$500 million default in China

[karluk]

Looming $500 million default to test China's banking system - Jan. 24, 2014

A high-yield investment product offered by China's largest bank is facing imminent default, an event that will cost investors millions and raise questions about the country's banking system.

The doomed 3 billion yuan ($500 million) trust -- cheerfully named Credit Equals Gold #1 Collective Trust Product -- is expected to go belly up at the end of January, the victim of a soured loan to a troubled coal mining company.

The trust, which promised investors a 10% return, was issued by China Credit Trust Company and marketed by Industrial and Commercial Bank of China, a state-owned enterprise that is among the largest and most profitable banks in the world.

Investors are now scrambling to figure out whether a bailout from the issuer, bank or government will materialize. Meanwhile, outside observers are watching to see how China handles the potential default of an investment product generated by the country's shadow banking system -- a rapidly growing but opaque part of the financial system.

 

[Fermion]

$500 million? That is peanuts to China. They probably spend that much on rice at the Foxconn factory per day.

 

[jon-nyc]

I wonder what the exposure of western banks is.

 

[Midpack]

If JP Morgan can lose $6-7B plus fines on the London whale and still easily be net profitable, $500M is probably a "bad day" for China's banking system in the grand scheme of things...

 

[Spanky]

$500 million? That is peanuts to China. They probably spend that much on rice at the Foxconn factory per day.

+1 - a drop in a big bucket.

 

[karluk]

$500 million? That is peanuts to China.

Perhaps, but if I had to take a stab at quantifying it, I would call it a "5% hit" rather than "peanuts". That, at least, is the overall drop in the China ETF, FXI, since the news broke.

To be honest, however, I know next to nothing about the Chinese economy and don't actually have any idea if this default is being perceived over there as the primary cause of the sharp drop in Chinese stocks. I am hoping that some of our members with more connection to China will weigh in on what is going on over there.

 

[samclem]

Maybe this will be a good indication of the state of free enterprise in China. If the default is allowed to occur in an orderly manner and investors take their lumps while any true malfeasance/deception is handled fairly in the courts, it will indicate China is making strong and continued progress toward free economic markets. If, on the other hand, the government jumps in and rescues favored constituencies while making everyone pay for the losses, then their future is less bright (but they won't be alone).

 

[Texas Proud]

I agree that the amount is a drop in the bucket...

But, I think that what people are watching is will the gvmt come to bail out the investors or let them take the loss... IOW, will they allow more capitalism...

 

[Chuckanut]

If China goes down it will take the whole world with it.

Just kidding...

However, if I was a business owner that depended entirely on Chinese factories to make my products, I would seriously be considering diversifying production, ASAP.

 

[clifp]

Maybe this will be a good indication of the state of free enterprise in China. If the default is allowed to occur in an orderly manner and investors take their lumps while any true malfeasance/deception is handled fairly in the courts, it will indicate China is making strong and continued progress toward free economic markets. If, on the other hand, the government jumps in and rescues favored constituencies while making everyone pay for the losses, then their future is less bright (but they won't be alone).

+1 that seems to be the interesting question. Although given the state of crony capitalism in the world, I suspect that bailing out the favored investors is actually the expectation.

 

[traineeinvestor]

The Chairman of ICBC (which sold the products to investors) has said publicly that ICBC will not compensate investors for their losses. Whether ICBC can stick to this under rumoured political pressure to avoid unrest is another matter.

The larger concern is not that this particular product goes into default but that there are lot of similar products out there.

The other issue which was used to explain the fall in HK/China markets last week was the latest HSBC FLash PMI falling to below 50 (indicating a mild contraction in manufacturing activity).

 

[karluk]

The Chairman of ICBC (which sold the products to investors) has said publicly that ICBC will not compensate investors for their losses. Whether ICBC can stick to this under rumoured political pressure to avoid unrest is another matter.

The larger concern is not that this particular product goes into default but that there are lot of similar products out there.

The other issue which was used to explain the fall in HK/China markets last week was the latest HSBC FLash PMI falling to below 50 (indicating a mild contraction in manufacturing activity).

Thanks for your input, traineeinvestor. I think you're right that the concern is not over this one trust. As others have noted, it's too small to threaten an economy as big as China's. But from what I've been able to glean online, there are between $2 and $3 trillion in similar loans in China's so-called "shadow banking" system. That's a huge amount by anyone's standards. The concern is doubtlessly that many of these loans will also default and leave investors with huge losses that won't be made good. That's the kind of prospect that can lead to widespread panic and a freeze in the credit markets.

All in all, a very interesting story that has yet to be played out. I'll try to monitor it as it develops.

 

[traineeinvestor]

Update: it looks like investors are to be bailed out and will be given an opportunity to sell their investments for an amount equal to principal (i.e. they will only lose their interest). It is not clear who is writing the cheques.

 

[brewer12345]

I have no real opinion on the trust, the implications of a default or bailout, or anything to do with China's economy. But you have to love the name of the trust. I mean, "Credit Equals Gold #1 Collective Trust Product" - if an American author made up that name on their own they would be shouted down as racist.

 

[samclem]

But you have to love the name of the trust. I mean, "Credit Equals Gold #1 Collective Trust Product"

The label can be key.
"You have to remember that these hedge funds have very good names." (at 5:35)Bird and Fortune - Subprime Crisis - YouTube

 

[robnplunder]

+1 - a drop in a big bucket.

But methinks there will be more drops ....

 

[karluk]

Update: it looks like investors are to be bailed out and will be given an opportunity to sell their investments for an amount equal to principal (i.e. they will only lose their interest). It is not clear who is writing the cheques.

The reports I've seen indicate that some anonymous third party has stepped in to repay principal but not interest. This strikes me as being really bad for everybody except the investors whose money is being repaid. What is the banks' responsibility for promoting high risk investments that may go sour? How much risk are investors taking on if other trusts default in the future? Nobody knows because nobody knows who stepped up this time and how deep their pockets are or how likely they are to be willing to fund additional bailouts.

 

[karluk]

This is the first article I've seen about possible defaults in China's shadow banking system since the $500 million trust was bailed out in January. Then, as now, the trust in danger of default is relatively small, but attracted attention because of the potential of being a harbinger of many more troubled loans coming due in the future. We'll see how this one is handled.

China has just settled a high-profile failure of one shadow-banking product and already another has emerged, with analysts expecting a wave of potential defaults ahead.
"We definitely expect to see more trust-related products souring through 2014 and maybe next year as well," with the difficulties likely coming from stressed industries, such as coal, as the economy slows, said Ruta Cereskeviciute, senior economist at consultancy IHS.

Get ready for more China shadow-banking defaults - Yahoo Finance