China’s Zhongzhi Crisis Underscores Risk Of Economic Collapse

An opaque Chinese conglomerate with a trillion yuan in assets spread across everything from real estate to private equity to mining rights. What could go wrong?

If you’ve never heard of Zhongzhi Enterprise Group, don’t feel bad. It’s not exactly a household name in the West, but it’s a big deal in China’s $3 trillion trust industry. On Monday, Zhongzhi was in the news for the wrong reasons.

Zhongzhi has ownership stakes in half a dozen licensed Chinese financial institutions, including Zhongrong International, which bought into flailing property projects last year in what some characterized as a self-serving gamble by Chinese trusts on the nation’s giant stock of unfinished homes. Zhongzhi has “strategic shares” in Zhongrong which missed payments to at least three clients, one of whom is a residential property manager.

Every now and again, investors get an unwelcome reminder of the labyrinthine nightmare that is China’s shadow banking system. This looks like one of those reminders. The “system” in “shadow banking system” might fairly be described as a misnomer in the Chinese context. There’s not much that’s systematic about it. It’s a head-spinning tangle of cross-holdings and overlapping risk that conceptually resembles a bomb you might see in a Diehard sequel — it needs to be defused, but nobody knows which wire to cut. That’s true of all shadow banking, but as SocGen once put it, the situation in China is “mind-boggling.”

Zhongrong’s missed payments are (self-evidently) tied to a liquidity problem somewhere, probably at Zhongzhi itself. That problem, in turn, is almost surely a function of renewed meltdown concerns in the property sector, where Country Garden looks like it may be the next Evergrande. On Sunday, Country Garden suspended trading in a slew of local notes while attempting to work out a payment extension agreement for a CNY3.9 billion bond due early next month.

“Despite the difficult situation in the industry, the Company has always resolutely and earnestly fulfilled its own responsibilities,” Country Garden said, in the suspension notice, expressing “gratitude to all investors for their continued care and assistance” and promising to “live up to the trust of all sectors of society.” If the bond extension arrangement is agreed, it’d be the first ever for the company.

The stock dropped nearly 20% to below HKD1. The bonds are indicated at pennies

You don’t have to be an analyst of any kind to understand why this is all so perilous. Shadow banks are a funding source for the property sector, so when developers run into trouble, it not only creates liquidity issues for trusts, but also makes those entities less likely to invest in real estate projects. That, in turn, worsens the liquidity crunch, and so on. JPMorgan called it a “vicious cycle” on Monday. When the trusts run into issues, they miss payments, and that impacts investors large and small. It’s “a domino effect,” as someone from Natixis put it.

The government can’t let unfinished property projects languish in purgatory. That raises the risk of social unrest and so, by the way, do missed payments on wealth management products, a separate, but intimately related, issue. If trusts and other shadow banking conduits refuse to roll financing for developers, Beijing could instruct banks to step in. Then they’re saddled with real estate risk.

China has long sought to rein in and otherwise clean up shadow banking but, again, it’s a “Which wire do we cut?” problem. As it turns out, Beijing set up a “task force” last month to assess risks at Zhongrong, which one source told Bloomberg “funneled nearly half of the funds [it] raised” to its parent “or affiliated units.” In the same linked article, Bloomberg, citing data provider Use Trust, said Zhongrong has CNY40 billion coming due in 2023 across almost 300 products which yield almost 7% on average.

If you’re inclined to suggest this is all too absurd to be true, I’d say you’re not wrong in feeling that way. But, unfortunately, you are wrong. Because it is true.

In addition to its considerable interests in trusts and financial services providers, Zhongzhi has stakes in a number of other industries and areas including, but not limited to, semiconductors, big data, early childhood education, new energy vehicles, environmental protection, business outsourcing services and “unicorn fostering platforms.”

According to its website, it also has 4.5 billion tons of proven coal reserves and owns metal and non-metal mines which it says have “a potential value of more than CNY120 billion,” tied to gold, silver, copper, iron, tungsten, manganese and lithium, as well as “aggregates of sand and gravel.”