Too Much Trust in Local Finances: It would seem Chinese local governments didn’t get the memo about reining in credit risks

May 9, 2013, 5:57 PM

Too Much Trust in Local Finances


It would seem Chinese local governments didn’t get the memo about reining in credit risks.

According to data issued Wednesday by the China Trustee Association, a government-backed industry body, trust companies funneled 461 billion yuan ($75.2 billion) worth of new funding to infrastructure projects in the first three months of 2013 (here in Chinese–-more than in the preceding six months combined.

In the third and four quarters of 2012, trusts — a type of wealth management company common in China – provided a total of 458.3 billion yuan worth of new infrastructure financing.

The massive expansion in lending to infrastructure projects – most of which likely went to investment platforms backed by local governments – comes as Beijing grows increasingly uneasy about the level of local government debt.At the end of December, the Ministry of Finance issued rules explicitly banning some of the methods local governments had been using to raise money from trusts, leasing firms and finance companies, such as requiring local public employees to buy investment products backed by infrastructure developments.

In April during a State Council meeting, Premier Li Keqiang flagged the need to guard against the risks rising from local government debt as an economic priority. A week later, local newspaper China Business News cited China Banking Regulatory Commission Chairman Shang Fulin as saying that the failure of local governments to repay their debts could result in rising nonperforming loans for the banking sector, and on May 6, the State Council said it would push to make local government budgets more open and transparent as a way of controlling credit risks.

When it comes to infrastructure construction, Beijing has been sending out mixed messages. While clearly concerned about the credit risks, Premier Li Keqiang has flagged urbanization as being the key driver of China’s future economic growth.

A People’s Daily commentary in mid-April said that local governments shouldn’t use urbanization as an excuse to take on excessive debt, although some analysts warn that particular horse may have already bolted.

But the problem – at least as far as the involvement of trust companies is concerned – is as much about supply as it is demand. Yes, local governments are clearly happy to borrow, whether it be to fund new projects or repay loans that the banks are unwilling to rollover. But the trusts also need to find somewhere to park an ever increasing torrent of cash coming through their front doors.

In the first three months of 2013, the volume of assets under the management of the trusts increased by 1.23 trillion yuan (about $200 billion). About 37% of that went toward infrastructure, up from 22.5% of total new funding the previous quarter.

There’s not a lot of other places that the trusts can put the money and get the 10% annualized return investors have grown accustomed to. While trusts were once key financiers to real estate developers, the central government all but stopped the flow of new trust funding to property in late 2011. Things have loosened up a bit since then, but at the end of March total outstanding trust financing for property was up only 12% from a year earlier. Even bank loans to the property sector grew faster, at 16%. Property as a share of total trust financing has declined for the last 6 quarters.

Moreover, with many industrial sectors plagued by industrial overcapacity and high debts levels, it isn’t easy for trusts to find the right companies to lend to.

But local government tax revenues have slowed over the last year – and are not likely to significantly rebound in 2013 given the relatively sluggish economy – even as their debt burden has risen. The trusts are likely hoping that if a local authority runs into financial distress, a higher level of government will stump up the cash to cover its debts. They might even believe, given the priority given to urbanization, that any loans to infrastructure projects are implicitly supported by the central government.

Both assumptions still need to be tested.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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