Rating agencies criticise China’s bailout of failed $500m trust

January 30, 2014 8:32 am

Rating agencies criticise China’s bailout of failed $500m trust

By Josh Noble in Hong Kong

Global rating agencies – often among the more sanguine voices on China – have warned that this week’s bailout of a soured $500m trust loan was a wasted chance to address rising moral hazard in the country’s shadow banking sector.

The words of caution follow a last-minute deal to avert the default of a Rmb3bn trust product backed by loans to a now-defunct coal mining company. The product’s issuer, China Credit Trust, on Monday said it had raised the cash needed to pay back investors from three unnamed backers.

Though such products have failed in the past, a full or partial default of the “Credit Equals Gold No. 1” trust would have been the most high-profile case in whichinvestors were left nursing losses.

Instead their investments were made good, with only the third year of interest payments held back – something ratings agencies have billed as a missed opportunity to address skewed risk perceptions within the shadow banking sector.

“By bailing out investors in this particular instance, the authorities are perpetuating moral hazard within the Chinese financial system – and this risk may in fact have become a whole lot bigger,” wrote Jonathan Cornish, an analyst at Fitch, in a research report. “We think the authorities have missed a chance of putting a clear marker in the sand that non-bank products would certainly not be supported.”

Moody’s analysts said that while the resolution of this particular trust had limited the risks of contagion across the financial system, the government had failed to create a useful framework for future defaults.

“Although the current proposed settlement does entail losses to investors in terms of foregone interest, by fully repaying their principal, it reinforces the perception that investors will be bailed out one way or another when the products go sour, which is contrary to the establishment of sound market discipline and a healthy credit market,” said Moody’s.

Liao Qiang, credit analyst at Standard & Poor’s, described the fund rescue as “counterproductive in the long run”, as it would undermine efforts to rein in the growth of such products.

The shadow banking system has risen to account for roughly a third of new credit inChina’s debt-fuelled economy. About $660bn of trust loans are due for repayment or refinancing this year, according to estimates from Bank of America Merrill Lynch, raising the prospect that investor jitters over the sector could feed into the real economy.

Trust loans, the largest form of shadow financing, have often been used by local governments to fund infrastructure projects, and by developers to buy land and build apartment blocks. Difficulty in rolling over such debts could dent economic growth across the country.

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Some analysts say the impact is already being felt. On Thursday, a survey released by HSBC showed the first contraction in the manufacturing sector in six months, which Zhang Zhiwei, an economist at Nomura, said had been caused in part by rising financing costs within China.

In spite of this week’s bailout, most analysts expect more trust products to sour this year, as the economy slows, and as authorities look to introduce more market-driven mechanisms for pricing risk.

The debt problem building within China’s shadow banking system this year is likely to be “more important to the global economy than Fed policy”, Nikko Asset Management said in a research note.