by Chris Black
Last summer, I wrote a brief article about how China’s property sector is, structurally, a bubble.
And as with all bubbles, policymakers are equipped with a toolkit limited to delaying, mitigating, or perhaps even changing (https://genco.substack.com/p/the-great-financial-reset-of-2009) the inevitable “burst”.
And while Beijing has done a mostly admirable job over the past decade of delaying the debt crisis, a sort-of countdown to D-day has begun.
In less than a week, not only did we learn that China’s largest property developer Country Garden has entered a grace period on two of its bonds (https://t.me/disclosetv/11752), but that one of China’s biggest private wealth managers missed payments on multiple shadow banking (i.e. high-yield investment) products, stoking fresh worries about contagion amid deflationary pressures (https://www.bbc.com/news/business-66435870) and, of course, a precarious real estate sector which, as a reminder, is by far the largest asset class on earth.
The turmoil at the private wealth manager, Zhongzhi Enterprise Group, which Bloomberg describes (https://archive.is/LcyLl) as a “secretive financial conglomerate with about 1 trillion yuan ($138 billion) in assets”, has emerged as the latest debt-crisis trigger after several of its corporate clients disclosed overdue payments by a trust unit.
Chinese banking authorities have set up a task force to examine risks at Zhongzhi (https://archive.is/B0yVh), signaling contagion fears.
Zhongzhi is a big player in China’s $2.9 trillion trust industry (https://archive.is/vgDl7), a key anchor to its shadow banking sector.
“Shadow banks” is an umbrella term for various kinds of financial institutions that combine (https://penpoin.com/shadow-banking/) banking, private equity, wealth management, and other sub-disciplines.
Shadow banks will (https://www.imf.org/external/pubs/ft/fandd/basics/52-shadow-banking.htm) pool savings from wealthy households & clients to invest in real estate, stocks, bonds & commodities, and offer bank loans.
As a result, they are usually the first to blow up any time China enters into one of its trademark phases of “economic turbulence”.
What appears to have sparked the crisis at Zhongzhi’s trust unit are its bets in stakes in real estate projects last year, betting on a market rebound that has so far failed to materialize.
“The biggest risk with the Zhongzhi fallout now is that it causes confidence in the entire trust industry to collapse,” said (https://www.bnnbloomberg.ca/china-shadow-banking-giant-alarms-investors-with-missed-payments-1.1958551) Shen Meng, a director with Beijing-based Chanson & Co. “If the situation continues to worsen, expect the scale of the risks to be no less than when a leading property developer defaults.”
Three firms said late Friday they failed to receive payments on products issued by companies linked to Zhongzhi, including Zhongrong International Trust.
Zhongzhi is the second-largest shareholder of Zhongrong Trust, with its ownership at around 33%.
The conglomerate also holds stakes in five other licensed financial firms, including a mutual fund manager and two insurers, and invested in five asset management companies and four wealth units, according to its website.
It also controls listed companies and owns 4.5 billion tons of coal reserves among its industrial operations.
The missed payments show “how the real estate’s liquidity problem can create a domino effect on other sectors, including the trust industry,” said (https://www.straitstimes.com/business/china-shadow-banking-giant-alarms-investors-with-missed-payments) Gary Ng, senior economist at Natixis. “It would not be surprising to see more trusts with a high asset allocation towards real estate face payment issues.”
Use Trust data shows (https://www.businesstimes.com.sg/international/global/why-chinas-us29-trillion-trust-industry-sparking-fears-contagion) Zhongrong Trust alone has 270 products totaling 39.5 billion yuan due this year.
The average yield on those products amounted to 6.88%, compared with the benchmark 1.5% one-year deposit rate paid by banks. Real estate accounted for 11% of Zhongrong Trust’s trust assets, following 42% in industries and 33% in financial institutions, according to its annual report (http://en.china-zrg.com/cn/page/46.html).
With property developers like Country Garden (https://t.me/disclosetv/11752) and China’s shadow banking sector on the verge, it’s no surprise that Chinese credit creation has ground to a halt: loans extended by Chinese banks fell (https://www.zerohedge.com/markets/chinas-crashing-loans-show-risk-beijing-acting-too-late) to the lowest level since 2009 last month (image above), in a sign of waning demand from businesses and consumers and that China is facing a brutal period of debt deleveraging-driven deflation.