It Begins… Another High-Yield Chinese Shadow Banking Trust Defaults

While the eyes of the world were focused on the now infamous “Credit Equals Gold #1” Chinese wealth management product – it’s imminent default and last-minute bailout by ‘investors’ unknown – the coal industry in China continued to collapse (as we noted here). We noted at the time how bailing out current high-yield product investors would merely amplify the problems down the line and it seems that Chinese authorities have heard that message. As Reuters reports, a

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.

and the risk of more defaults is not going away – in fact will onkly get worse in the next 3 months!!

For those who have forgotten, below is a quick schematic of what a WMP looks like:

As Michael Pettis, Jim Chanos, Zero Hedge (numerous times), and now George Soros have explained. Simply put –

“There is an unresolved self-contradiction in China’s current policies: restarting the furnaces also reignites exponential debt growth, which cannot be sustained for much longer than a couple of years.”

The “eerie resemblances” – as Soros previously noted – to the US in 2008 have profound consequences for China and the world – nowhere is that more dangerously exposed (just as in the US) than in the Chinese shadow banking sector as explained above.

The bottom-line is that China seems to be testing the reaction of markets to small ‘technical’ defaults (such as this one)…

Technical defaults caused by repayment delays have occurred before, but market watchers say that China’s shadow bank sector is still waiting for a precedent-setting default in which investors are forced to absorb substantial losses.

Such an event could shatter the widespread assumption that even high-yielding investments carry an implicit guarantee from state banks. But Jilin Trust is apparently still looking for ways to recover investors’ funds.  

The question is – doe s the PBOC really think that desparate borrowers will stop borrowing – and contract the size of the shadow-banking system reining in the out of control credit creation (and its subprime-like consequences)…

As we previously noted,

…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…

However, this just hit the wire…

• *CHINA BANS BOND TRADE BETWEEN PROPRIETARY, WMP ACCOUNTS

Which sounds ominously like the PBOC won;t allow banks to bail their own WMP investors out and take the risky crap back on their off-balance-sheet books… i.e. The PBOC wants real defaults… not ‘technical’ defaults

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