China Trust ‘Timebomb’ Ticks as Credit Suisse Sees Rejig

The threat of financial contagion posed by a repayment bulge this year for China’s trust funds has been delayed rather than dealt with, industry data suggest.

Credit Suisse Group AG, analyzing figures from Chinese data provider Wind Information Co., estimates policies are due to repay 1.5 trillion yuan ($242 billion) in the first quarter of next year, compared with the about 1.3 trillion yuan this quarter. Nomura Holdings Inc. also predicts the maturity peak, at about 1 trillion yuan, is now more likely to come in 2015 than this quarter.

China’s $1.9 trillion trust fund industry sparked turmoil in emerging markets in January as a near-default prompted Moody’s Investors Service to draw parallels to the complex financial instruments that preceded the 2008 financial crisis. The opaque bailout that avoided that failure formed a pattern for subsequent refinancings. While policy makers have pledged to allow defaults to reduce debt accumulation, their attention has shifted to defending economic growth, which slipped below a 7.5 target in the first quarter.

“They haven’t deactivated the time bomb,” said Dong Tao, a Hong Kong-based economist at Credit Suisse. “When the trust funds can’t make interest payments and it looks like no one is going to roll them over, they ask local governments to take over their assets. Local government financing vehicles don’t have money, so they ask the banks.”

Default Brink

Li Jianhua, the 48-year-old in charge of the China Banking Regulatory Commission’s division overseeing the boom in trust companies, died of “long-term overwork” in April, his employer said last month. He had traveled to 10 provinces in the second half of last year and met with all of China’s 68 trust companies.

The nation’s trust assets more than quadrupled from four years ago to a record 11.7 trillion yuan in March, according to China Trustee Association data. Trust companies drew investors with an actual annual return of 6.44 percent in the first quarter and as much as 9.75 percent in 2011, compared with the 3 percent bank savings deposit rate set by the government.

Trust funds are part of the shadow banking industry, which includes wealth-management products issued by banks and was worth 38.8 trillion yuan as of the end of last year, according to a Barclays Plc report.

The sector came under close scrutiny in January when a 3 billion-yuan product issued by China Credit Trust Co. to raise funds for a coal miner teetered on the brink of default. Emerging-market stocks posted their worst month in seven in January while Asian currencies fell the most since August. Just before the payment date, Industrial & Commercial Bank of China Ltd., the product’s distributor, said investors could recoup their funds, without saying where the money would come from.

Assets, Repayments

Since then, the trusts have largely stayed out of the headlines. Some banks have rolled over products by issuing new ones while companies set up by local governments and asset management firms have taken over the assets of some troubled funds, according to Credit Suisse. Trust companies may have to repay 194 billion yuan in the remainder of this year and 284 billion yuan in the first half of 2015, according to Use Trust, a research firm that compiles data based only on publicly available information.

Premier Li Keqiang said in March the official 2014 growth target of 7.5 percent is “flexible” and some financial product defaults may be unavoidable, echoing pledges in November to give markets a “decisive” role. Last month, he said the government will “ensure” the minimum expansion goal.

Monetary Policy

China loosened monetary policy and lowered reserve requirements for some banks as growth fell to 7.4 percent in the first quarter while exports contracted in February and March. The 10-year sovereign bond yield slid 44 basis points in the last three months, the biggest quarterly drop since 2011, to

4.06 percent on June 30. The yuan has declined 2.5 percent this year, the worst performance in Asia. It rose 0.09 percent to

6.2075 per dollar as of 10:52 a.m. in Shanghai today.

The nation’s banking regulator told trust companies in April to either restrict their businesses and reduce net assets or have shareholders replenish capital when the firms suffer losses. It will also impose a strict approval process on their entry into new businesses and products.

Trust loans increased an average 67.8 billion yuan each month in 2014, compared with 153.7 billion yuan last year, according to official data. Issuances declined 13 percent from the previous period to 236.4 billion yuan last quarter, according to Use Trust data.

Negative Impact

“Policy makers agree theoretically that what’s supposed to default should be allowed to default, but the motivation for that is less strong now than earlier in the year,” said Chen Xingdong, a Beijing-based economist at BNP Paribas SA. “This is not good for building a healthy debt market, but the short-term negative impact of allowing defaults is larger than the will to allow defaults now.”

There won’t be a “large-scale explosion” in trust defaults as regulators have a good grasp of maturity dates and amounts due and often call the trusts ahead of time to ensure payment, Chen said. If the firms express difficulty, the government will want various parties to work harder, he added.

While Premier Li allowed privately-owned Shanghai Chaori Solar Energy Science & Technology Co. to become the first onshore bond issuer to default in March, Hong Kong-based Nomura economist Zhang Zhiwei said China may be less willing to tolerate a failure now.

The yield on one-year corporate bonds rated AA-, the equivalent of speculative grades globally according to Haitong Securities Co., tumbled 189 basis points in 2014 to 5.73 percent yesterday.

Structural Reforms

Financial liberalization and other structural reforms may make it easier for China to resolve the issue of rising trust debt, said Alicia Garcia-Herrero, chief emerging-market economist at Banco Bilbao Vizcaya Argentaria SA in Hong Kong. She estimates the maturity peak may be postponed by six to 12 months from this year’s May-August period.

Policy makers lifted a cap on lending rates in July while leaving controls on deposit rates. They have also pledged to expand direct financing such as stock and bond sales as they seek to contain off-balance-sheet financing and boost smaller enterprises.

Ideally, the government should set up a transparent mechanism to restructure loans, according to London-based Adam Wolfe, director of emerging Asia at Roubini Global Economics.

“It’s probably the correct decision not to just push through defaults, but the way they’ve gone about that is backdoor deals and opaque restructuring,” Wolfe said. “It cuts against the idea that they’re trying to introduce credit risk and reduce the moral hazard problem.”

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