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The Bubble’s Revenge: China’s Stock Market Is Littered With ‘Pledged-Share Land-Mines’ Buried During 2015 Mania

Summary:
Via Investing In Chinese Stocks blog, Back during the 2015 stock market bubble, many investors and companies pledged their shares for loans. Standards were low at the time. In addition to taking insanely overvalued shares as collateral, banks also loaned money against shares that the owner didn't have the right to sell. Here's a post I wrote nearly 3 years ago, back in July 2015, detailing what I thought was the craziest example: Is This Peak Insanity? Blanket Company With P/E of 6000 Pledges 30% of Shares As Collateral A blanket company had a P/E of 5800 at the peak. Shares have plunged, but the P/E is still above 3000. Shares fell more than 60% from their peak. This week, they were limit down on Monday, halted for three days, and limit up on Friday. Just in case you think the P/E

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Via Investing In Chinese Stocks blog,

Back during the 2015 stock market bubble, many investors and companies pledged their shares for loans. Standards were low at the time. In addition to taking insanely overvalued shares as collateral, banks also loaned money against shares that the owner didn't have the right to sell. Here's a post I wrote nearly 3 years ago, back in July 2015, detailing what I thought was the craziest example: Is This Peak Insanity? Blanket Company With P/E of 6000 Pledges 30% of Shares As Collateral

A blanket company had a P/E of 5800 at the peak. Shares have plunged, but the P/E is still above 3000. Shares fell more than 60% from their peak. This week, they were limit down on Monday, halted for three days, and limit up on Friday.

Just in case you think the P/E ratio may be distorting things, the price-to-sales ratio is above 70. Debt-to-assets is 23 times. Price-to-book 159 times.

By itself, this is crazy enough to show how the bull market was an indiscriminate liquidity driven momentum trader market. But this is not the end of the story.

Reuters: China's companies at risk of stock-backed loan recalls

Chinese companies that borrowed money using shares as collateral may have to put up more assets or repay their debts, carrying the ripples from the stock market plunge into the wider economy.

A near 30 percent collapse in share prices has started to endanger some businesses using such financing, and the country's banking regulator said on Thursday it would let financial institutions renegotiate lending terms in these circumstances.

Bank and other loans backed by listed shares officially increased around 260 percent in May to 58.4 billion yuan ($9.4 billion) from a year earlier, representing about 4.8 percent of total social financing for the period.

"There is no doubt all the companies are facing a financing dilemma," said Zhang Jihong, board secretary at Hubei Landing Holding Co Ltd, a textile company that suspended its shares from trading on Tuesday - roughly half of all shares on mainland bourses are now suspended - after its stock fell 61 percent.

Hubei Landing has 29.9 percent of its shares pledged as collateral for a loan from a trust company.

The stock trading under the symbol of Hubei Landing is now called Gosun Holding after acquiring Gosun Technology in August 2015. Shares are at a new post-2015 low.

The Bubble's Revenge: China's Stock Market Is Littered With 'Pledged-Share Land-Mines' Buried During 2015 Mania

More importantly, the "financing dilemma" is back for many companies. Already, more than 10 companies have run into trouble this month. That may be far from the worst of it as 98 percent of A-shares companies have pledged shares. Some major shareholders have pledged 100 percent of their holdings, while other companies have more than 70 percent of outstanding shares pledged. 
 

In fact, judging from recent years, this landmine of equity pledges was buried in the bull market in 2015. At that time, the stocks in the entire market soared. Many shareholders who did not have the necessary conditions for reducing shareholdings used the stock pledge to finance and increase leverage. This became a direct incentive for the rapid development of the A share stock pledge business at that time.

From the perspective of the pledged ratio, among the 3,453 A-share companies that have pledged their stocks at present, there are 1,250 listed companies with more than 20% of the pledged shares, accounting for 36.2%, and 129 listed companies with more than 50% of the pledged shares. Among them, 51 listed companies pledged more than 60%, and 10 companies pledged more than 70%. Among them, the proportion of pledged stocks of Tibetan Song is 78%, ranking first.

The top ten companies by pledged shares as a total of outstanding:

The Bubble's Revenge: China's Stock Market Is Littered With 'Pledged-Share Land-Mines' Buried During 2015 Mania

Earlier this week Zhongnan Red Cultural Group saw its shares halted. 

Nasdaq: China Stocks-Factors to watch on Wednesday

Zhongnan Red Cultural's share trade to halt as shares pledged by controlling shareholder triggered margin call

Nanfeng Ventilator (300004) is in the midst of a stock pledge crisis and it's largest shareholder, and chairman, is missing.

East Money: 股权质押危机之一:南风股份股权质押爆仓 实控人失联留下官司一堆

On June 12, Nanfeng Co., Ltd. (referred to as "Nanfeng Shares", 300004.SZ) issued the "Announcement on the Progress of the Missing Chairman-related Issues." He said that on May 3, he was informed of the company's actual controller and chairman. Yang Zishan lost contact and has not yet obtained contact with him. Loss of association, restructuring failed, the company’s multiple accounts were frozen, and the chairman’s pledged stock was taken. Namfung’s shares have yet to come out of the shadows of the dark May.

