Want a crash course on shadow banking on the mainland? There is no better place to start than China Chengtong Development.
It is a Hong Kong-listed company. Everything you are going to read here comes from its annual reports and announcements. For so-called shadow banking does not happen in the shadows.
It has done almost everything: wealth management products, entrusted loans, financial leases, back-to-back trades … you name it.
It is the listed vehicle of one of the 100-something central state-owned enterprises. After all, who has the cheapest funds and the least risk awareness?
Chengtong is a company that does everything and therefore nothing. It is involved in property development, commodity bulk trading and tourism.
Nevertheless, given its status and a booming yuan bond market, it raised 600 million yuan (HK$752 million) via bond sales in 2011. While private enterprises were paying double-digit interest rates, Chengtong paid only 4.5 per cent.
It puts every penny into shadow banking. First, some leasing deals that are very peculiar both in terms of their short maturity and the industry involved. In one of the deals, Chengtong brought some equipment - air conditioners, beds and wardrobes, elevators, washing machines and cars - from a hotel for 50 million yuan and then leased it back at a fee.
In three months, the hotel regained the equipment for 51 million yuan. That is a three-month loan charging a rate of 9.38 per cent, double the official one. That return became peanuts as Beijing tightened credit and private developers scrambled for cash. Chengtong turned to entrusted loans.
It loaned out more than 113 million yuan and 744 million yuan in 2011 and 2012 respectively. The money was entrusted to banks and then lent to designated borrowers. The banks exercise supervision over and receive repayment from the borrowers but assume no risk of default, according to Chengtong.
Chengtong charges the borrowers between 12 per cent and 18.5 per cent interest.
The participating banks, Bank of Communication, China Minsheng Bank, Shanghai Bank and Shenzhen Development Bank, got a 0.01 per cent to 0.12 per cent fee, the off-the-balance-sheet business and increased market share. The borrower, mainly developers of hotels, malls or houses, got the much-needed cash.
It would not be fair to say Chengtong has not been risk-averse. All of these loans were charged against some properties and shares.
Nobody knows who else has their loans charged to these properties or whether Chengtong will have legal access to these properties. Chengtong said in its 2012 annual report that it has seen no defaults so far.
(Interesting enough, Chengtong has recently loaned 195 million yuan to a Beijing restaurant and catering company, two weeks before the latter was due to repay its 200 million yuan loan.)
The rampant growth of entrusted loans came to an end in late 2012 as mainland regulators tightened their grip. Regulatory requirements on entrusted loans are now no less than those on a normal loan. Banks turned to wealth management products to do off-the-balance-sheet lending. So did Chengtong.
In the past four months, Chengtong put 880 million yuan into wealth management products provided by the Agriculture Bank of China, OCBC Bank and Bocom.
Chengtong offers little information on the products. The only exception is a 142 million yuan investment with Bocom that says no more than 70 per cent of the money will go to trust schemes, assets and portfolios other than bonds. In the mainland, "trust scheme" is a synonym for "lending".
If the 4.5 per cent return from the products, which is equal to its bond issuing cost, does not look attractive, Chengtong has some "better deals". It is a back-to-back arrangement that allows Chengtong to create returns from nothing.
First, a subsidiary of Chengtong received a 220 million yuan loan from OCBC China by issuing to the bank some notes. Chengtong said the money would be solely for use in Hong Kong. Under mainland rules, the loan has to be approved by mainland authorities if it goes into the mainland.
Second, another subsidiary of Chengtong invested 220 million yuan into some investment products managed by OCBC China. "The subscription is to facilitate the issue of notes", Chengtong said.
Translation: The left hand made use of the ample liquidity in Hong Kong and loaned a sum at 2.9 per cent while the right hand put up the same sum for 3.7 per cent on the mainland, resulting in a 0.8 per cent return. Chengtong and the bank are to conduct 780 million yuan of similar arrangements in the future.
None of the above returns are guaranteed. What if the underlying asset or debts get into trouble? Mmm … that's a good question.