Barclays Asia Themes Financing China - In Orderly Default We Trust

Cross Asset Research10 March 2014 BarclaysCapitalInc.and/oroneofitsaffiliatesdoesandseekstodobusinesswithcompanies coveredinitsresearchreports.Asaresult,investorsshouldbeawarethatthefirmmayhavea conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. This research report has been prepared in whole or in part by equity research analysts based outside the US who are not registered/qualified as research analysts with FINRA. FOR ANALYST CERTIFICATION(S) PLEASE SEE PAGE 29. FOR IMPORTANT FIXED INCOME RESEARCH DISCLOSURES, PLEASE SEE PAGE 29. FOR IMPORTANT EQUITY RESEARCH DISCLOSURES, PLEASE SEE PAGE 30. Asia Themes Financing China In (orderly) default we trust Recentcasesofnear-defaultamongbank-distributedtrustproductshaveraised concerns over potential risks in the trust sector and how banks might be affected.In thisreportanalystsfromourequity,creditandratesresearchteams:1)summarizethe troubledtrustproductsofrecentyears;2)analyzenear-termrisksfacedbythetrust sector; 3) discuss the implicit guarantee issue; 4) estimate China banks exposure to trust risks; 5) discuss the risks presented by the coal sector and the outlook for coal pricing and funding; 6) look at the knock-on effect for the real estate sector; 7) and assess the impact on credit and rates pricing.We believe an orderly trust default is possible and expect the central government to push reform in 2014. Trustfailurescouldreducebankingsectornetprofitsby6-9%,underourscenario analysis: As per the estimates of equity research banks analyst May Yan, under a severe scenario, trust failures could reduce banking sector net profits by 9.2%/6.2% in 2014 if potential trust loss were to spread over the next 2/3 years. In addition, we also expect averageinterestratesontruststorise,andtotalsocialfinancing(TSF)andtrustasset growth to slow.EquityResearch:Trustdefaultsmayleadtoshort-termnegativesentimentinthe market, but would remove an element of overhang on China bank stocks and be good fortheminthelongrun.Thecoalindustrysuffersfromexcessleverageandhas approximately8%(Rmb130bn)oftotalsectordebtintrustproducts,butposesno systemicthreattothefinancialsystem.TherealestatesectorhasRmb1.0tnof exposuretotrustproducts,andwillbeexposedtoincreasedfundingcosts,whichwill accelerate consolidation one of the governments planned objectives for the sector.CreditResearch:Improvementinpropertydevelopersliquidityandamorediversified funding base over the past three years has reduced exposure to trust products to 10% of total debt. However, pockets of risk still sit with smaller developers in the high-yield space.CreditStrategy:IfChinasbanksdosharelossesontrustproducts,ratingspressure could increase, and downgrades would weigh on investor sentiment, especially for USD bond issuers. Our credit strategist remains cautious on the bonds of Chinese banks. Ratesstrategy:ThePBoCsmovetoaneutralstancein4Q13mayhavepre-empted somefalloutfromtrustdefaultsthisyear.Despitethis,allowingdefaultsontrust products would lead to a re-pricing of risk premia, putting upward pressure on interest rates with the increased demand for liquidity creating spikes in repo markets. EQUITYRESEARCH Asia Ex-Japan Banks May Yan +852 2903 4756 [email protected] Barclays Bank, Hong Kong Asia ex-Japan Metals & Mining Ephrem Ravi +852 2903 4892 [email protected] Barclays Bank, Hong Kong Asia ex-Japan Real Estate Alvin Wong +852 2903 4535 [email protected] Barclays Bank, Hong Kong ASIA CREDIT RESEARCH Christina Chiow, CFA * +65 6308 3214 [email protected] Lyris Koh * +65 6308 3595 [email protected] ASIA CREDIT STRATEGY Krishna Hegde, CFA * +65 6308 2979 [email protected] RATES STRATEGY Rohit Arora * +65 6308 2092 [email protected] *These authors are members of the Fixed Income, Commodities and Currencies Research department and are not equity analysts. Barclays | Asia Themes 10 March 20142 INTRODUCTION Equity Research: China trustsKey topics Q&A Q. Are troubled trust products something new?A. Not really Threemonthsinto2014,twotroubledtrustproductsChinaCreditTrust/ICBCs Chengzhijinkai#1andJilinTrust/CCBsSonghuaRiver#77havedrawnwidespread market attention to Chinas trust sector, raising concerns over the impact on banks and the overallfinancialsystem.Weobserve,however,thatnear-defaultoftrustsisnotsomething new.Since2012therehavebeenatleast22reportedcasesoftroubledtrustproducts amountingtoRMB13.7bnintotalassetsaccordingtomediareports(seeFigure1),which accountsforonlyasmallproportionofthetotalfigureofRMB10.9tninoutstandingtrust assets by end-2013, according to the China Trustee Association. Inourview,thekeyfocusfromabankingsectorperspectiveistheunbrokenimplicit guaranteeinthefinancialsystem,whichimpliesextracontingentrisksonChinabanks, especiallyasassetqualityislikelytobegindeterioratingamidthecurrenteconomic slowdown.Inparticular,webelievethereasonrecentlytroubledtrustshavedrawnsuch interestinclude:1)banksinvolvementinthetrusts;2)thelargesizeofthetrustsand borrowers liabilities; 3) concentrated risks in the coal sector; and 4) rising concern over the broad asset quality in Chinas financial system. Whilemanyofthetroubledtrustshavetechnicallydefaultedbymissingpaymentsdueor incurringinterestlosses,therehashardlybeenacasewhereatrustproducthasdefaulted onprincipal.TheChengzhijinkai#1wasbailedoutatthelastminutebyanunidentified thirdpartyand,accordingtorecentreports(eg,Wallstreetcn,27Feb2014),investorsof Songhua River #77 are likely to be paid first, with money from the borrowers guarantors.Q. Why might 2014 be special? A. Increasing pressure from maturing trusts Webelievethisyearmaybeparticularlychallengingforthetrustsectorbecauselarge numbersoftrustsarematuring.Onourestimates,forcollectivetrustswhichwebelieve are riskier than single trusts and more likely to require enforcement of implicit guarantees thereisatotalofRMB1.1-1.3tnininterestandprincipalpaymentsduein2014.Forthe wholetrustsector,weestimatethatRMB4.5tninproductswillmaturethisyear,up77% compared to the actual matured amount of RMB2.6tn in 2013.Inaddition,accordingtodatafromTrust-Use,weobservethattheaveragematurityof collectivetrustshasdeclinedsincethesecondhalfof2011tolessthantwoyears,which indicatesthattheborrowersoftrustloans wouldhavetorollovertheirdebtmorequickly; otherwisetheycouldfaceliquidityproblemsandbecomefinanciallystressed.Webelieve the increasingly difficult liquidity situation will likely lead to defaults and thus expose risks in the trust sector. Q. How did recently reported trusts get into trouble?A. Sector-specific problems with coal companies BoththetroubledChengzhijinkai#1andSonghuaRiver#77aretrustloanstocoal companiesinShanxiprovince.Inourview,thesetwoarenotisolatedcasesbutrather reflect the difficult conditions faced by coal companies in the whole sector, especially those in Shanxi. ASIA EX-JAPAN BANKS Industry view: NEUTRAL May Yan +852 2903 4756 [email protected] Barclays Bank, Hong Kong Sean Hung, CFA +852 2903 4799 [email protected] Barclays Bank, Hong Kong Mimi Kong +852 2903 4671 [email protected] Barclays Bank, Hong Kong Barclays | Asia Themes 10 March 20143 Webelievethecurrentsituationofthecoalsectorwaslargelyduetothereforminitiatives thelocalgovernmentcarriedoutin2008-09,whichhaveledto:1)highinvestmentand merger&acquisitionactivitiesresultinginlargeamountsofdebt;2)maturitymismatchin debtstructuresofcoalcompanies;and3)unsolvedambiguityanddisputesregardingcoal minerightsandownership.Moreover,thedeclineincoalpriceshassignificantlyhurtthe sectorsprofitabilityandthehighfundingcostsoftrustsmayhaveexacerbatedthetighter liquidity situation. Hence, we believe the coal sector contains high risks and that there might be more coal-related defaults going forward. Q. Is the coal sector a systemic risk?A. Probably not While we believe the coal sector is of particularly high risk, we do not consider the sector a systemicthreattoChinasfinancialsystem.Onourestimates,bytheendof2013,total interest bearing debt (IBD) of the coal sector was approximately RMB1.6tn, which consisted of RMB1tn of bank loans, RMB460bn of bonds and RMB130bn of trust products. These are stillsmallamountscomparedtototalbankingsystemloansofRMB71.9tn,total outstandingcorporatebondsofRMB8.4tn,andtotaltrustassetsundermanagementof RMB 10.9tn at end-2013. Webelieverisksinthecoalsectorareunevenlydistributedgeographically,andweidentify Shanxi,InnerMongoliaandShaanxiastheprovincesthatwouldbemostaffectedbya downturn of the coal sector. Nevertheless, after examining local fiscal conditions, we believe governmentsintheseregionshavethecapacitytobailoutthesectorincaseofserious problems and prevent any knock-on impact to the local economies or the financial system. Q. What might happen next? A. Orderly default is possible and would be a good first step for reform in our view Whileitmayhaveprotectedthepublicinterestincertaincases,webelievesustainingthe implicitguaranteefortrustshasmultiplenegativeeffectsonChinasfinancialsystem, includingdivertinginvestorsawarenessofrisks,incentivizinginappropriatesalespractices bybanksandtrustcompanies,andcompromisingauthoritiespolicytargets.Breakingthe implicitguaranteebehindtrustproductsappearstoustobeanecessity,andwebelieveit would be good for the banking sector in the long run, despite a short-term negative impact on market sentiment. Wethinkanorderlydefaultispossible,asrisksarelikelytobeunevenlydistributedacross differentsectorsandregions.Withmoreproperriskawarenesscultivated,defaultscould helpsqueezefundsfromtroubledsectorstothosewithbetterassetquality,andthus enhanceriskpricinginthefinancialsystem.Inourview,thegovernmentwilllikelypush reformatagradualpace,bylettinginvestorsbearsome,butnotall,lossofprincipal,for example.Shouldthishappen,weexpecttheaverageinterestrateontrustproductstorise and growth of the trusts sector and TSF to slow, at least in the short term. Inourview,thegovernmentmightbemorecomfortablewithallowingtruststodefault whenotherregulations,includingmorecomprehensiveshadowbankingrulesanda financialsafetynet,suchasthedepositinsurancesystem,arealreadyinplace.Weexpect anacceleratedpaceofreformin2014,likelyaftertheNationalPeoplesCongress Conference in March. Q. How might risks in the trust sector be quantified for China banks?A. We estimate a likely 6-9% decline in net profits for the banking sector, higher trust interest rates and slower TSF growth Weestimatethatbyend-1H13,Chinabanksexposuretothetrustsectorwas approximatelyRMB6tnandisriskierthantheloanportfolio.Incaseofpotentialtrust Barclays | Asia Themes 10 March 20144 defaults,webelievethebankswouldneedtobearfulllossesontrustsunderlyingtheir WMPs but might only need to take partial responsibility for trusts they distributed.Onourestimates,ifallriskscontainedinbankstrustexposureweretomaterializeand losses spread over three years to happen, net profits of the whole banking sector would be reduced by 6.2%/5.6%/5.2% in 2014/2015/2016. Under a more severe scenario, whereby therisksandlossestohappenwithintwoyears,weestimatethatsectornetprofitswould be reduced by 9.2/8.5% in 2014/2015.Inadditiontoadirectimpactonbanksnetprofits,webelievetrustdefaultswouldalso pushupaverageinterestratesontrustsduetoachangeinriskawareness,whichmight worsen asset quality of loans as some companies become financially stressed due to greater funding pressure.Inthemeantime,totalsocialfinancing(TSF)growthisalsolikelytoslowasdemandfor trustproductssubsides,atleastintheshortterm.Assuminga10%annualgrowthratein 2014and5%oftrustloansasapercentageofTSF,weestimatethatnetnewtrustloans would be RMB949bn in 2014, down 48% y/y compared to RMB 1.83tn in 2013. Stock implications for China banksWebelieveBOC(OW)hasrelativelylessexposuretotrustproductsas:1)BOChasfewer domestic branches than its big bank peers, hence less distribution capability; and 2) BOCs ex-Chairman has been less enthusiastic about expanding off-balance sheet products in the past few years. We expect more information to be disclosed at the 2013 earnings briefings duringresultsseasonatend-2013.BOCremainsatoppickinourChinabankscoverage universe. Barclays | Asia Themes 10 March 20145 CONTENTS INTRODUCTION ................................................................................................. 