$138 billion from China's shadow bank spirals into a terrible time for Xi

(Bloomberg) – Zhongzhi Enterprise Group Co., Ltd. In 1995 as a timber company, it has grown into a financial conglomerate with more than 1 trillion yuan ($138 billion) in management. Now it risks becoming the latest Chinese financial giant to fail.

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The under-the-radar group, often dubbed China’s Blackstone by local media, operates at the heart of China’s high-flying shadow banking market, which regulators have sought to control since 2017. The company has now sounded alarm bells in the region. Chinese markets after subsidiaries defaulted on payments on some investment products.

Investors are not the only ones who fear the repercussions of its potential demise. Chinese authorities have already set up a task force to study any possible infections, with the banking regulator examining risks in Zhongzhi, according to people familiar with the matter.

Zhongzhi is one of the last free-wheeling private wealth managers Beijing is trying to rein in to reduce the risk for the hundreds of thousands of retail customers who have bought these high-yield products assuming they are safe. The timing couldn’t be worse for Xi Jinping’s government, with China already grappling with a weak economy and emerging from a moribund real estate market that threatens to drive giants like Country Garden Holdings Co. to default.

Zhongrong International Trust, partly owned by Zhongzhi Corporation, is among the largest in the country’s $2.9 trillion trust industry, which pools savings from wealthy families and corporate clients to invest in and make loans to real estate, stocks, bonds and commodities. The company, which has defaulted on at least two payments, has 270 products totaling 39.5 billion yuan due this year, according to data provider Use Trust.

This is “the thing that everyone knew was going to explode,” said Jason Hsu, chief investment officer of Rayliant Global Advisors. He said Zhongrong’s troubles were likely related to its sales of real estate-related investment products.

Zhongzhi’s rise and possible downfall closely mirror China’s trajectory over the past three decades. The once thriving economy is now mired in difficulties after a crackdown on private companies, including the country’s famous technology firms, has shocked investors. Consumer sentiment remains stagnant after years of severe Covid restrictions.

It’s not the only company facing difficulties. A total of 106 trust products worth 44 billion yuan defaulted on their debts this year as of July 31, according to Use Trust. Real estate investments accounted for 74% of defaults by value. Last year also saw defaults worth billions of dollars.

Zhongzhi is the second largest shareholder of Zhongrong Trust, owning about 33%. The group also owns stakes in five other licensed financial firms, including a mutual fund manager and two insurance companies, and invests in five asset management firms and four wealth units, according to its website. It also controls listed companies and owns 4.5 billion tons of coal reserves among its industrial operations.

Founder

The company’s founder, Xie Zhikun, died of a heart attack in 2021, just as pandemic lockdowns were slowing China’s economy and causing markets to be volatile. While his replacement, Liu Yang, has pledged to keep the company focused on industrial and asset management businesses, the economic downturn and downturn in the real estate market have affected its operations.

China Real Estate Business reported Aug. 12 that Xie made a fortune in the 1980s with a printing factory, before expanding into troubled assets including real estate. One billion yuan managed by Shimao Group Holdings Ltd. , and an office building that was once the headquarters of the Jia Yueting Group, according to the report.

Many of these projects were left in the doldrums amid the stagnation of the real estate market and after Xie’s death.

Even as rival companies sought to minimize risks, Zhongzhi and its subsidiaries, especially Zhongrong, provided financing to struggling developers, taking assets from companies including Kaisa Group Holdings Ltd. and Shenzhen Wongtee International Enterprise Co., Ltd. Now China Evergrande Group faltered between 2014 and 2016. Zhongrong’s real estate trust asset ratio more than doubled to 18% in 2020 from 6.6% in 2017, according to the paper.

Those real estate investments have soured after the failure of the expected turnaround in real estate. Home sales in China fell by the most in a year last month, denting returns for developers such as Country Garden, whose stocks and bonds collapsed after it defaulted on coupon payments to bondholders this month.

Zhongrong hasn’t revealed much to the public about its situation, though it said it was aware of fake messages being shared on social media claiming the company could no longer operate. The company reported the messages to authorities, according to a statement on its website.

In one unverified message that circulated, Zhongzhi’s wealth manager apologized to his clients, saying the group’s wealth arms had delayed payments on all products since mid-July. According to the letter, the accident involves more than 150,000 customers with outstanding investments totaling 230 billion yuan.

A person familiar with the task force said that nearly half of the money raised by Zhongrong has been transferred to the parent company or its affiliated units.

Analysts say Beijing’s long battle against the excesses of the confidence sector may now be reaching its climax.

“The Window’s guidance has been very discouraging to anyone and everyone who has been involved in some kind of trust business, wealth business, with regard to the sale of mortgage-backed securities,” Hsu said. “Maybe the last of this ugly cycle has come to an end.”