Owner Of The Plaza Hotel, Once Trump's Crown Jewel, Hires Broker To Pursue A Sale

Here’s some news that might interest the President.

The Indian owners of the Plaza Hotel have hired a broker to tell the New York City landmark, according to the Wall Street Journal. The step is “a sign that a world-wide scramble among investors, celebrities and governments to acquire the property could be nearing an end.”

Perhaps more than any other property (Trump Tower included), the Plaza Hotel is emblematic of Donald Trump’s meteoric rise in the world of New York City real estate. The hotel had for years been an object of fascination for Trump, who reportedly jumped at the opportunity to buy it from Texas billionaire Robert Bass in 1988. According to the New York Times, Trump paid $400 million for the hotel, an unprecedented sum for a hotel at the time.

However, it would also eventually become a symbol of his debt-fueled brush with ruin, as the property was eventually forced into bankruptcy in 1992; in 1995, he bitterly agreed to sell it to a group of Saudi investors.

More than 30 years after Trump was forced to sell it, industry experts believe the hotel could fetch more than $500 million. However, that sum isn’t even close to the highest ever paid for a NYC hotel: Back in 2015, China’s Anbang Insurance Group Co. bought the Waldorf Astoria for $1.95 billion to the highest price ever paid for a U.S. hotel, according to data tracker STR Inc. Now Anbang is being pressured to sell the Waldorf, along with its other foreign assets. Regulators are concerned that a foreign buying spree by Anbang and other Chinese conglomerates has left domestic corporations dangerously overleveraged.

“While it is unclear how much a buyer would pay for a trophy property like the Plaza, hotel investors and brokers suggest it could be one of the most expensive hotel sales on a per-room basis, a popular industry metric. By that method of valuation it could bring in more than $500 million.”

A representative of the company to told WSJ that a buyer has been found, and “a sale is under process and not yet competed.

Per WSJ, the list of potential buyers includes both the Qatari sovereign-wealth fund and Pras Michel, former member of the Fugees.

“Dozens of real estate moguls, foreign government funds and other hotel investors around the globe in recent years have looked into buying the Plaza after Sahara indicated it would listen to offers, according to people familiar with the matter.

A Qatari sovereign-wealth fund, a Shanghai municipal investment fund and Pras Michel, the Grammy-winning co-founder of the hip-hop group Fugees, are among those that have expressed interest, say people who have been close to the process."

Sahara Chairman Subrata Roy reportedly handled some of the negotiations while serving time in a New Delhi jail.

“Sahara founder and Chairman Subrata Roy, who spent two years in a New Delhi jail on contempt charges, even negotiated with potential buyers from the jail’s guesthouse, according to people familiar with the situation.”

According to WSJ, several interest parties walked away from talks early on because they didn’t think Sahara was serious about selling hotel (i.e. Sahara wouldn’t budge from its asking price, whatever it was). However, the hiring of a broker suggests that this time, they intend to close.

"Sean Hennessey, chief executive officer of the hotel consultants Lodging Advisors told WSJ that hiring a broker suggests that Sahara is, in fact, serious about pursuing a sale of its crown-jewel hotel.

“This suggests a commitment to consummate a transaction,” he said, adding that a professional broker handling the process “might draw people back that looked once and walked away.”

Because of its appearance in classic works of American film and cinema, the hotel has a cultural cache that few can match.

“It has been featured in novels like “The Great Gatsby” and numerous films, including Alfred Hitchcock’s “North by Northwest.” Marilyn Monroe and the Beatles stayed there. John F. Kennedy’s sister Patricia Kennedy held the reception after her wedding to Peter Lawford in the Plaza’s ballroom.

Previous owners of the 110-year old property include hotelier Conrad Hilton and Donald Trump, who once compared it to the Mona Lisa.”

Unfortunately for the Plaza’s owners, they’re selling at a difficult time for the Manhattan real-estate market. As we mentioned above, Chinese authorities are cracking down on foreign real-estate transactions to stanch capital outflows that have helped drain the country’s foreign reserves and put pressure on its currency, the yuan. The effects of these new regulations have already begun to manifest: The average Manhattan hotel sales price in the first half of 2017 was about $515,000, down 26% from the recent peak in the first half 2015, according to data company Real Capital Analytics.

According to a team of analysts at Morgan Stanley, the Manhattan real estate market is headed for a valley as purchases of foreign-real estate by Chinese companies are expected to decline by 84% in 2017, and another 18% in 2018. The influx of Chinese buyers in the aftermath of the financial crisis helped drive bull markets in hot urban markets like New York City, London and Hong Kong.
 

Look Out Manhattan - Chinese Foreign Real-Estate Spending Plunges 82%

Earlier this month, Morgan Stanley warned that commercial real estate prices in New York City, Sydney and London would likely take a hit over the next two years as Chinese investors pull out of foreign property markets.