2 Equity Research: China trusts .................................................................................................................. 2 EQUITY RESEARCH: CHINA BANKS .............................................................. 6 Risk of trust products under the spotlight ............................................................................................ 6 2014 faces increasing pressure of maturing trust products ............................................................ 8 Recent coal trust concerns trace back to industry reform initiatives a few years ago ............. 10 Coal sector does not pose systemic risk ............................................................................................. 12 Trust default: an important step to break implicit guarantees ...................................................... 16 Impact of trust sector on China banks and TSF ................................................................................ 17 Further reading ......................................................................................................................................... 19 EQUITY RESEARCH: CHINA COAL ............................................................... 20 Coal prices to remain range-bound in the near term ....................................................................... 20 Lower domestic coal supply as producers face reality .................................................................... 20 Positive short-term indicators of coal demand ................................................................................. 21 Stock pick ................................................................................................................................................... 22 EQUITY RESEARCH: CHINA PROPERTY ..................................................... 23 Short-term pain inevitable but risk is manageable ........................................................................... 23 CREDIT RESEARCH: CHINA PROPERTY ..................................................... 25 Sensitivity to domestic funding ............................................................................................................. 25 Ratings risks likely to increase ............................................................................................................... 26 RATES STRATEGY ........................................................................................... 27 Higher rates volatility the new normal ............................................................................................. 27 Barclays | Asia Themes 10 March 20146 EQUITY RESEARCH: CHINA BANKS Risk of trust products under the spotlight Trust product defaults are not something new Recently,twocasesoftroubledtrustproductsChinaCreditTrust/ICBCsChengzhijinkai #1andJilinProvinceTrust/CCBsSonghuaRiver#77havedrawnwidespreadmediaand marketattention(seeourreport,ChinaBanks:ChinaCreditTrustraisesconcernsover China'strustindustryoverall,Jan27 2014andChinaBanksDaily,Feb13 2014).According to the latest media report (Wallstreetcn, 27 Feb 2014), investors of Songhua River #77 have beentoldbyaCCBbranchthatnineguarantorsofLianshengGroup,theborrowerofthe trust, will provide RMB1.5bn in funds that will be used to settle collective trust payments as a priority. In our view, it is likely that the collective trust liabilities of Liansheng Group will be eventually paid off, albeit with some payment delays and interest losses. Near-defaultofatroubledtrustproductisnotsomethingnew.Since2012therehave alreadybeenmultiplemediareportsoftroubledcollectivetrustproductsandsomeof them have technically defaulted by missing due payments on maturity dates. Nevertheless, apartfromsomecasesofinterestlosses,therehavebeenhardlyanyprecedentsweknow of, of a default on principal payments in the trust sector yet. FIGURE 1China trusts: Recent reported cases of troubled trust products Issuance date Maturity (yrs) Amount (RMB mn) Expected annual return Trust companyTypeBorrowerIndustry InvestorlossNote Aug-102.57109-13%CITIC TrustCollective Shielspeare Group Real estate No loss The borrower could not make payments on maturity, and CITIC Trust subsequently initiated a settlement process. CITIC Trust paid the retail investors first and, by May 2013, it had claimed a total of RMB650mn through selling collateralized land assets, which fully covered the principal and interest payments. Aug-101.53859-11%Zhongrong International Trust Collective Qingdao Capland Property Real estate No loss Zhongrong International Trust paid investors on maturity date and filed lawsuits to sell the borrowers collateralized land assets. The value of the land had reportedly declined significantly since issuance of the trust. Aug-10328513.5%CPFCO TrustCollective Zhongjinjiacheng Property Investment Real estate Interest loss In Aug 2013, CPFCO Trust paid investors principal and only 8% interest, whereas the expected return was 13.5%. Sep-1025478.2%Huaxin International Trust Collective Xisensanhe Group Agriculture Interest loss The trust paid all principal but not interest for the last period.Jan-1131,1809-15.75% Anxin TrustCollective Zhejiang Jinlei Property Real estate No loss The trust was terminated before maturity and paid in full with funds provided by the guarantor. Jan-1138509.8-12%New China Trust Collective Shanghai Lurun Property Real estate No loss Trust paid investors on maturity date, but said that the source of funds was not its own but another institution. Feb-1133,0309.5-11%China Credit TrustCollective Shanxi Zhenfu Group Mining Interest loss The borrower could not make due payments and the collateral was worthless due to unsettled mining rights issues. Near maturity date, an outside investor took over the trust and investors were paid full principal but only partial interest. Mar-1122009-10.5%Jilin TrustCollective Nanjing Mudanyuan Properties Real estate No loss but delayed Payments were delayed for 8 days until Huarong AMC took over. Apr-11240010-11.8% Anxin TrustCollective Wenzhou Taiyu Property Real estate No loss Anxin Trust elicited a third-party property developer to bail out the trust when it could not make payments in April 2013. May-111.5-21,16410-14%Zhongrong International Trust Collective Ordos Kaichuang Property Real estate No loss but delayed The trust company terminated the product in May 2012 and investors were paid in early 2013. Source: News sources, including: JRJ, Netease, Sina Finance, Investor Newspaper, China Business Journal, China Securities, Wealth Management Weekly, Economic Observer, 21chb, Guangzhou Daily, Shanghai Securities; Barclays Research ASIA EX-JAPAN BANKS Industry view: NEUTRAL May Yan +852 2903 4756 [email protected] Barclays Bank, Hong Kong Sean Hung, CFA +852 2903 4799 [email protected] Barclays Bank, Hong Kong Mimi Kong +852 2903 4671 [email protected] Barclays Bank, Hong Kong Barclays | Asia Themes 10 March 20147 FIGURE 1 (CONTD) Recent reported cases of troubled trust products Issuance date Maturity (yrs) Amount (RMB mn) Expected annual return Trust companyTypeBorrowerIndustry InvestorlossNote Jun-11287111-15%Zhongrong International Trust Collective Langfang Hairunda PropertyReal estate No loss Due to slump in Langfang property market, borrowers project kept being postponed. The trust terminated the product and paid investors only one year after issuance. Jun-111.5-240010.5-13.5%Minmetals International Trust Collective Shanghai Rongteng Property Real estate No loss The trust paid investors on maturity date and is currently filing lawsuits against the borrower.Jul-111.525015.2%Guolian TrustSingle Shenzhen Zhongji Industry and Commerce Real estate Interest payments delayed; in lawsuit The single trust investor, Jiangsu Yaxing, had yet to receive interest payments of the trust as of 3Q13 and initiated disposal auction process.Aug-111.531010-13%New China Trust Collective Shandong Huoju Property Real estate NA Undergoing lawsuit since Nov 2013 when the borrower could not make payments. Sep-111.510010.5-11.5%Sichuan TrustCollective Zhejiang Yangchengjindu Property Real estate No loss An outside investor took over the trust and initiated restructuring process with the borrower. Investors were paid in full. Nov-111.515010.5-11.8%Jilin TrustCollective Laiwu Nanshan Construction Material Construction Material No loss but delayed The borrower reportedly forged fake projects to get loans, which exposed weak internal controls of Jilin Trust. Investors were eventually paid in full in March 2012. Nov-111.5-26458-10.5%Hua'ao International Trust Collective Dalian Shide Plastic Construction Material ConstructionMaterial NA Hua'ao sued Shide as its owner Xu Ming was investigated for economic breaches. In addition, the trust was suspected of providing loans to Shide Groups real estate projects, instead of materials. Reportedly settled outside of court. Dec-11220011%SDIC TrustCollective Shanxi Tailai Energy Mining NA The borrower was exposed by media reports to have questionable qualifications, in terms of both poor operating records and illegal mining rights transfer. SDIC Trust was accused of improper due diligence. Dec-1111,3349.5-11%CITIC TrustCollective Sanxia Quantong Coating Plate Material No loss CITIC Trust was going to dispose of the troubled trust through public bidding. However, an outside private enterprise eventually took over and investors were paid in July 2013. end-2011NA31NAZhongtai Trust Single Shanghai Gaoyuan PropertyReal estate NA The borrower went bankrupt and the owner reportedly fled. The investor was a trade company in China. The borrower missed the third and fourth interest payments, and the trust filed a lawsuit against it in Dec 2012. 