corporate and shareholding structure: The executive wrote in the email that there were “too many irregularities in the historical and current shareholding and corporate structure,” of HNA and pointed at the “opaque nature of some of the existing shareholders.”
- The sudden scrutiny by Chinese regulators of HNA and its complex business model.
- The allegations of political connections – a reference perhaps to accusations by Chinese billionaire Guo Wengui that, as The Times put it, “HNA is controlled by one of the most powerful families in China and by the relatives of people running the country’s anti-corruption campaign” – allegations that HNA has denied as “completely unfounded and false.”
Other Chinese conglomerates that have surged practically out of nowhere and that have been loading up with debt and binge-buying overseas include Anbang Insurance Group, Dalian Wanda, and LeEco. They’re all highly leveraged and have complex and opaque ownership structures that create worries about corporate governance, conflicts of interests, inscrutable transactions with related parties (including friends and family), and ultimately financial soundness. Since they’re burdened by layers and layers of debt, the banks are on the hook.
Chinese authorities are publicly worried about the loans their state-owned banks have extended to these conglomerates to fund their acquisition binge at top prices, and they’re worried about the “systemic risk” these conglomerates pose to the banks. And they’re now pressuring banks to examine their exposure to the conglomerates, including HNA. And numerous deals have since fallen apart due to lack of funding and as LeEco put it, a “cash crunch.”
“The debt addiction is threatening China’s economy as concerns swirl that some of the biggest conglomerates represent a hidden risk to the country’s financial system,” The Times reported separately. “Chinese officials have begun to clamp down on prolific deal makers like Anbang, whose chairman was recently detained by the police for undisclosed reasons.”
Bank of America’s decision to pull out of any deals with HNA shows the concerns other US and European banks must have as well, and that they too might be getting second thoughts about the risks of doing business with Chinese conglomerates, especially since even Chinese authorities are loudly fretting about the exposure of their own banks to these conglomerates, and their fear that the conglomerates threaten China’s very fragile financial stability.
When banks step back from an opportunity to make vast sums of money because they finally see the risks, it’s the moment the music stops for these conglomerates. That’s when debt cannot be refinanced or serviced anymore. That’s when the whole multi-layered debt constructs come tumbling down, and when Chinese authorities come face to face with their own black-swan event.
In the second quarter, Chinese entities accounted for half of the commercial real estate purchases in Manhattan. Read… What’ll Happen to US Commercial Real Estate as Chinese Money Dries Up?
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Was HNA previously in existence in 1990s Japan?
Richard Fuld is an adviser of HNA. /sarc
Funny Wolf, about halfway through I thought,”the swan has chosen its pond and is about to land” You amaze me with your clear, succinct writing, this story will be 2000 words on Bloomberg.
“…this story will be 2000 words on Bloomberg.”
Only after it occurs
This. I’ve seen this movie before, the first time it was in Japanese in the late 80s.
Mike G – And they’ve never really recovered.
1) As an accountant, I have no trouble asking, “Does this mean some accountants are finally doing their job?”
2) I know some people have insisted throughout Real Estate Bubble 2.0 that all of these “cash buyer” deals from China aren’t really cash. Specifically, Ben Jones at the Housing Bubble Blog has been asserting this for quite some time. This article would seem to validate that notion and is very interesting.
So many people have thought, “Well, the Chinese have all of this money from selling to the US. They’re using it to buy our real estate.” Maybe not? Maybe Bubble 2.0 has tons of bad debt going on as well, but just not American debt?
If half the rumors about Chinese financing are true it’s all terrible debt and shady lending. My question is how long can a government in complete collusion with their financial system and major businesses plug holes and keep its borrows and lenders from having to service the debt with real assets and earnings?
“My question is how long can a government in complete collusion with their financial system and major businesses plug holes and keep its borrows and lenders from having to service the debt with real assets and earnings?”
Look at the last 8 years in the USA to find your answer
1 Take Zoomlion, a lossmaking Chinese machinery company that is partially state-owned: its total debt stands at 83 times its EBITDA. “Zoomlion’s bid is a desperate attempt to remain relevant,” said Mr Pillay.
2 Or how about Fosun, a serial Chinese acquirer that spent $6.5bn on stakes in 18 overseas companies during a six-month period last year, had a a 55.7x total debt/EBITDA in June 2015. “Fosun has bought brand names such as Club Med and Cirque du Soleil as well as a host of other assets including the German private bank Hauck & Aufhaeser.”