... According to the announcement, as of the announcement date, it was initially understood that Yang Zishan’s personal borrowings excluding stock pledges amounted to approximately 360 million yuan (without involving the company), and there may be a debt amount of approximately 380 million yuan in the name of the fraudulent company as a borrower or guarantor (not yet Verified) and other personal debts not involving the company (exact amount is unknown).

The company stated that the verification company confirmed that the relevant borrowings or guarantees were not corporate actions and none of the company’s board of directors or the shareholders’ meeting decided or approved the company. The company was unaware of this, and the related loan money did not enter the company. The company did not grant any related matters. The accreditation clearly stated that it would not assume related responsibilities and had reported the case to the public security agency.

...At present, Yang Zishan holds 12.37% of the company's shares, accumulative pledged shares accounted for 99.12% of its total shareholding, accounting for 12.26% of the company's total share capital. If Yang Zishan’s shares are closed or judicially auctioned, there will be no change in the actual control of the company. A person in charge of the company told the China Times reporter that the actual controller of Nanfeng shares was lost, which may be related to the debt crisis. Problems in funding led to an increase in the gap.

The article puts some value on pledged shares:

As of June 12, 129 listed companies had pledged more than 50% of the total share capital. According to statistical data, the stock pledges of the controlling shareholders of 404 listed companies have hit a closing line with a market value of RMB 328.9 billion. There are 86 listed companies with a market value of more than 1 billion yuan pledged by controlling shareholders, and 9 companies with more than 5 billion yuan. Industry insiders told the China Times reporter that the stocks held by the major shareholders and actual controllers of listed companies all have limited time for sale, and they cannot realize real-time liquidity. The equity pledge model has become a fast financing channel. In the field of listed companies, it is not surprising that major shareholders or actual controllers complete cash financing through equity pledge. The problem is that the risk is relatively large. The amount of financing with certain discounted proportions is financed through the market value of the pledged equity. If the stock price fluctuates, there may be a series of risks such as the inability to repay the principal due to pledge of equity.

Shares are experiencing "flash crashes" as a result of this "land mine" risk.

East Money: 6月以来逾10家A股公司股权质押“炸雷” 你的股票有强平风险没?

[More than 10 A-share companies with pledged shares have "hit mines" since June. Have you had a strong risk in your stock? Since the beginning of this year, the share prices of some listed companies of A shares have seen multiple rounds of "flash crashes." If it is said that the “first flash crash” in the previous quarter is closely related to the “deleveraging” of institutional trust products, then in the “second quarter of the flash crash” that is coming, a high proportion of equity pledges will increasingly become a new "Gate of Life" for stocks. (Securities Times)
No stocks and no deposits: 98% of A-share companies pledged

  Judging from the characteristics of the recent market, whether it is the stock price drop triggering the risk of equity pledge closing (such as the South China Culture), it still triggers a real closeout behavior (such as Huayi Jiaxin), the stock price “flash collapse second quarter” and equity The relationship between pledges is particularly close.

Here's the charts of Zhongnan Red and Spearhead Integrated Marketing (Huayi). The former has halted trading.

The Bubble's Revenge: China's Stock Market Is Littered With 'Pledged-Share Land-Mines' Buried During 2015 Mania

The Bubble's Revenge: China's Stock Market Is Littered With 'Pledged-Share Land-Mines' Buried During 2015 Mania

Pledging shares is a way to obtain cheap financing, what could go wrong?

The equity pledge has the advantages of low cost, high efficiency, flexible business, and wide source of funds, which has become an important reason for the high enthusiasm for equity pledges in recent years. At the same time, investment bankers also told reporters that the prevalence of equity pledges, in addition to the relevant shareholders of the assets of the bank's assets, but also with the background of bank tightening, some projects can not achieve loans, loans have reached limits and other closely related. This makes the relevant shareholders more willing to finance through equity pledges.

In fact, judging from recent years, this landmine of equity pledges was buried in the bull market in 2015. At that time, the stocks in the entire market soared. Many shareholders who did not have the necessary conditions for reduction used the stock pledge to finance and increase leverage. This became a direct incentive for the rapid development of the A share stock pledge business at that time.

Under the huge scale of equity pledges, if the company's value grows steadily and the secondary market performs smoothly, it will be calm. However, with the increase of external interference factors and the resulting price below the A-share market valuation center, equity pledges have become a major explosion. Since June of this year, more than 10 A-share companies have already announced the existence of pledges. The risk of equity liquidation involves the market value of nearly 10 billion yuan.

Naturally, there's possible fraud involved. One investment banker lays out a 3-step process that started with manipulating share prices higher:

"Three steps"

“Equity pledges have been an important way of capital operation.” The aforementioned investment bankers explained that, for example, some of the fixed-income participants replaced the previous bridge loans used for the increase in the number of shares, and some of the companies The method of equity pledge achieves the change of major shareholders, in order to bypass the threshold of “can't backdoor”.