2011-2012 2979.8-12%Jilin TrustCollective Shanxi Liansheng Group Mining NA Liansheng Group, the borrower, filed for restructuring in Nov 2013. Jilin Trust is one of many financial creditors of the group. The local government is handling the restructuring process at. Collective trusts are likely to get higher seniority in the settlement. Apr-121-25709.5-11%Shaanxi International Trust Collective Yufeng Fertilizer Chemical No loss The borrower showed signs of trouble at end-2012. Shaanxi International Trust paid investors with its own funds in Aug 2013. Source: News sources, including: JRJ, Netease, Sina Finance, Investor Newspaper, China Business Journal, China Securities, Wealth Management Weekly, Economic Observer, 21chb, Guangzhou Daily, Shanghai Securities; Barclays Research Recent cases reveal potential risks for China banks The reasons that the recent two products were highlighted, in our view, include: Banksinvolvementinthetrusts:EventhoughtechnicallyICBCandCCBactedonlyas distributorofthetrusts,accordingtomediareportsthebankswereundergreat pressuretobailoutthetrustsduetoanassumedimplicitguaranteeandpossible misconductinsalespractice.Thisraisedawarenessofthe extrariskexposureofChina banks to the trust sector. Largesizeofthetrustsandborrowersliabilities:InadditiontoChengzhijinkai#1s relativelylargesizeofRMB3.03bn,theborrowerofSonghuaRiver#77,Liansheng Group,usedtobeaninfluentiallocalcorporateandhadnearlyRMB30bnoffinancial debt owed to multiple trusts and banks.Barclays | Asia Themes 10 March 20148 Concentratedrisksinthecoalsector:Bothofthetroubledborrowerswerecoal companies in Shanxi province. This has led to concerns over the coal sector as a whole and its impact on China banks. RisingconcernoverbroadassetqualityinChinasfinancialsystem:Rapidexpansion of the trust sector in recent years has likely meant the lending of large amounts of credit to some risky sectors. As economic growth slows, asset quality in the financial system, especially the trust sector, is likely to deteriorate. In 2014, we believe the risks accumulated in the trust sector during its rapid expansion are more likely to be exposed, and China banks might be directly as well as indirectly impacted by potential defaults.Directimpacts:Webelieveinthecaseofapotentialtrustdefault,bankswouldbeunder pressuretosharelossesastheyareoftenassumedtobeprovidingimplicitguaranteefor the products they distribute. In addition, the on-balance-sheet trusts and underlying WMPs are likely to be riskier than normal loans, in our view.Indirectimpacts:Allowingdefaultswouldlikelyalterriskperceptionsinthemarket,inour view,thuspotentiallypushingupinterestratesontrustsandslowingthetrustsectors growth.Consequently,somecompanieswouldlikelyfacegreaterfundingpressureand becomefinanciallystressed,whichwouldalsonegativelyaffectbanksifthesecompanies had bank loans as a source of funding. 2014 faces increasing pressure of maturing trust products Collective trusts are more likely to enforce implicit guarantees and pose extra costs on China banks Inourview,collectivetrustsmaybeagreaterchallengethansingletrustsfortrust companiesandbanksinthenearterm.Webelievethattheassetqualityofsingletrustsis likely to be better, as banks usually use them to lend off-balance-sheet credit to borrowers they consider relatively safe.Inaddition,asinvestorsofsingletrustsaremostlyinstitutions,whenatrustgetsinto trouble, it is easier for the trust company to negotiate terms with the institutional investor or movethecaseintolegalprocess.Incontrast,collectivetrustsareoftendistributedtoless risk-tolerant retail investors, who normally request rigid payments and constitute a greater threattotrustcompaniesandbanksreputation.AsshowninFigure1,ofthe22cases reported in the media, 20 were about troubled collective trusts. AlthoughthelawsandregulationsgoverningtrustsinChinaexplicitlystipulatethattrust companiesshouldprovidenoguaranteetotheirproducts,inreality,webelieveregulators wouldinmostcasesimplicitlyrequestthemtomakebesteffortstoensurepaymentsto investors. However,webelievethatinthecaseoflarge-scaleactualdefaultsoftrustproducts,trust companiesareunlikelytohaveadequatecapitaltobearthelossifimplicitguaranteesare enforced.Inrecentyears,thetrustsectorleverage(trustassetsundermanagement-to-equity)hasrisenrapidly,from23xin1Q10to43xbytheendof2013.Hence,webelieve thatasdistributorsandsometimesinitiatorsofmanytrustproducts,Chinasbanksmight beaskedbytheauthoritiestopartlybearanypotentiallossesinordertomaintainsocial stability. This would results in extra expenses for banks.As we have observed in the case of Chengzhijinkai #1 and Songhua River #77, even though thecollectivetrustswereoff-balance-sheet,thebanksareunderpressurefrominvestors, Barclays | Asia Themes 10 March 20149 the media and local governments to take responsibility, as they are often the sales channel and initiators of the trusts. RMB1.1-1.3tn in interest/principal payments of collective trusts due in 2014 We believe 24 months is a good estimate of the average maturity of outstanding trusts. As showninFigure2,wefindthatquarterlyamountsofmaturedtrustscorrespondwellwith those issued 24 months earlier. Thus, on our estimates, the total number of trusts that will maturein2014shouldbethoseissuedduring2012,whichamountstoatotalof approximatelyRMB4.5tn,up77%y/ycomparedtotheactualmaturedamountof RMB2.6tn in 2013. Collective trusts account for only a relatively small proportion of total trust assets. The share ofcollectivetrustspeakedat28.7%in2Q12andhasdippedto24.9%byend-2013, accordingtodatafromtheChinaTrusteeAssociation.Assumingthesamematurity structureofcollectivetrustsassingletrusts,weestimatethatapproximatelyRMB1.1tnof collectivetrustswillmaturein2014,andsincetrustsusuallyoffera10%interestrate,the total principal and interest payment due we estimate at around RMB1.1-1.3tn in 2014. Shortening average maturity indicates greater liquidity challenge of collective trusts Furthermore, we think the shortening maturity of collective trusts may amplify the pressure. AccordingtostatisticsprovidedbyUse-Trust,athird-partytrustresearchagency,since 2011whenquarterlyissuanceofcollectivetrustsincreasedintheindustryasawhole,the average maturity of collective trusts has in fact dropped, from a little above 2 years in 2Q11 to under 1.6 years by 4Q13.Inourview,thetrendofshorteningmaturityindicatesmountingpressureformaturing collective trusts in 2014-15, as the borrowers of the trusts would need to turn over funding sources more quickly, which might lead to more liquidity risk. FIGURE 2Assuming average maturity of 24 months yields good fit with actual data; liquidity pressure mounting in 2014-15 FIGURE 3Collective trusts account for a relatively small proportion of total trust assets Note: X-axis represents date of maturity. Source: China Trustee Association, Barclays Research Source: China Trustee Association, Barclays Research -200 400 600 800 1,000 1,200 1,400 1,600 1,800 1Q122Q123Q124Q121Q132Q133Q134Q131Q142Q143Q144Q141Q152Q153Q154Q15RMB bnEstimated maturing trusts (issuances preceding 24m)Actual quaterly maturing trusts02,0004,0006,0008,00010,00012,0001Q102Q103Q104Q101Q112Q113Q114Q111Q122Q123Q124Q121Q132Q133Q134Q13RMB bnCollective trust Single trust Property management trustBarclays | Asia Themes 10 March 201410 Recent coal trust concerns trace back to industry reform initiatives a few years ago Bothoftherecenttroubledtrustproductsthathaddrawnwidespreadmarketattention were trust loans lent to coal companies in Shanxi province which has raised concerns over thecoalsectorasawhole.Inourview,trustproductsfundingthecoalindustrymayface particularly high risks in 2014, due to the reasons explored below. High financing demand resulting from industry reform has caused large debt accumulation Inanattempttoimprovecoalmineworkingsafety,eliminateoutdatedindustrialcapacity andenhanceindustrystructure,theShanxiprovincialgovernmentlaunchedasweeping reformofthelocalcoalindustryduring2008-09,whichaimedtoreducethenumberof operatingcoalminesintheprovinceandincreaseproductioncapacityofbothcoalmines and coal companies.In the #10 document titled Notification from the Shanxi provincial government on speeding up M&A of coal companies issued in August 2009, the government set a target that by the end of 2010 the number of coal mines in Shanxi would be reduced from 2,598 to 1,000 and the annual production capacity of a single coal company should be at least 3mt. In addition, thedocumentalsostipulatedthatallcoalminesshouldupgradetofullymechanized mining, instead of using outdated blasting mining technology, with production capacity not less than 0.9mt per year. TheShanxicoalindustryexperiencedahugewaveofmergersandacquisitionsfollowing thelaunchofthereform.Inearly2010thenumberofcoalcompaniesinShanxihadbeen reduceddrasticallyfromover2,200to130,withthenumberofcoalminesdownfrom 2,598 to 1,053, according to a media report (Beijing Youth, 21 Feb 2010), meaning that the averagenumberofcoalminesownedbyonecompanyincreasedfrom1.2to8.1.In addition, coal mines with annual production of less than 0.3mt had all been eliminated, and the average production capacity of a single mine had increased to more than 1mt per year. These M&As, together with the required mining technology upgrades that followed, created highfinancingdemandforthecoalcompanies.Onthebackofloosecreditdrivenby government stimulus plans at the time, outstanding loans to the mining industry grew 35% y/y in 2009, from RMB 521bn to RMB 705bn, according to data from the CBRC. FIGURE 4Trust sector AUM-to-equity ratio has been rising rapidly FIGURE 5Average maturity of collective trusts has been on the decline Source: China Trustee Association, Barclays ResearchSource: China Trustee Association, Use-Trust, Barclays Research 23x26x27x29x31x31x33x37x41x42x43x 43x0x5x10x15x20x25x30x35x40x45x50xLeverage (Trust AUM/Equity)1.0 1.2 1.4 1.6 1.8 2.0 2.2 -50 100 150 200 250 300 350 400 450 1Q102Q103Q104Q101Q112Q113Q114Q111Q122Q123Q124Q121Q132Q133Q134Q13years RMB bnQuaterly new collective trusts (LHS)Average maturity (RHS)Barclays | Asia Themes 10 March 201411 Moreover, mining technology upgrades usually take several years to complete. According to a report in Wealth Management Weekly (23 Dec 2013), of the 11 coal mines of the troubled LianshengGroup,8werestillundergoingtechnologytransformationasoflate2013,and thus were not operating. As credit growth slowed in the years following the stimulus, some coal companies especially those that were privately owned with comparatively less access tobankloansbegantoresorttootherfundingsources,includingtrustsandprivate lending, in our view. According to Use-Trusts disclosed data, quarterly issuance of mining-relatedcollectivetrustsincreasedsharplysincethesecondhalfof2011,peakingat RMB24.4bn in 3Q11, of which approximately 90% was related to the coal industry. Maturity mismatch in debt structure of coal companies Whilecoalcompaniesneededtokeepborrowingtosupporttheirlong-terminvestingin miningtechnologyupgrades,theirfundingwasusuallyshortduration,whichcreated maturitymismatchesandsubjectedthemtogreaterliquidityrisk.AccordingtoLiansheng