HYW.US
Hywin faces redemption issues

Some products distributed by the real estate-focused wealth management company may be having trouble paying promised returns

Key Takeaways:

  • Hywin said it was dealing with “redemption issues” over some asset-backed products it distributed, sparking a massive selloff of its shares
  • The company traditionally relied heavily on real estate-linked wealth management products, but has been trying to move into other businesses like healthcare services

  

By Warren Yang

China’s ailing property market is fast infecting other parts of the economy, the result of years of investment by other sectors seeking to cash in on a real estate market that boomed for two decades. Some of that pain is being spread by the country’s vast shadow banking system, which moves assets across sectors using vehicles like wealth management products.

Last Thursday, one provider of such wealth management services, Hywin Holdings (HYW.US) informed its shareholders that it was dealing with “redemption issues” over some asset-backed products it distributed. It said “the asset managers of these products were unable to reach an agreement with the relevant clients to defer redemption.” That suggests that assets backing some of the wealth management products Hywin distributed to its clients failed to earn sufficient cash to make promised payments those clients were owed.

And although Hywin only distributed the products, the actual holders of the products are now going after the company to get back their money. Although Hywin didn’t provide much detail on the products in question, media reports suggest they are linked to the real estate companies, which was traditionally one of the company’s main focuses.

Hywin’s statement doesn’t explain its own liability in the matter. But media reports say payments have been missed to holders of some of the wealth management products it distributed, typically asset-backed products that promise regular, fixed income, similar to interest on bank deposits. In simpler terms, the assets behind the products – most likely real estate – haven’t generated enough cash to pay investors the returns they were promised. So now investors are asking Hywin, as the one that sold them the products, to pay them the money they’re owed.

While it’s unclear how much money is at stake, it’s not too hard to understand why this drama is quickly plunging the firm into crisis, sending its shares down 28% in the two trading days after the revelation. The stock had already taken a beating even before the announcement as rumors of its problems circulated in the market. 

“Any failure to adequately deal with these redemption issues could materially and adversely affect our reputation, client relationship, business, financial condition and prospects,” Hywin said, adding that it formed a special committee to investigate the matter.

Hywin is one of China’s largest distributors of real estate-backed wealth management products, which accounted for 28% of the total value of the company’s wealth management products in the 12 months to June. While large, the proportion was actually down considerably from the more than 58.2% such products accounted for just two years ago, reflecting the company’s efforts to reduce its exposure to China’s troubled real estate sector.

The products Hywin distributes are typically created by third-party companies and backed by real estate assets. Underlying assets can include things like securitized accounts receivable from real estate or construction companies, as well as actual equity investments in real estate projects.

In the run-up to its IPO in early 2021, Hywin widely advertised its ties to property giant Evergrande Group (3333.HK), which is now tottering on the brink of insolvency due to the slump. Nowadays, the company’s property sector exposure is hardly a selling point it wants to discuss.

Real estate risks

On a conference call to discuss its annual results for its fiscal year through June, Hywin CFO Wai Lok appeared to downplay risks to the company from its heavy involvement in the property sector. He emphasized that the company itself doesn’t invest in the products it distributes or make leveraged bets on distressed assets. But he didn’t discuss the potential for the company’s clients to suffer losses if the wealth management products it distributed ran into problems.

Wealth management products are a key part of China’s shadow banking system, a vast gray area that has proliferated outside the world of officially regulated banks and other financial institutions. In typical cases, companies that need new funds attract investors with attractive yields, often more than 10%, that are paid with money generated from an underlying asset like a real estate project.

Wealth management products are especially attractive as a fundraising tool for companies that might have difficulty borrowing from banks or tapping traditional capital markets.

But as real estate developers suffer with loads of unsold inventory and insufficient funds to complete their projects, their lack of funds undermines their ability to pay investors holding their wealth management products. In a recent high-profile case, Evergrande in August declared that it couldn’t make payments for its wealth management products due to a lack of funds. About two years earlier, the company also missed payments, sparking investor protests. Around that time, another property developer Kaisa was in a similar predicament.

In such an environment, Hywin has been trying to diversify away from real estate-backed products. One new focus area is healthcare services, where Hywin itself is directly investing.

It remains to be seen if that newer bet will pay off. One big problem with Hywin’s healthcare business, at least at the moment, is its high costs, so it’s nowhere near profitable. In the six months to June, Hywin’s loss from its healthcare services was more than twice as large as the business’ actual revenue due to high management costs and other various expenses.

Hywin shares have lost about three-quarters of their value since their IPO and trade at a trailing price-to-earnings (P/E) ratio of less than 4, much lower than the 7.2 for Noah Holdings (NOAH.US; 6686.HK), which owns 20% of China’s independent wealth management market, and has been aggressively growing its offshore business.

Its latest difficulty may well serve as the wakeup call that Hywin needs to accelerate its shift away from real estate. Only by doing so – and showing it can make money in other areas outside the property market – can Hywin slowly rebuild both its reputation as a wealth manager, and also its valuation.

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