A default of the “Credit Equals Gold #1” trust product has been avoided. What happens in the coming months will either push China closer towards a financial crisis or help it gradually step back from the edge, Forbes reported.
The lack of details that emerged from the trust bailout will undoubtedly draw criticism from foreign investors and analysts alike. Industrial and Commercial Bank of China Ltd. told investors that they could sell the rights in the RMB 3 billion product issued by China Credit Trust Co. to an unidentified buyer at a price equal to the value of the principal. Separately, China Credit Trust announced that it had reached an agreement with a third party to sell the shares it had acquired in Shanxi Zhenfu Energy Group, the coal miner which took out the original loan. According to that statement, investors would not receive interest on the third and final year of the product, equivalent to around RMB 300 million. Neither ICBC nor China Credit Trust acknowledged where the funds came from to repay investors or who the third party was.
In reality, it is possible that we will never know the details of the third party. In 2012, there were two trust defaults, one for a product distributed by Huaxia Bank Ltd. and one sold by CITIC Trust. While we learned that Zhongfa Industrial Group in the end guaranteed the first, the solution to the second was never made public.
As a result of the uncertainty, we will now enter a period of second guessing on reform and concerns that risks in China’s financial sector will only intensify. As argued by Christopher Wood at CLSA:
“If there is a total bailout — or perhaps even worse a bailout through the backdoor as some speculate — it will be a signal that the government’s talk of pursuing reform isn’t perhaps for real. This will increase macro risks, with China’s trust assets now totaling more than 10trn yuan.”
China’ financial system is clearly under more stress than it has ever been given the large sums of money that are now invested in trust and wealth management products (WMPs), which in turn are used to extend loans to different segments of the economy. The degree of risk is unclear, however. China bears will argue that a vast majority of the trust loans cannot be repaid, which will eventually require substantial bailouts and lead to a collapse in the banking system and a larger economic crisis. Even if this is exaggerated and the assets are good, huge liquidity risks exist given the known mismatch between the duration of trust loans and their underlying investments. Read more.
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