The pullback, they said, would be driven by China’s latest crackdown on capital outflows and corporate leverage, which they argued would lead to an 84% drop in overseas property investment by Chinese corporations during 2017, and another 18% in 2018.

Sure enough, official data released by China’s Ministry of Commerce have proven the first part of Morgan Stanley’s thesis correct. Data showed that outbound investment in real estate was particularly hard hit during the first half of the year, plunging 82%.

“According to official data, outbound investment by China’s real estate sector fell 82% year-on-year in the first half, to comprise just 2% of all outbound investment for the period.”

Overall, outbound direct investment to 145 countries declined to $48.19 billion, an annualized drop of 45.8%, according to China Banking News.

The decline is a result of a crackdown by Chinese authorities after corporations went on a foreign-acquisition spree that saw them spend nearly $300 billion buying foreign companies and assets, with China’s four most acquisitive firms accounting for $55 billion, or 18%, of the country’s total. The acquisitions aggravated capital outflows, creating a mountain of debt and making regulators uneasy. Late last month, Chinese authorities ordered Anbang Insurance Group to liquidate its overseas holdings. In June, authorities asked local banks to evaluate whether Anbang and three of its peers posed a “systemic risk” to the country’s financial system. As Morgan Stanley noted, these firms were responsible for billions of dollars of commercial real-estate investments in the US, UK, Australia and Hong Kong.

The pullback will likely be equally as devastating for residential home prices. Average sales prices for Manhattan residential real estate has continued to climb, but cracks are starting to appear. As we pointed out two days ago, 25% of homes sold in 2Q still experienced a price cut, with that number rising to 40-60% in trendy neighborhoods like the Upper East Side.

While falling real-estate prices would be an inconvenience for corrupt Chinese officials and other shady investors trying to stash their money as far away as possible from their homeland, they’d be a welcome relief for renters and young couples or individuals looking to buy their first home.

Across the US, asking rents hit all-time highs earlier this year.

Here's The Most Alarming Sign Yet That Manhattan Real Estate Is Heading For A Crash

The Chinese government’s latest crackdown on capital outflows and corporate leverage is intensifying, and that’s bad news for Manhattan’s property market.

According to a report by Morgan Stanley cited by Bloomberg, new restrictions being imposed on the most acquisitive Chinese companies will likely lead to an 84% drop in Chinese overseas property investment this year, and a further 18 percent drop in 2018.

The markets most vulnerable to this slowdown, according to MS, are the US, UK, Hong Kong and Australia, with commercial properties the most vulnerable.

Manhattan commercial real-estate prices could fall sharply.

“Manhattan is a particular worry, with about 30 percent of transactions in the borough that’s home to Wall Street involving Chinese parties in 2017. In Australia, China is the largest foreign real estate investor, accounting for as much as 25 percent of office property transactions in the last two to three years, according to Morgan Stanley.”

As we reported on Tuesday, the Chinese government is pushing Chinse insurance company Anbang – the company that was in talks with Jared Kushner to buy his company’s stake in 666 Fifth Ave. -  to liquidate most of its overseas holdings and repatriate the proceeds of the sale. The company, whose chairman was detained by Chinese authorities in June, responded by saying it has no plans to comply...but we think the Communist Party will find a way to convince the company’s executives that deleveraging is in their best interest.

Chinese authorities appear to be trying to reverse the global M&A binge that helped aggravate capital outflows, leading to a massive drawdown of the country’s foreign-exchange reserves.

Back in June, China’s Banking Regulatory Commission dealt an embarrassing blow to Anbang and three of the country’s other top conglomerates by demanding that banks examine “systemic risks” posed by Anbang, HNA, Dalian Wanda and Fosun International before lending to them. The announcement triggered a sharp drop in the share prices of companies controlled by these conglomerates.

Since 2015, the four companies completed a combined $55 billion in overseas acquisitions, 18% of Chinese companies’ total.

Anbang also got caught up in a crackdown on “improper innovation” in the securities markets after it helped finance its expansion with sales of lucrative wealth-management products that offered among the highest yields compared with peers, a key spoke of China"s $9 trillion shadow banking universe. The move forced regulators to implement restrictions on high-yield, short-term investments.

Weakening demand from Chinese individuals and corporations represents another headwind for real-estate markets in the most expensive US cities, which are facing a boom of new supply in the coming quarters. Commercial real-estate sales in New York fell to a six-year low during the first quarter in anticipation, as we’ve previously reported.

Residential real-estate markets are already feeling the pinch of the Communist Party’s efforts to suppress foreign real-estate deals with new capital controls. Already, New York City is seeing fewer apartments sell for above the listing price, a sign that demand in one of the world’s hottest residential markets is cooling. In a nightmare scenario for New York real-estate developers: Demand is ebbing just as an influx of new supply is hitting the market. You can probably guess what kind of impact that will have on prices.
 

