Default Alarm Rings as Trust Loans Jump Sevenfold: China Credit

A seven-fold jump in last month’s lending by China’s trust companies is setting off alarm bells for regulators to guard against the risk of default.

So-called trust loans rose 679 percent to 264 billion yuan ($42 billion) from a year earlier, central bank data showed on Jan. 15. That accounted for 16 percent of aggregate financing, which includes bond and stock sales. The amount of loans in China due to mature within 12 months doubled in four years to

24.8 trillion yuan, equivalent to more than half of gross domestic product in 2011, and the People’s Bank of China has set itself a new goal of limiting risks in the financial system.

“Short-term financing instruments such as trust loans have been rising really quickly,” said Zhang Zhiwei, chief China economist at Nomura Holdings Inc. in Hong Kong. “Quite a number of companies resort to trust loans when they face financing troubles. A breakdown in this financing chain will eventually lead to a default on debt this year.”

The growth in trust loans that are typically extended to higher-risk companies such as property developers or local-government investment vehicles pose a threat to banks selling wealth-management products that include such assets should insolvencies ripple through the economy, the International Monetary Fund said in October. Beijing-based Huaxia Bank Co. said last month that it will negotiate repayment with investors who lost money following the default of a trust savings product.

Fitch Warning

The People’s Bank of China announced on Dec. 28 its new policy objective of controlling risks and said it will seek “stable and appropriate” growth in loans, stocks and bond sales. The China Banking Regulatory Commission said on Jan. 14 that banks are banned from selling wealth-management products without authorization, and should stop offering private-equity-related products or misleading customers into buying such investments.

Fitch Ratings warned last month that this “more mobile, expensive and short-term” funding base may create repayment risks and present challenges to profitability and asset-liability management for lenders.

Chinese banks have been relying on wealth-management products, which offer higher returns than benchmark deposit rates, to dissuade households from moving their savings elsewhere over the past few years. The outstanding amount of such investments may have climbed to 13 trillion yuan on Dec. 31, from 8.5 trillion yuan a year earlier, according to Fitch.

‘Time Bomb’

“Their underlying assets can be quite dodgy,” said Weisheng He, a strategist at Citigroup Inc. in Shanghai. “A lot of dodgy borrowers use high interest rates to lure unsophisticated investors. At this stage, the risk is controllable but if they continue to grow in size without strict regulation, it could be a time bomb.”

The trusts typically offer better rates of return than banks, pooling deposits from businesses and households to invest in real estate, stocks, bonds, commodities or other assets. They oversaw 5.3 trillion yuan at the end of June, up 90 percent in just two years and on course to exceed the size of China’s insurance industry, the IMF said.

At least eight trust products set up by Chinese lenders faced default risks last year, including Huaxia Bank’s 160 million yuan trust product that defaulted in November, according to China International Capital Corp., one of the nation’s biggest investment banks. There are some 60 to 70 trust companies in China, according to Christine Kuo, a Hong Kong-based banking analyst at Moody’s Investors Service.

“The instances similar to Huaxia Bank could probably pop out every now and then,” Kuo said. “The improving economy certainly would help but not every company will survive. Some companies will no doubt face troubles, though we are not seeing systemic risk from China.”

Quickening Growth

Signs of a pickup in the world’s second-biggest economy are building, supporting asset values and helping borrowers pay loans. The value of home sales rose 18 percent in November from October and industrial production and retail sales both increased at the fastest clip since March, official data show. Service industries grew the most in four months in December, while aggregate financing surged 28 percent from a year earlier.

GDP probably expanded 7.8 percent in the October-December period, after a third-quarter gain of 7.4 percent that was the smallest in three years, according to the median estimate of economists surveyed by Bloomberg before a government report tomorrow.

Funding Stress

“The focus of my concern currently is that economic activity in China is being funded more and more with short-term financing, which is a change from the recent past,” said Colin Bell, vice president of emerging markets for Auerbach Grayson Co. in New York. A jump in such loans “could certainly become a problem in the future as it appears to reflect some amount of stress in the funding structure of large Chinese banks.”

Citic Trust Co., a unit of the nation’s biggest state-owned investment company, said on Dec. 21 that it missed a payment to investors in one of its wealth-management products after a steel company failed to pay interest on a loan.

The likelihood of China’s first bond default is higher in 2013 than it was last year, according to an annual report by China Central Depository & Clearing Co. published Jan. 6 on, the government bond clearing house website. There is pressure on yields to climb and bonds issued by small-and medium-sized companies accounted for 9.1 trillion yuan of the 26 trillion yuan of outstanding debt at the end of 2012, it said.

Default Risk

Harbin Huijiabei Foods Co., a company that sold a joint bond with three other companies in 2010, said that it would not be able to deposit its payable principal and interest to a reserve account on time, according to a statement posted Dec. 20 on Chinabond. The payment was due Dec. 30 and the bond, rated AA+ by Dagong Global Credit Ratings, yielded 80 percent on Jan. 15 compared with 8.5 percent a year ago and 18 percent on Dec. 28, Chinabond prices show.

Five-year credit-default swaps protecting China’s sovereign debt against non-payment rose two basis points yesterday to a two-month high of 68 in New York, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. The yuan was little changed at 6.2173 per dollar in Shanghai today, after touching a 19-year high of 6.2124 on Jan. 14.

‘Ponzi Scheme’

Some of the wealth-management products sold by Chinese banks are “fundamentally a Ponzi scheme,” wrote Xiao Gang, chairman of Bank of China Ltd., the nation’s fourth-largest lender by assets, in a China Daily commentary in October. Andrew Colquhoun, the Hong Kong-based head of Fitch’s Asia-Pacific sovereign ratings unit, said in a teleconference on Jan. 8 that China’s shadow banking system is a “concern” as anecdotal evidence is building the nation has a debt problem.

Lending by trust companies surged 645 percent last year to

1.29 trillion yuan, PBOC data show. The share of non-bank finance in aggregate credit has surged to about 45 percent this year, from 30 percent in 2008, according to central bank data.

“The trust-loan sector is an area we are keeping on close watch,” said Kuo at Moody’s. “For those companies that are using short-term loans to finance long-term projects, there will be liquidity issues once there’s a sudden stop of supply.”