January 23, 2014 / 3:40 AM / 6 years ago

UPDATE 2-China provincial govt may bail out shadow bank to avert default

* Shanxi province may provide 50 pct of rescue funds - report

* ICBC, trust firm could each provide additional 25 pct - report

* Parties seek to avoid landmark shadow-bank default

* China Credit Trust in talks with potential white knight (Recasts, adds report on possible bailout)

By Gabriel Wildau

SHANGHAI, Jan 23 (Reuters) - A Chinese provincial government may help bail out investors in a troubled high-yield investment product, local media reported on Thursday, in a closely watched case viewed as a potential landmark precedent for defaults in China’s shadow bank sector.

Shanxi province in central China, home to the struggling coal company that received a high-interest loan through an investment trust, may provide half of the funds necessary to repay investors when the trust product matures on Jan. 31, the 21st Century Business Herald reported on its website on Friday, citing an unnamed source.

China Credit Trust Co Ltd and Industrial Commercial Bank of China may both pitch in a further 25 percent of the necessary funds, the paper reported.

ICBC, which helped market the trust product to wealthy investors through several branches, has previously said it would not bear the “main responsibility” for repaying investors.

A default of the 3 billion yuan ($496 million) product could shatter the widespread assumption that off-balance-sheet investments carry an implicit guarantee from state banks and their partner institutions.

Regulators have warned that investors must assume the risks from high-yielding investments and not expect protection from losses unless such guarantees are explicit.

But local governments have largely ignored these injunctions and have stepped in repeatedly in recent years with bailouts for local firms facing default on corporate bonds and trust loans.

The report of a possible government rescue comes a day after China Credit Trust reported progress in its efforts to ensure that investors are repaid.

The firm told investors in its “Credit Equals Gold #1 Collective Trust Product” on Wednesday that it was in discussion with new investors to raise funds necessary to pay off current investors.

“The trustee is currently in negotiations with a certain number of interested investors and is intensely discussing the specific details,” China Credit Trust said in a statement to investors that was obtained by Reuters.

China Business News also reported on Thursday that the trust company was in negotiations with an unnamed insurance company to purchase the collateral used to secure the trust loan to Zhenfu.

The trust firm had previously told investors that it may be unable to pay out principal and interest when the high-yield product, which is based on a loan to a struggling coal company, matures on Jan. 31.

China Credit Trust also told investors on Wednesday that the coal company, Shanxi Zhenfu Energy Group Ltd, had received a key government permit that would enable it to restart production on one of its coal mines.

Zhenfu also resolved a property-rights dispute with villagers over another mine, the trust said.

“The value of these two mines will now rise significantly. Basically these two assets have been revitalised,” the official China Securities Journal quoted an unnamed trust industry executive as saying on Thursday.

The progress on the mines could pave the way for Zhenfu or its creditors to sell the mines in order to raise the funds necessary to repay Zhenfu’s debt, though it is unclear whether China Credit Trust would be first in line among Zhenfu’s various creditors.

When contacted by Reuters, China Credit Trust declined to comment. ICBC’s news spokesman did not immediately answer calls seeking comment.

$1 = 6.0513 Chinese yuan Editing by Jacqueline Wong

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