How long are the shadows cast by the shadow-banking system?
That's the question China-focused investors are posing themselves, as a prominent trust manager acknowledges missing payments on its products. The problems could cause a cascade of failures in the shadow-banking sector, which at US$3 trillion in assets is about the size of the British economy, and US$1 trillion bigger than that of Canada.
Zhongrong International Trust missed payments on a batch of products on August 8, the company's board secretary told investors at a meeting this week, according to Bloomberg. That's after delays on payments for at least 10 other products since late July, the executive, Wang Qiang, reportedly told investors. At least 30 products are now overdue, with Zhongrong halting redemptions on some short-term instruments, without a current plan to make investors whole.
Zhongrong is one of the largest companies in China's trust sector. Its parent, Zhongzhi Enterprise Group, is China's equivalent of the Blackstone Group (BX) , managing US$138 billion in all, and may well have problems that expand out of its subsidiary.
The company faces a "tsunami" of questions from its investors, who are promised regular payouts on their trust products, which often invest into the real-estate sector. Wang asked for patience as the company looks to recoup some value on its holdings.
Much of the root of the issue stems from trouble in the real-estate sector. We had confirmation Wednesday that house prices fell 0.1% in July, compared with the prior year, according to numbers from the National Bureau of Statistics. They also fell from the June data, meaning the real-estate industry has been in close to a consistent decline for the better part of three years.
China's banking regulator has set up a task force to examine the risks at Zhongzhi, looking to get a handle on its outstanding debts and the risk they pose. Three companies have stated publically that they have missed payments from the group. The problem for regulators is controlling the Zhongzhi risk without provoking contagion throughout the trust sector.
Zhongrong bought into property developments in 2022, betting on a recovery that has yet to materialize. It needs cash from the sale of those projects to fund payments, but transactions in China are slow and few between. Instead, as I reported last week, China's largest developer by sales, Country Garden (HK:2007) (CTRYY) , has missed coupon payments on its bonds, part of its US$194 billion in liabilities, and is a 30-day grace window away from default.
Trust companies take in household deposits, promising regular, relatively high payouts. But they invest them much like private-equity managers, into property projects, early-stage companies, and even stocks and commodities. The average yield on Zhongrong's products is 6.9% compared with the 1.5% interest paid by banks. It has C¥39.5 billion (US$5.4 billion) in assets in 270 products that are due in 2023 alone, according to numbers from data company Use Trust.
Trusts have been sold as low-risk products to investors while disclosing little about how the money is invested. Beijing regulators have tried to cut out excess in the sector and have outlawed "funding pools" in which incoming money is used to make payouts to existing investors, a process that clearly has similarities to a Ponzi scheme.
Not that you'd hear about it from the company, directly, or in the media. Only a handful of outlets have reported on the topic, mindful of the direction from regulators to avoid discussing negative aspects facing the economy. Analysts, think tanks and university staff alike say they've been told to avoid coverage of issues such as deflation and capital flight. Some resort to euphemisms such as "subdued inflation."
The statistics bureau has simply stopped publishing problematic numbers such as consumer confidence. As of this latest round of numbers on the economy, which badly missed the mark, it no longer breaks out youth unemployment, which doubled in the last four years and stood at a record 21% when last reported for June. The stats bureau says the numbers need to be "further improved and optimized."
After a meeting of China's cabinet in July prompted optimism about government efforts to stabilize financial markets, Chinese stocks have resumed their downward trend this month. The CSI 300 index of the largest listings in Shanghai and Shenzhen is down 4.9% in August, with a particularly sharp selloff in the last week.
Hong Kong stocks tend to bear the worst of any selloff, since it's easier for global investors to buy and sell there, and mainland investors have relatively few options for reallocating assets. The Hang Seng Index is down 8.7% in August, leaving the market down by two-thirds since a post-Covid peak in February 2021.