GroupsdeputygeneralmanagerMaYongming(asreportedinWealthManagement Weekly,23Dec2013),mostofLianshengsbankloansareshort-term,butareusedfor longer-term projects that would not generate profits immediately.Besides bank loans, the maturity of trust loans of coal companies is also mostly short, thus resultinginlargeamountsof coal-relatedtrustsbeingissuedbetween 2011and2012and maturing recently. According to Use-Trusts statistics, the average maturity of mining trust products sold in 2011 was only 1.81 years, and in the first half of 2012 was 1.77 years. High funding costs exacerbated liquidity conditions Inaddition,highfundingcostsforcoalcompanies,especiallyontrustproducts,also exacerbated liquidity conditions, in our view. The Use-Trust statistics show that for mining-relatedtrustssoldbetween2010and1H12,theaverageexpectedannualizedreturnwas 9.2%, 50bps higher than the overall level of 8.7%, which did not include fee expenses paid totrustcompaniesandbanks.Meanwhile,theweighted-averageloaninterestrateduring the period was 6.8%, 240bps lower than that of mining trust products. FIGURE 6Mining-related trust issuance increased since 2011 FIGURE 7Maturity of mining-related trusts is on average under 2 years Source: Use-Trust, Barclays ResearchSource: Use-Trust, Barclays Research 2.22.3 5.4 3.8 5.8 6.4 24.4 11.5 16.1 15.4 -100%0%100%200%300%400%500%-5.0 10.0 15.0 20.0 25.0 30.0 RMB bnIssuance amount q/q growth rate1.86 1.89 1.80 1.63 2.28 1.79 1.91 1.64 -0.50 1.00 1.50 2.00 2.50 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12yearsAverage maturity of mining trusts issuedBarclays | Asia Themes 10 March 201412 Complication of coal mine ownership and mining rights Lastly,theaggressivewaveofgovernment-encouragedmergersandacquisitionsofcoal mines during 2008-09 has created some enduring mining rights and ownership disputes in Shanxis coal industry, in our view. Since many coal trusts use the borrowers coal mines as collateral,ambiguityinownershipcouldseverelyunderminevaluewhenliquidation becomes a necessary option.As seen in the case of Chengzhijinkai #1, Zhenfu Group, the borrower of the trust, had never obtainedtheminingrightsfortwoofitslargestcoalminesuntiltherepaymentcrisiswas exposed and the local government as well as financial institutions intervened. Nevertheless, uponinitiationofthetrustproductcollateralwasnotonlyusedassolecollateralforthe trust, but was also estimated by the trust company to yield a quite safe LTV ratio of 30%.Decline in coal price caused industry-wise deterioration in profitability In addition to increasing debt and higher funding costs, the price of coal decreased since its peakin2011,significantlyhurtingprofitabilityofthewholecoalminingindustry.The averageROEofA-sharelistedcoalcompanieshasdroppedcorrespondingly,fromabove 20% during in 2010-11 to only 6% by the end of 3Q13. Moreover,accordingtoareportbyCaijing(11Nov 2013),asprofitabilityandcashflowof the industry deteriorated, banks began to reduce their loans to coal companies, worsening liquidity conditions and compelling coal companies to borrow from more expensive sources suchastrustsandprivatelenders.Eventhoughlocalgovernmentsissueddocuments encouragingbankstokeepprovidingfinancingsupporttocoalcompanies,inrealitythese efforts were mostly in vain. FIGURE 8Mining-related trusts have higher interest rates than bank loans and overall trust products FIGURE 9Coal prices have been declining since 2011, dragging down industry overall profitability Source: Use-Trust, PBOC, Barclays ResearchSource: Wind, Barclays Research Coal sector does not pose systemic risk RMB1.6tn of outstanding interest-bearing debt at end-2013 We estimate that as of the end of 2013, there was approximately RMB1.6tn of outstanding interest-bearingdebt(IBD)inChinascoalsector.Weconsiderthisunlikelytohavea significantimpactonChinasfinancialsystem(ie,itdoesnotposesystemicrisk)evenif asset quality was to deteriorate severely. We estimate the amount of outstanding IBD in the sector using two approaches, one top-down and another bottom-up. 0.0%2.0%4.0%6.0%8.0%10.0%12.0%1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12Mining trust Overall trustWeighted average loan rate0%5%10%15%20%25%4006008001,0001,2001,4001,6002010-01 2011-01 2012-01 2013-01 2014-01RMB /tonPrice of coking coal (LHS)Price of thermal coal (LHS)Average ROE of A-share listed coal companies (RHS)Barclays | Asia Themes 10 March 201413 Top-down approach According to data released by the National Bureau of Statistics (NBS), as of the end of 2013, totalliabilitiesofcoalcompanieswithtotalannualrevenuesaboveRMB20mn1 were RMB3.1tn, up from RMB1.8tn in 2010 at a CAGR of 20.7%. We reference data provided by theState-ownedAssetsSupervisionandAdministrationCommissionoftheStateCouncil (SASAC),whichshowthatasofend-2012theindustryaverageIBD-to-liabilitiesratioof SOEsinthecoalsectorwas51%.Meanwhile,listedcompaniesfinancialsshowthattheir average IBD-to-liabilities ratio was 53% as of 3Q13.Basedonthesefigures,weestimatethatoutstandingIBDofthecoalsectorwas approximately RMB1,644bn as of end-2013 (Figure 10). Bottom-up approach Todoublecheckandexamineinmoredetailthebreakdownofthecoalsectorsfinancial debtstructure,wealsoadoptabottom-upapproachinestimatingthesectorIBDfigure, whichsumsuptheoutstandingbalancesofbankloans,trustsandbondsissuedbycoal companies.Ourbottom-upapproachindicatesthattheoutstandingbalanceofcoalsectorIBDwas RMB1,597bn at end-2013, in line with our estimate using the top-down approach. Outstanding bank loans were RMB1tn as of 2013, accounting for 63% of IBD AccordingtotheCBRCsdisclosure,asoftheendof2012outstandingbankloanstothe miningindustrywereRMB1.4tn.Basedonasectorliabilitybreakdowninthemining industry,weestimatethattheoutstandingbalanceoftotalbankloanstothecoalsector stoodatRMB1tnasof2013(Figure10).Accordingtoourestimate,bytheendof2013 bankloansaccountedfor63%oftotalIBD.However,althoughbankloansarestillthe primaryfundingsourceforthecoalsector,bankssharehasbeendecreasinginrecent years, reflecting broad disintermediation in Chinas financial system. Bonds issuance increased rapidly, with balance reaching RMB 460bn in 2013 Bonds have become an increasingly important funding source for coal companies in recent years.GrowingataCAGRof62%,theoutstandingbalanceincreasedfromRMB109bnin 2010toRMB460bnbytheendof2013.Thebondissuancewasprimarilyconcentratedin the interbank market, which took up 88% of the balance in 2013. Trusts account for a rather small proportion of total coal sector IBD Estimatingtheoutstandingtrustloanslenttoaspecificsectoristricky,duemainlyto limited available information especially so as single trusts need not to make disclosure. We make the estimate based on collective trust data provided by Trust-Use, according to which miningtrustsaccountfor3-8%ofthebasicindustrytrustsandmostoftheminingtrusts issued were to the coal sector. Thus, assuming that coal trusts account for 5% of the basic industry trusts, we estimate the outstanding coal sector trusts to be RMB130bn as of end-2013, based on statistics from the China Trust Association. Asacross-check,wemakeanotherestimateusingcollectivetrustdataprovidedbyWind (note this data set is quite patchy and therefore less useful in its entirety), which has a trust productsampleconsistingof7,185trustswithdisclosedsizeissuedsince2000(5,542in 2012and2013).Byassumingauniversalmaturityof24months,weestimatethebalance of coal trusts was RMB231bn at end-2013, using this sample.

1 The NBS changed its statistical method in 2011. Prior to the change, the threshold had been RMB5mn. We believe the change was due to reasonable adjustments concerning inflation and do not observe notable variance in the sample. Barclays | Asia Themes 10 March 201414 Whilethereissomevarianceintheestimatesunderthesetwoapproaches,ithasno significant impact on our overall estimate of coal sector IBD, since trusts account for only a smallproportion.WeincludeinFigure10ourestimatesusingthefirstapproachbasedon the more stable and coherent sample provided by China Trust Association, as Winds data is patchy, in our opinion, for the earlier years.Accordingtoourestimate,whilecoalsectortrustsincreasedrelativelyfastaswell,ata CAGR of 38% since 2010, they still account for less than 10% of total IBD for the whole coal sector as of end-2013. FIGURE 10Outstanding IBD of the coal sector approximately RMB1.6tn, according to both top-down and bottom-up estimates Note 1: This is a 3Q13 figure as companies have not published annual results. Note 2: We estimate the 2013 loan figure assuming the growth rate in 2013 was the same as that of total liabilities of coal companies. Source: NBS, SASAC, CBRC, CTA, Use-Trust, Wind, Barclays Research estimates No systemic threat, but concentrated regional risks may deserve attention Overall,itappearstousthatthecoalsectordoesnotposeasystemicthreattoChinas financialsystem,asitsoutstandingIBDaccountsonlyforasmallproportionofthetotal. However,webelievethatregionalrisksconcentratedinsomeprovinces,namely,Shanxi, Inner Mongolia and Shaanxi, deserve concern, due to the high degree of contribution of the coal sector to the local economies. According to disclosed data, by the end of 2011, the total coal sector industrial output value of 26 provinces and municipalities was RMB2.5tn, close to the reported national aggregate of RMB2.9tn. Of the 26 regions, Shanxi, Inner Mongolia, Shandong and Shaanxi are the top fourprovinceswiththemostcoalsectorindustrialoutputvalue,contributing 25%/15%/11%/7% to the national total, whereas the rest account for only 41% combined.We look at the coal sector industrial added value, which is a component of GDP, to measure the coal sectors importance in each region. As shown in Figure 12, Shanxi province has the RMB bn, % 2010 2011 2012 2013Total liabilities of coal companies 1,7652,2132,6653,107 Coal sector SOEs' average IBD/total liabilities ratio 49% 51% 51% NAA-share coal companies' average IBD/total liabilities ratio42% 45% 48% 53%(1)Estimated total IBD sof coal sector 804 1,054 1,314 1,644 RMB bn, % 2010 2011 2012 2013Mining industry loans9161,1521,4141,615(2)Coal sector liabilities as % of that of the mining industry 61% 60% 61% 62%Estimated coal loans 562688863 1,007 Interbank market99 195 265 405 Shanghai Stock Exchange6 10 24 47 Shenzhen Stock Exchange4 8 8 8 Outstanding bonds issued by coal companies 109214297460 Outstanding basic industry trusts9951,0161,6502,603 Mining trust as % of basic industry trustsCoal trust balance, assmuing 5% of basic industry trusts50 51 83130 Bank loans as % of IBD 78% 72% 69% 63%Bonds issued as % of IBD 15% 22% 24% 29%Trusts as % of IBD 7% 5% 7% 8%Estimated total IBD of coal sector 720952 1,242 1,597 Top-downBottom-up3-8% for collective trustsBarclays | Asia Themes 10 March 201415 highestcoalsectorindustrialvalueadded/GDPratioof33%amongall13regionswith discloseddatabytheendof2011,followedbyInnerMongolia,ShaanxiandNingxia,with the ratio at 16%/10%/10%, respectively.Hence, we identify Shanxi, Inner Mongolia and Shaanxi as the three provinces that would be