3 Or maybe the highly publicized purchase of China Cosco Holdings of the Greek Piraeus Port Authority for €368.5m. Cosco has promised to invest €500m in the Greek port despite having total debt at 41.5x its EBITDA!
4 Or Cofco Corporation, which recently reached an agreement with Noble Group under which its subsidiary, Cofco International, would acquire a stake in Noble Agri for $750m (in the process preventing the insolvency of the biggest Asian commodities trader), has total debt equivalent to 52 times its EBITDA!
5 Or how about Bright Food, which bought the breakfast group Weetabix for $1.2bn last year, and has total debt at 24 times EBITDA!
Their buying RE also in my country, they fly COPTER and choose villas in the air, don’t even land! and buy not one but between 3 and 5!
Great info Manuel. Thanks for taking the time to post.
Debt in which currency?
good point, reminds of the Japanese buying pebble beach in the nineties. also if HNA stops making their payments will the state run banks initiate foreclosure proceedings ?
The chinese have adopted western NEO financialization structures/models . They are realizing the inherent risks.
This China story has played before in the likes of Paul Reichman. An aura of invincibility while the real numbers were carried around in Paul’s old leather briefcase.
“So many people have thought, “Well, the Chinese have all of this money from selling to the US. They’re using it to buy our real estate.” Maybe not? Maybe Bubble 2.0 has tons of bad debt going on as well, but just not American debt?”
A lot of people thought this about Japan during their 1980’s buying spree. Turns out it was all just a big credit bubble waiting to burst, and then it did. This time is not different.
I think that the situation is a little different than what happened in the 1980’s Japan buying spree.
This Chinese ponzi scheme seems to be using Chinese stocks and interconnected Chinese shareholdings as a basis for valuations and borrowing.
The Japanese buying spree was based on Japanese commercial real estate and the borrowings on that property.
For example, a real life example from my wife’s former neighbourhood in Japan with the name changed:
Good ole Mr Tanaka parents finally died leaving him that big block of land with an old house on it. After paying the inheritance taxes good ole Mr Tanaka wanted to be a RE tycoon and using the value of the land went on to borrow against it and bought two more adjoining blocks of land in order to build a huge condominium tower on the consolidated holdings.
But poor ole Mr Tanaka didn’t plan well and the bubble burst. Mr Tanaka was unable to obtain financing for the construction of the tower and in turn was unable to service his debts.
Mr Tanaka’s bank not only took over the two blocks of land, but foreclosed on Mr Tanaka’s house as well. Poor Mr Tanaka, having owned his former parents’ house land free and worth over US$50 million at one time now has nothing.
The ‘poor’ bank which lent the money now has a big block of land worth a whole lot less and no prospects of ever getting its money back.
What to do? If they classify the land as being held for future development they don’t have to write down the value. If they put it in the ‘to sell’ category they have to write its value down and wipe out a large chunk of retained earnings…………….
So the land still sits there years later with a dumpy old empty house in the middle of a big block of land.
Repeat hundreds or thousands of times with bigger blocks of land and buildings.
Japanese borrowed against the value of the land because it was cheaper to do so than sell the land, pay huge capital gains taxes, and then invest the money.
Illiquid RE markets in Japan, the capital gains tax on RE, and lack of internal investments were the drivers for Japan’s buying spree.
IMO very different from the current situation presented by China now.
1) Yes, but not because accountants have become more ethical. Bank of America is afraid of the ponzi scheme imploding before they can sell their position on to the greater fool.
2) Yes, very true. Few people around the world are actually buying expensive assets with cash from savings or outright sale of equity/fixed income securities. Most cash come from low cost, easy to access loans from another country…like Canada.
I’ll give your questions #1 a shot: I think accountants have done (or were trying to do) their job all along, but they’re routinely shoved aside with their inconvenient quibbles. When someone up high finally listens to them, it may be a sign that it is late in the game.
The CCP has been clandestinely printing CNY/RMB in huge amounts to “Fund this spree” Effectively printing its way into western assets for nothing and loading western banks with worthless chinese corporate debt..
With the intent of financially destroying the west.
