A narrow escape from default of the USD495 million of the trust fund, organized by the ICBC for the Shanxi Zhenfu Energy Group in the last week of January, is not the end of the troubles for other trust funds, writes shadow banking expert Sara Hsu in The Diplomat. “A liquidity crisis might expose more problems.”
A little publicized document called the “Trust Industry Risk Assessment Report,” released by Shanghai Jiaotong University, expands on these conclusions. After conducting stress tests on 60 trusts, the report found that solvency risk is relatively low, but that liquidity risk may present a real problem. The report also found that trust products are not priced for risk of the underlying asset. This, coupled with rapid expansion of the trust industry and with an implicit payment guarantee, has heightened the risks associated with trust products.
The report does not mention the types of loans that trust products are based upon, and this is also a rising concern. Some of the trust loan defaults have been based on loans to the coal industry, which has declined in profitability. A full third of trust loans have been extended to the real estate or infrastructure construction industries, which have experienced price bubbles and low levels of occupancy. Growth in these sectors is expected to decline in 2014. With these reversals, the credit risk associated with trust loans will only rise.
All of these risks in fundamentals add to growing concern about China’s trust sector. This, coupled with a lack of regulation, and absence of risk control departments in most trust firms, sets the stage for a potential trust industry failure. Such an event may be triggered by an overall reversal in consumer sentiment—should households stop buying trust and wealth management products that contain these trust loans, the maturity mismatch inherent in the trust lending process (borrow short from households and lend long to firms) may truly present a problem. A liquidity crisis in the trust sector will expose some of the risks that have been covered up by steady income streams, and then these unregulated entities may face a final collapse.