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Moody’s abruptly cut its credit outlook for China this week, reinforcing concerns that the crisis in the country’s real estate market is spilling over into the wider economy.
Analysts say China is not experiencing a “Lehman moment”, although the risk of contagion is rising, especially from losses in so-called shadow banks. global financial crisis.
Still, investors outside China should exercise caution because of the implications for China’s growth, said Larry Hu, chief China economist at Macquarie Group.
“The current real estate downturn has been the biggest hurdle for China’s economy in the past few years, and it’s also the biggest tail risk at the moment,” he said, pointing to what is unlikely to happen but could still happen. Mentioned.
Of particular concern is the ripple effect on the shadow banking sector, a huge and mysterious part of China’s financial landscape.
The industry is worth about $3 trillion at its narrowest definition and $12 trillion at its most. If you have asset management products or consumer finance, include, Two major companies have been in the spotlight in recent months for failing to pay investors. Both companies have significant exposure to the real estate market.
Zhongzhi Enterprise Group, China’s largest financial conglomerate, declared bankruptcy last month after failing to make payments on dozens of investment products. The company is currently at the center of a criminal investigation by police.
Two weeks after Zhongzhi revealed his financial problems, Chinese state media reported that Hangzhou investment and asset management company Wanxiang Trust was delaying hundreds of millions of dollars worth of payments on a number of investment products.
Shadow banking “meltdown”
Following problems with two investment companies, there are growing concerns about the risk of financial spillover to investors who do not directly purchase homes due to the worsening slump in the real estate market. Giant developers such as Evergrande and Country Garden defaulted on their debts.
“Shadow banking has generally been an important source of funding for real estate developers, but the collapse of private developers is now shaking up the shadow banking sector,” said Brock Silvers, chief investment officer at Kaiyuan Capital in Hong Kong. Stated.
Shadow banking refers to financial activities that take place outside the traditional banking system.
In Europe and the US, financing from private equity firms and hedge funds is often involved. In China, various forms of financing activities are involved, including banks. Common forms of shadow banking include the use of wealth management products, trust products, or entrusted loans.
Mr Silvers said problems affecting shadow banks were likely not limited to Zhongzhi Bank and Wanxiang Bank, adding: “A broader meltdown could occur.” [in the industry] It seems imminent. ”
Stringer/AFP/Getty Images
This aerial photo taken on November 27, 2023 shows fog hanging over a house in Wuhan, central China’s Hubei province.
On Tuesday, shortly after Moody’s announcement, S&P Global Ratings said spillover effects from China’s real estate industry could ripple through the economy through losses for banks and other financial institutions, or a negative impact on investor and consumer sentiment. I was warned that it was sexual.
The broader shadow banking industry totaled $12 trillion and accounted for 86% of China’s GDP in 2019, according to a report released by the country’s top banking regulator. The report is also the first government report on an opaque sector.
Trust companies, which pool savings and offer loans, have been one of the fastest-growing sectors of shadow banking over the past decade. The industry has become a popular way for cash-starved property developers and local governments to raise capital from millions of Chinese citizens.
According to the China Trust Association, by the end of 2022, the total assets held by trust companies will be 21 trillion yuan ($2.9 trillion), an eightfold increase since 2010.
Defaults in trust investment products, especially real estate-related products, have been increasing over the past two years. According to Chinese data provider UseTrust, real estate trust defaults in 2022 will be 93 billion yuan ($13.1 billion), up slightly from 91.7 billion yuan ($12.9 billion) in 2021.
Zhongrong International Trust, which is partly owned by Zhongzhi, invests about 10% of its funds in real estate, the company said. It has provided loans to several struggling real estate developers, including Evergrande Group and Sunac China, which have also defaulted on their loans.
Wanxiang Trust also has significant exposure to real estate, with 58% of its assets managed in this sector. One of the troubled company’s trust products invests in Kaisa Group, which defaulted on its debts in 2021 and is currently facing liquidation in a Hong Kong court.
Florence Lo/Reuters
The office building of Zhongrong International Trust, a trust company partly owned by Zhongzhi Enterprise Group, in Beijing on August 22, 2023.
A liquidity crunch among trust companies could cause turmoil in local bond markets and put financial pressure on Chinese companies and local government agencies.
Citi analysts said in an August note that trust companies may need to sell more liquid assets in their portfolios, such as corporate bonds and municipal bonds, to prepare for repayments on maturing trust products.
“This could cause a correction in bond prices and hinder companies from raising capital,” they said.
This could potentially lead to debt service challenges and default pressures for facing businesses and certain local government financial institutions. It added that debt payments would be completed in the short term.
The rapid increase in local government debt in China is mainly due to a sharp decline in land sales revenue due to the real estate recession and the effects of prolonged lockdown implementation costs due to the pandemic.
China’s local government debt will reach 92 trillion yuan ($12.9 trillion) in 2022, up 50% from 2019, according to International Monetary Fund data.
Of this debt, $10 trillion is in so-called “hidden debt,” which is typically concentrated in municipal financial institutions and does not appear on government balance sheets, according to an October analysis by research firm Mars Macro. There is a possibility that it will reach nearby.
China’s shadow banks may be in trouble, but they are unlikely to spark a broader banking crisis. Because, according to experts, they are still only a small part of the banking system.
“In my opinion, the recent woes of the shadow banking sector will not lead to a systemic crisis, mainly because the formal banking sector has very limited exposure to these trust companies,” Hu said. said.
“Furthermore, trust products are mainly sold to wealthy investors and not to the general public,” Hu said.
According to Chinese regulations, individuals eligible to invest in trust products must have a minimum net worth of 3 million yuan ($421,793) or an average annual income of 400,000 yuan ($56,239) or more in the past three years. There must be.
Trust assets accounted for just 5.3% of banking industry assets in the first quarter of 2023, according to CNN calculations based on data from the China Trustees Association and the People’s Bank of China.
Trust companies are also reducing their exposure to the real estate market. Real estate trust investment in the first quarter of this year was 1.13 trillion yuan ($159 billion), accounting for 5.3% of total trust investment and 0.3% of banking system assets. The amount decreased by 28% compared to the same period last year.
” [contagion] “The trust industry’s real estate exposure has decreased significantly, so risks are manageable,” said Ming Tan, director at S&P Global Ratings. It added that it did not believe the default would cause a banking crisis.
“This gives the government some latitude for market-based resolutions,” he added.
Analysts also believe the Chinese government will intervene to prevent widespread damage.
Moody’s said last month: “As domestic banks play a quasi-policy role and are majority owned by the state, Chinese authorities have a very strong will to ensure financial system stability despite the downturn in the real estate market. “We still have the ability.”
Governments have a variety of tools they can use to prevent a domino effect, including providing liquidity. to distressed financial institutions, they added.
Last month, Chinese leaders pledged to more systematically address risks and maintain stability across the financial sector.