As we showed over the weekend [8], it is abundantly clear that for all the talk of reform, Chinese authorities have found the gap between words and deeds uncrossable. First, Chinese authorities bailed out the relatively small CEG#1 Trust (for fear of contagion) [9]; second, the PBOC injects CNY 375 bn into short-term repo to save banks from a liquidity crisis at year-end; third, total social financing rose by the largest amount on record in January (despite all the talk of deleveraging following the Plenum); and now, fourth, thanks to a CNY 2bn loan (to an entirely insolvent coal company), Chinese authorities have bailed out a 2nd wealth-management product [10] - this time even smaller.
We noted the "technical default" of Jilin Trust last week [10], and despite its de minimus size, China Development Bank loaned CNY 2bn to the verge-of-bankruptcy Liansheng coal company [11], and thus bailed out investors in the trust - piling on the moral hazard.
The Jilin Trust default, as we noted last week, was the second notable 'technical' default among Chinese wealth management products recently and caused consternation among investors:
Investors in the Jilin Trust product are demanding that CCB also take responsibility for compensating investors, 21st Century Business Herald reported on Friday.
Bankers have warned that China's lenders are exposed to vast swathes of loans extended by their non-bank partners and sold to bank clients as off-balance-sheet wealth management products. Though banks are not legally responsible for repaying investors in such cases, they may face pressure to do so in order to maintain their reputations and uphold social stability.
"A few days ago, we went looking for CCB. CCB's leader in Shanxi still says it's not his responsibility. In the end, if they really don't take responsibility, we'll go to CCB and fight a war to the last drop of blood," the paper quoted an unnamed product investor as saying.
Investors told the paper that all paperwork and fund transfers related to their purchase of the Jilin Trust product had occurred on CCB's premises and CCB sales staff had verbally assured investors that the product carried no risk. They also said their willingness to invest was based on their confidence in CCB as a large state-owned bank.
And so what do the Chinese authorities do? Instead of letting a small trust face actual losses, they do what JPMorgan warned would "amplify future losses" [12]...
Via Bloomberg,
China Development Bank lent 2b yuan to coal company Shanxi Liansheng, which owes almost 30b yuan to lenders including banks, trusts and asset management firms, 21st Century Business Herald reports, citing unidentified people.
The policy bank is the co.’s largest creditor, with 4.51b yuan in outstanding loans, the report says
The loan will be used to repay maturing trust products sold to retail investors: report
Three local firms will also pay 3b yuan to buy 50 percent of Liansheng, which is based in the northern province of Shanxi, the report says, without identifying cos buying stake
Funds from the stake sale will also be used to repay maturing trust products: report
Repayment of bank loans and single trusts will be delayed
Liansheng, the largest private coal miner in Shanxi, is owned by Chinese entrepreneur Xing Libin, according to the report
Liansheng borrowed more than 5b yuan through 6 Chinese trust firms including Jilin Province Trust and Chang’an Trust, China Securities Journal reports separately, citing unidentified people.
As a reminder, this is what one analyst said of the Chinese coal industry that just got yet another bailout:
Shares of China’s biggest listed coal producers have dropped to their lowest valuations on record as falling fuel prices make it harder to repay debt.
[13]
China’s coal industry is “dead,” said Laban Yu, a Jefferies Group LLC analyst in Hong Kong with an underperform rating on all three stocks. “There are 10,000 producers in China. A lot of them are taking on debt. It gets harder and harder to service debts when coal prices keep falling.
Of course, it's not over yet - as the following chart shows, there are a lot more "maturing" trusts to come in the next 3 months alone...
[14]
Allowing investors to be bailed out merely exacerbates the risk-taking mentality and solidifies a belief in a government back-stop (to 10%-yielding highly risky loans to an insolvent industry!!)...
As we previously noted, [15]
...borrowers are facing rising pressures for loan repayments in an environment of overcapacity and unprofitable investments. Unable to generate cash to service their loans, they have to turn to the shadow-banking sector for credit and avoid default. The result is an explosive growth of the size of the shadow-banking sector (now conservatively estimated to account for 20-30 percent of GDP).
Understandably, the PBOC does not look upon the shadow banking sector favorably. Since shadow-banking sector gets its short-term liquidity mainly through interbanking loans, the PBOC thought that it could put a painful squeeze on this sector through reducing liquidity. Apparently, the PBOC underestimated the effects of its measure. Largely because Chinese borrowers tend to cross-guarantee each other’s debt, squeezing even a relatively small number of borrowers could produce a cascade of default. The reaction in the credit market was thus almost instant and frightening. Borrowers facing imminent default are willing to borrow at any rate while banks with money are unwilling to loan it out no matter how attractive the terms are.
Should this situation continue, China’s real economy would suffer a nasty shock. Chain default would produce a paralyzing effect on economic activities even though there is no run on the banks. Clearly, this is not a prospect the CCP’s top leadership relishes.
So the PBOC's efforts are merely exacerbating the situation for the worst companies...