Chinese stockholders borrowing money against some $720bn worth of shares threaten to exacerbate the equity market sell-off and drive up corporate defaults, if falling prices force the sale of the shares held as collateral, investors and analysts have warned.
Chinese corporations and some large individual shareholders commonly pledge shares to banks as collateral to secure funds for purposes ranging from working capital to debt refinancing. Some 90 per cent of companies listed in mainland China have some level of their shares pledged as collateral, according to industry estimates.
The value of shares pledged has expanded by more than Rmb200bn annually since 2014, according to S&P, taking the total to Rmb5tn ($720bn).
But the fall in China’s stock market in recent weeks has reduced the value of that collateral, putting pressure on lenders to sell the pledged shares to claw back the amount lent. Fears of a chain reaction have prompted the Chinese government to take mitigating action.
Investors and analysts warn that large-scale selling of shares used as collateral could perpetuate the stock market sell-off while leaving companies more highly leveraged and under pressure to refinance their loans.
China’s stock market has dropped 6 per cent over the past few weeks, with global geopolitical tensions on the rise and the trade impasse between the US and China showing little sign of abating.
The loan amounts tend to be at a discount to the shares’ value, according to analysts. If the share price falls below a designate threshold, borrowers must repay some of the loan or pledge more shares as collateral. Otherwise, the lender will sell the pledged shares to recoup their money, driving the stock price even lower.
Felix Lam, a senior fund manager of Asia Pacific equities at BNP Paribas Asset Management, said that share pledges have “been a good source of funding” for many companies, noting that about 11 per cent of China’s market capitalisation is pledged. “But a lot of them would have money due in the second half of 2018, given the share price movements, especially in October.”
“It is a concern that it will add liquidity pressure on borrowers,” said Cindy Huang, a director of corporate ratings at credit rating agency S&P. “For companies where we see they have pledged a high percentage of their listed subsidiary shares, it indicates their funding capability is not very strong, or that they are very aggressive. So share prices under pressure, combined with tight liquidity, declining confidence, and market access, is a concern for us.”
Rising default risk is also an issue. A “high number of companies that defaulted in the onshore market this year borrowed against shares, in many cases pledging close to 100 per cent of all owned shares of listed subsidiaries”, according to S&P.
Engineering, construction and real estate sectors tend to be most prolific in pledging shares for funding, analysts said.
Chinese authorities have in the past week taken a series of steps aimed at boosting confidence in the stock market amid growing concern over forced stock sales.
The People’s Bank of China on Monday announced plans to facilitate financing of private enterprises that are fundamentally sound but are experiencing financing difficulties as a result of the stock markets sell-off.
“While details of the mechanism have yet to be announced, in principle it will provide more liquidity and financing opportunities for private companies to refinance their share-pledged loans that need to immediately repay or top up collateral due to prevailing market volatilities,” said Ivan Chung, a managing director at Moody’s.
“It would also reduce the risk of massive disposal of pledged-shares by the lenders if the borrowers could not repay or top up the share-pledged loans. We need to know details of this mechanism to see how effective the new measures can address the problem.”
Additional reporting by Tom Hancock in Shanghai
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