Holding Chinese Brokerages’ Debt Is Risky Business Amid Rout

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Investors are demanding ever steeper yield premiums to hold the offshore bonds of some Chinese brokerages as Moody’s Investors Service warns about the risks of relaxing margin financing rules.

The extra spread over Treasuries on Haitong Securities Co.’s $670 million of 3.5 percent notes due 2020 soared to a record 263.1 basis points Wednesday, the most since they were sold in April, Bloomberg-compiled prices show. The spread on Citic Securities Co.’s $800 million of 2.5 percent 2018 debentures registered its steepest one-day jump in more than two years.

China’s securities firms raised more than $32 billion selling bonds in the second quarter, using the proceeds to help fuel a stunning 468 percent rise in margin lending in the 12 months to June 15, when stocks began to nosedive. Equities have lost more than $3.2 trillion since, prompting authorities to relax lending rules, including allowing real estate as an acceptable form of collateral for traders.

“We see elevated risk for Chinese brokerages after the rule change that relaxed controls on margin financing,” said Xuanlai He, a credit research analyst at Commerzbank AG in Singapore. “This has added credit risk to the brokerages because they’re more exposed to potential market volatilities.”

‘Weakens Controls’

The China Securities Regulatory Commission on July 1 published new rules on margin financing and securities lending. The watchdog eliminated a requirement brokerages sell a client’s stock if the collateral falls below 130 percent of the value of margin loans and isn’t replenished to 150 percent within two trading days.

That “weakens controls against losses, and allows the industry to increase its risk,” Moody’s analyst Sean Hung wrote in a report e-mailed Monday. “The easier rules will increase securities companies’ risks, especially if the current market correction deepens.”

The Shanghai Stock Exchange Composite Index has dropped 32 percent from its June 12 peak, including a 5.9 percent slump today that was the worst one-day performance in almost two weeks.

The $32.1 billion of bond sales among brokerages in the three months to June 30 was the most in a quarter ever in Bloomberg data going back to 2005 and more than double the $14.8 billion issued the first three months of the year.

Haitong, Citic

Haitong Securities led offerings, getting $1.37 billion alone from two U.S. currency notes, Bloomberg data show. According to its annual report, Shanghai-based Haitong’s entire financing business, which includes securities lending, more than tripled last year, helping to deliver an 81 percent rise in net interest income.

Citic Securities, which sold the equivalent of $4.6 billion of bonds last quarter, had 91.4 billion yuan in margin accounts as at March 31. The spread on its 2018 bonds has risen to 154.6 basis points from a record low 119.8 basis points June 9, Bloomberg-compiled prices show. The notes were sold at a 185 basis-point premium in April 2013.

Officials at Beijing-based Citic Securities and Haitong Securities didn’t immediately reply to two telephone calls and an e-mail each seeking comment.

The yield on Qilu Securities Co.’s 1.5 billion yuan of Dim Sum bonds due 2017 rose 44 basis points Tuesday, the steepest increase since they were issued in August. Yields rose a further 10 basis points Wednesday to 7.17 percent.

Good times with margin financing risk turning sour, especially given some punters used margin loans to bet on illiquid stocks, according to Wei Hou, a senior equity analyst for Chinese banks at Sanford C. Bernstein & Co.

“Investors may not be able to sell the shares, even under margin calls,” Hong Kong-based Hou said. “That could lead to losses at brokerages, which would in turn hurt their profits or even capital.”

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