Zhongrong opens offshore funding channel for China’s shadow banks

SINGAPORE, June 11 (IFR) – By selling what market sources say is the first offshore bond from a Chinese trust company, Zhongrong International Trust has opened a new funding route for the country’s shadow banks as they look to expand overseas.

Zhongrong, China’s second largest trust company in asset terms, issued a US$225m three-year bond on Monday at par to yield 6%.

While an order book of US$575m from 64 investors is far from a blowout response, it gives China’s trust sector a foothold in the international capital markets.

“Not everyone in the market is built for this,” said one source close to the deal. “People either had a problem with the overall business or they could get comfortable with it.”

Trust companies have played a big part in the rapid expansion of shadow banking since 2008, by packaging bank loans into wealth-management products or acting as trustee for products originated by banks. Growth slowed last year amid heavy criticism of lending standards, and some investors had questions about safeguards Zhongrong had put in place to protect against rising default rates in China’s slowing economy.

Zhongrong had extended loans to Shanghai Chaori Solar Energy Science and Technology, which last year became the first company to default on a domestic Chinese bond.

“People who know the company well are comfortable enough, so it’s really catering to Chinese investors,” said one investor. “For the amount of work I have to do to examine the company, I would want 9%.”

Almost half of the bonds went to private bank investors. There were strong anchor orders from China, with Asia accounting for 95% of the Reg S deal.

Overseas expansion

While Zhongrong has said the proceeds will be for general corporate purposes, expectations are that it will use the funds to invest in overseas assets, joining the crowd of Chinese companies heading to the international markets.

As the first deal of its kind, it was tough to find relevant credits for price comparison. Three Chinese asset-management companies have issued US dollar bonds, but all those deals are rated three to four notches higher than Zhongrong and trade around 300bp tighter.

While China’s banks benefit from expectations of support from the government, it is not clear if trusts would benefit from state or parent support.

Standard & Poor’s did not factor in state support in calculating Zhongrong’s BB rating.

“The track record of the Chinese Government providing support to trust and investment companies is quite poor,” said Qiang Liao, senior director, financial institutions ratings at S&P, noting that China was trying to break the habit of saving investors from losses.

In 1998, state-owned Guangdong International Trust & Investment Company defaulted on its international debt, rocking investors’ expectations that the government would honour its obligations.

Since 2001, the government has introduced comprehensive new regulations. As a result, the new wave of trust companies are very different from the old ones, which used to make much of money from the spread business – borrowing to lend at a higher rate – something that is no longer allowed.

Trust companies may face pressures from customers to make them whole if there are defaults in the actively managed products they originate.

“Trust companies are under no legal obligation to provide support, but may do so for reputation and future business considerations,” said Harry Hu, associate director, financial institutions ratings at S&P.

On the other hand, responsibility may ultimately fall on the banks that originate the products. After a high-yield trust product that China Credit Trust issued ran into difficulties last year, its originator, ICBC, agreed to repay the principal to investors that had bought it through the lender’s wealth management division, though only after heated complaints of clients.

Tighter risk management Trust companies have been under pressure to improve their risk management processes. They do their own due diligence when they originate a deal and some now record conversations with their customers to show that the risks have been made clear.

Some are now venturing offshore to expand their product offerings, which could lead to more international fundraising. Brokerages like Haitong Securities have been expanding into overseas assets and are now competing for Chinese wealth-management clients, making it important for trusts to deliver a wide range of products.

Trust companies are not expected to be big issuers of bonds as their debts are capped at 20% of net assets. They can also access onshore money markets at a cost of around 4%-5% for one-year debt.

Zhongrong has total assets of Rmb12.2bn (US$2.0bn) and assets under management of Rmb710.6bn. Total assets under management in the Chinese trust industry grew to around Rmb14trn last year from around Rmb3trn in 2010.

According to the China Trustee Association and S&P, most trust products are single-fund trusts, which are typically based on loans. Around a third are collective-fund trust programmes, which can include loans, asset-backed securities, equities or even art works, while asset rights trusts, based on land and infrastructure investments, make up the remainder.

Huatai Financial Holdings (Hong Kong), Barclays, DBS and Haitong Securities were joint bookrunners for Zhongrong’s deal. The issuer of the bonds is Zhongrong International Bond 2015 and the guarantor is Zhongrong International Holdings, with Zhongrong International Trust providing a keepwell deed.