Many observers of China’s trust industry have been nervous through the early months of 2014, with trust products facing potential default with the deterioration of the mining, property, and infrastructure sectors. Potential default incidents at the beginning of this year involved a mining trust product sold by China Credit Trust Company, “Credit Equals Gold No. 1” and a mining product sold by Jilin Province Trust Company, “Songhua River #77 Shanxi Opulent Blessing Project.” As the economy declines, the promise of high returns has been increasingly difficult to meet.
Fallout in May of this year was fortunately limited, despite a number of products coming due. Part of this may be attributed to increasing regulation and monitoring of the industry. Trust companies were required, starting in April, to provide funding or sell off their holdings when facing a liquidity crunch. The China Banking Regulatory Commission also raised the bar on the criteria for approving new products. The trust industry has been in the media spotlight as some trust products faced potential default, creating worry that further fallout would affect the rest of the financial system and heightening scrutiny of these companies.
But another part of the limited fallout was likely due to new policies regarding local government financing vehicle debt. In recent years, local government financing vehicles were allowed to take on trust loans in order to build up infrastructure. Although RMB 392 billion ($63 billion) of infrastructure trust products matured in May, the largest amount to mature in 2014, there were no defaults. This is likely due to the promise of rolling over some of the debt into bonds. The local governments of Shanghai, Zhejiang, Guangdong, Shenzhen, Jiangsu, Shandong, Beijing, Jiangxi, Ningxia and Qingdao have been permitted to roll out bonds this year for their financing needs. Should these local governments find themselves unable to pay their debts in the form of trust loans or otherwise, then, they have the option of obtaining financing through this route. The total amount of trust infrastructure debt to expire in 2014 amounts to about RMB 1.4 trillion.
The main concern currently in the trust industry is the real estate sector. As the property market continues to sour, trust products with underlying loans to real estate developers may face liquidity and solvency issues. Currently, real estate based trust products account for more than 10 percent of assets under management. Property developer Mao Daqing at Vanke stated in a leaked recording last month that he believed new residential construction was already at capacity, while property tycoon Pan Shiyi last week compared China’s property market to the Titanic about to hit an iceberg. Both comments suggest severe weaknesses in the real estate sector.
China’s property market reflects a general downturn and restructuring, as fixed asset investment has reached its peak. The state economic plan is set on turning away from an investment-fueled economy to a consumption-led economy. However, the economy must first survive the deflation of the property bubble. The first shoe to drop was the March failure of Zhejiang Xingrun Properties, with RMB 3.5 billion in debt. Then, new home prices fell for the first time in about two years in May as demand in many regions of the country slackened. Some developers are now saddled with empty apartment buildings and the number of developers facing financing problems is on the rise, with small and medium sized firms already strongly affected.
A cooling property market will have repercussions for the trust industry. The question is, to what extent? Ten percent of the trust industry (accounted for by real estate loans) amounts to more than RMB 1 trillion. Suppose that a large proportion of these loans stop performing – say, 60 percent. That is about RMB 600 billion, almost equivalent to the amount of overdue loans by year end 2013 announced by China’s top ten banks two days ago. Banks’ overdue loans are expected to be supported by the Chinese government through implicit financial assistance (liquidity injections where needed) and, for the top four banks, removal of non-performing loans to asset management companies. Trust companies, by contrast, do not enjoy state support, explicit or implicit. The liable parties are the trust product holders themselves who may be left holding the bag if trust companies cannot deliver on property-based trust product payments.
What this indicates is that the trust industry is one to keep an eye on at least through the end of 2014, as additional real estate trust products come due and the property market and real economy continue to suffer. About RMB 5.3 trillion in trust products will mature in 2014, and how these debts are settled will have a lasting impact on China’s financial landscape.
Follow Sara Hsu on Twitter @SaraHsuChina