For the “2010 China Credit / Credit Equals Gold #1 Collective Trust Product” bugs out there

For the “2010 China Credit / Credit Equals Gold #1 Collective Trust Product” bugs out there

David Keohane

| Jan 17 07:22 | 4 comments | Share

Part of the UP SHIBOR CREEK… SERIES

Here’s the structure you placed your trust in…

(Chart from Barclays. Do click to beat the image size cap we’ve illiberally imposed on our home page)

As we wrote yesterday, this is the sad story of a trust product gone bad called “2010 China Credit / Credit Equals Gold #1 Collective Trust Product” which ICBC helped to market and which they are now refusing to bail out. It was issued by China Credit Trust Company, the country’s third largest such group by assets, and the funds raised were used to make loans to a coal company that is now facing bankruptcy.More particularly, what Barc’s web above shows is that…

On 1 February 2011, China Credit Trust Co, a major domestic trust firm, launched a trust product called Chengzhijinkai No. 1 that raised RMB 3.03bn and made an equity investment in Zhenfu Energy Group, a Shanxi-based coal miner, with a 3-year maturity and 10% investment return. RMB 3bn of the trust product was sold by ICBC’s branches in Shanxi to its private banking clients (usually with RMB 3mn in investable assets) and another RMB 30mn of the trust product was bought by the shareholders of Zhenfu Energy Group.

After the equity investment, the trust product holds a 49% shareholding in Zhenfu Energy Group. Moreover, the shareholders of the Zhenfu Energy Group also pledged their 51% shareholding to the trust company (Figure 1). When the trust products matures on 31 January 2014, the shareholders agreed to buy back the 49% shareholding from the trust product.

However, since 2012, the coal miner has been facing a series of lawsuits regarding illegal fund-raising and absorbing underground deposits with most of its mining projects have been suspended. The company reportedly is also having difficulties in buying back the shares from the trust product, which also means the trust product could face default.

The problem, then, is who is going to pay if things go belly up. The ICBC has said “no thanks very much” according to Reuters on Thursday because, well, it only marketed this problem child and analysts like Nomura’s Zhiwei Zhang are saying the case is a now a focal point for the trust sector in China with the big question being whether investors take a loss for the first time on such a product. As Zhang said:

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.

The FT has China Credit Trust Company preparing to pick up at least part of the tab in an effort to shore up its own credibility and that of the wider trust sector, presumably with an eye on refinancing (more in the usual place).

And let’s face it, that’s pretty much the way this has to go if the government decides to row in behind ICBC — and we have people familiar with the matter telling us that ICBC had effectively used its political backing from the Communist Party to force China Credit Trust to take responsibilty for providing at least some compensation to investors in the product. Shocking.

In case you were wondering, Barc are relatively chilled (our emphasis):

Regulators likely to allow trust product default

If the trust product goes into default, we believe it would be the first default to test the financial system. We believe that the regulators and government would probably allow the trust product default because:

1) The government appears fairly determined to reform the financial system and instill proper risk pricing so there is a decent chance for this to happen.

2) We believe the government plans to control the rapid growth of trust business, particularly when such growth involves guarantees of highly risky products. At the end of 3Q13, the total trust assets surged to RMB 10.1tn, up 60% y/y). In Document No. 107 released recently, the State Council reportedly plans to rectify the trust business.

3) Each trust product is transparent on the investment project that it is invested into; hence, there is less room for lawsuits of mal-investment practices, such as asset-pool investments.

4) Different from wealth management products (WMPs), the buyers of trust products are high-net worth investors (usually with RMB 3mn or more in investable assets) who are supposed to understand investments and who are less likely to protest on the streets.

Trust products have shown substantial growth since 2011 with most products averaging 2-3 years in maturity. We expect that more trust products could face difficulties in repaying investors and go into default when they become mature.

Will it spill over to the financial market and trigger a system collapse?

We believe the chance for this to happen is low as 1) the government and distributing bank have the ability to step in any time to bail out, 2) wealthy investors are less likely to protest so there would likely be less social impact and 3) investors still have other investments to choose from (WMP, bonds, deposits, equities, properties etc).

While the local government may be concerned about the social impact for promotional reasons and the distributor and trust company for reputational reasons if there were a default, we believe it would be a healthy market practice for this to happen.

Short-term negative impacts, but long-term benefits

In our view, the default of trust products could trigger some short-term negative impacts on China’s financial sector and the reputation of financial institutions. However, we believe it is positive for the healthy development of financial system in the long run because the default could do the following:

1) Be a step to reduce the implicit guarantee of financial institutions for investment products. Banks could shift their financial liabilities back to the investors.

2) Increase the risk awareness of both investors and financial institutions, which could correct the pricing of investment products to more risk-oriented.