China's 3 Trillion Yuan Margin Call Time Bomb Is About To Explode

Tyler Durden's picture

Make no mistake, investors didn’t need any more reasons to be bearish on Chinese equities.

Mainland markets are veritable casinos dominated by retail investors who until last summer, were enthralled with the prospect of easy riches in an environment where shares only seemed to know one direction: up.

All of that changed last June when a dramatic unwind in the half dozen backdoor margin lending channels that helped to fuel the rally triggered an epic rout that became self-fulfilling once the retail crowd (which accounts for 80% of the market) became rip sellers rather than dip buyers.

Since then, successive efforts on the part of the CSRC to stabilize the situation by pouring CNY1.5 trillion into A-shares has met with limited success as periods of calm are interrupted by violent bouts of selling like those we saw earlier this month when China tried and failed to implement a circuit breaker.

Throw in the ongoing yuan deval fiasco and there’s every reason not to be involved in Chinese stocks.

But when it rains it pours, and now, analysts say margin calls on SCLs are the next landmine that may pose a “systemic risk” for China’s battered markets.

“Some companies that had pledged shares as collateral for loans are now faced with a stark choice - dump them under pressure from impatient brokers and banks and book a loss, or stump up fresh cash or other assets to make up for the difference in value,” Reuters writes.

This is a rather large problem. Over half of all listed companies have their shares pledged. As BofA notes, “1,411 A-share companies have had some of their shares been pledged for SCLs by their major shareholders, representing 50.2% of the total number of A-shares. The value of stocks pledged for SCLs has been rising consistently - from Rmb2.36tr on 1 July 2015 to Rmb3.05tr by 1 Jan 2016, i.e., up by 29% in 2H15.”

In short, the steep decline in margin financing paints an incomplete picture when it comes to understanding how much leverage is in the system. 

On one hand, the headline figure on margin financing suggests quite a bit of deleveraging has taken place since things hit peak absurdity last spring. Here's a look at how quickly the unwind materialized once things began to get dicey:

But as the SCL chart shown above demonstrates, the decline in headline margin debt only tells part of the story. Indeed, BofA says even the CNY3.05 trillion number for SCLs may be underestimate the amount of leverage in the market. "Our SCL data might have under-estimated the true extent of such activities because 1) only major shareholders, i.e., those who own more than 5% of a company’s stocks, are obliged to disclose their SCL activities; and 2) we have assumed a 12-month duration for the 2,889 deals, 44% of the total, that have no ending date disclosed vs. over 16 months on average for those that have," the bank writes. 

Where things get truly frightening is when one looks under the hood on these deals. 

Have a look at the following table which shows that of companies with pledged shares, an astonishing 82% were trading at a multiple of 50X or more at the time of their pledging:

"The collateral value," BofA says dryly, "is far from solid."

"If the market continues to fall, equity pledging-related selling pressure could increase significantly," Gao Ting, head of China strategy with UBS warns. 

To let BofA tell it, fully a third of SCLs will face margin call pressure and some 371 of the 1,411 stocks pledged have already hit their triggers. "Assuming 40% loan-to-asset value at the time of SCL granting, our analysis suggests that by now, 371 stocks, worth Rmb641bn based on their current market values, have seen their share prices reached the stop-loss levels; and additional 281 stocks, worth Rmb310bn, the warning levels."

What happens when the margin calls start you ask? Well, nothing good.

"When a position has to be closed for transactions using floating shares as collateral, the pledger sells on the secondary market, putting further pressure on the stock market," Ting cautions.

Right. Which means stocks fall further and trigger more margin calls which means more forced liquidations in a never-ending, self reinforcing loop. Or, as Reuters puts it: "[It's] a vicious cycle where further share price drops are likely to trigger more margin calls and threaten further forced sales."

And this isn't some hypothetical - it's already started. "On Jan 18, some stocks of a company used as collaterals for a SCL were liquidated by the lender, which prompted its share price to limit down the next day," BofA recounts. "The stock had been suspended from trading since then. So far, at least 11 A-shares have been suspended as their prices approached the cut-loss levels."