mostnegativelyaffectedbyadownturninthecoalsector,duetobothhighproductionof coal and local economic dependency on the coal sector. FIGURE 11Each regions contribution to the total coal sector industrial output value, as of 2011 FIGURE 12Coal sector industrial added value as % of GDP for each region, as of 2011 Source: NBS, Wind, Barclays Research estimatesNote: Inner Mongolias coal sector industrial added value is estimatedSource: NBS, Wind, Barclays Research Local governments capable of bailing out troubled companies in coal sector However,wethinkthattheserisksmaybemanageable,asthefiscalconditionofthese regions is general healthy. According to disclosure by the audit offices of each regions, as of theendof2012(exceptforGuizhouprovince)thecomprehensivedebtratios(which includes a proportion of guarantee and contingent liabilities) of local governments in these highly coal-dependent regions are all within safe ranges under 80% (Figure 13). Therefore, webelievethelocalgovernmentswouldhaveadequatecapacitytobailoutcompaniesin the coal sector in case of serious default, and are likely to be able to prevent turmoil in the financial system. FIGURE 13Local governments in coal-dependent regions have moderate debt levels in general, as of 2012Region Coal sector industrial added value/GDPComprehensivedebt ratio(1)Shanxi33% 53%Inner Mongolia16% 77%Shaanxi10% 69%Ningxia9% 50%Guizhou8% 92%Qinghai6% 58%Anhui5% 53%Note 1: Debt ratio is defined as outstanding debt divided by total fiscal revenues, including budgetary fiscal income (tax and fees) and off-budget incomes such as land sale proceeds; comprehensive means that the debt amount includes proportion of guaranteed and contingent liabilities of the government Source: Local audit offices, NBS, Wind, Barclays Research 0% 10% 20% 30%ShanxiInner MongoliaShadongShaanxiHebeiSichuanGuizhouAnhuiTianjinHeilongjiangBeijingOtherCoal sector as % of industrial output value0% 10% 20% 30% 40%ShanxiInner MongoliaShaanxiNingxiaGuizhouQinghaiAnhuiHenanYunnanXinjiangFujianJiangxiBeijingGuangxiIndustrial added value of coal sector/GDPBarclays | Asia Themes 10 March 201416 Trust default: an important step to break implicit guarantees Implicit guarantee on principal has yet to be broken InthecaseoftroubledChinaCreditTrust/ICBCsChengzhijinkai#1,asolutionwas eventually reached as an unidentified outside institution intervened and took over the trusts underlying assets (according to a report by 21cbh, 31 Jan 2014), which generated cash flow forthetrustcompanytopayoffinvestors.Eventhoughtheinvestorsreceivedonly2.8% interestforthelastyear,farlessthanthe9.5%-12%expectedreturnandconstitutinga technicaldefault,theprincipalwaseventuallyfullypaiddespitethetrustproductbeingin trouble upon maturity. In the case of Jilin Province Trust/CCBs Songhua River #77, the borrower, Liansheng Group, is still undergoing a restructuring process. As of 20 Feb 2014 the first five matured tranches hadalreadytechnicallydefaultedbymissingpaymentstoinvestors.Nevertheless,ithas been reported (by Wallstreetcn, 27 Feb 2014) that RMB1.5tn from guarantors of Liansheng Group will be used to settle collective trust payments as a priority.During the restructuring process of Liansheng Group, local media (eg, Securities Times, 17 Feb2014)reportedthatinordertoobtainhigherseniorityindebtsettlement,JilinTrust, ShanxiTrustandChangAnTrusthadjointlysubmittedtotheCBRCstatementsthatthey would refuse to accept or implement the restructuring plan if requests were made for their maturedcollectivetrustproductstorollover ratherthanbe paid,asbankloansandsingle trustswerelikelytodo.Theemphasisonredeemingcollectivetrustsfirst,inourview, reflected the government and financial institutions need to pay off and calm retail investors as a priority. Implicit guarantee has negative effects on the financial market Webelievethattheassumedimplicitguaranteeincasesoffailedtrustproductshas distorted the risk pricing mechanism of the financial market. While this may have protected thepublicinterestincertaincases,ithasalsocreatedmoralhazardonthesideofretail investors who customarily assume implicit guarantees when purchasing financial products frombanks,andtaketheexpectedyieldlevelabove10%asarisk-freerate.Fromthe perspectiveoffinancialinstitutions,inordertoattractcustomerstheyarecompelledto offerhighexpectedreturns,often,webelieve,withoff-the-recordpromisesofprincipal guarantee.Thishaslikelyledtoinappropriatepracticesinbanksinitiation,saleand management process of financial products, in our view.This kind of misperception of risk not only poses potential threats to the public interest, but mayalsocompromisepolicytargetsoftheregulators.Webelievethatsomecredit generatedbythesehigh-yieldingfinancialproductsmighthaveflowedintoless-efficient companies.Suchcompaniesmaybeindifferenttounsustainablyhighfundingcosts because they simply require funding of whatever sort in order to remain in operation.Astheallocationefficiencyofthefinancialmarketworsens,overallcreditriskswithinthe system increase. In addition, since financial products including trusts and WMPs are de jure off-balance-sheetactivitiesforthebanks,inmanycasestheirrisksareneitheradequately monitorednorproperlypreparedforthroughmethodssuchasprovisioning.Byproviding implicitguarantees,banksandotherfinancialinstitutionssubjectthemselvestoextrarisk exposure, which would erode their capital bases if they have to bear the losses. Barclays | Asia Themes 10 March 201417 Orderly trust default is possible, and would be positive for banking sector in the long run As we argued in the case of China Credit Trust/ICBCs Chengzhijinkai #1, we believe letting theproductdefaultwouldbegoodforthedevelopmentofChinasfinancialsysteminthe long-run (see China Banks: First financial product default? A short-term pain, but long-term gain,17Jan2014).Whilewedosympathizewiththegovernmentscautiousstancein dealingwiththesituations,breakingimplicitguaranteesappearstoustobeanecessary task, and is becoming more pressing over time.Intheshortterm,breakingtheimplicitguaranteebylettingsometrustsdefaultislikelyto have a negative impact on market sentiment. However, we believe that such reform would remove an element of overhang on China bank stocks and be good for them in the long run. Inourview,adefaultwouldnotnecessarilyleadtosystemicrisks,andanorderlytrust default would be possible due to reasons, including: Investorsoftrustproductsaremostlyhigh-net-worthindividualsthathavehigher toleranceforeconomicloss,andthenumberofhouseholdsaffectedismuchsmaller compared to that of WMPs.The case of Songhua River #77 and some other troubled trusts seems to indicate that a default would have limited impact, as the matured tranches for these trusts have already technically defaulted by missing due payments, and yet there has not been any financial system turmoil so far.Risks of trusts may be unevenly distributed across difference sectors and regions; hence, through proper cultivation of public risk awareness, defaults could compel funds to exit riskier sectors and flow into safer ones. Asinmostcases,webelievethegovernmentwillpushthereformprocessatagradual pace. Letting investors bear some, but not all, loss of principal would be a good first step, in ourview.Meanwhile,wealsobelievethataprecedenttrustdefaultwouldaltertherisk appetiteinthemarket.Asaresult,interestratesontrustproductswouldlikelyriseand growth of trusts slow, at least in the short term. Trust default more likely to take place when other regulations are ready Inourview,thegovernmentmightbemorecomfortablewithallowingtruststodefault whenotherregulations,includingmorecomprehensiveshadowbankingrulesanda financialsafetynet,suchasthedepositinsurancesystem,arealreadyinplace.Weexpect anacceleratedpaceofreformin2014,likelyaftertheNationalPeoplesCongress Conference in March.Impact of trust sector on China banks and TSF Direct impacts on banks might reduce sector net profits by 6-9% in 2014 China banks direct exposure to the trust sector consists of four main components, namely: 1)collectivetrustproductsdistributedbybanks;2)bank-trust(BT)cooperativeproducts underlyingWMPs;3)reversereposcollateralizedontrustbeneficiaryrights(TBRs);and4) investmentsinTBRs.Onourestimates,asoftheendof1H13,totaloutstandingbank exposuretothetrustsectorwasapproximatelyRMB5.98tn,accountingfor63%oftotal trust assets and equivalent to 8.8% of total loans. Barclays | Asia Themes 10 March 201418 FIGURE 14China banks exposure and potential loss to the trust sector, as of the end of 1H13 RMB bn , as of 1H13Outstanding amount Total collective trusts2,210 Bank-distributed third-party collective trustsa 1,547 Other channels 663 Total single trusts6,697 Bank-trust cooperative productsb 2,085 TBR in reverse repoc 1,057 TBR in investmentsd 1,291 Non-bank single trusts2,265 Total bank exposure to trustsa+b+c+d 5,979 Potential loss under a severe scenario416 Note: Sector-wise TBR in reverse repos and investments is estimated based on disclosure by A- and H-share listed banks. Source: Company data, CBRC, CTA, Barclays Research estimates Werunascenarioanalysistoexaminethedirectimpactsthetrustsectorcouldhaveon Chinabanks.Underourseverescenario,weassumenon-performingasset(NPA)ratiosof bank-distributedthird-partycollectivetrustsandTBRreverserepoandinvestmentstobe 20%, and the NPA ratio of bank-trust cooperative products to be 10%.In addition, we assume banks need to bear all losses on TBR reverse repo and investment as theyareon-balance-sheetitems.Wealsoassumebankswouldneedtobearalllosseson bank-trustcooperativeproductsunderlyingWMPs,whicharemostlysoldtoordinary citizens.However,weassumethatbankswouldonlyhavetoshare50%ofthelosseson third-partytruststheydistributetoreflectourviewthattrustssoldtowealthyindividuals may be the first step to break implicit guarantee. Thus,byapplyingalossratioof50%,thepotentiallossofChinabankstrustexposure could be RMB 416bn as of 1H13, under our severe scenario (Figure 14). Furthermore, if the potential loss is to be spread over the next 2/3 years, we calculate that it could reduce net profits of the China banks sector by 9.2%/6.2% in 2014 and 8.5%/5.6% in 2015, assuming the sector net profit growth to be 10%/9%/8% in 2014/15/16, a constant net profit/PPOP ratio of 80%, and an effective tax rate of 25% (Figure 15). FIGURE 15Scenario analysis: impact of trust default and loss on China banks net profits RMB, bn2014E 2015E 2016ENet profits 1,560 1,700 1,836 PPOP 2,600 2,834 3,060 Scenario 1: potential loss to be spread over 3 years Adjusted net profits 1,464 1,604 1,740 Impacts on net profits-6.2% -5.6% -5.2%Scenario 2: potential loss to be spread over 2 years Adjusted net profits 1,416 1,556 Impacts on net profits-9.2% -8.5%Source: CBRC, CTA, company data, Barclays Research estimates Indirect impacts: higher funding costs and slower TSF growth In addition to banks direct losses due to trust failures, we believe defaults of trust products would also have indirect impacts on the banking sector, through likely higher funding costs for the real economy and slower TSF/trust asset growth. Barclays | Asia Themes 10 March 201419 Atleastintheshortterm,trustdefaultswouldchangethecurrentriskawarenessinthe market,inourview,andtrustproductswouldhavetoofferhigherinterestratesto compensate for perceived risks, even though the underlying fundamentals remain the same. Asaconsequence,weexpectrisksinbankloanstoriseaswell,duetoincreasingfunding difficulties for some financially stressed borrowers. Meanwhile,wealsoexpectTSFgrowthtoslowwithmoderationofthetrustsectors expansion.In2013,trustloansaccountedfor10.6%oftheTSF,upfrom2.7%in2010. Assuming 10% annual growth rate in 2014 and 5% of trust loans as percentage of the TSF, weestimatethatnetnewtrustloanswouldbeRMB949bnin2014,down48%y/y compared to RMB 1.83tn in 2013. FIGURE 16Trust loans accounted for 10.6% of TSF in 2013 Source: PBOC, Barclays Research Further reading Barclays related research reportsBelow, we provide links to past research on related topics that might be of interest (please click on title to view full report on Barclays Live). Report 1: China Banks: China Credit Trust raises concerns over China's trust industry overall, Jan 27, 2014 Report 2: China Banks: First financial product default? A short-term pain, but long-term gain, Jan 17, 2014 -5%-3%0%3%5%8%10%13%15%-300 -150 0 150 300 450 600 750 900 RMB bnNet new trust loans (LHS) Trust loans as % of TSF (RHS)Barclays | Asia Themes 10 March 201420 EQUITY RESEARCH: CHINA COAL Coal prices to remain range-bound in the near term A new normal range is being established for coal prices in China (and coal freight rates as well).OurviewhasbeenthatthetroughofcoalpriceswouldbeintheRMB500-530/t range,withthepeakataroundRMB600-630/t.Ourrationaleforthisrangeisalsothatit reflects the 85th to the 99th percentile of the Chinese domestic producers cost curve, in our view, between which commodity prices usually oscillate in an oversupplied market. Forthenextsixmonths,Chinacoastalfreightrates,oneofthebestleadingindicatorsfor coal prices and demand from the main coal users, have reversed from the 50% drop in late December, which indicates coal prices are stabilizing at current levels.Lower domestic coal supply as producers face reality CoalminingcapexhasbeenmoderatinginChinaforawhile,withtherateofgrowth slowingin2011andthenflat-liningin2012,primarilydrivenbytheexpectationthat investment growth in the industry would further decline due to lower coal prices. When FAI data for individual industries in China for 2013 was released by NDRC, it showed a decline in coalFAIforthefirsttimeinthe15yearssincedatacollectionstarted.Althoughthe magnitude of the decline in 2013 was marginal (-0.4% y/y), it is a big change in the context ofa32%y/yCAGRduring2004-2011.AnnualcoalminingFAIgrew6xduringthe2004-2011 period while coal production doubled. However, in 2012 coal mining FAI grew 7% y/y while coal production grew just 3.5% y/y, and the 2013 negative FAI growth led to negative coal production growth in China. FIGURE 17China coal mining FAI growth was flat in 2013 FIGURE 18Negative FAI growth led to decline in domestic coal supply 0100,000200,000300,000400,000500,000600,0002004 2005 2006 2007 2008 2009 2010 2011 2012 2013China coal FAI (mn RMB)Coal FAI -8.0%-6.0%-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%10.0%12.0%14.0%-10%0%10%20%30%40%50%60%70%2005 2006 2007 2008 2009 2010 2011 2012 2013Coal FAI Coal productionSource: CEIC, Barclays ResearchSource: CEIC, Barclays Research We believe that the decline in both indicators of medium-term coal supply is a symptom of thelackofprofitabilityandcashflowsinthe coalminingindustry.Evenwithay/ydropin coalminingFAIin2013,capacityincoalminingisincreasing(especiallyatthelowendof thecostcurve),bututilizationratesaredroppingduetotheweakcoalpriceand supply/demand trying to find a balance.CoalminingFAIinChinacouldcontinuetoundershootcoalproductionforsometime,in ourview.Thisisnaturalandpartoftheprocessofnormalizationofthesupply/demand balance in the commodity, as demand for domestic coal began to normalize in 2013 due to anumberoffactors,including:1)therebalancingoftheeconomyfrombeingdrivenby ASIA EX-JAPAN METALS & MINING Industry view: Neutral Ephrem Ravi +852 2903 4892 [email protected] Barclays Bank, Hong Kong Krishan Agarwal +852 2903 4543 [email protected] Barclays Bank, Hong Kong Ada Dai +852 2903 4052 [email protected] Barclays Bank, Hong Kong Dixon Lau +852 2903 4838 [email protected] Barclays Bank, Hong Kong Barclays | Asia Themes 10 March 201421 industrialinvestmenttobeingconsumer-driven,2)afocusoncleanerenergytoreduce pollution, and 3) rising coal imports, all leading to lower coal prices in 2013. We believe less investment in coal, and the likely subsequent lower supply, will support coal prices and coal mining profitability in the long run. Consolidation has been an ongoing theme in the industry for a decade although it remains veryfragmentedstill.Followingconsolidationactivitiesthatarereferredtointheearlier sectionofthisreportanalysingShanxicoalindustryfinances,weseeitalsoasimperative thatproducersinvestinandupgradefacilitiestoproducecoalatacompetitivecost.We believethisaspecthasbeenlagginginpursuitofvolumesinChinainthepast.Ourvisitto Shanxicoalproducersin2012highlightedthatvolumesratherthancostefficiencieswere thefocus(see our12March 2012report Coal:PostcardFromShanxi:WillShanxispoilthe coking coal party?) Positive short-term indicators of coal demand Chinese coal prices (and seaborne coal prices for that matter) are back to where they were before the rally in August 2013. Chinese coal prices went from RMB510/t in August 2013 to RMB635/tinearlyJanuary2014,andinlessthantwomonthshavecomebackdownto RMB538/t(theNewcastlecoalexportpriceoutofAustraliahasalsomadethefullround tripfromUS$75/tinAugust2013toUS$87/tandisatUS$77/tcurrently).Asinvestors ponderthedirectionofthecoalpriceatitscurrentlows,oneofthebestindicatorsofthe direction of short-term coal prices suggests prices have troughed for the time being.CoastalseabornecoalfreightrateshavebeengoodleadingindicatorsofChineseIPPcoal restocking/destockingcycles(andconsequentlycoalspotprices).Theyheraldedthe recovery of the coal price in August 2013, the biggest rally in two years, with prices peaking out and a subsequent collapse in prices in late 2013. FIGURE 19Rebound in coal freight indicates growing demand from main coal users 01020304050607080Jan-12Feb-12Mar-12Apr-12May-12Jun-12Jul-12Aug-12Sep-12Oct-12Nov-12Dec-12Jan-13Feb-13Mar-13Apr-13May-13Jun-13Jul-13Aug-13Sep-13Oct-13Nov-13Dec-13Jan-14Feb-14China coastal seaborne freight rate (RMB/t)Qinhuangdao-Guangzhou Qinhuangdao-ShanghaiHuanghua-ShanghaiSource: Sxcoal, Barclays Research Thelate-February2014coastalseabornefreightrateinChinatickedupforthefirsttime sincemid-December2013asthefreightrateforthelongQinhuangdao-Guangzhouroute ratecamedownbyc50%andtheshorterQinhuangdao-Shanghairouteratedeclinedby 60%. Incidentally, absolute freight rates are back where they were before the rally began in August 2013.Barclays | Asia Themes 10 March 201422 Stock pick China Shenhua (OW, PT HK$31) Structural earnings upside with non-coal assets easing earnings volatility China Shenhua offers pure-play exposure to thermal coal with more than 98% of its annual averagesalesvolumecomingfromthermalcoal.Ourinvestmentcasehasthreemajor components,giventhecompanys:1)faster-than-industrygrowthincoalvolumes;2) integratedlogisticssupplynetworkdrivinghigherprofitabilityandsupportingitsvolume growthvs.peers;and3)exposuretopowergeneration,whichlowersearningsvolatility driven by coal prices vs. peers.Shenhuahasstrongbalancesheetwithagearingjustunder10%byendof2013,onour estimates.OurforecastforanetdebtofRMB26.8billionbyend2013inthecontextofits annualised free cash flow of over RMB30 billion in 2014E underscores the relative strength, which will likely improve further as we estimate the annualised free cash flows to increase in next three years by c50%. ThesizeofShenhuasbusinesshasnearlydoubledsince2008(withoutaddingondebt), whichreflectsitsearningspotential.Weexpectcoalequivalentvolumestojumpfrom 270mtin2008to535mtin2014E,andthatthecompanywillgenerateEBITDAof RMB91.1bnin2014E,evenafterconsideringtheimpactofcurrentlowcoalprices, comparedwithEBITDAofRMB49.5bnin2008.Inaddition,thecompanyannouncedthree non-coalmininginvestmentsin2013tofurtherdiversifyawayfromcoalpricingrisks, namelythecoal-to-olefinplantacquisitioninInnerMongolia,acquisitionoftheJiujiang power plant, and formation of a US JV to explore and produce shale gas in Pennsylvania.OurpreferenceforShenhuaisdrivenbyanumberofcompany-specificdriversandisnot basedsolelyonhighercoalprices.Thehigherrailwaytariffalreadyannouncedbythe ChinesegovernmentinJanuary2014couldincreaseourbasecaseearningsestimateby 12%andcoincideswithhigherrailwayvolumesin2014.WhileShenhuaiscontinuingto maintainhigherROEthanitsChinesecoalpeers(2014EROEat17%vsChinesecoal producersaverageROEof10%)withadividendyieldof5.5%,webelievethecurrentP/B of 1.1x 2014E does not fully reflect its strong return profile. Barclays | Asia Themes 10 March 201423 EQUITY RESEARCH: CHINA PROPERTY Short-term pain inevitable but risk is manageable Asconcernsovertrustdefaultshaverisen,weexpectadecreasingappetiteforriskto furthertightentheincrementalquotaoftrustfinancinganddriveuprefinancingcostsfor Chinas developers. Should scrutiny over trusts continue, we expect to see some short-term negativeimpacts:1)aggressivepropertypricecutscouldcomefromfinanciallystretched developers,especiallysmaller/localplayers,astheyseektofulfildebtrepayment obligations; however, we dont expect to see this across the whole sector; and 2) refinancing costswilllikelyriseformostdevelopersasaresultofalowerriskappetiteandtightening liquidityinthebroadeconomy.Nevertheless,wedonotexpectthistobecomeasystemic risk for Chinas real estate sector. Instead, with the credit pressure likely offering more M&A opportunitiesfordevelopersthatarecash-rich,weexpectmarketconsolidationwill accelerate,withthebigdevelopersbecomingevenbigger.AmongtheChinastockswe cover, we expect Evergrande (EW; PT HK$3.30) and Poly Property (UW; PT HK$3.80) could be more vulnerable given their relatively higher exposure to trust financing (see Figure 23).Real estate trusts were booming in 2013According to data from China Trustee Association, the trust loan balance for the real estate sector stood at Rmb1,034bn at the end of 2013. Excluding offshore financing and entrusted loans,thisaccountedfor18%ofdeveloperstotaldebtbalance(wenotethatdomestic bond financing has not been available for developers, except for cases of affordable housing construction). Driven by brisk home sales, the issuance of real estate trusts surged by 116% y/y to Rmb685bn in 2013 and the issuance cost declined by 56bps to 9.55% (vs. 10.11% in 2012).Shouldinvestorsriskappetitedeclineamiddefaultconcerns,weexpectthis momentum will inevitably slow in 2014, and refinancing costs will rise.FIGURE 20Balance of real estate trust and financing cost FIGURE 21Average lending cost for 14 developers under our coverage Source: China Trustee Association, Barclays