China Banks: The myth and reality of banks' trust products in China

- Bank trust product market size: "We estimate the outstanding trust product market to be slightly over Rmb3T as of June 10, split evenly between loan-related products and other products in other financial assets. Gross new sales were Rmb2.9T in 1H10 vs. Rmb1.7T in all of 2009. Trust loan sales are estimated at Rmb1.3T in 1H10. The balance, however, may
decline as many products will mature during the year. The net increase in trust loans is also less than Rmb1.3T."
- What is the market worried about? "Loan-related trust products effectively represent credit in the system, and hence aggregate credit growth in 1H 10 would be 13.5% hoh (vs. 11.6% hoh stated); the CBRC recently asked banks to suspend sales of trust loan products to ensure adherence to loan quotas. This has given rise to the following concerns. (1) Will a lack of liquidity result in accelerating NPL formation? (2) While these products are not contractually guaranteed, do banks have an implicit obligation, similar to structured products sold in HK/Singapore? (3) What is the implication for banks’ earnings?"
- Addressing market concerns: "(1) Liquidity: The cessation of trust product sales is likely to boost sales of banks’ own WM products or deposits, which still mean ample system liquidity. However, a lower flow of credit may add challenges to system credit quality, although we believe they are very manageable. (2) Defacto guarantees: Unlike structured products sold in HK/Singapore that resulted in claim liabilities, loan-related trust products
have generally been low-risk loans, are collateralized, and/or third-party guaranteed (see pages 5-8), and importantly do not involve derivatives. Historically these loan-related trust products had exceptional track record on asset quality. (3) Revenues: Banks will likely lose some fees partially offset through deposit spreads (200-300bp fee vs. 150bp deposit spread recouped)."
- Background on trust products: "In existence since late 2002, trust products typically target the mass affluent segments (ticket size of Rmb100,000+) seeking yield enhancements. Most of these products (some 10,000 bank trust products have been sold in last five years, 6,000 of which were trust loan products) are low-risk, low yield, with relatively short maturities (typically six months). Collateralized, often third-party-guaranteed, these products
have delivered robust asset quality with no single case of known credit losses. We believe banks are aware of reputational risks and hence have adopted strict credit controls; this is not a channel for risky asset disposal."
- Our sector stance remains positive: "While regulatory measures, effectively designed to reduce cyclicality (through coverage build-up, higher capital requirements, and controlling credit flow), somewhat reduced near-term earnings visibility slightly, earnings changes are likely to be modest. Sector valuations are not only attractive, but appear to be affected by “rolling worries” on asset quality, which we see as premature. Our top stock picks are BOC-H, BoCom-H and Citic-H."
JPMorgan China Banks 20100716

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