China’s ICBC says won’t compensate investors in troubled shadow bank product

China’s ICBC says won’t compensate investors in troubled shadow bank product

Wed, Jan 15 2014

BEIJING/SHANGHAI, Jan 16 (Reuters) – Industrial and Commercial Bank of China, the world’s largest bank by assets, said on Thursday that it has no plans to use its own money to repay investors in a troubled off-balance-sheet investment product that it helped to market.ICBC’s shares have fallen this week amid speculation that the bank would be forced to help repay investors in a 3 billion yuan ($496.20 million) high-yield investment product issued by China Credit Trust Co Ltd but marketed through ICBC branches. The product is due to mature on Jan. 31.

“Regarding this unsubstantiated rumour, a situation completely does not exist in which ICBC will assume the main responsibility (for the trust product),” an ICBC spokesman told Reuters by phone on Tuesday.

The trust product, called “2010 China Credit / Credit Equals Gold #1 Collective Trust Product”, used the funds it raised from wealthy investors in 2010 to make a loan to unlisted coal company Shanxi Zhenfu Energy Group Ltd.

But in May 2012, Zhenfu Energy’s vice chairman, Wang Ping Yan, was arrested for accepting deposits without a banking licence.

Following an investigation, China Credit Trust told investors that Zhenfu Energy had taken out high-interest underground loans totaling 2.9 billion yuan, bringing its total liabilities to 5.9 billion yuan and threatening its ability to repay the trust loan.

China’s coal industry has been battered by falling prices over the last year. Several other banks and trust companies are facing losses on loans to another coal company, Liansheng Resources Group.

Analysts have expressed increasing concern in recent years about Chinese banks’ exposure to off-balance-sheet risks.

While trust products and other so-called wealth management products typically don’t carry a formal guarantee from banks that help to create and sell them, bankers worry that investors widely perceive them as carrying an implicit guarantee from state-owned banks.

That means that banks may face pressure to shield investors from losses in order to protect their reputations, even if they are not legally required to do so.

 

A trust product test case in China

David Keohane

| Jan 16 08:58 | Comment | Share

This is from Reuters and makes a nice little moral hazard gauge for China. The story involves a trust product, called “2010 China Credit / Credit Equals Gold #1 Collective Trust Product” which just screams “buy me” but maybe not “stand behind me when I go bad”:

Industrial and Commercial Bank of China, the world’s largest bank by assets, said on Thursday that it has no plans to use its own money to repay investors in a troubled off-balance-sheet investment product that it helped to market.

ICBC’s shares have fallen this week amid speculation that the bank would be forced to help repay investors in a 3 billion yuan ($496.20 million) high-yield investment product issued by China Credit Trust Co Ltd but marketed through ICBC branches. The product is due to mature on Jan. 31…

“Regarding this unsubstantiated rumour, a situation completely does not exist in which ICBC will assume the main responsibility (for the trust product),” an ICBC spokesman told Reuters by phone on Tuesday.

What happened? Well apparently the trust used the funds it raised from wealthy investors in 2010 to make a loan to unlisted coal company Shanxi Zhenfu Energy Group Ltd. Sadly, Zhenfu Energy’s vice chairman, Wang Ping Yan, was arrested for accepting deposits without a banking licence. Oops.

Here’s Nomura’s Zhiwei Zhang (emphasis ours):

The trust product was launched by Zhongcheng Trust Company in 2010 and distributed by the Industrial and Commercial Bank of China. Funds raised were invested in the Zhenfu Energy Company in Shanxi province.

According to the newspaper, Zhenfu Energy has already been declared bankrupt. Total assets have been valued at less than RMB500m while the company faces total debts that may be as high as RMB5.9bn. This trust product comes due on 31 January (on the lunar new year in China).

In the past, similar events have happened, but default has been avoided as trust companies found ways to pay investors, sometimes with their own capital. Zhongcheng Trust reportedly has RMB7.2bn of net capital, giving it the capacity to absorb the loss and avoid a default, but given the extent of the losses, the trust company is reluctant to take that hit. This case has become the focal point of the trust sector in China, with interested parties wondering if this will become the first case in which investors take a loss. If events do play out that way, it is only natural to expect a downturn in sentiment in the trust sector which would have the potential to trigger a ripple effect on the financial system which is going through a deleveraging process.

A quick reminder of what happened when Huaxia bank found itself in a tight spot on the back of a WMP gone bad might be useful here (although important to note Huaxia denied knowledge), from Standard Chartered’s Stephen Green:

In December 2012, retail investors who had purchased a WMP (‘中鼎财富投资中心 (有限合伙)入伙计划’) from the Shanghai Jiading branch of Huaxia Bank were told the product had defaulted. The funds raised had been channelled to an asset management company, which then on-lent the funds to a car dealership in Henan province. The dealer defaulted. Some noted that the dealer’s parent company was also involved in construction and real estate in the new district of Zhengzhou city.

Huaxia management claimed that this WMP had not been authorised for sale, had actually been sold by a staff manager operating without authorisation, and that the bank was not liable for the losses. Investors protested outside the branch and attracted considerable media attention. In January 2013, investors were repaid their principal by a guarantee company which suddenly appeared. Some wondered where the guarantee company had found the funds.

Another case happened in July 2013 at an ICBC Suzhou branch, according to Hong Kong-based media reports. Investors were encouraged to buy a product based on a single entrustment loan, for a return of 12-15% and minimum investment of CNY 1mn. Investors appear to have believed that the product was a WMP. After the loan went bad, the bank branch claimed it was only acting as a trustee (受托人) and had no obligation to repay. 11 clients who had lost CNY 22.3mn protested outside the branch, which caught the regulator’s attention. The investors were later repaid, a banking source in Suzhou tells us.

Protest, eh? No fun being a creditor. Apropos of that, here’s the last line from that Reuters piece:

While trust products and other so-called wealth management products typically don’t carry a formal guarantee from banks that help to create and sell them, bankers worry that investors widely perceive them as carrying an implicit guarantee from state-owned banks.

That means that banks may face pressure to shield investors from losses in order to protect their reputations, even if they are not legally required to do so.