As nobody can compete with the CCP printing press funding entities that ARE NEVER REQUIRED TO EVER MAKE A TRUE PROFIT
The Mafia/Triad clan in charge of the CCP currently ,realises, when this implodes, EVERYBODY not just the west goes. It is trying to undertake damage limitation for the chinese part of the global financial system
When this unwinds, the silver crisis in the west, caused by china, that lead ultimately to the opium wars.
Will look like, the first course of a a Preschool “Sunday School Picnic.”
This is not an if it is a when as the chines bankers do not have the skills to keep this running for ever and the intention always was that it should implode. Financially destroying the west leaving chinese companies with the Western assets for free with no debt to the west.
BOA is one of the worst American corporate financial criminal enterprises, That they smell a chinese rat and are walking is a very bad sign.
The MASSIVE Capacity of the CCP to clandestinely physically print , And to turn trillions in NPLS into worthless equity, at the flick of a CCP chop, leaves when, not if, as the only non insider time frame analysis. unfortunately.
“That has entailed allowing HNA to borrow money against the shares of the company that it is acquiring.”
Gee where did they learn this trick? /s
GAAP of Accounting 101
Debt is an instrument of temporary liquidity that must be returned over a specified time period, along with any and all fees and interest charges.
Yet non-GAAP “creative accounting” lists this debt as an asset, on the asset side of a ledger, versus where it belongs as a liability.
First law of economics:
‘All debt will be paid. Either with pennies worth dollars, or with dollars worth pennies. It will be paid’.
The amount of debt in the global financial system is so high, that no one has, or can grasp, an idea of the sheer size. It is more than huge. When this house of cards implodes, some of that debt will be repaid in blood.
I have to say borrowing/lending Borrowing/lending is fine, even at extreme scale. It is what make capitalism work.
But it should be done with 2 principles.
1. You borrow from savings, not printed money. Yhis puts the borrow/lend activities in line with underlying economy.
2. If the debt go bad, there is no bail out. This will limit the risk taking.
Both of above are violated.
2009 violated 2, QE/ZIRP violated 1 and people are suggesting borrowing/lending should be controlled,scrutinized/regulated.
It is just too much work and creates all kinds of unnecessary jobs and barriers and controls.
If you do nothing, like no bailout, no QE, lending/borrowing would work fine.
Some would have gone to prison, and many people will become homeless and economy will look like 3rd world for a short 3 years, and then life would become better for the mass, not the 1%.
“You borrow from savings, not printed money.”
When you borrow from your bank to buy a car, the money is created out of thin air by the bank. Banks don’t lend deposits.
Yes, it does come from deposits. Why wouldn’t it? The cost of funds for banks is as close to 0 as at any point in history.
(Others, please correct me if I’m wrong.)
Banks don’t lend against reserves. They can lend, period, and then after the fact can borrow whatever is needed to meet their pointless, inadequate, fractional reserves. It’s an important point, the timing.
Banks aren’t restricted by their reserve total for lending. They can lend to their hearts’ desires and then borrow from each other or the Fed at 0% to meet the reserve standard.
I was surprised to learn this myself over the last year.
to Wilbur 58 (and J Bank, also):
Wilbur is correct, as is Kent’s statement above J Banks;
banks do not lend out deposits. There is no pool of cash that is used to give out as loans.
When a bank “loans” money it just puts numbers and zeros into your account ledger. No physical cash or electronic cash is actually moved from them to you.
Your Loan can then be used as collateral by the bank for it’s own activities with other institutions.
The US banks , in fractional reserve banking leverage deposits, sometimes by several hundred %.
For every dollar they lend, they may have 5 Cents in reserves.
Its all good until, All the Joe averages, decide they want their money back, at the same time.
Which is why the US has to have FDIC. To under-pin its system.
What you are alluding to is how the system should work. Not how it does.
I am not sure about cars, but if you buy real estate, the money is covered by issuing bonds. Some lenders have no branches or deposits at all, and just issue bonds and exists on difference between the (their) bond rate and mortgage rate. Then, there is ING/Tangerine, that relies more heavily on deposits.
So the mortgage rate depends on government bond yields.
“1. You borrow from savings, not printed money. Yhis puts the borrow/lend activities in line with underlying economy.”
Please explain, then, how money enters the system. How does the money supply expand to accommodate economic expansion?
“How does the money supply expand to accommodate economic expansion?”
Ideally by expanding whatever is used to back the scrip used in the scenario. In an asset backed monetary scheme, the issuing government would have to acquire more of the asset (PMs or other commodity) before the M1 money supply build to support expansion.
