How the Big Three got Huarong so wrong

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How the Big Three got Huarong so wrong

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• Big Three blamed: In 2008, once Lehman Brothers collapsed and global financial crisis engulfed the world, the big 3 rating agencies got the flak as enablers of the 'US housing crisis'. Why? Because they gave good ratings to badly made securitised products that were then easily sold worldwide, and then sank everyone.
• Latest drama, in China: The Chinese SOE Huarong Asset Management Co. is a distressed asset manager, and now a distressed asset itself. Its ratings are "safe as cash", but its perpetual bond is trading at 70 cents to a dollar! 
• Rating agencies' reaction: The three are disassociating quickly. S&P Global Ratings and Moody's Investors Service have put Huarong on negative credit watch. Fitch cut its rating from A to BBB (three levels down). All this is a too little, too late.
• Scam in the making: Wrong ratings (higher ones) enabled Huarong to become China's largest offshore debt issuer. Terms were unfavourable for investors, as bonds are not guaranteed by its Beijing HQ, but a small offshore subsidiary. A fallout of Huarong was that some good firms (e.g. Yunnan Energy) saw dollar bonds tumble as well. Clearly, investors don't trust ratings here!
• Why raters got it wrong: Huarong is a State Owned Enterprise (SOE) and rating such a firm involves two things - its own financial strength, and government's possible support in crisis. Sometimes they're so tightly linked that standalone credit analysis means little. 

1. In 2020, Huarong was 57% owned by Ministry of Finance
2. Set up in 1999, Huarong worked to help banks dispose their bad debts, and there was $2.7 trillion worth distressed assets around (govt. would give lot of support, as per raters)
3. On a standalone basis, it had a B1 junk rating, but final score was seven levels up, at A3

• Not good for China: These rating methods don't work here because top level financial priorities can change suddenly. SOEs can simply fall out of favour and fashion overnight, once their job is done. Rating agencies may miss the shifts. 

1. An example of this is the sudden closure of many coal mines as President Xi Jinping announced the net zero emissions target by 2060
2. Some coal related SOE entities began defaulting (while ratings remained investment-grade)

• Political changes: China added a fifth bad debt manager recently - China Galaxy Asset Management Co. - in over twenty years. In Jan 2021, Huarong's former CEO was executed for financial crimes! (a rarity)
• China's directional change: It is emboldened by sudden macroeconomic positives, and is pushing for corporate deleveraging. That plan was stopped due to US President Trump's trade war in 2017-18-19, and then Covid pandemic. Now, major restructuring is happening, and credit rating agencies better take note.

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