However, under the equity pledge and the expected collapse of share prices, a "three-step" model is emerging in the market.

“From a certain point of view, the major shareholder of the equity pledge is a group of smart capital players. Sometimes, they first blow the market value to achieve the maximum financing, but then the stock price will often appear due to the return value of the stock price It fell, and the institutions of the pledges became anxious at this time."

Here's one example: 361 shareholders of one company pledged all their shares, equivalent to nearly 50 percent of outstanding shares:

Statistically, many stockholders' stock pledges are conducted at relatively high stock prices. This is not only related to the overall downward trend of the market itself, but also related to the choice of shareholders for the pledge of specific time nodes.

Three hundred and sixty-one controlling shareholders, Tianjin Qixin Zhicheng Technology, pledged 3.297 billion shares in one breath in March, which accounted for 100% of their shares, and also accounted for 48.74% of the company’s total share capital. At the time of its pledge, it was precisely when the stock price of three hundred sixty-six had the strongest performance. The company recently issued an announcement that the pledge was not a new issue, but a pledge of 460 shares in the equity of the controlling shareholder at the time of the privatization of US stocks.

Tianjin Qixin is a private company that has a stake in Qihoo. It says the shares are related to the delisting of Qihoo from the U.S. market.

Step two in this process is halting shares after they collapsed in price:

Secondly, after the equity pledge, under the influence of the big market, the stock price of the relevant company has become the norm. Most of the major shareholders have adopted a suspension to protect the interests. However, this approach is a double-edged sword, although it can suppress the stock price decline in the short term, it will also Bring the loss of stock liquidity. And in the context of stricter regulation of suspension, it cannot be used frequently.

According to the aforementioned investment bank sources, in fact, after the major shareholders pledged their money, some of them are not afraid of falling stock prices. They are most afraid of the stock price falling but they are their pledges. “From this point of view, it is equivalent to the major shareholders transferring the risk to the pledgee. Therefore, the institutional equity pledge business including some brokerage companies has begun to shrink.”

In accordance with the conventional practice, since the pledges reach the warning line, it is generally required to make up the position within 2 days, and to add additional pledged stocks or direct cash compensation. If it breaks below the open line, it will notify the emergency plan the next day: either, the priority shareholder redeems, the redemption amount = principal + unpaid interest; or, if there is no money to redeem, it will be equal.

According to the preliminary review of the announcement, in the past month, the equity pledges of more than 20 listed companies have been liquidated, and the number has quadrupled compared with April.

Finally, after stock prices fell due to equity pledges, if major shareholders cannot protect stock prices through repurchase or other means, there is no way to cover short positions and there is no way to repay loans. When financial institutions sell off, they will have an impact on the secondary market. As a result, stocks with a high ratio of pledges have seen their shares collapse.

Here's a list of companies whose controlling shareholders have pledged 100 percent of their shares:

The Bubble's Revenge: China's Stock Market Is Littered With 'Pledged-Share Land-Mines' Buried During 2015 Mania

Some companies are avoiding collapse by pledging more collateral. Others, such as Nanfeng discussed above, have shifted risk to the lender thanks to the court freezing the assets. 

Take Ruikang as an example, the company received a letter from the company's controlling shareholder, Hangzhou Ruikang Sports Culture Co., Ltd. on June 12th. Due to the continuous decline in the stock price of the company in recent days, some of the shares of Ruikang Sports Pledge have already exceeded the liquidation line. . As a result, Ruikang Sports and its controlling shareholder Shenzhen Shenliyuan Investment Group Co., Ltd. began to actively negotiate with the pledgee to sign a supplementary agreement and added 20 sets of commercial houses and 5 sets of residential buildings totaling 5770.07m2 as collateral.

Taking Southwind as an example, the shares of Yangzishan, one of the company's actual controllers, had already touched the liquidation line as early as the end of May. However, since all of its shares have been frozen by the judiciary, the shares pledged by Yang Zishan will not be forced. Warehouse transfer. This also means that the relevant risks have been accumulated here at the pledgee.

Final advice for investors:

The pledge rate of equity is below 30%, which is generally safer. Conversely, more than 70% of them belong to high-risk varieties, because once the warning line is touched, they may face the dilemma of no assets available for compensation. At the same time, for cases where the proportion of equity pledged exceeds 50%, it should always pay close attention to the changes in the stock prices of related companies and the latest equity pledge information.

So much for default risk from China's deleveraging effort being contained.

Tyler Durden
Tyler Durden (a pseudonym) represents the idea that a return to truly efficient markets is a possibility and a necessity. After having experienced the inner workings of capitalism at various asset managers and advisors, Tyler believes that the current model is flawed and a deleveraging at every level of modern society is needed to reinspire the fundamental entrepreneurial spirit.

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