China’s Shadow Banks Could Be Another Property Casualty

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China’s Shadow Banks Could Be Another Property Casualty
The Wall Street Journal Logo
Aug. 14, 2023

Missed payments from a well-connected trust firm come as China’s property market sinks again—and banks step back

By guest author Jacky Wong from the Wall Street Journal.
China gen 1 A Three companies say they haven’t received payments from investment products managed by Zhongrong International Trust, which has offices in Beijing. Photo: Bloomberg News
China’s real-estate downturn is entering a more acute phase again. Problems are also popping up in another perennial trouble spot: the nation’s enormous and opaque shadow banking sector.
The last thing the nation needs now is tighter financial conditions. But if more shadow banking investment products start going belly up, that might happen anyway.
Three companies haven’t received payments from investment products managed by Zhongrong International Trust, according to exchange filings in recent days. Over the weekend, Shanghai-listed Nacity Property Service disclosed that it hasn’t received principal and interest due from a 30 million yuan (USD 4.2 million) Zhongrong trust product which came due last week. Materials company KBC Corp says it is missing 60 million yuan due from two maturing Zhongrong trust products. And tool manufacturer Xianheng International hasn’t received payments due from one Zhongrong product and two other products from a separate trust firm.
Trust companies, a venerable part of China’s “shadow banking” system of nonbank lenders, make investments on behalf of their clients. In addition to managing assets entrusted to them, many also sell high-yield investment products directly to companies and individuals. They then invest the proceeds in a variety of assets, or lend directly to companies or property projects—often ones that cannot secure regular bank or bond market financing.
The country’s trust industry had around USD 2.9 trillion of assets as of March, according to the China Trustee Association. About 72 % are held by these so-called financing trusts which peddle investment products to wealthy investors and companies.
Unsurprisingly, the worsening crisis in China’s housing market has already dealt a blow to the trust industry. In mid-2019, around 15 % of financing trust assets were invested in real estate. But defaults on trust investment products—especially those linked to real estate—picked up over the past couple of years, and many financing trusts scaled back their investments in property. Such outstanding investment in real estate has dropped 62 % since 2019, and accounted for only 7.4 % of total financing trust assets as of March. But the absolute outstanding amount—around USD 156 billion—is still rather sizable.
And though the size of the missed payments announced by the three companies isn’t that big in the grand scheme of China’s labyrinthine financial system, it’s still concerning since Zhongrong has some important backers. Zhongrong’s top shareholders are a state-owned enterprise, Jingwei Textile Machinery, and private asset-management company Zhongzhi Enterprise, which is one of the largest in the industry.
That raises the spectre of further trouble in the industry: especially since China’s housing sector seems poised to sink even further.
Country Garden, one of the largest surviving private property developers, missed coupons on two of its bonds last week. The developer had been considered one of the sturdier private players remaining in the industry. And the new trouble in the trust sector comes with an additional ominous backdrop: Chinese banks in July extended the smallest amount of net new loans since 2009.China’s trust sector isn’t quite the heavyweight it was before the shadow banking crackdown of recent years, but it’s still important to watch because it is a source of capital for marginal borrowers—and intimately connected with key sectors such as housing and infrastructure. Investors would do well to keep a close eye on China’s trusts—especially if, as seems likely, the nation’s property sector takes another turn for the worse in the late summer.