It’s time to let China’s wealth management house of cards fall apart. A potential US$500 million default at China Credit Trust (CCT) next week is the perfect place to start.
The 345 investors that bought CCT trust products through Industrial and Commercial Bank of China (ICBC) in 2011 aren’t sitting on buried treasure. Rather, the underlying assets for those products are a few dilapidated coal mines in Shanxi province. The price of coal has dropped 40% since a group of hungry investors poured their cash into the trusts, a form of wealth management product (WMP). The plant and equipment at the mine have also no doubt fallen in value.
CCT, a major trust firm, is now trying to liquidate the coal operation, Zhenfu Energy Group, in an attempt to pay back investors. The product, which carried a 10% investment return, matures on January 31. Zhenfu Energy is tied up in lawsuits and hasn’t been in operation since 2012. Needless to say, without a bailout from above, there will be little for investors to collect on the due date, the last day of China’s lunar calendar, usually a time for celebration.
A bailout is not out of the question. When a US$22.5 million wealth product sold by Huaxia Bank defaulted in December 2012, the guarantor of the product, Zhongfa Investment Guarantee, paid back 91 investors, giving the risk-laden industry, which by that time had an estimated US$1 trillion value, an implicit guarantee.
The industry has grown rapidly since then, to an estimated US$1.5 trillion at the end of June. The stakes have been raised with CCT’s US$500 million impending default.
This time around, it’s unlikely ICBC will get behind the toxic products. China’s biggest bank told the media late last week that it has no plans to bail out the investors. If regulators such as People’s Bank of China and China Banking Regulatory Commission don’t lean on ICBC, an institution that could pay out the cash without flinching, that will signal the start of the end for an industry that should have never grown to the size it is today.
Policymakers at the top might even let that happen.“We believe that the regulators and government would probably allow the trust product default because … the government appears fairly determined to reform the financial system and instill proper risk pricing so there is a decent chance for this to happen,” Barclays Research said in a note.
Unlike the Huaxia case, investors in CCT don’t appear to be short on cash in the first place. Because the default is unlikely to put anyone out on the street, the government will be more likely to allow a default, Junheng Li, head of research at JL Warren Capital, wrote to clients.
“Wealthy investors are less likely to protest so there would likely be less social impact,” Barclays said.
By doing so, the government would paint a very clear picture that many of the gold mines that investors thought they were sitting on are actually shabby coal pits.
A default at CCT could just be the beginning of a complete shake up of the industry, Lu Ting, China economist at Bank of America Merrill Lynch, said in a note.
“We do believe the chance of trust product defaults is to rise significantly in 2014 as about a third of the outstanding [US$760 billion] trust loans will mature this year, while a more confident government with successful power consolidation in 2013 sees the need to break the so called ‘implicit guarantee’ on trust and bond products,” he said.
This is exactly what the central government needs to do. It would be doing everyone a favor by putting its foot down sooner rather than later on an industry that has channeled investors’ hard earned cash into bottomless pits.