China Trusts’ Road to Bust

China Trusts’ Road to Bust

AARON BACK

Feb. 13, 2014 7:03 a.m. ET

Sooner or later, someone in China’s trust-products universe is going to lose real money.

Weeks after a hasty bailout was arranged for a troubled Chinese trust product, another shadow lender, Jilin Trust, has failed to make payments on tranches of an investment product that came due over the past few months. Jilin is set to miss another payment next week. Once again the product in question is linked to a troubled coal miner, and was sold to investors by one of China’s big four state banks, in this case China Construction Bank.601939.SH +0.25%

The product’s six tranches amount to nearly 1 billion yuan, or around $165 million, smaller than the $500 million worth of ICBC 601398.SH 0.00% -sold products rescued last month by a mysterious third party. Trust investors in that case lost interest payments but no principal. Another shadowy resolution in which investors eventually get their principal back can’t be ruled out. Jilin Trust told investors the coal company is in restructuring as it attempts to pay back debt. The final tranche matures in March.

It’s also possible authorities will let investors take a bigger hit. Even if not, more distressed trust situations are inevitable and will test Beijing’s resolve. Bernstein Research estimates that about 40% of the about 10 trillion yuan in trust products outstanding will mature this year. The trust companies themselves are thinly capitalized, with an equity base equivalent to 2.6% of assets under management. A feedback loop could form: Investors steer clear of new trust products, and trust companies are then unable to roll over old loans to stressed borrowers, causing more defaults.

China’s big banks will be insulated so long as they can hold the line that they aren’t liable for failed products that they distributed. If banks are seen to be involved in a bailout, investors will be right to question how much of this off-balance-sheet activity needs to be accounted for on the books.

In theory, China’s trusts are economically useful, directing credit to dynamic companies that banks don’t reach because of their bias toward serving other state-owned enterprises. In practice, trusts tend to be lenders of last resort to the least-productive sectors that the banks have been told to avoid. The China Trustee Association says 35% of trust assets are invested in the infrastructure, energy, mining and real-estate sectors. Nomura economist Zhiwei Zhang reckons the true proportion is over 50%.

The good news is Chinese investors are getting reacquainted with risk. The question is whether this can happen without sparking a broader crisis of confidence.

 

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 (www.heroinnovator.com), 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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