Luckily, here in the US and most other larger Central Banks, all they need is the Full Faith and Credit offered by the country. I am sure that every time they “print”, they look around in the crevices of the sofa, under the bad and in the laundry to find a little bit more FF&C they back their currency with.
As far as the local banker waving his hands and creating money from thin air – it *is* a little more complicated than that. When I sold a truck to this fellow, he went to the bank for a loan. I went there and let the local loan officer look over the truck, showed him the title and compare the VIN to make sure I was presenting the correct vehicle as collateral. The loan officer signed off on the loan, and as I insisted on cash he went to the back and brought it out to me. It wasn’t freshly printed, as many of the big bills were already showing signs of wear. That money had to come from somewhere, even if it was from a cashiers till where she had just placed another customers deposit.
“That money had to come from somewhere, even if it was from a cashiers till where she had just placed another customers deposit.”
As you like me had the Audacity to demand the physical cash instead of accepting a credit in an account.
The money was “created” by the Bank.
When they credited the purchasers account, with the value of the loan.
Which they drew against, to withdraw your cash, from the tellers daily cash stock.
The first crack in the veneer was the Hong Kong crash of small cap Growth Enterprise Markets in June. For whatever reason this has not been talked about. Read up on David Webb’s Enigma Network. It was a shell of 50 companies who all own each other and basically are not worth anything other than the key players are all major share holders of each other. The first domino to fall was an Umbrella maker in China. LOL
Wanda (owned by China’s second richest man) selling of assets is the second crack.
Anbang is another bogus scam to get money out of China via Hong Kong through weird insurance policies…money laundering via insurance. A year or 2 ago there was only one story published about people flying to HK and buying phony insurance in the US…some were swiping their credit cards up to 80 times to get over the limits allowed.
The signs are everywhere but nobody is paying attention.
Thanks for this story! The narrative of money leaking out of China is fascinating. I haven’t figured out how firms falsify invoices to move money out of China as yet – how does that work?
Borrow in china to pay for goods to export, sell good offshore, do not repatriate funds.
Also sell on credit, transfer payment from foreigners to third country.
A lot of the limited run chinese junk on the shelves in the west, is part of this system.
Cant send cash, send containers of commodities, tires, roman blinds, coats, chainsaws, Etc, Etc. I see multiple containers of this type every week , in just 1 transfer facility, in a small country.
Container load of new tires CIF starts at 50 K.
Reversal with imported goods, in china, invoiced at 200% of true CIF value.
Fijian indians have been doing this for years, the state knows, but the tax take is too good to raise to much fuss over it. Unless you are on the wrong politically undesirable’s list.
I’ve mentioned this before, but I am still seeing no reaction from FTSE/Xinhua China 25 Index ETF. And the inverse (1x so non leveraged) index ETF has been dropping like a rock.
“This year, one of HNA’s subsidiaries agreed to buy a major stake in SkyBridge Capital, an investment firm founded by Anthony Scaramucci, a former Trump campaign fund-raiser who was eyeing a role in the White House. The move was seen by some as a way to influence the Trump administration.
Last week, HNA was the subject of wild online speculation after a fugitive Chinese billionaire said in a television interview that relatives of a senior Chinese leader, Wang Qishan, had a stake in the company. No proof was provided.
The allegations leveled by the billionaire, Guo Wengui, who has ties to China’s former spy chief, is part of his broader war on the Chinese government. From his New York apartment, Mr. Guo, using his Twitter account and Google’s YouTube, has been making claims of widespread government corruption. China has requested his arrest, on separate corruption charges.
As speculation swirled that HNA could be drawn into a political firestorm, shares of one of the company’s Hong Kong affiliates tumbled late last month. Soon after, critical news articles on the group began disappearing from Chinese websites, prompting concerns that government censors had handed down orders to delete unfavorable news about HNA.”
Fascinating article! Thanks for the link.
“Given the importance of maintaining rigorous client selection standards” – BofA.
That is very much a LOL statement, coming from the criminals at BofA.
Yes, and a clear sign that they’ve eliminated their position Jin the company.
‘HNA’s Mr. Chen has seemed unfazed in the past. “After you’ve accumulated so much lice, you no longer feel the itching,” he said in an interview some years ago. “When you borrow a lot of money, you have no problem sleeping.”