Research Source: Company data, Barclays Research Aggressive price cuts expected but unlikely to be contagious Whenfacingcreditpressure,developersarelikelytoturnfirsttocuttingprojectselling prices with the aim of accelerating cash collection. We expect this to happen among smaller local developers, given their limited access to refinancing facilities. Aggressive price cuts by thesedeveloperswouldlikelyexertsomepricingpressureonadjacentprojectsbutwe expecttheimpactshouldberelativelyshort-livedgiventhestillhealthyinventorylevels across the sector as a whole. Current inventory across 14 cities we track hovered around 11 8.94%10.07%10.11%9.55%8.2%8.7%9.2%9.7%10.2%01,5003,0004,5006,0002010 2011 2012 2013Balance of real estate trust (RMBbn)Balance of construction loan (RMBbn)Financing cost of newly-issued real estate trust6.4%7.6%8.4%8.07%8.32%8.57%9.07%0%2%4%6%8%10%2010201120121H131H13+25bps1H13+50bps1H13+100bpsASIA EX-JAPAN REAL ESTATE Industry view: NEGATIVE Alvin Wong +852 2903 4535 [email protected] Barclays Bank, Hong Kong Jianping Chen +852 2903 4451 [email protected] Barclays Bank, Hong Kong Barclays | Asia Themes 10 March 201424 monthsinFebruary,lowerthanthe17-20monthsnotedfromNovember2011toMarch 2012.Thatsaid,whilewethinkdeveloperspricingwillturnmoreconservative,spiralling price cuts across the whole sector are unlikely in the near term, in our opinion.Impact of higher financing cost will be primarily reflected in 2015 Another impact of the increasing scrutiny on trust loans is the rising cost of refinancing. We expect this to impact developers bottom lines only in 2015 as the majority of gross interest expense incurred in 2014 will likely be capitalized. Average financing cost for 14 developers under our coverage was 8.07% in 1H13, on our calculation. Based on total debt level at end-June 2013, we estimate that hikes of 25bps, 50bps and 100bps in average borrowing costs would translate into a net margin squeeze of 16bps, 32bps and 64bps in 2015E, and could lowerour2015netprofitestimatesby1.1%,2.3%and4.5%,respectively.Please seeLiquidityexpectedtotighten;qualitydeveloperswilllikelylessaffectedof27January 2014.High exposure to trusts is not necessarily bad; sales execution also counts Whiletrustloanscostmore(eg,9.55%in2013)thanotherfinancingfacilities,suchas domesticconstructionloans(eg,8.0%evenata30%premium),higherexposuretotrust financing by developers is not necessarily bad for all developers, in our view. For some small developers,webelievehighnetgearingisatrade-offforthemtogrowinscaleatafaster pacefromalowerbase.Webelievesalesexecutioncapabilityalsocountsinan unfavourableliquidityenvironment.Amongthe14stocksunderourcoverage,Evergrande (EW;PTHK$3.30),Sunac(OW;PTHK$6.45)andPolyProperty(UW;PTHK$3.80)have higherexposuretotrustfinancing.Nevertheless,givenSunacsproventrackrecordof strongexecutionsalesexecutionandqualitylandreserves,wethinkEvergrandeandPoly will be the more vulnerable to rising trust default concerns.FIGURE 22Proportion of short-term debt vs. total debt FIGURE 23Developers exposure to trust financing as of Jun-13 Source: Company data, Barclays Research Source: Company data, Barclays Research Big developers to become bigger Should the scrutiny of trusts continue to escalate, we do not rule out the possibility of small developers running into financial difficulties given their heavier reliance on shadow banking activities. Nevertheless, we believe the chance of such scrutiny amplifying into systemic risk for Chinas real estate sector is small. Instead, with credit pressure likely offering more M&A opportunitiesforthecash-richdevelopers,weexpectmarketconsolidationwillaccelerate andthebigdeveloperstobecomeevenbigger.COLI(OW;PTHK$26.80),inthiscontext, wouldbeoneofthemajorbeneficiaries,inouropinion,givenitsstrongcashposition, proven track record on sales execution and profitability. 0%10%20%30%40%50%60%CGCOLILongforKWGCRLGZ R&FCOGOAgileShimaoSino-OceanSunacGreentownEvergrandePoly Prop.2011A 1H130%5%10%15%20%25%30%EvergrandeSunacPoly Prop.GZ R&FAgileSino-OceanShimaoCRLCGKWGCOLICOGOGreentownLongforBarclays | Asia Themes 10 March 201425 CREDIT RESEARCH: CHINA PROPERTY Sensitivity to domestic funding Smaller developers more sensitive to trust loans Chinese developers have used trust loans from time to time to fund their business activities for reasons of debt timing differences, flexibility and accessibility. Although trust loans are a riskieralternativetolong-termoffshorebonds,offshorebankloansandonshore constructionloans,wethinkmoderateandmanageduseofthemisacceptable.For developerswithaccesstotheUSDbondmarket,trustloansaresimplyanotherfunding option.Butforsmallerdevelopersthatdonothaveaccesstooffshorefinancialmarkets, they are likely to be more exposed to changes in Chinas trust loan market.Overall exposure among developers to trust funding is manageable Manydevelopershaveimprovedtheirliquiditypositionsanddiversifiedtheirfunding sourcesoverthepastfewyears.AttheendofDecember2012,weestimatedthatthe exposureof34selectdevelopersintheUSDbonduniversetotrust/entrustedloans averaged only 6.4% of their total debt (median basis) or 12.6% (average basis). For further details,seeFigure9 Chineserealestate:Sensitivitytodomesticfunding,16July2013.Ata sector level, we estimate this ratio remained around 10% of total debt (average) in 2013. In general, we think these 34 developers increased their exposure to trust loans in 2013, given competitive costs and accessibility, while their total debt also likely rose in 2013.China Vanke in the high grade space and Glorious Property in the high yield space stand out asbigusersof trustloans.As attheendofDecember 2013,we estimatetheratiooftrust loanstototaldebtwasc.40%forVankeand40-50%forGlorious(includingentrusted loans). But given its market position, strong liquidity and robust sales, Vanke looks to be in a much better position to withstand potential volatility in the trust loan market than Glorious (Underweight15s&18s).Gloriousliquidityalsoremainstight,withrestrictedcashof CNY1.1bn, which is less than its short-term debt of CNY8.1bn at the end of June 2013.No imminent systemic risk We believe the likelihood of default among property-related trusts to be less than for other industries,particularlythosewithsignificantovercapacity.GiventhegrowthofChinas propertymarketinthepastfewyearsand,hence,equityvalue,wethinkdevelopersare more likely to monetise property projects to repay outstanding debts, rather than be at risk of defaulting on their loans. Nonetheless, we think a knock-on impact of (potential) defaults in other sectors would likely see a reduction in investors risk appetite and stricter terms (ie, higher risk premium) for developers wanting to access trust loans, which would likely result inreducedavailability.Shouldthetrustloanmarketbeshutdownforaprolongedperiod, some of the smaller developers may face consolidation pressure due to liquidity constraints. ASIA CREDIT RESEARCH Christina Chiow, CFA* +65 6308 3214 [email protected] * This author is a member of the Fixed Income, Currencies and Commodities Research department and is not an equity research analyst Barclays | Asia Themes 10 March 201426 CREDIT STRATEGY Ratings risks likely to increase When markets were concerned that ICBC would bail out China Credit Trusts Chengzhijinkai No.1 product, S&P released a commentary stating that If, contrary to our current thinking, ICBCdoesbailouttheCTP[CollectiveTrustProgram],wewillhavetoreviewour assumptionsaboutChinesebankscreditexposurestoshadowbanking.AbailoutbyICBC maytriggeranevent-drivenreviewofourBankingIndustryCountryRiskAssessmenton China and our stand-alone credit profile assessment of ICBC.Consequently,ifChinesebanksbegintosharelossesontrustproductswherenolegal obligationexists,wethinkratingspressureonChinesebankscouldincrease.Inparticular, among the Chinese banks with USD bonds outstanding, we think S&Ps issuer credit ratings onAgriculturalBankofChinaandBankofCommunications(BOCOM)couldbe downgraded one notch, to A- and BBB+, respectively. We expect the issuer credit ratings of IndustrialandCommercialBankofChina(ICBC)andBankofChina(BCHINA)toremain unchanged, but we think their standalone ratings could see one-notch downgrades to bbb-.Overall, we think ratings downgrades could weigh on sentiment towards the Chinese banks, eveniflossesrelatedtothetrustproductsaremanageablerelativetoearnings.Thiscould eventuallyleadtospreadwideningintheChinesebanksseniorbondsandtheirCDS.In particular, we think the spread differential between the bonds of BOCOM and BCHINA/ICBC could widen, given the ratings cliff effect of the Bank of Communications falling out of the A-rating bucket.At current levels, we continue to recommend a cautious stance on the bonds of the Chinese banks.Inourview,persistentnegativenewsflowrelatedtotrustproducts,aswellas continuedsupplyfromtheChinesebanks,willlimitoutperformance.WenotethatYTD, supply from the Chinese banks (including SBLC-backed bonds) accounts for about 41% of total supply from Asian banks.Trade ideas SellBOCOM23s;BuyACIRC22s(ChinaDevelopmentBank,CDB)ataspread differentialof15bp.Asdiscussedabove,webelievetrustbailoutsbyChinesebanks couldresultinBOCOMsratingsbeingdowngradedtoBBB+fromA-.ACIRCbonds (Aa3/AA-) are issued by Amber Circle Funding, a SPV, but benefit from a guarantee by CDB. In our view, the spread differential of 15bp is very low, given the difference in the strategicnatureofthetwoentities,thedifferenceinratingsandtherisksofa downgradeatBOCOM.Webelieveamoreappropriatespreaddifferentialisabout30-40bp. BuyBCHINA5yCDSandsellCDB5yCDSatacostof10bp.Thespreadbetween BCHINAandCDBhasbeensteadyat10bpoveranextendedperiodoftime(reflecting themarketviewthatCDBenjoysagreaterdegreeofsovereignsupportasapolicy bank).Asadeposit-takingbankwithwidedistribution,BankofChinaismoreexposed tolossesfromtrustproducts.IftheprecedentofChinesebankssharinglosseson products thatare not on balance sheet is established, we expect the spreaddifferential betweenCDBandBCHINAtowiden.AfurtherpositivecatalystforCDBislikelytobe fiscalreformsthatresultinamorebenignviewofitsexposuretolocalgovernments. Overall,weviewthistradeasalow-risktradewithanegativecarryof10bp;however, liquidity and bid-offer spreads could present a challenge for large positions. ASIA CREDIT STRATEGY Krishna Hegde, CFA* +65 6308 2979 [email protected] ASIA CREDIT RESEARCH Lyris Koh* +65 6308 3595 [email protected] * These authors are members of the Fixed Income, Currencies and Commodities Research department and are not equity research analysts Barclays | Asia Themes 10 March 201427 RATES STRATEGY Higher rates volatility the new normalAllowingdefaultsontrustproductscouldalterriskperceptionstowardsChina,inour view, thus putting upward pressure on interest rates. Moreover, if defaults are conducted inanon-transparentmanner,thiscouldhaveimplicationsforalready-declining interbanklendingvolumes,andleadtoawiderdispersioninlendingrates.Banks increaseddemandforliquidassetsinsuchanenvironmentcouldleadtospikesinrepo