China’s financial sector may be hit by Zhongrong’s missed payments

The ongoing property sector downturn poses a larger risk for the trust industry.

Missed payments on a few maturing trust products by a Chinese trust company is triggering concerns for contagion risk on the broader banking sector, but effects should be limited, said S&P Global Ratings.

In mid-August, reports emerged that Zhongrong International Trust has missed payments on a few maturing products. This follows speculation that its second largest shareholder, Zhonzhi, also missed payments on some products sold to retail investors through its wealth management arm.

S&P noted that these events were remnants of old practices which Chinese regulators have reported phased out from the trust industry.

“We believe further that the type of trust sector products that are coming under pressure represents just a fraction of assets in the financial system, and that contagion risk to the broader banking sector is limited,” the ratings agency said in a commentary.

The investment products involved are those that regulators have pushed out in a revamp of rules governing asset managers way back in 2018, noted S&P Global Ratings credit analyst Yiran Zhong. These legacy shadow banking activities make up just RMB3t of the neary RMB400t assets within China’s banking system.

“While at-risk assets could continue to accumulate amid prolonged weakness in the property sector, we view contagion risk as manageable,” Zhong further noted.

Regulators gave the industry an extended grace period to exit certain investment categories. Trust companies were noted to have been generally slower to clean up noncompliant instruments, likely because they have been granted an extended grace period to exit certain product categories. 

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“We assume the trust companies will still face pressure to repay customers for failed investments of actively managed trust products that function as loans,” Zhong added.

More defaults possible
Whilst contagion risks should remain contained, the trust sector still faces trouble should the property market downturn persist.

“A prolonged property market downturn would likely trigger more defaults of some risky products, but we view this risk as manageable,” Zhong said, noting that the trust industry’s property exposure has dropped to under 5% of assets under management or RMB1.1t in the first quarter of 2023, from a peak of RMB2.9t in 2019.

"What we are seeing is the last gasp of risky practices in the trust sector, which the regulator has explicitly banned for years," said Zhong. "Events may serve as a welcome reminder to the trust sector to exit these product categories, and to investors that they are ultimately responsible for their risks."