"Wealth management products in China have come under the
spotlight after a series of missed payments raised concerns over
the shadow banking sector that often directs credit to firms shut
out from bank lending or capital markets,"
Reuters said in February, after reporting that
CITIC (China's top brokerage), was looking at ways to repay
investors after the issuer of one of the wealth management products
the broker sold missed a $1.12 million payment to investors.
That news came a little over a year after the now infamous "
Credit Equals Gold #1 Collective Trust Product"
incident and a
subsequent default scareon a similar product
backed by loans to a struggling coal company.
Although wealth management products and CTPs (which differ from
WMPs) are often described as "murky" and "opaque", the basic
concept is fairly simple. WMPs are marketed to investors as a way
to get more bang for their buck (er.. yuan) than they would with
bank deposits. Funds from these investors are then invested at a
higher rate. If the
assets investors' money is used to fund run into
trouble, that's not good news for WMP
investors.Simple.
The main issue here is the sheer size of the market. As
FT notes, "in 2010, as regulators tried to rein
in the explosion in bank credit resulting from the country’s Rmb4tn
economic stimulus plan, banks turned to trusts to help them comply
with lending controls." So essentially, trusts helped banks offload
credit risk at the behest of the PBoC. Here’s the process whereby
banks use trusts to get balance sheet relief:
The amount of trust loans outstanding in China has ballooned to
nearly CNY7 trillion (total trust assets under management is
something like CNY14 trillion) and now,
Hebei Financing Investment Guarantee Group - which, as
Caixan notes, is "the largest loan guarantee
company in the northern province of Hebei [and] is wholly owned by
the provincial regulator of state-owned assets" - is apparently
broke, and that’s bad news because it guaranteed some CNY50 billion
in loans made by dozens of trusts who in turn issued wealth
management products to investors.
In short, if Hebei can’t guarantee the loans, WMP investors
could be forced to take a loss and as anyone who follows
developments in China’s financial markets knows, Beijing is not
particularly keen on permitting SOEs to collapse - especially if
there’s a risk of rattling retail investors’ fragile psyche. Here’s
FT with the story:
Eleven shadow banks have written an open letter to the top
Communist party official in northern China’s Hebei province asking
for a bailout that would enable the bankrupt credit guarantee
company to continue to backstop loans to borrowers. If the
guarantor cannot pay, it could spark defaults on at least 24
high-yielding wealth management products (WMPs).
Hebei Financing Investment Guarantee Group has guaranteed
Rmb50bn ($7.8bn) in loans from nearly 50 financial
institutions,according to Caixin, a respected financial
magazine. More than half of this total is from non-bank lenders,
mainly trust companies, who lent to property developers and
factories in overcapacity industries
The letter appeals directly to the government’s concern about
social stability and the fear of retail investors protesting the
loss of “blood and sweat money”. The 11 companies sold 24 separate
WMPs worth Rmb5.5bn.
“The domino effect from the successive and intersecting
defaults of these trust products involves a multitude of financial
institutions, an immense amount of money, and wide-ranging public
interests,” 10 trust companies and a fund manager wrote to Zhao
Kezhi, Hebei party secretary.
“In order to prevent this incident from inciting panic among
common people and creating an unnecessary social influence, we
represent more than a thousand investors, more than a thousand
families, in asking for a resolution.”
Hebei Financing stopped paying out on all loan guarantees in
January, when its chairman was replaced and another state-owned
group was appointed as custodian.
Though Hebei Financing guaranteed loans underlying WMPs, the
products themselves did not guarantee investors against losses.
Caixin reported that several trust companies, fearing reputational
damage, have used their own capital to repay investors.
The 11 groups behind the recent letter have taken a different
approach, pressuring the government for a rescue.
There a few things to note here. First, the reason the underling
assets are going bad is because WMP investors' money was funneled
into real estate development and all manner of other parts of the
economy which are now struggling mightily. Second, the idea that
China should allow for defaults on trust products is nothing new.
In fact, we've been saying just that for
at least a year. Finally, and perhaps most
importantly, the banks' playing of the social instability card
underscores an argument we made when China's equity market was in
the midst of its harrowing plunge last month. In "
Why China's Stock Collapse Could Lead To
Revolution" we warned that "it is only a matter of time before
all the 'nouveau riche' farmers and grandparents see all their
paper profits wiped out and hopefully go silently into that good
night without starting mass riots or a revolution."
Yes, "hopefully", but maybe not because as is becoming
increasingly clear by the day, simultaneously micro managing the
stock market, the FX market, the command economy, the media, and
just about every other corner of society is becoming a task too
tall even for the Politburo and sooner or later, something is going
to break and shatter the "everything is under control"
narrative.
Whether or not the catalyst for widespread social upheaval will
be a catastrophic chain reaction in the shadow banking system we
can't say for sure, but as FT reminds us,
technical defaults on trust products have in the past been
met with "public protests by angry investors at bank
branches."
Here's a snapshot of WMP issuance (note the durations as it
gives you an idea of what kind volume we're talking about on
maturing products):
As you might have noticed from the above, it appears that
maturity mismatch could be a real problem here. Here's what the RBA
had to say about this in a
bulletin dated June of this year:
A key risk of unguaranteed bank WMPs is the maturity
mismatch between most WMPs sold to investors and the assets they
ultimately fund. Many WMPs are, at least partly, invested in
illiquid assets with maturities in excess of one year, while the
products themselves tend to have much shorter maturities; around 60
per cent of WMPs issued have a maturity of less than three
months(Graph 5). A maturity mismatch between longer-term
assets and shorter-term liabilities is typical for banks’ balance
sheets, and they are accustomed to managing this. However, in the
case of WMPs, the maturity mismatch exists for each individual and
legally separate product, as the entire funding source for a
particular WMP matures in one day.
This results in considerable rollover
risk.
In other words,
the WMP issuers
are perpetually
borrowing short to lend long.The degree to which this is
the case apparently varies depending what type of WMP (or trust
product) one is looking at, and we will mercifully spare you the
breakdown of the market by type (other than to include the pie
chart shown below), but the important thing to note here is that
it seems highly likely that at least CNY8 trillion in WMPs
are exposed to the "considerable rollover risk" mentioned
above.
Allow us to explain how this could end. If China allows a
state-run guarantor like Hebei Financing Investment Guarantee Group
(the subject of the FT article cited above) to go broke and that in
turn triggers losses for investors in WMP products, demand for
those WMPs will dry up - and right quick. If that happens, WMPs
will stop rolling, freezing the market and triggering a cascade of
forced liquidations of the underlying (likely illiquid)
assets.
It's either that, or China bails everyone out. As the RBA
concludes, "a key issue is whether the presumption of implicit
guarantees is upheld or the authorities allow failing WMPs to
default and investors to experience losses arising from these
products."
And while that is certainly
akey issue,
thekey issue is what those investors will do next.