China Insurers Face Shadow Banking Default Risk: Ratings Agencies

By Justina Lee | October 29, 2014

A doubling in the trust holdings of China’s insurers has prompted ratings companies to warn the industry may be taking on too much shadow banking default-risk.

Insurers held 281 billion yuan ($46 billion) of trust products on June 30, surging from 144 billion yuan at the end of last year, China Insurance Regulatory Commission data show. The companies’ shadow bank assets, including wealth management products and other financing kept off commercial lenders’ balance sheets, reached 1.14 trillion yuan, or 13 percent of their investments, Standard & Poor’s estimated, adding that this made them “vulnerable in times of stress.”

China Pacific Life Insurance Co., Taiping Life Insurance Co. and Du-Bang Property & Casualty Insurance Co. all expanded trust investment fivefold or more in the first half, a “credit negative” for companies traditionally focused on fixed-income securities, according to Moody’s Investors Service. Fifty-one percent of the trust investment was directed to real estate and infrastructure, making insurers vulnerable to a cooling property market, according to Fitch Ratings.

“If the insurers experience any liquidity problems, they won’t be able to easily turn these trust investments into cash,” said Sally Yim, a Moody’s analyst in Hong Kong. “These assets also tend to be more volatile. The yield may be higher, but there may also be defaults.”

Financial Competition

Chinese insurers’ assets doubled in the past five years to 9.6 trillion yuan last month, as premium income climbed an average of 14 percent annually. Squeezed by competition from wealth management products sold by banks and online funds, insurers started offering policies with investment characteristics to compete for money.

“Over the last two or three years, banking product rates have been quite competitive compared with some of the rates offered by the insurers,” said Terrence Wong, a director at Fitch in Hong Kong. “So to enhance the yield, they have to seek investment instruments with higher returns.”

The CIRC in 2012 started allowing insurers to invest in WMPs, collective trusts and asset-management plans. As of Sept. 30, the industry had 28.6 percent of its assets in bank deposits, 40.5 percent in bonds, 10 percent in stocks and funds buying securities and the rest in other investments, the regulator said. Trust products delivered an average annual yield of 6.87 percent in the second quarter, according to China Trust Association, compared with the average 5.92 percent on five-year corporate bonds rated AA- and 3.55 percent for similar government debt.

While there were 24.7 trillion yuan of bonds in China’s interbank market as of Sept. 30, only 8 percent was held by insurers, with commercial lenders owning 63 percent, Chinabond data show.

Bond Supply

“If the bond market can supply enough AAA, AA rated corporate bonds I think insurance companies won’t need trust products,” said Jian Li, an analyst at Macquarie Group Ltd. in Hong Kong. “But the corporate bond supply is still not enough, so insurers need more choices to diversify their investment portfolio and improve returns.”

Trust companies, whose assets have swelled fourfold since 2010 to 12.5 trillion yuan on June 30, are part of China’s shadow financial system that operates beyond regulators’ control on bank leverage.

Default Risk

Fifty-one percent of insurers’ trust investments were directed to infrastructure and property, while the proportion was more than 90 percent for at least eight insurers named by the CIRC. China’s new-home prices fell last month in 69 of 70 cities monitored by the government, the most since January 2011 when the government changed the way it compiles the data. Home sales slumped 11 percent in the first nine months of this year.

“If there are any market-wide problems with property developers, that might lead to some defaults on trust products,” said Fitch’s Wong. “The situation could be even more complicated. Trust is only one of the product lines. Insurers may even have some property-related stocks and they themselves may also have some investments in the sector.”

China Pacific Insurance (Group) Co., the nation’s third- biggest listed insurer by assets, boosted its investments, including in WMPs and trusts, by 638 percent in the last three quarters to 10.2 billion yuan. Three calls to the company’s press office went unanswered yesterday. Two calls to Taiping Life Insurance and Du-Bang also didn’t get a reply.

Slower Growth

At least 10 trusts backed by assets spanning coal mines in Shanxi to forests in Fujian have had issues with repayments, sparking protests by investors outside banks that distributed their products. China Credit Trust Co. delayed payments on a 1.3 billion-yuan high-yield trust product backed by coal-mining assets after the borrower failed to raise funds to repay investors in July. A Shanghai Goldstate Brilliant Asset Management Co. wealth management product missed a payment in August.

Lower economic growth is adding pressure to trust products, which are often sold to fund corporates unable to obtain bank loans. China’s economy expanded 7.3 percent in the third quarter, the slowest pace since 2009. Haitong Securities Inc. estimated in July 6.3 trillion yuan of trust payments would be due next year, more than this year’s 5.2 trillion yuan.

The Chinese currency has gained 0.6 percent in the past month to 6.1119 per dollar as of 11.46 a.m. in Shanghai, China Foreign Exchange Trade System prices show. Credit-default swaps insuring the nation’s debt against nonpayment dropped 25 basis points from this year’s highest level reached in January to 80.4 basis points yesterday.

Bank Partners

Insurers offering investment products may become a useful partner for banks for shadow lending as the former have a wider capital base and a better reputation, according to David Cui, a strategist at Bank of America Corp. Lenders may work with other financial firms to structure shadow-banking products for insurers, Cui said.

“Because all these segments of the financial market are regulated by different regulators and all of them are competing for market share, what ultimately happens is the industry keeps putting pressure on the regulators to allow them to do more and more,” Cui said. “These new investment policies from insurers suddenly have the capacity to serve banks’ off-balance-sheet lending activities.”

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