Beijing Blowback Begins: China Orders Anbang To Sell Its Overseas Assets

Two weeks ago, when discussing the troubles plaguing one of China"s conglomerates and "boldest dealmaker", HNA Group - recently best known for acquiring Anthony Scaramucci"s SkyBridge capital in a transaction that has yet to close - we said that what until recently was one of the world"s most aggressive roll-ups of varied companies from around the globe, including stakes in Hilton Companies and Deutsche Bank, as well as countless Chinese acquisitions, could very soon become the "reverse roll-up from hell", as the stock price of HNA tumbled, putting the roughly $24 billion in loans that had been taken against HNA stock in jeopardy of breachin their LTV limits, forcing a massive margin call, and potential firesale liquidation of the company"s assets as shown in the chart below...

... which have been hit with the double whammy of various rating agency downgrades in recent months, further eroding the collateral value of all of HNA"s various assets.

Yet while the fate of HNA"s conglomerate future still remains largely in the hands of the market, which could easily prompt a firesale if it were to push HNA stock low enough, another Chinese conglomerate may not have the benefit of the market"s potential generosity, because according to Bloomberg, Chinese authorities have asked HNA"s peer, Anbang Insurance Group, the insurer whose chairman was recently detained in June and was classified as a potential "systemic risk" to China"s economy, to sell its overseas assets.

In addition to demand a liquidation of many if not all assets acquired by Anbang over the past three years, the government also asked the company - whose Chairman will surely comply following his brief "detention" - to bring the proceeds back to China after disposing of holdings abroad, suggesting not only growing concerns about Chinese capital outflows, but Beijing"s apparent intention to undo the massive Chinese M&A wave that swept the globe from 2014  through most of 2016, and led to the infamous "Chinese acquisition premium."

Bloomberg notes that it is not clear yet how Anbang will respond, and in a WeChat message, the insurer said that “Anbang at present has no plans to sell its overseas assets," although that is sure to change once Beijing asks again, less politely this time. "Currently, Anbang’s various businesses and operations are all normal, and the company has ample cash and sufficient solvency capabilities.”

Anbang, together with HNA, Wanda and Fosun, were the four most prominent Chinese conglomerates which unleashed a buying binge across the globe, fueled by soaring sales of investment-type insurance policies. Since 2015, the four companies completed a combined $55 billion in overseas acquisitions, 18% of Chinese companies’ total, and according to some, were instrumental in accelerating China"s capital outflows over the same period.

Anbang first emerged in the public arena with its high profile 2014 acquisition of New York’s Waldorf Astoria hotel. Subsequently, Anbang and its peers acquired such trophy assets as AC Milan, Legendary film studios and Hilton Worldwide.

Anbang alone made billions in acquisitions in such businesses as the Westin St. Francis, InterContinental Miami, Rabobank"s mortgage portfolio and various other M&A targets around the globe.

However, it all ended with a thud in mid-June, when Anbang Chairman Wu Xiaohui was detained for questioning, while the policies fueling the company"s growth have been all but banned by regulators. At this moment Anbang is merely a shell corporation, with virtually no new business creation, one whose massive debt load threatens to careen the company soon if it does not find sources of cheap liquidity and fast.

At a twice-a-decade conference on financial regulation convened by President Xi Jinping this month, policy makers pledged to rein in corporate borrowing and said that preventing systemic risk was an “eternal theme.”

Making matters worse is that Anbang’s rise in recent years was fueled by sales of lucrative wealth-management products that offered among the highest yields compared with peers, a key spoke of China"s $9 trillion shadow banking universe. China’s insurance regulator this year started clamping down on what it termed “improper innovation” and tightened rules on high-yield, short-term investment policies. Anbang and other aggressive insurers such as Foresea Life got caught up in the crackdown.

Where Anbang"s death spiral could turn especially aggressive, is if Anbang customers start surrendering their policies and stop buying new ones, a feedback loop that would accelerate a continuing cash drain at the company, while forcing its existing product suite of wealth products to default, leading to the biggest risk facing China"s economy: a shadow bank run.

One Anbang product, called Anbang Longevity Sure Win No. 1, boosted the firm’s life insurance premiums almost 40-fold in 2014 by offering yields as high as 5.8 percent. That helped provide fuel for the firm’s more than $10 billion of overseas acquisitions since 2014 and equally ambitious investing in the domestic stock market.

If investors realize that not only China"s M&A party is over, but that the shadow banking sector is facing a potential default cliff, the scramble to recover invested capital will be unprecedented.

