Bank of China president Xiao Gang. Photo: Bloomberg

New dangers lurk in trust firms' rush to finance

Under-regulated funding sources are emerging, the second of a two-part series explains

A new financial danger is emerging on the mainland, with dozens of under-regulated trust companies channelling funds from clients and bank wealth management products into a range of capital-hungry companies and overexposed local government financing vehicles.

Problematic borrowers began turning to the trust firms last year when banks and bond markets tightened scrutiny over such loans.

Thanks to the premiums that such borrowers are prepared to pay, the trust companies have been able to attract clients with expected annual returns of over 10 per cent, sharply higher than the 3 per cent benchmark interest rate for one-year deposits. As of the end of December, their total assets under management surged by about 46 per cent year on year to more than 7 trillion yuan (HK$8.62 trillion), surpassing the insurance sector for the first time.

The trust sector, now ranked second only to banks in terms of assets under management, is supervised by the non-bank financial institution division of the China Banking Regulatory Commission, unlike banks, securities companies and insurers, which fall under the supervision of powerful industry regulators.

"Many companies are queuing up to get financing from us," said Nina Zhao, an executive of a trust company in Beijing. "We have no time to look into the projects for which they are raising funds. As long as they have land or property as collateral, we give them the money."

Trust companies made 1.29 trillion yuan in new loans last year, 1.09 trillion yuan more than the 2011 total, according to the People's Bank of China.

Many borrowers turned to trust companies after banks rejected them over concerns about the security of cash flows from unprofitable projects of local government financing vehicles and the solvency of industries that are either subject to regulatory crackdowns, or burdened by oversupply.

Once they get the green light for financing from trust firms, these companies find their way into the country's banking system through bank wealth management products. Funds then flow from savers to the products, to trust companies, and to the final problematic borrowers.

A borrower's collapse or default can affect links all along the financing chain.

Defaults are already occurring. Last month, Beijing-based Citic Trust said Hubei-based steel firm Three Gorges Quantong Coated and Galvanised Plate Company defaulted on 591 million yuan of repayments due to buyers of an 18-month trust product. It's uncertain what the final result will be.

A big portion of trust loans extended over the past couple of years will mature this year. According to China International Capital Corp, real estate developers have repayment liabilities on trust loans of 310 billion yuan this year - up 76 per cent on their 175.8 billion yuan 2012 liability.

Outstanding trust loans to developers account for a 17 per cent of mainland trust loans at the end of 2011, the second-largest share of all industries, according to the China Trustee Association. There are risks that the trust product related-wealth management products could "ultimately negatively affect banks in the way that are not easy to predict", Moody's analysts said last week.

The banking regulator has already asked lenders to tighten scrutiny over wealth management products. Bank of China president Xiao Gang, one of the first to warn of risks from these products, is tipped to become the new head of the China banking regulator around March. It is widely expected that his appointment will slow the growth of the products.

Bank of America Merrill Lynch analyst Winnie Wu said the likely slowdown in high-risk wealth management products would mean that banks would benefit from less competition for deposits, increased demand for on-balance sheet loans, and higher demand for bond issuance with underwriting fees offsetting lowered fees from wealth management product distribution.

But, the flow of liquidity from the non-banking sector would slow, and this could negatively impact GDP and raise the risk of rising non-performing loans in the formal banking sector, she added.

Nevertheless, defaults of wealth management products are unlikely to trigger a nationwide liquidity crunch in the near term because the huge pool of household savings provides enough ammunition to the banking system, many economists said.

But, such failures could hurt banks' credibility and put the regulator's supervisory ability under the spotlight, they said.

This article appeared in the South China Morning Post print edition as: New dangers lurk in trust firms' rush to finance