Kaisa fallout hangs over China trust industry

China analysts are expecting every attempt to be made to avoid the nation's first onshore trust default, with the securities regulator expected to scrutinise the industry more closely in future.

Shenzhen-based (and Hong Kong-listed) developer Kaisa failed to make payments on a bank loan with HSBC earlier this month. It has seen its share price plunge after confirming the government banned it from selling three property projects in Shenzhen. It came amid reports its chairman, Kwok Ying Shing, had been detained by authorities. The company denied this, although the chairman subsequently resigned.

At least 20 financial institutions, including five trust firms, have in recent weeks asked courts in China to grant them ownership protection of Kaisa’s assets. The firms, which have at least 12 products worth Rmb10 billion ($1.6 billion) backed by Kaisa’s projects, are facing default risk.

“This will send a warning to the whole (trust) industry, given the number of products and trust companies involved,” said Shuai Guorang, an analyst at Use-trust, a Chinese online distributor specialising in trust products.

One of the 12 products was issued by Ping An Trust, the trust platform of Ping An Group. The Rmb2.5 billion product was due to mature last week. Reports said Kaisa had failed to make payments, with attempts made to give a third party control of its assets to repay money to investors. 

Ping An Trust confirmed it had trust products backed by Kaisa’s projects. A spokeswoman said Ping An was investigating the situation, but declined to comment further. 

Kaisa’s latest annual report did not disclose its level of financing from trust products. A Kaisa spokesperson declined to comment on how many trust products the company had issued. 

Unlike the bond managers who have suffered a technical default on their holdings in Kaisa’s outstanding $2.5 billion offshore bonds, onshore trust investors are facing a more uncertain future. 

Most of the trust products were distributed to high-net-worth individuals through collective trust programmes, said Shuai. 

There is uncertainty over whether Kaisa will default on these products, but Cao Zhanqing, an analyst at Beijing-based third-party distributor Gesafe Wealth Advisory, noted it was possible for interest payments to be deferred to avoid such an outcome.

He explained that since the trusts are backed by property assets, trust companies tended to look for new buyers for them, which is what happened to the distressed trust of China Credit Trust Company (CCTC) in January last year. 

In fact, this is typically the outcome in distressed Chinese trust products. At least 16 “near-default” cases occurred in China's trust industry last year, but they were either bailed out, restructured or had payments deferred to avoid an actual default, according to Use-trust data. 

“Trust products are the third-largest debt financing channel in China after bank loans and offshore bonds, so it is quite common for property developers to get loans from trust financing,” said Christopher Yip, director of corporate ratings at Standard & Poor's. 

He noted that trust products backed by property projects saw significant growth after 2011 due to the explosive growth of the real estate market and high yields. However, he added many trust firms were now lowering their exposure to the sector as they grew more cautious of the risks. 

Total assets held by trust companies grew 18.7% to Rmb12.9 trillion in the first nine months of last year, while property-backed trust products accounted for 10.38%. The value of newly-issued property-backed trust products dropped 29% year-on-year to Rmb285 billion at the end of 2014, according to Use-trust.  

Trust companies issue products in various sectors, typically dealing in loans based on projects and assets of industrial and commercial enterprises, local government infrastructure projects and property. Both Goldman Sachs Research and S&P have noted that a trust behaves like a bond with a private placement. 

Trust products have become an alternative financing channel over the past 10 years for Chinese companies unable to obtain sufficient capital from the traditional banking system. However, the industry has also become a form of shadow banking, with financial firms' subsidiaries issuing off-balance sheet loans. 

Analysts have been warning that China faced rising risks in the trust industry. But despite there being a number of “near-defaults”, S&P noted that no single actual failure had occurred since 2005 as all the distressed trusts had been bailed out by local governments and trust companies. 

The China Banking Regulatory Commission announced a reorganisation two weeks ago, including the establishment of a division that will supervise the trust industry. The regulator has also set up an insurance fund to act as a safety net in the event of restructuring, bankruptcy, illegal activities or a liquidity shortage.

“The regulator’s actions are intended to curb such uncertainties and risks [such as the Kaisa case], but they could regulate the industry with an even heavier hand,” suggested Shuai.