ratesandhighervolatility,whichweexpecttobeamorefrequentmarketphenomenon goingforward.WethinkthePBoCsneutralstanceonliquiditycouldprovideacushion, but would be unlikely to restore confidence in the market. Higher risk premia required. While the likelihood of trouble in Chinas trust sector has been generallyknownsince2012,thesignificantamountoftrustproductsmaturingin2014 ourbanksequityanalystsestimateCNY4.5trn(up77%y/y)makesthe currentsituation more sensitive, in our view, particularly if regulators become comfortable allowing trusts to default. Moreover, with an estimated CNY1.1-1.3trn of riskier collective trusts maturing this year, we believe banks could see losses on trusts in their WMPs. These factors the trusts maturityscheduleandembeddedriskswouldrequirehigherriskpremiainfixedincome markets.Iftrustdefaultsarehandledonacase-by-casebasis,whichweconsiderlikely giventhepotentialmagnitudeofthesectorsproblems,wethinkthisislikelytocreate uncertainty and lead to a re-pricing of risk premia. In particular, as shown in Figure 24 and Figure25,interbanklendingvolumestendtofallintimesofmarketstress,andthe differentiation between banks increases.FIGURE 24 Volatility: Down, but not out; dispersion likely to be routine as shadow banking deleveraging continues FIGURE 25 Money market squeezes likely to be regular events in 2014 Source: China National Interbank Funding Center, Barclays ResearchSource: Bloomberg, Barclays Research We think the PBoCs shift to a neutral stance in February could have been pre-emptive to dampenpotentialvolatilitygiventhelikelihoodofcrediteventsinthenearterm.The PBoCalsosoundedlesshawkishinitsQ413monetarypolicyreport,statingthatitwould maintain appropriate levels of liquidity and create a stable monetary-financial environment. Oureconomistsbelievethepolicyshiftreflectschangingeconomicconditions,asgrowth hasmoderatedandinflationhasbeensofteningonthebackofhigherinterestratesand slowermoneygrowth(seeChinaPBoCWatch:Lesshawkish,moreflexible,12February 2014).AlthoughinterestratesmoderatedinearlyJanuaryamidreducedinterbankmarket stress and the PBoCs special liquidity operations ahead of Chinese New Year, release of the 0%5%10%15%20%25%30%02468101214Jan-12 Jul-12 Jan-13 Jul-13 Jan-14%Median O/N ShiborDispersion in quotes (RHS)0246810120.20.40.60.81.01.21.4Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13CNY trn1d repo weekly volumes7d repo rate (%, RHS)RATES STRATEGY Rohit Arora* +65 6308 2092 [email protected] * This author is a member of the Fixed Income, Currencies and Commodities Research department and is not an equity research analyst Barclays | Asia Themes 10 March 201428 banksQ413monetarypolicyreporton8Februarytriggeredasharprallyinfixedincome markets. Stop-losses being triggered on medium-term payers are likely to have exacerbated the moves, in our view. While we acknowledge the PBoCs change in stance from hawkish to neutral, we think the centralbankstoleranceofamorethan200bpdropinmoneymarketratesmayindicate either:1)concernsabouttheimplicationsofvolatileinterbankmarketsonthebroader financialsystemandanalready-slowingeconomy;or2)apre-emptivemovetoprovidea liquidity cushion ahead of potential defaults among trust products.FIGURE 267d repo rate spikes have become quite frequent FIGURE 27..and more than seasonal events or driven by broad liquidity shortages Source: Bloomberg, Barclays ResearchSource: Bloomberg, Barclays Research 020406080100120140160180200Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-147d repo rate 1m rolling vol-100-50050100150200250300350400450 2.002.202.402.602.803.003.203.403.60Dec-10 Sep-11 Jun-12 Mar-13 Dec-13%Excess Reserves7d repo spread over policy rate (RHS, bp)Barclays | Asia Themes 10 March 201429 ANALYST(S) CERTIFICATION(S): In relation to our respective sections we, May Yan, Sean Hung, CFA, Ephrem Ravi, Alvin Wong, Rohit Arora, Christina Chiow, CFA, Krishna Hegde,CFA and Lyris Koh, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. FICC: IMPORTANT DISCLOSURES CONTINUED BarclaysResearchisapartoftheCorporateandInvestmentBankingdivisionofBarclaysBankPLCanditsaffiliates(collectivelyandeach individually, "Barclays"). For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Research Compliance, 745 Seventh Avenue, 14th Floor, New York, NY 10019 or refer to http://publicresearch.barclays.com or call 212-526-1072. BarclaysCapitalInc.and/oroneofitsaffiliatesdoesandseekstodobusinesswithcompaniescoveredinitsresearchreports.Asaresult,investors should be aware that Barclays may have a conflict of interest that could affect the objectivity of this report. Barclays Capital Inc. and/or oneofitsaffiliatesregularlytrades,generallydealsasprincipalandgenerallyprovidesliquidity(asmarketmakerorotherwise)inthedebtsecuritiesthatarethesubjectofthisresearchreport(andrelatedderivativesthereof).Barclaystradingdesksmayhaveeitheralongand/or shortpositioninsuchsecurities,otherfinancialinstrumentsand/orderivatives,whichmayposeaconflictwiththeinterestsofinvesting customers. Where permitted and subject to appropriate information barrier restrictions, Barclays fixed income research analysts regularly interact withitstradingdeskpersonnelregardingcurrentmarketconditionsandprices.Barclaysfixedincomeresearchanalystsreceivecompensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income, Currencies and Commodities Division and the potential interest of the firms investing clients in research with respect to the asset class covered by the analyst. To the extent that any historical pricinginformationwasobtainedfromBarclaystradingdesks,thefirmmakesnorepresentationthatitisaccurateorcomplete.Alllevels,pricesand spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication ofthisdocument.Barclaysproducesvarioustypesofresearchincluding,butnotlimitedto,fundamentalanalysis,equity-linkedanalysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research may differ from recommendations contained in other types of research, whether as a result of differing time horizons, methodologies, or otherwise. Unless otherwise indicated, Barclays trade ideas are providedasofthedateofthisreportandaresubjecttochangewithoutnoticeduetochangesinprices.InordertoaccessBarclaysStatement regardingResearchDisseminationPoliciesandProcedures,pleasereferto https://live.barcap.com/publiccp/RSR/nyfipubs/disclaimer/disclaimer-research-dissemination.html.InordertoaccessBarclaysResearch Conflict Management Policy Statement, please refer to: http://group.barclays.com/corporates-and-institutions/research/research-policy. Explanation of the Barclays Research High Grade Sector Weighting System Overweight:Expected six-month excess return of the sector exceeds the six-month expected excess return of the Barclays U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index, as applicable. MarketWeight: Expected six-month excess return of the sector is in line with the six-month expected excess return of the Barclays U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index, as applicable. Underweight:Expectedsix-monthexcessreturnofthesectorisbelowthesix-monthexpectedexcessreturnoftheBarclaysU.S.CreditIndex, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index, as applicable. Explanation of the Barclays Research High Grade Credit Rating System The High Grade Credit rating system is based on the analyst's view of the expected excess returns over a six-month period of the issuer's index-eligible corporate debt securities relative to the Barclays U.S. Credit Index, the Pan-European Credit Index or the EM Asia USD High Grade Credit Index, as applicable. Overweight:The analyst expects the issuer's index-eligible corporate bonds to provide positive excess returns relative to the Barclays U.S. CreditIndex, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months. MarketWeight:Theanalystexpectstheissuer'sindex-eligiblecorporatebondstoprovideexcessreturnsinlinewiththeBarclaysU.S.CreditIndex, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months. Underweight:Theanalystexpectstheissuer'sindex-eligiblecorporatebondstoprovidenegativeexcessreturnsrelativetotheBarclaysU.S.Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months. Rating Suspended (RS):The rating has been suspended temporarily due to market events that make coverage impracticable or to comply withapplicable regulations and/or firm policies in certain circumstances including where the Corporate and Investment Banking division of Barclays isacting in an advisory capacity in a merger or strategic transaction involving the company. Coverage Suspended (CS):Coverage of this issuer has been temporarily suspended. Not Rated (NR):An issuer which has not been assigned a formal rating. For Australia issuers, the ratings are relative to the Barclays U.S. Credit Index or Pan-European Credit Index, as applicable. Explanation of the Barclays Research High Yield Sector Weighting System Overweight:Expected six-month total return of the sector exceeds the six-month expected total return of the Barclays U.S. High Yield 2% Issuer Capped Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. MarketWeight: Expected six-month total return of the sector is in line with the six-month expected total return of the Barclays U.S. High Yield 2% Issuer Capped Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High YieldBarclays | Asia Themes 10 March 201430 FICC: IMPORTANT DISCLOSURES CONTINUED Corporate Credit Index, as applicable. Underweight:Expectedsix-monthtotalreturnofthesectorisbelowthesix-monthexpectedtotalreturnoftheBarclaysU.S.HighYield2% IssuerCappedCreditIndex,thePan-EuropeanHighYield3%IssuerCappedCreditIndexexcludingFinancials,ortheEMAsiaUSDHighYieldCorporate Credit Index, as applicable. Explanation of the Barclays Research High Yield Credit Rating System TheHighYieldCreditResearchteamemploysarelativereturnbasedratingsystemthat,dependingonthecompanyunderanalysis,maybe applied to either some or all of the company's debt securities, bank loans, or other instruments. Please review the latest report on a company to ascertain the application of the rating system to that company. Overweight:Theanalystexpectsthesix-monthtotalreturnoftherateddebtsecurityorinstrumenttoexceedthesix-monthexpectedtotal returnoftheBarclaysU.S.2%IssuerCappedHighYieldCreditIndex,thePan-EuropeanHighYield3%IssuerCappedCreditIndexexcluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Market Weight: The analyst expects the six-month total return of the rated debt security or instrument to be in line with the six-month expected total return of the Barclays U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Underweight:The analyst expects the six-month total return of the rated debt security or instrument to be below the six-month expected total returnoftheBarclaysU.S.2%IssuerCappedHighYieldCreditIndex,thePan-EuropeanHighYield3%IssuerCappedCreditIndexexcluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Rating Suspended (RS):The rating has been suspended temporarily due to market events that make coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including where the C