For now, Anbang can delay the inevitable cash call by following Beijing"s demands, and slowly - at first- begin liquidating its trophy offshore assets, and repatriating the proceeds, effectively inverting the outbound M&A surge that marked the past three years. The good news is that at least at this moment, there are plenty of willing buyers for the upcoming Anbang firesale..

"It Feels Like An Avalanche": China's Crackdown On Conglomerates Has Sent A "Shock Wave" Across Markets

The first to suffer Beijing"s crackdown against China"s private merger-crazy conglomerates, wave was the acquisitive "insurance" behemoth, Anbang, whose CEO Wu Xiaohui briefly disappeared as the Politburo made it clear that the "old way" of money laundering - via offshore deals - is no longer tolerated. Then, several weeks later and shortly after the stocks of the "famous four" Chinese conglomerates plunged after China officially launched a crackdown on foreign acquirers amid concerns of "systemic risk", it was HNA"s turn, which as we described last week, risks becoming a "reverse rollup from hell", as HNA"s stock tumbled, sending the LTV of billions in loans collateralized by the company"s shares soaring and in danger of unleashing an catastrophic margin call among the company"s lenders.

Then Beijing"s attention shifted to the biggest conglomerate of them all: billionaire Wang Jianlin’s Dalian Wanda Group, which as the WSJ and Bloomberg reported was being "punished" by Beijing, and would see its funding cutoff after China "concluded the conglomerate breached restrictions for overseas investments."

The scrutiny could rein in Wang’s ambitious attempt to create a global entertainment empire, including Hollywood production companies and a giant cinema chain he’s built up through acquisitions from the U.S. to the U.K. Six investments, such as the purchases of Nordic Cinema Group Holding AB and Carmike Cinemas Inc., were found to have violations, said the people, who asked not to be identified discussing a private matter. The retaliatory measures will include banning banks from providing Wanda with financial support linked to these projects and barring the company from selling those assets to any local companies, the people said.

The move is an unprecedented setback for the country’s second-richest man, who has announced more than $20 billion of deals since the beginning of 2016. By targeting one of the nation’s top businessmen, the government is escalating its broader crackdown on capital outflows and further chilling the prospects of overseas acquisitions during a politically sensitive year in China.

Summarizing the abrupt shift in sentiment in China was Castor Pang, head of research at Core-Pacific Yamaichi, who said that “to investors, political risk is now the biggest concern when investing in Chinese companies. Not only Wanda, every Chinese company won’t find it easy anymore to acquire assets overseas. Stabilizing the yuan is the top priority for Beijing now.”

While it is not exactly clear just why Beijing so quickly soured on foreign transactions - as we explained back in 2015, it was abundantly clear back then these were nothing more than a less than sophisticated way to launder money offshore - unless of course the capital flight out of China is far worse than what Beijing would disclose, what has become quite clear is that Wanda was among the conglomerates including Fosun International, HNA Group and Anbang Insurance whose loans are under government scrutiny after China’s banking regulator asked some lenders to provide information on overseas loans to the companies.

In other words, the foreign merger party is over. In fact, for some of the above listed 4 conglomerates, the party may be over, period.

And now as the WSJ reported over the weekend, it has become clear that China’s government reined in one of its brashest conglomerates with the explicit approval of President Xi Jinping, "according to people with knowledge of the action—a mark that the broader government clampdown on large private companies comes right from the top of China’s leadership."

The measures, with President Xi’s previously unreported approval last month, bar state-owned banks from making new loans to property giant Dalian Wanda Group to help fuel its foreign expansion.

The cutoff in bank financing for the company’s foreign investments highlights Beijing’s changing view of a series of Wanda’s recent overseas acquisitions as irrational and overpriced. In short, and as noted above, Yuan stability above all.

For the local market, the shift in Beijing"s strategy is nothing short of a seismic shift:

“It feels like an avalanche,” said Jingzhou Tao, a lawyer at Dechert LLP in Beijing, who does mergers and acquisitions work. “This is sending a shock wave through the business community.”

* * *

Regular readers are aware of what, until recently, was China"s unquenchable thirst for foreign money laundering transactions, something we first pointed out at the start of 2016, and which had - until recently - grown exponentially. Since 2015, the four companies completed a combined $55 billion in overseas acquisitions, 18% of Chinese companies’ total. In recent days, however, as reported here 2 weeks ago, Wanda’s billionaire founder Wang Jianlin has been shrinking his empire by selling off assets and paying back the company’s bank loans.

What is surprising about the sudden shift, is that Beijing had for years been encouraged Chinese companies to scour the globe for deals. Now, in a dramatic U-turn, it is reining in some of its highest-profile private entrepreneurs in what officials say is growing unease with their high leverage and growing influence. As the WSJ notes, "the measures serve as a stern warning for other big companies that loaded up on debt to buy overseas assets, officials and analysts say."

