Securities Firms’ Earnings Torpedoed by Pledged-Share Crisis

The plunge in Chinese stocks this year and the pledged shares crisis that’s engulfed the market have contributed to a deepening slump in profits at the country’s listed securities firms.

Combined net profits of the country’s 31 publicly traded brokerages dropped by 33% year-on-year in the first nine months of 2018 to 47.3 billion yuan ($6.9 billion), according to data compiled by Shanghai-based securities research firm SWS Research. Analysts at UBS AG put the drop at 35.1% and said that the slump for the third quarter alone was 51% year-on-year.

The combined revenue of the 31 companies fell 12.3% year-on-year in the first nine months to 182.5 billion yuan, while income from commissions, the biggest source of revenue for most securities companies, dropped 17% due to low transaction volumes, SWS Research said in a note.

China’s two stock markets — in Shanghai and Shenzhen — have been among the world’s worst performers this year as investors have grown increasingly concerned about the outlook for economic growth, rising risks from bond defaults, and deepening trade tensions with the U.S. The benchmark Shanghai Composite Index has dropped 24.5% since the beginning of the year.

The slump has been exacerbated by the extensive use of listed-company shares by major shareholders as collateral to get loans from brokerages and banks. As the market has fallen, borrowers have had to stump up more stock as collateral and lenders have been dumping shares on the market when the loans turn sour or shareholders can’t provide more shares, creating a vicious downward spiral.

Pledged-shares crisis

Regulators have over the past few months announced a series measures to try and control the damage by limiting the use of pledged shares as collateral for loans and curbing lenders’ ability to sell off the stocks.

Nevertheless, securities firms have been forced to increase provisions against losses on their pledged-share loans. Guangxi-based Sealand Securities, for example, increased the charge against its profits from impairments in the value of its pledged-share loans by almost 300% since the beginning of 2018. The company also disclosed eight pledged-stock default cases totaling 928 million yuan in its third-quarter earnings report that have not yet been accounted for on the bank’s balance sheet because they are still being dealt with through the courts. The total amount of losses is not yet known.

Everbright Securities, which is part of state-owned Everbright Group, recorded impairment charges of 36 million yuan in the third quarter and disclosed in its earnings report that it had started legal action against two customers on Sept. 29 and Oct. 22 over defaults of pledged-share loans involving 373 million yuan.

Brokerages revenues are also suffering from a decline in trading as investors steer clear of the market. In the first nine months of 2018, 71.8 trillion yuan worth of shares were traded on the Shenzhen and Shanghai stock exchanges combined, a 15.8% drop compared with the same period last year, according to data compiled by financial data provider iFind.

Contact reporter Liu Jiefei (jiefeiliu@caixin.com)