THE EXEMPLARY DEFAULT of a high-yielding wealth management product was always going to have to be carefully managed. The default would have to be painful enough to instruct Chinese investors that their assumption that high-yielding investments sold through state banks carry an implicit guarantee is misplaced, but not so painful that it put the shadow banking system at any sort of systemic risk that could ripple through to the mainstream financial system. With China’s trust assets increasing 46% last year to a record 10.9 trillion yuan ($1.8 trillion), it could potentially be a powerful ripple.
But the best laid plans of man, and all that…
With China Credit dodging the bullet, what appears to be the trust company fated to play the fall guy, Jilin Province Trust Co. Ltd, sold a number of high-yielding trust products through China Construction Bank, the funds raised going to a now delinquent coal company, Shanxi Liansheng Energy. Last week, state media reported that Jilin Trust had failed to pay off 763 million yuan of maturing high-yield investments it sold to China Construction Bank clients. It now appears that, according to the official China Securities News, it is just one of six trust companies who lent a total of 5 billion yuan to Shanxi Liansheng.
The concern is that their exposure could trigger similar defaults, and what was intended to be an orderly default, turns into something altogether more panicky within the shadow banking system. Beyond the inherent undesirability of that, it would put the big state-owned banks in an awkward position. They are not under a legal obligation to repay investors who bought trust products through them, but they may feel a need to do so — or be made to feel a need to do so — in order to maintain their reputations (if the pressure is from below) and uphold social stability (from above).
For now, it seems that provincial officials are working on a debt restructuring for Shanxi Liansheng to forestall things getting out of hand. The coal company was said last year to owe as much as 30 billion yuan. The restructuring discussions involve not just creditors but also the trust companies and the state owned banks. This Bystander suspects the banks will end up extending new loans to the coal company that can be used to pay off the trusts. Not at all the lesson intended. If anything, quite the reverse.
THIS MIGHT HAVE been the day that China saw its first high-profile trust default, but a bailout of China Credit Trust averted that undesired outcome. Under a last-minute deal struck this week, the 700 private investors in the three-year high-yield 3-billion-yuan ($500 million) trust will get their capital back but forego the final year of interest payments that remain unpaid.
This Bystander noted previously that how the potential default was resolved — whether by allowing a quick and orderly default, or by shoving it under the carpet via a provincial government bailout — would be an indication of how well the ticking time bomb of local government debt tied to the shadow banking system and its wealth management products is likely to be defused. In the event, it seems that the corner of a carpet was lifted amidst the last-minute negotiations between provincial officials and the financial institutions involved. These included the Industrial and Commercial Bank of China through whose private banking arm the product was sold, but which had said it wouldn’t stand behind the troubled loan.
A mysterious third party has acquired both the investors’ trust rights and the shares in the now defunct mining company that the trust funded, Zhenfu Energy, that had been held as collateral. This is what has let the trust pay off its 700 investors. One local press report says the unnamed white knight was backed by the state investment fund Citic. Meanwhile, Zhenfu Energy has unexpectedly got its mining license back from the Shanxi provincial government and will restart operations.
Economists at the Japanese securities firm Nomura say they have counted 28 similar deflected defaults since 2012. The evil but necessary day when a troubled Chinese wealth management product is allowed to default to show investors the real risks of such investments remains in the future. But how far in the future?
A CANARY IN the coal mine: a high-yield investment trust that funded a Shanxi coal mine, Zhenfu Energy, that has gone bust is at risk of default. The three-year $500 million loan was marketed to wealthy individuals, who were promised a 10% yield by issuer China Credit Trust. The trust loan was sold in 2010 through the private banking arm of Industrial & Commercial Bank of China (ICBC), one of China’s Big Four banks. ICBC has said it won’t stand behind the loan, prompting a seemingly angry response from investors.
The trust represents a slither of the $1.2 trillion trust market. Yet how the potential default is resolved — whether by allowing a quick and orderly default, or by shoving it under the carpet via a provincial government bailout — will be an indication of how well the ticking time bomb of local government debt tied to the shadow banking system will be defused.
So far no trust loans have defaulted, despite trusts being bigger by assets than the insurance industry. That is partly because they have become a significant alternative to bank lending for funding local government infrastructure projects so have had friends in the right places to maintain the veneer of wholeness so far. Investors also have had a blind faith that trusts’ issuers offer an implicit ironclad guarantee that investors will get their money back.
There is $16.5 billion of trust loans to mining companies falling due this year. Beyond the case of Zhenfu Energy, at least two other trust loans to coal mines are reportedly in similar straits. A trust loan that funded a Chengdu housing development is also said to be in trouble.
The government, long concerned by the potential instability and credit risk lurking in the shadow banking system, is looking at ways to bring it into the mainstream. It was a regulatory priority agreed at the Party’s Third Plenum last November. Draft regulations being circulated suggest the approach will be to bring the informal banking sector under greater monitoring and regulation rather than curb the lending function that it is fulfilling for capital-hungry small and medium-size businesses that the mainstream banks do not. The recently announced plan for a pilot scheme for five new privately owned banks is one step in this direction.