How does the president fit into all of this? According to the WSJ, "Xi acted after China’s cabinet set the government machinery in gear by directing financial regulators, the economic planning agency and other bureaucracies to take a hard look at foreign acquisitions, once seen as a means for China to showcase its economic might."

And, as previously reported, the crackdown started at Anbang and HNA, when Chinese banking regulators first ordered banks to scrutinize loans to Anbang in June, and other highfliers including airlines-and-hotels conglomerate HNA Group, which has pulled back on overseas investments. HNA said in a statement it continues to take a “disciplined approach” to identifying “strategic acquisitions across our core areas of focus.”

Discussing the government"s crackdown on conglomerates, officials at Fosun said the firm has “overseas funds and other stable financing channels,” including a fund of around U.S. $1 billion to invest, but emphasized it “fully respects the government regulations both in China and overseas markets.” Fosun has a listed unit in Hong Kong, and its strategy to invest in health care and technology “adheres to China’s global investment strategy,” said a spokesman, Chen Bo.

In any case, the most likely outcome is that in the future China’s private companies will have trouble getting capital, which would help shift financial clout further in favor of big state-owned enterprises, which may also explain President Xi"s change in opinion. Beijing’s sterner line comes as big private businesses and others have been amassing capital and influence that challenge the authoritarian Chinese leadership’s firm hold on the economy.

Its grip has been tested over a bumpy few years. After a 2015 stock market meltdown and a botched government rescue, a gush of money flowed out of the country looking for better returns. That in turn put pressure on China’s tightly controlled yuan and foreign-exchange reserves, both seen by Beijing as barometers of confidence in the economy. It has also led to a chilling effect on Chinese outbound investment which has crashed as shown in the chart below.

Putting the foreign merger spree in context, Chinese firms completed $187 billion in outbound deals last year, according to Dealogic, as private companies snapped up trophy properties, soccer clubs and hotels, while Chinese with means bought homes and pushed up real-estate prices from Texas to Sydney.

The private sector’s share of overseas spending shot up from barely above zero about a decade ago to nearly half of China’s total overseas investments in 2016, before slipping back to 36.9% in the first half of 2017, according to Derek Scissors, a China expert at the American Enterprise Institute.

But the most important factor, and among the main reasons for the current crackdown, is that amid the rush of investments, Beijing burned through nearly a trillion dollars in foreign-exchange reserves trying to steady the yuan. That ultimately led government regulators to clamp controls on money exiting the country and to scrutinize all proposed major offshore investments.

Just as we predicted over a year ago would happen, once the government finally realized that all that M&A is nothing more than capital flight.

As the WSJ puts it, "the latest scrutiny is a watershed moment in the Communist government’s relations with a private sector it has never been comfortable with. Though some senior leaders, particularly Premier Li Keqiang, are urging a new culture of startups and small businesses, Mr. Xi has promoted plans to make already-large state enterprises larger and strengthen their sway over the economy."

There are other reasons for the crackdown too: one is the still fresh memory of what happened in Japan when it did the exact same thing. China is acutely aware that as Japan rose to economic prominence in the 1980s, its companies splurged on American real estate and other trophy assets, resulting in losses that cascaded through Japan’s banking sector.

But mostly, it is about power and control:

Mr. Tao, the Beijing lawyer, says the government’s new aggressive posture is driven in large measure by a need for control. “State-owned assets, whether in China or abroad, are still state assets,” he said. “But when private entrepreneurs take their money out, it’s gone. It’s no longer something that China can benefit from or the Chinese government can get a handle on.”

And since in any power struggle between Chinese companies and Beijing in general, and Xi Jinping in particular, the latter will always win, the market"s reaction was to violently selloff any big Chinese conglomerate stocks. An early sign of government discomfort with overseas spending was Anbang’s unsuccessful $14 billion bid for Starwood Hotels & Resorts Worldwide Inc. in 2016. Authorities expressed displeasure with the bold move, believing that Anbang had offered too much, according to a person with knowledge of the situation.

Anbang, which had appeared unstoppable in 2014 when it struck a $2 billion deal to buy the U.S. Waldorf Astoria hotel, fell deeper in trouble. This past June, special government investigators looking into economic crimes detained Anbang’s chairman, Wu Xiaohui, who hasn’t appeared in public since.

Separately, in the case of Wanda, regulators acted in the belief the company overpaid in efforts to expand beyond shopping centers and hotels and into entertainment, according to the people with knowledge of the action.

Its largest such acquisition was of Legendary Entertainment, the Hollywood producer and financier behind films including “Jurassic World” and “The Dark Knight.” Wanda spent $3.5 billion to buy Legendary in 2016; In Hollywood, industry insiders widely believed the company paid too much. Legendary said this week that it is well-capitalized, operating normally and able to fund its film and television productions.

