UBS has a warning for those seeing China stock respite

[BEIJING] For Chinese investors betting the Shanghai Composite Index will bottom at 2,500, UBS Group AG has a warning: watch out for an onslaught of forced sales.

With thousands of companies pledging their own shares to get loans as stocks soared through mid-2015, the equity rout is forcing more of them to either provide extra collateral or sell holdings to pay back debts, Gao Ting, the head of China strategy at UBS in Shanghai, wrote in an e-mail on Wednesday. Firms at risk of having to dump shares in the market following Tuesday's selloff comprise about 8 per cent of Chinese market capitalization, rising to almost 13 percent if equities decline by a further 10 per cent, he estimated.

"If China's stock market continues to fall, equity pledging-related selling pressure could increase significantly, putting further pressure on the stock market," said Mr Gao, who moved over from the Swiss bank's asset-management unit last year. He was an analyst at China International Capital Corp in 2010, when it was the top-ranked brokerage for China research, according to Asiamoney magazine.

Strategists and technical analysts surveyed by Bloomberg this week are targeting a bottom of 2,500 for the Shanghai Composite after the index tumbled 6.9 per cent in the past two days to close at 2,735.56 on Wednesday. The gauge fell 1.5 per cent at 9:37 am on Thursday. Since the June high, the index has plunged 48 percent as the government clamped down on the use of leverage to buy stocks and data signaled a deepening economic slowdown. Margin debt fell for a record 18th day on Tuesday in Shanghai to 559 billion yuan (S$121 billion), the lowest level since December 2014.

The Shanghai gauge's plunge to a 13-month low of Tuesday was the catalyst for a wave of trading suspensions that may have preempted forced sales. Shenzhen Comix Group Co, Searainbow Holding Corp, Yunnan Tin Co and Fujian Guanfu Modern Household Wares Co. all requested halts after their stock prices plunged to levels that would require their major shareholders to put up additional deposits or collateral for loans they made by pledging their stocks with financial institutions.

During the start of the Shanghai Composite's rally in mid-2014 that led to a doubling of stock prices in less than a year, major owners of publicly traded companies pledged their stocks with financial institutions such as brokerages, banks and trust companies for loans, taking advantage of gains in the value of their holdings. Securities firms, the largest provider of such loans, were also eager to lend as they sought to reduce their reliance on the traditional brokerage business. The impact on the financial system from forced selling by major holders failing to put up additional collateral will probably not be severe, said Chen Jiahe, a Shanghai-based analyst at Cinda Securities Co, citing easing market liquidity and stock valuations.

Shenzhen Comix's controlling shareholder pledged about 27 per cent of the company's stocks for loans with Guosen Securities Co, China Citic Bank Corp, Huarong Securities Co and Industrial & Commercial Bank of China Ltd., the company said in an exchange filing. Shenzhen Comix plunged 9.7 per cent to 14.74 yuan on Tuesday before shares were suspended, triggering margin calls for some of the pledged stocks. The shareholder is taking measures to replenish its margin accounts to reduce risks, Shenzhen Comix said.

Searainbow's controlling shareholder is also working on plans to top up its margin accounts with Tianfeng Securities Co after a 10 per cent stock plunge triggered margin calls on some of the pledged shares, according to the company's filing with the Shenzhen exchange on Tuesday. The controlling shareholder of Yunnan Tin, which borrowed from BOC International China Ltd by using its holdings as collateral, is also seeking ways to bring its margin requirements back up, Yunnan Tin said in a filing.

Loans backed by stocks whose prices have fallen below forced-selling levels amounted to 4.1 billion yuan as of Jan 14, or 0.6 per cent of the total of such loans, Deng Ge, a spokesman with the China Securities Regulatory Commission, said at a Jan 15 press conference. Most borrowers managed to keep their shares by putting up additional collateral for their loans and none had been forced to sell their shares as of Jan 14, Mr Deng said.

Risks from stock-pledged loans turning sour remain manageable for financial institutions that provide those loans, Mr Gao said. Brokerages have a 58 per cent share of the equity- pledging business while banks, trust companies and other financial institutions make up the rest, he said, citing data from Wind, a Chinese financial information provider.

BLOOMBERG