ICBC trust product default not a harbinger of bigger problems
Investors are increasingly asking themselves whether the recent problems with an ICBC trust product may be the harbinger of bigger problems for the banks sector or even the broader economy. Our view is that headline risk remains the primary risk as authorities continue moves to curb the shadow banking industry.
China banks have been under pressure as international media has reported that a trust product distributed by ICBC will probably default when due on 31 Jan. ICBC has announced that it will not bail out the product. Notably, this news has been well covered in the domestic media for several weeks. The trust product raised Rmb3bn in 2011 for the Shanxi Zhenfu Energy group, a coal miner that subsequently collapsed. Our understanding is that, in line with most such products, ICBC is under no contractual obligation to bail out the product.
What We Think
Headline risk from more trust-loan type products getting into trouble is the main risk, as authorities continue to slowly curb some shadow banking activity. That is, we expect similar cases to emerge in the months ahead. In our view, the trust credit sector (in the forms of trust loans, long-term equity investments and leasing) in isolation is too small (9.87% of GDP) and too fragmented (average of 1,703 products issued per month during 9M13) to create systemic risk. In addition, most of the credit in the trust sector is probably intermediated outside the fractional reserve banking model, and hence any default is unlikely to have a domino-effect on other parts of the financial system. ICBC’s tough stance, very likely with the acquiescence of regulators, further suggests that banks will not be on the hook if these investment products go sour. We believe the biggest risk lies in indirect linkages between the banking and shadow banking systems. For example, some borrowers borrow money cheaply from banks and invest in higher yielding trust products (interest rate arbitrage) according to our anecdotal information.
What You Should Do
In spite of the headline risk, we continue to have an Overweight rating on China banks with ICBC one of our top picks. The sector is trading at 0.8x FY14 P/BV for 18.7% ROE and 4.6x FY14 P/E for 6.9% EPS growth and yields 7.1%.
local media for several weeks and only shot to international prominence over the past week. The details, as far as we know, are as following:
1) The trust product was established by China Credit Trust (non-listed) on 1 Feb 2011 with a maturity of three years. A total of Rmb3.03bn was raised and invested in Shanxi Zhenfu Energy group (non-listed), a coal miner, as long-term equity investment.
2) Rmb 3bn was distributed by ICBC to its customers and Rmb 30mn was purchased by the actual controllers of Shanxi Zhenfu Energy group.
3) Zhenfu Energy planned to use the money to purchase a coal mine, build coal-washing plants and upgrade existing facilities. After the investment, Zhenfu Energy’s total assets reached Rmb6.9bn, with total equity of Rmb4.14bn at the end of 1H11. By the end of 2011, Rmb2.55bn had been used by Zhenfu Energy and Rmb0.48bn was left in the custodian account.
4) Zhenfu Energy owned 5 coal mines and 1 coal-washing plant. Equity in Zhenfu Energy and 2 subsidiaries (non-listed) was used as collaterals. In Jun 2012, China Credit Trust reported that Zhenfu Energy got involved in several court cases. Equity in one coal mine and two subsidiaries was transferred to China Credit Trust as collaterals, but the transfer of other collateral was blocked by the local court.
5) The expected annual yield of the whole product is 10%, with a minimum expected annual yield of 9.5%/10%/11% for its Class A/B/C preferred beneficiaries.
Publish date: 21/01/14