As for HNA, recall that it was the stealthy buyer of Anthony Scaramucci"s SkyBridge Capital, another deal which will soon fall under tremendous scrutiny, and which could be unwound in the coming weeks if concerns about conflicts of interest emerge again, only this time not between the US and Russia - especially once the "Russia collusion" story is finally over - but the White House and Beijing.

Stocks Of China's Serial Foreign Acquirors Crash Amid "Systemic Risk" Crackdown

Last February we described some of the "horror stories" of corporate leverage that emerged as a result of China"s unprecedented offshore M&A spree that emerged in 2015 and raged through most of 2016: after all, with over $100 billion in foreign acquisitions, the bulk of the funding would inevitably come from debt. These were some of the examples we highlighted:

• 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.


• 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."


• 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!


• 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!


• Or how about Bright Food, which bought the breakfast group Weetabix for $1.2bn last year, and has total debt at 24 times EBITDA!

The visual summary was far more stunning, and showed some Chinese foreign acquirers ompanies had levered up as much as 83x.

As we summarized, "what is going on in China"s massively overlevered corporate sector, is that virtually every company has become one massive "rollup" a la Valeant, hoping to deflect investors" and analysts attention from their deplorable credit metrics by engaging in a scramble of global M&A at any price, just to buy 1-2 more quarters of silence from skeptics, even as leverage continues to build at multiple turns of EBITDA every single quarter."

The offshore merger spree did not last long: following a recent crackdown by Beijing on offshore (debt-funded) M&A, China"s foreign acquisition spree came to a screeching halt earlier this year, when virtually no new Chinese deals have been announced.

And now comes the hangover, because overnight China"s regulator finally started a crackdown on the debt-funded mess that emerged in China as a result of this spree.

It started with a report in China"s Caixin, which said that the China Banking Regulatory Commission has expressed concerns about "systemic risks" at some big companies, which just happen to be China"s most prolific overseas acquirers, and has asked banks to report their exposures to the companies after last year’s unprecedented outbound takeover spree.

Warning companies can transmit risks to upstream and downstream industries and banks, the CBRC added that it will closely track risks when problems occur in big companies. More to the point, the CBRC ordered checks on HNA, Dalian Wanda, Fosun and other prominent foreign buyers and asked banks in mid-June to conduct risk analysis and check loans made to these companies.

As Bloomberg adds, the regulator asked some banks to provide information on overseas loans made to Dalian Wanda Group Co., Anbang Insurance Group Co., HNA Group Co., Fosun International Inc. and the owner of Italian soccer team AC Milan. "The inquiries, which come a week after reports of an investigation into Anbang’s chairman, are likely to put a further chill on China’s outbound takeovers after tighter capital controls cut deal activity this year by 56 percent from the same period in 2016. 

Why the crackdown now? By targeting some of the country’s most powerful tycoons, Xi Jinping’s government may be sending a signal of its commitment to cleaning up the financial system before a key Communist Party leadership reshuffle later this year, according to Bloomberg.

“We are now in an environment where preventing financial risks is lifted as the top priority, so I think the regulators are trying to gauge the total exposure,” said Wei Hou, a Hong Kong-based analyst at Sanford C. Bernstein. “Regulators must have seen some red flags.”

The market reaction was prompt, and led to the negative close of the Shanghai Composite noted earlier, despite the solid green start in Chinese trading: as news of the CBRC’s request spread through China’s financial markets on Thursday, shares of companies linked to Wanda and Fosun tumbled and the Shanghai Composite Index erased an early gain. The turbulence came less than 36 hours after MSCI Inc. said China’s domestic equities would join its benchmark indexes, a stark reminder for international money managers of the risks in a market where opaque regulatory decisions are commonplace.

The market impact was swift as shares of billionaire Guo Guangchang’s Fosun and various related companies tumbled in Hong Kong, in line with the plunge of Wanda shares. Fosun fell as much as 9.6%, while Fosun Pharmaceutical Group dropped as much as 7.8%.

The sudden drop dragged down the entire Chinese market.

When asked by Bloomberg to comment on their sharp stock price declines all the named companies denied they had any idea what was going on: Fosun spokesman Chen Bo said “all is normal” at the company, representatives at Anbang and Wanda declined to comment, while HNA didn’t immediately comment. A representative for AC Milan’s owner didn’t return calls seeking comment.

The regulator, however, provided some additional details: Zhiqing Liu, a deputy director at the CBRC, said "we are generally concerned with systemic risks posed by big firms."

The CBRC required banks to provide information on loans related to the five companies’ overseas investments, especially in property, cinemas, hotels, entertainment businesses and sports clubs, people familiar with the matter said. Banks need to submit their assessment of potential risks for such investments and any measures they have in place to deal with risks, the people said.

