Trust Disaster Unfolding In Sichuan

Large potential trust defaults looming in the next year have grabbed the headlines, but these defaults may pose no systematic risk, even if they eventually end up on a bank's balance sheet. The greater risk may lie with the credit guarantee firms that have backed trust and bank loans in many areas. Consider the situation unfolding in Sichuan, where a credit guarantee firm is at the heart of multiple trust products that consist of loans to small and medium enterprises (SMEs). These loans were marketed as 80% prime and 20% subprime, but in one trust 80% of the loans are in default. In this situation, instead of one big borrower going bust and putting a trust in default, there are hundreds of firms involved across multiple trusts. Dozens of lawsuits are underway from the one trust that matured in August 2013; potentially hundreds loom if ensuing trusts fail at the same rate. These court cases will chill business activity and since many loans are in the same geographic area, the potential for systematic risk in local economy is higher, even though the trust amounts are much smaller and the individual loan amounts yet smaller still.

China Fortune International Trust and Jingu International Trust have made many trust loans cooperating with the Hopeto Credit & Guarantee Co (Huitong), a firm which is now in the process of being rescued by the government. Dozens of loans from a single trust, Sunflower SME Loans No.3 issued by Jingu, have gone bad and Jingu has sued dozens of borrowers in addition to credit guarantee firms that guaranteed the loans (see prior posts for background). That trust came due in August 2013, long before Huitong went bust. With the credit guarantee firm now in trouble, the problem could grow exponentially. The executives of Huitong are missing since July 6. The company (with help from the government) is working to gain the support of banks and creditors, discover the extent of the problem, and to gradually reduce risk.

One trust in question is Fortune's Xinhui SME Loan No.2, issued in February 2014, with ¥57 million in SME loans and a yield of 9% to 9.6%. The loans were secured by Huitong and Huitong guarantees investors' money should the loans go bad.

A manager of a credit guarantee firm explains that the trust companies became vehicles for excessive risk taking and leveraging. Credit guarantee firms became the lead actors: they issued the loans to the small borrowers who should not have had access to credit obtain trust loans, while the trust company handled fund raising. He also said that this is seldom seen with government credit guarantee firms, but often seen with private firms. The loans have costs of 16-18% (interest plus fees), with 12% going to the trust company and about 4% to the credit guarantee firm.

There are other trusts at risk. Fortune also issued Xinhui SME Loan No.1, No.3 and No.4. Except for No. 3 issued at the end of 2013, the others were issued in the first half of 2014. The last, No.4, was established on June 13 with ¥178 million in assets. As for No. 1 and No. 4, they are 80% prime loans and 20% subprime, with Sichuan Jingda Hengying Investment Management guaranteeing the subprime portion. Huitong is guaranteeing the rest. The 80/20 split is no consolation for investors. Only 20% of the loans in the Sunflower SME Loans No. 3 have been repaid and that trust launched in 2012 with the same 80/20 split. If the characteristics of the credit bubble in the U.S. has any similarities, the failure rate of more recent trusts is likely to be even higher. Along those lines, Sichuan Jingda Hengying itself was recently established in September 2013 with ¥50 million in capital.

Another trust in question: Sunflower SME Loans No.9, a 12-month trust that loaned ¥102 million to 13 SMEs in Chengdu, comes due on August 2. Another: Sunflower No.15 which came due in June and like Sunflower No.3, made loans to firms in Zhejiang, epicenter for the current real estate slowdown and an area experiencing an economic slowdown. Many firms there face tight credit conditions and business difficulties; there's no news on the repayment of those loans.

Yet another: Sunflower No.1 which made ¥250 million in loans to companies in Foshan, Guangdong province. Supposedly the split there was 90% prime/ 10% subprime. The adviser on those loans is Cinda (1359.HK).

Cinda owns 92.29% of Jingu Trust.

Source: 中小企业信托风险信号:华鑫、金谷信托接连卷入担保危局

Prior coverage: Largest Privately Run Credit Guarantee Firm in Sichuan Goes Bust
Credit Slows With Private Credit Guarantee Firms Under Pressure in Sichuan
Guarantee Companies Behind Sunflower 3 Trust Bad Debts

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