China Braces for $38 Billion in Losses in Troubled Trust Sector

China’s $2.9 trillion trust industry is emerging as yet another threat to the world’s second largest economy.

(Bloomberg) — China’s $2.9 trillion trust industry is emerging as yet another threat to the world’s second largest economy.

After being restructured at least six times since its inception in 1979, the sector is facing another round of losses that Goldman Sachs Group Inc. analysts say may swell to the equivalent of $38 billion. Private wealth giant Zhongzhi Enterprise Group Co. and its affiliate Zhongrong International Trust Co. have halted payments on scores of high-yield investment products since last month, even sparking rare protests in Beijing.

Zhongzhi’s size — it manages more than 1 trillion yuan ($137 billion) — and its interconnectedness with wealthy investors, struggling developers and other financial institutions has spurred concern that troubles are beginning to cascade in the broader financial industry.

“There’s going to be a dangerous dance going on between the shadow banks and the banks themselves,” Andrew Collier, managing director of Orient Capital Research, said in a Bloomberg TV interview. “And that’s going to play out in the second half of this year and it’s going to be very messy.”

Here’s the trust industry by the numbers:

Still Large

Chinese trusts have been under pressure after regulators began clamping down on the nation’s shadow-banking excesses six years ago. The industry peaked in 2017, and has since shrunk by about 24%. Still, the industry looms large, with its size equal to almost a fifth of China’s economy. 

Investment Mix

Trusts pool money from clients and invest them into a variety of instruments and projects. About 7.4% of trust companies’ funds are invested in real estate-related assets as of March. That may undercount the sector’s exposure since it’s not clear to what extent other investments like bonds and equities are also tied to the property sector. 

There is also an even more opaque part of the shadow banking business: the trust firms private lending to developers. It’s likely trust companies had about 1.6 trillion yuan of credit exposure to the property sector at the end of march, according to Goldman Sachs estimates.

Rolling Defaults

Property-linked products have accounted for more than 70% of the defaults in recent quarters. The nation’s property developers are mired in a slump with former giants such as China Evergrande Group defaulting on their debt as home sales and prices decline. 

Higher Yields

Trust firms have been able to attract money despite their risks because of the higher returns promised to clients. The average yield for a trust product with a maturity date within 2 years was 6.6% in July, compared with the benchmark 1.5% one-year deposit rate paid by banks.

The Maturities

Authorities have had some success in trying to corral the industry since 2017, but the current blowups could be at least the beginning of the end of the most aggressive practices in the trust industry. 

As turmoil swirls, trust firms have billions of payments due to investors. Zhongrong Trust alone has 270 products totaling 39.5 billion yuan due this year, according to Use Trust. Still, it is only ninth largest. 

The Biggest

“The Zhongrong saga is the end of a chain reaction that began with China’s property tightening,” Raymond Yeung and Xing Zhaopeng, economists at Australia & New Zealand Banking Group Ltd., wrote in a note. “As property woes worsen, China will likely see more defaults in its financial ecosystem.”

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