We have previously profiled the extensive acquisitions undertaken by Chinese companies, but here as a reminder, is the case study of HNA, an "acquisition airline group" as the FT puts it.

HNA has announced more than $30 billion of asset purchases since last year, according to data compiled by Bloomberg, ranging from from stakes in hotel operator Hilton Worldwide Holdings Inc. to asset manager SkyBridge Capital and Deutsche Bank AG.

Wanda has spent more than $10 billion, including the purchase of Hollywood film producer Legendary Entertainment, since 2016.

Fosun, which owns stakes in Club Med and Cirque du Soleil Inc., has also been pursuing billions of dollars of assets overseas.

Anbang’s international holdings include New York’s Waldorf Astoria hotel.

Among the more notable acquisitions by these Chinese companies were AC Milan, Club Med, the Wolverhampton Wanderers Football club, Cirque du Soleil, and real estate in NYC, London, and Sydney, but that period of wanton foreign purchases, many of which led to what was dubbed the "Chinese M&A premium", is now over.

To be sure, as a result of last year"s crackdown on capital outflows, today"s move was largely expected: as Bloomberg points out, "Chinese policy makers have already made it more difficult for acquirers to move money overseas as the government tries to stem capital outflows and prop up the yuan. The curbs have contributed to a spate of canceled deals, including the $1 billion purchase of Dick Clark Productions Inc. by billionaire Wang Jianlin’s Wanda. This year’s drop in announced deals is the biggest for a comparable period since the depths of the global financial crisis in 2009, according to data compiled by Bloomberg."

Meanwhile, the focus on banks’ exposures to foreign acquisitions comes against a backdrop of tightening financial conditions in China and a regulatory crackdown on risky behavior by banks, shadow-lending institutions and insurers, as well as the detention of the chairman of one of China"s most aggressive foreign acquirors: Anbang.

As reported last week, Anbang’s Chairman Wu Xiaohui was detained as part of a probe that includes looking into the sources of funding for Anbang’s overseas acquisitions, possible market manipulation, and “economic crimes." Anbang said last week that Wu was unable to perform his duties for personal reasons.

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Meanwhile, going back to the Chinese stock market which just two days ago was added to the MSCI EM index, the Beijing intervention showed just why anyone rushing to invest in China may want to think twice. “I don’t think it’s the right time to invest or buy into these companies,” said Alex Wong, director at Ample Capital in Hong Kong. “Sometimes this kind of event can accelerate very quickly.”

And while the latest Chinese crackdown is bad news for local stocks, it is good news for US equities where the Chinese potential "merger premium" can now be eliminated, resulting in a fractionally more rational market. As for how far Beijing"s attempt to "normalize" its corporate sector will reach, and whether it will lead to even more deflationary outflows from the mainland, jury selection has only just started.

Chinese Insurer Warns Of "Mass Defaults, Social Unrest" Due To "Mass Redemption" Run

One month ago, China came "this close" to the one event which terrifies Beijing more than anything: a run on China"s shadow banks.

As a quick reminder, 150 customers of China"s Mingsheng Bank, the country"s largest private bank, were furious in mid-April when they learned that some 3 trillion yuan invested in Wealth Management Products, the backbone of China"s shadow banking system, had vaporized after bank employees had engaged in fraud and embezzled the funds without ever investing it (later it emerged that Mingsheng employees had put the money into “cultural relics” and jewelry, for their own use).

And while fraud and embezzlement are both endemic in China, the bigger concern raised by the article was the threat of a bank run across China"s massive and unregulated, nearly $10 trillion shadow banking system. Indeed, while there have been numerous allegations and warnings that China"s entire shadow banking facade, dominated by WMPs and other "investment products", is nothing but a giant ponzi scheme in which  recoveries - should there be a bank run, a topic recently discussed on Bloomberg - would be non-existent if there is ever a bank run, defaults of WMPs issued by big banks – and this case an unapproved WMP – are rare, as are shadow bank runs.

For now.

However, in a stunning announcement made by one of China’s largest insurers, Foresea Life has warned of "mass defaults and social unrest" unless China"s regulator lifts a recent ban on its issuance of new products. In a letter to China’s insurance regulator, first reported by the Financial Times, Foresea Life Insurance which is a heavy investor in WMPs, has warned  that the company expects "redemptions" of 60 billion yuan, or $8.7 billion, this year and might be unable to meet payouts unless it is able to sell new products.

Jut so there is no confusion, this is the definition of a ponzi scheme, and now that it has been so explicitly framed the result could be even greater redemptions, i.e., "bank runs" across companies that invest in WMPs.

