Alongside the chronically ill Evergrande property developer, another Chinese giant is in trouble. Trust company Zhongrong International Trust (ZRT) started missing payments to its extensive client base on August 8th, with no remedy in sight.

Zhongrong is under the umbrella of Chinese financialization provider Zhongzhi Enterprise Group (ZEG). Zhongzhi is China’s mini-BlackRock, managing $138 billion in assets. The firm’s board secretary, Wang Qiang, informed investors earlier in the week that no redemptions are incoming for at least 30 financial yield products due to dried-up short-term liquidity.

Real Estate and Financialization: GFC 2.0?

The Global Financial Crisis of 2008, triggering the Great Recession, started as a speculative drive on the real estate market. Not only were borrowing standards loosened, but the financial sector packaged and leveraged those bad subprime mortgages as securities.

In turn, securitization of bad credit gave the banks leeway to make more loans, increasing the vulnerability of the entire financial system. The same deadly combo of the over-extended housing market and financialization transpires in China.

It is estimated that 70% of China’s average household wealth is tied up in the housing market. Evergrande Group is China’s second-largest property developer, having accrued $340 billion in debt by the end of 2022. On August 28th, the group is yet to decide on its $3.2 billion restructuring plan to stave off collapse.

Amid this overleveraging, China’s new home prices are starting to fall. For the first time in 2023, July’s National Bureau of Statistics (NBS) data shows a 0.2% month-over-month drop. In less metropolitan regions, average new homes depreciate in at least 35 smaller cities, continuing a 17-month depreciation streak.

Zhongrong Catching Contagion?

The freshly troubled Zhongrong is one of the holders of real estate liabilities as a part of China’s $2.9 trillion trust sector. Use Trust data shows that Zhongrong offers 270 yield products, expected to deliver ~$5.4 billion this year. With short-term liquidity running dry, that plan is now under a big question mark.

Spilling out of real estate exposure, China’s financial contagion could now spread to trust products. Since Friday, the immediate loss doesn’t appear to be severe enough to destabilize companies’ daily operations. KBC Corp (688598.SS) reported delayed yield on the firm’s $8.3 million assets in Zhongrong, while Nacity Property Service (603506.SS) had the same issue with its $4.15 million trust stake.

However, most companies declined to even comment on any delayed trust payments. This is likely the result of China’s recent crackdown on reporting negative economic news to prevent contagion.

“The risk of a systemic shock to the Chinese financial system is not great, but the downward pressure on the economy will intensify,” 

Yan Wang, Alpine Macro’s chief emerging markets and China strategist

This month, China suspended youth jobless data reporting while pressuring economists to refrain from publicly discussing China’s macro conditions. One of those stumbling points is the estimated decline in GDP growth, having recently been cut from 4.9% to 4.5% by Barclays.

China’s Shadow Banking as the Cherry on the Macro Cake

China’s economy is a hybrid blend between officially sanctioned state capitalism and a grey economy. This has been evident for years in the crypto market, wherein China still produces the second-largest Bitcoin mining hashrate, despite cryptocurrencies being officially banned.

In the traditional sector, this manifests as shadow banking, ramping up in the late 1990s. As unregulated financial activities across trust companies and peer-to-peer lending, China’s shadow banking takes in riskier investments while presenting unfair competition to more regulated banks.

China’s shadow banking sector is estimated to be around $3 trillion, equal to the UK’s entire economy. In the present context of real estate exposure spilling into yield products, trust companies are the key pillars of this shadow sector.

The likes of Zhongrong have more leeway than banks to take in riskier exposure, and by doing that contagion risk is greater as well.

“This is something where the problems are probably not going to be confined to this individual trust but are going to spread to or become more evident in the trust industry as a whole,” 

Arthur Kroeber, Gavekal’s partner and head of research

In addition to cracking down on publicizing these problems, China is taking a more proactive approach. While Fed Chair Jerome Powell is still in the “higher for longer” mode, the People’s Bank of China (PBOC) unexpectedly cut interest rates on Tuesday, from 2.65% to 2.50%

“All of these add to the urgency that policymakers need to act fast before consumer and business confidence deteriorate sharply,”

Tommy Wu, Commerzbank’s senior China economist

This was China’s second rate hike in three months, aiming to bolster commercial banks as it reduces their losses on net interest margins. Increasingly negative China news outflow of China is also the likely culprit for Michael Burry’s $1.6 billion bearish bet against the stock market.

This article originally appeared on The Tokenist

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