What Happened With Anbang?
I wanted to give a little analysis on Anbang because I think the reality of what the regulators took it over is much more straight forward than what is being discussed. I should note at the beginning because we do not have the level of detail on their finances that we normally have, I think the theory I will present here fits all the data, but we cannot say for sure so there is some speculation here. This is kind of a follow up to my BloombergViews piece on Anbang but I focus more on the financial specifics here. (Brief warning: I am going to use round numbers here to simplify the analysis)
- As has been widely noted, Anbang was less insurance company and more enormously leveraged investment firm. This had two specific impacts on the problems we see now. First, it significant raised the cost of capital. In many short term products (say 1-2 years), Anbang was paying let’s say 5% for capital. Longer term (let’s say 3-5 years) it might have been paying 6-7%. That implies that the required return after expenses, needed to hit 8-10%. Forgetting Warren Buffet, for an insurance company whose primary investment vehicle is fixed income that is a really hard hurdle rate. Remember, the CIRC only allowed Chinese insurance firms to invest in stocks in beginning in about 2015. For an investment pool of that size to hit 8-10% based upon fixed income implies significant risk.
- Second, because Anbang was selling primarily short term debt products that implied an asset liability mismatch. Take a simple example. Assume Anbang buys an office building for $1 billion and they know it will sell for $1.5 billion in five years. They have hit their 10% hurdle rate. However, they have to roll over their 2 year products twice to even get to five years. In other words, if their customers do not lend them the money twice, Anbang cannot even get to five years. This problem played a major role in destroying Anbang.
- These two problems created a fundamental problem for Anbang. The vanilla assets (think corporate bonds) they were buying were enough to cover their hurdle rate and because they were rolling the dice to hit big numbers they were significantly overpaying for their non-traditional assets. This lowered their rate of return on the non-traditional assets (think Waldorf Astoria) meaning the only way Anbang remained in existence was by selling new products to new customers.
- If the only way you are remaining in existence is by selling new investments to new customers, you are the definition of a Ponzi scheme.
- To put this problem in perspective, prior to the order by the CIRC to stop selling new insurance and investment products, Anbang was offering (let’s use a round number that represents one specific product we know they sold) 5% return on a 2 year product. In 2016, 2 year ABS bonds were offering about 4% with 10 years yielding 50-60bps more. Vanilla corporate AAA at 2 and 10 years were yielding about 3-4%. In other words, if Anbang matched the 2 year duration, it would lose 1-2% on every sale. If it gambled at being able to roll over those 2 year customers five times, it would still lose 50-100bps every time. Given the fact that CIRC regulations required most “insurance” investment into these types of products, the non-traditional investment would have had to hit spectacular returns to keep them solvent. Real estate, stocks, and non-traditional debt/fixed income would have had to easily yield double digit returns. This was simply not possible.
- However, Anbang could keep this up as long as they could bring new investors in the door at rapid rates. For quite some time, they were able to do this and keep the plates spinning. The growth rates of insurance and investment product sales by Anbang were just spectacular, so with those growth rates, it disguised the fundamental problem that Anbang was losing enormous sums of money on their investments.
- When the CIRC halted all Anbang product sales in early 2017 that was an effective and near immediate death sentence. At most, Anbang had 60-90 days before its inability to bring new customers in would cause it to enter a death spiral at the rates it was making money losing investments. To provide some perspective, key cash flow streams dropped by roughly 80-98%. After that point, it was just waiting for official announcement. The only question about why the Anbang takeover was announced in February 2018 was why it was not announced 6-9 months earlier.
- That’s all the bad news and how we arrived at this point. However, there is some good news. First, I strongly suspect though have no inside information that the CIRC and PBOC waited to announce the Anbang takeover so they could draw an effective firewall around it. In other words, they probably sent a team in to figure what they were dealing with, wall off the major risks, prepare the financing to begin winding down Anbang or turning it into a much much smaller entity. I have no hard evidence of this, but given the timing and some other indicators, this is my hunch. It wouldn’t be the first time, Beijing regulators have acted and let the rest of the world know weeks or months later.
- Second, Anbang is insolvent but I doubt there are enormous relative losses if (and this is an ENORMOUS IF) they were investing remotely close to CIRC guidelines. What I mean by enormous losses is say losses of 30%+. Based upon their current estimated assets, 30% would imply value losses of $100-120 billion. I do think it is quite likely Anbang is facing losses of 15-25% which would still imply pretty significant losses in both relative and absolute terms. This will really come down to their asset portfolio. There are too many variables there to begin speculating but given that it is unlikely Anbang holds a large basket of defaults, their primary losses stem from yields that don’t meet payouts and any mark to market losses from the rise in yields which could be held to maturity depending on duration. Beijing is going to have to write a significant check regardless, but it is unlikely that we are staring down the barrel of a 50% loss here.
- Third, because of points #1 and #2, I do not think this poses a systemic risk or is China’s Lehman Brothers moment. There are significant problems here which I have detailed, but I do not think his is a major systemic risk or is a Lehman moment. People have mentioned this is Xi cracking down on the market, which is probably a nice by product, but I think the reality is simply that this was an insolvent insurance company.