Foresea"s displeasure is linked to a December decision by the China Insurance Regulatory Commission (CIRC), which banned Foresea for three months from applying to sell new products. Two months later, in February, the agency banned Foresea chairman Yao Zhenhua, China’s fourth-richest man, from the industry for 10 years.

Questions about potential fraud at the company have remained unanswered, however the life insurer which allocated billions to WMPs in pursuit of yield (what else) was all too vocal in a letter dated April 28, in which Foresea asked the CIRC to resume new product approvals “in order to avoid inciting mass incidents by clients and localised and systemic risks, producing greater damage to the industry”. According to the FT, the term “mass incidents” is commonly used in China to describe demonstrations, protests and riots. It was also used by Hank Paulson in 2008 when demanding a blank check from Congress threatening the US with widespread panic unless the US banking sector was bailed out.

That this warning has now moved to Chinese users of shadow banking is troubling.

To be sure, this is not the first time a near-insolvent Chinese company has threatened with social unrest if it does not get a bailout. One month ago, China"s - and the world"s - biggest aluminum producer China Hongqiao Group demanded that both the Chinese Non-Ferrous Metals Industry Association and the Chinese government come to its aid, warning in its March 4 letter of “serious effects” if nothing is done, including “regional systemic financial risks” and “dramatic social unrest.” Yet while the fallout from one major commodity company would be largely contained, mostly to its own angry workers, the social panic and mass defaults resulting from the failure of China"s $4 trillion Wealth Management Industry, would have far more dire implications.

Some more background on the troubled life insurer courtesy of the FT:

Foresea is a unit of Baoneng Group, a property and financial conglomerate that Mr Yao also chairs. Baoneng made headlines last year by attempting a hostile takeover of China Vanke, one of China’s largest residential developers.  Baoneng has used the sale of so-called “universal insurance” products to finance its stake in Vanke and other listed companies. Such policies are, essentially, investment vehicles offering high yields and guaranteed payouts on maturities. Distributed through banks, they bear little resemblance to traditional insurance, which pays out only in the event of a risk incident such as death, illness, or accident.

The mass proliferation of such "shadow banking" products, largely as a result of deregulation of the insurance industry in recent years, has led to the sharp rise of universal insurance sales, which has helped groups such as Foresea and Anbang Insurance Group to grow. As a reminder, Anbang - which has a very questionable reputation - is also one of the most prolific acquirers of global corporations as it seeks to find high yielding targets for its "shadow" funds.

As the FT also notes, while Foresea’s premiums soared from Rmb32bn in 2014 to Rmb100bn last year they since tumbled 61% in the first quarter this year.

More troubling is that the date of Foresea’s letter indicates that, by late April, the regulator had not yet approved new Foresea products, despite the expiration of the three-month ban. In a statement on its website late on Wednesday, Foresea said that “the company’s operations are normal and its cash flow is stable”, adding that it earned Rmb1.4bn in profits in the first quarter.  Needless to say, it wouldn"t say anything else until it was too late (see Canada"s Home Capital Group).

On one hand, the Chinese regulator"s initiative to limit WMPs is a welcome change to the Chinese funding "wild west." It was observed in the latest PBOC monthly credit update, which revealed that for the first time in a decade, a key component of China"s shadow funding, Entrusted Loans, declined.

The FT adds that in addition to Foresea, the CIRC has moved to contain universal insurance in recent months, amid President Xi’s call to curb financial risk. Analysts warn that the high yields offered by universal insurance force issuers to take risks in order to earn the returns necessary to meet promised payouts. 

Many universal insurance products ostensibly carry long durations of five or even 10 years but the policies often include generous redemption terms, enabling investors to cash out of the products with minimal penalties. 

Meanwhile, Foresea’s warning that "mass redemptions" could leave the group unable to meet payouts highlights the liquidity risk created by taking on short-term liabilities to purchase long-term, illiquid assets.  In a further crackdown on China"s unsustainable shadow banking system, in May the CIRC imposed a similar three-month ban on Anbang and accused the group of “wreaking havoc” in the market with aggressive sales tactics. The agency specifically criticized Anbang for selling products with short maturities.

On the other hand, however, while such a regulatory crackdown is long overdue, should the "shadow" funding of "insurers" like Foresea (and Anbang) be halted, the company  - which by its own admission is a ponzi scheme - would disintegrate.

For now, however, it faces a more immediate challenge: what happens if Foresea is not granted regulatory relief as it demands? If the insurer is unable to resume issuance of its traditional shadow funding products, and should the "redemption run" accelerate, the company will have no choice but to eventually demand a PBOC liquidity injection or outright bailout. Considering how generous the Chinese central bank has been, this request will likely be satisfied.

But a far bigger problem, one which not even the PBOC would be able to contain, is what happens if accelerated "redemption" problems, currently limited to just Foresea, spread to the rest of the nearly $10 trillion shadow banking industry.