Bad Loan Risks Rise as China Tightens Share-Dumping Rules, Moody’s Says

(Beijing) — Chinese securities brokerages could face higher risks of bad loans backed by pledged stocks, as borrowers are now subject to stricter limits in selling publicly-traded shares, Moody’s Investors Service warned.

The popularity of stock-pledged loans is growing in China, especially among securities brokerages, Moody’s said in a report on Monday.

Among the 19 listed Chinese brokerages that Moody’s surveyed, including Orient Securities Co. Ltd. and Guotai Juan Securities Co. Ltd., the outstanding amount of stock-pledged loans reached 360 billion yuan ($52.9 billion), up sharply from around 44 billion yuan at the end of 2013.

As of May, financial institutions in China were on the hook for 2.1 trillion yuan in loans that used publicly-traded shares as collateral, the credit ratings agency estimated. Of those loans, 55% were made by securities brokerages. Moody’s didn’t provide comparison figures.

Fresh risks have emerged for both borrowers and lenders, Moody’s said.

In late May, the China Securities Regulatory Commission (CSRC) surprised the market by rolling out new rules that include limits on share sales through block trades and private placements, a move that regulators said aims to crack down on unscrupulous investors that amplify market volatility by engineering trades at fake prices.

The new rules allow shareholders to sell no more than 2% of the company’s total shares every 90 days. That effectively caps the annual sale of shares through block trades to 8% of the company’s total shares for each seller. Also, investors are not allowed to sell more than half of their holdings in the open market within a year after the IPO lockup period expires.

Key shareholders and executives of listed companies often dispose of their shares to repay the stock-pledged loans provided by the securities companies after an IPO’s lock-up period IPO expires. The new rules, however, limit borrower’s self-refinancing ability and thus increase the lenders’ credit risks, Moody’s said.

“While lenders have taken several measures against the associated risks, the potential lack of liquidity for underlying stocks, especially in a distressed situation, still implies significant risk for securities companies,” Moody’s analyst Sean Hung said.

Unlike short-term margin lending, stock-pledged loans have become more popular because they have longer tenors, usually maturing in one to two years. Even during a lock-up period immediately following an initial public offering (IPO), shareholders of listed companies can still “use” the shares they own as collateral to raise fresh funds or pay down debts.

Contact reporter Dong Tongjian (tongjiandong@caixin.com)