Taken from NY Times article
“If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem”
J Paul Getty
“”Or maybe the highly publicized purchase of China Cosco Holdings of the Greek Piraeus Port Authority for €368.5m. Cosco has promised to invest €500m in the Greek port despite having total debt at 41.5x its EBITDA!””
At least Greece got some cash to fritter away… IF they are smart they will swap it for gold and wait for the fire sale – and buy it back for (place your favorite worthless currency here) on the dollar!
The drachma has had an interesting history, after the WW2 revaluation (50,000,000,000 to 1) it was revaluated at 1000 to 1 in 1954, and ended up at 400 drachma to the dollar at the end of its life (before the Euro conversion). (based on wikipedia). The French Franc has had a similar trajectory; just with fewer zeros in play. The Chinese Yuan has yet to go through this transformation. Near as I can tell – it all depends on how much buying versus selling pressure is placed on a currency. When nobody wants to buy the Yuan anymore – look out below.
JR: not to disagree cuz I don’t know but 50 billion to 1 means, in effect, zero.
Was it that bad? Because that approaches the point at which the note can’t pay for the paper and ink.
What was the nominal or face value of the largest note?
If you google “drachma billion” you will get images for 100 billion drachma notes. That is pretty good. And in other news – what is allegedly going on in Italy indicates the degree of creative business going on there. The reuters article states: “Bank of China said in a statement it had not committed any crime and was not admitting guilt by agreeing to pay the fine, which was a way of closing the case and saving time. ” – wherein the following alleged operations were going on : “According to the prosecutors, the proceeds sent to China came from a series of illegal activities, including counterfeiting, embezzlement, exploitation of illegal labour and tax evasion. ” You can find this by googling China money laundering. Allegedly certain name brands are “Made in Italy” – actually in Italy but using imported labor… Very creative.
Paying for paper and ink? Venezuela not long ago had skids of money printed overseas but couldn’t afford hard currency to pay for it, so yeah, it does happen.
As far as big nominal numbers are concerned, in 1946 one Hungarian pengo banknote was 100 million billion pengo. They also had one for a billion trillion pengo. The money is actually quite beautifully engraved, but like many of these currencies at some point they only printed one side. More recently a Zimabwe note was printed for 100 trillion dollars – less than 20 years before the Zim dollar was par with the US dollar.
Yugoslavia during the ’90s issued a 500 billion note. And Germany in 1923 issued a 500 million billion note, etc etc.
I have a lot of these kinds of notes. I also have a German bond from 1922 for 50,000 marks that somebody bought (that would have been 20,000 US at the time, maybe 600,000 in today’s money). All the interest coupons are intact, because next year it was worth … nothing.
The history of paper money is that it always goes to near zero, even the US dollar, twice. They just keep printing, then lop of zeros and declare it ‘new’ money.
Interesting that European Banks-US banks are involved in some of the lending with these Chinese companies.
Interesting from a European bank point of view when a lot of banks are trying to de-risk their loan books.
I think it’s particularly peculiar that UBS lent money to HNA in a complex deal so that HNA could buy shares of Deutsche Bank and pledge those shares as collateral to UBS.
Talking about a deal that doesn’t pass the smell test.
UBS the only Swiss bank to get burnt seriously in sub prime.
which proves they are a Swiss bank, in name only.
– Mathew Koder is pulling a “Rumsfeld”: “We don’t know what we don’t know”
This is how China is becoming so powerful in capturing global market share. Just look at the historic rise in Huawei and ZTE.
These companies capture market share because their customers get to borrow money from PBOC via a sovereign wealth fund at below market rates. Since these loans are way below market rates and it is hard for Cisco, Acatel, …etc to compete and they get underbid. I am not even sure if the PBOC even cares if the loans are paid back as this lets Huawei and ZTE capture market share and put companies out of business.
In the telecom heyday of nineties Europe, Huawei offered to build Vodafone’s network in Spain for free. It was not underbid.
chinese finance is very creative. 5000 year old culture.
given all the, what will be in hindsight, crazy stuff going on, modesty may make a comeback.
Yes very creative, it regularly creates civil wars .
The root cause of all the many many civil wars in china, since they first started using paper money.
Has been excessive money printing AKA Currency debasement, by the administration.
china is the global poster child of civil wars and revolts, sometimes leading to revolutions.