"On Thursday, trading in shares of Maoye Communication and Network Co Ltd was halted after it said it received notice that its controlling shareholder faces margin calls, one of at least eight companies that have made similar announcements so far this year," Reuters adds.

Note that if this entire thing were to unwind it would be larger than if every bit of margin debt were squeezed out of the system. BofA figures the  average loan-to-asset value is about 40%. Apply that to the CNY3.05 trillion pile of collateralized stocks and you've got the potential for a CNY1.22 trillion unwind.

And it gets still worse. Remember China's multi-trillion yuan black swan, the WMP industry? Well the WMPs are involved here too. Here's an example, again from BofA:

We cite a recently reported example involving the controlling shareholder of Guangxi Future Technology. According to articles by Securities Times (Jan 19) and 21st Century Business Herald (Jan 20), in December 2015 Pudong Development Bank set up a WMP called Tebon Huijin No.1 Asset Management Plan to fund the shareholder's purchase of its own company's shares. Essentially, the WMP buyers, as the senior tranche investors, lent money for the shareholder to buy their own stock. Similar to other structured WMPs, this product has a stop-loss clause, and the company's share price dropped below the stop-loss level on Jan 18. As the controlling shareholder did not put up additional margin, Pudong Development Bank liquidated all stock in the plan (equivalent to 2.13% of the company's outstanding shares). This is the first case of forced liquidation by such products but in our view there could be additional cases given how sharply the market has declined in recent weeks.

In short, this is a house of cards built on a still enormous amount of leverage. At the risk of mixing metaphors, the problem here is that once the dominos start to fall, it will be impossible to stop the downward momentum.

The takeaway: "we're going to need a bigger plunge protection team"...

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KesselRunin12Parsecs's picture

I thought Bibi was the bomb expert.

Baby Bladeface's picture

Different bomb type.

This looks like job for FASBman and trusty sidekick Mark-2 Unicorn...

max2205's picture

CNBS said we exited the correction so not to worry 

Soul Glow's picture

Everyone knows about the President's Working Group on Financial Markets aka the PPT.  Weekend reading....

The ESF Exchange Stabilization Fund -

https://www.treasury.gov/resource-center/international/ESF/Pages/esf-ind...

remain calm's picture

China:You mean you can't go from a bunch of pattie farmers to a world class economy without deception and fraud. How does this happen in 20 years? Wealth came quickly and easily and now it's going away quickly and without much resistence. Anyone surprised? 

Vampyroteuthis infernalis's picture

The big plunge is coming........ we are not there yet.

JRobby's picture

"All of that changed last June when a dramatic unwind in the half dozen backdoor margin lending channels that helped to fuel the rally triggered an epic rout"

Same old game. The fraudsters are everywhere and it is all PONZI

DirkDiggler11's picture

Gold ? Why would our Treasury want to deal with such a barbaric relic ?

Fester's picture

Promises, promises, promises.

SuperRay's picture

Bring all that shit on. While you're at call Hercules to clean out this whole fucking stable of horse shit. Reset ASAP!

Soul Glow's picture

BoJ deny then strike - or in other words lie - in an attempt to give Japanese institutions, and all institutions for that matter, room to get out of the market before China implodes.

Copy that.  

Girlfriend is out of town this weekend so I am going to be drinking a lot of beer!  Can't wait for Monday!

JoeySandwiches's picture

This Japan NIRP shit seems like it's just gonna make the end come sooner than later to me.

Jap Nirp - China deval - dollar strength - EM currency crisis/dollar debt defaults - Saudi depeg - More NIRP/QE in EU - US QE4/NIRP

 

What do they call this again? Currency war? Race to the bottom?

bagehot99's picture

They call this 'an elite gzroup of well positioned know nothings trying to guess their way out of trouble they guessed their way into'.

In other words, a vast shit storm that ought to cause a wholesale realignment of the entire world order. But they might keep the con running for a little while yet.

JRobby's picture

Which version of "We have lost control of this thing and we are not at all sure what will happen next" do you want to hear????

This fucked shit show is terminating and there are a thousand plus "versions" of that denial in double speak on a daily basis.

tarabel's picture

 

 

You prefer Mondays to a weekend spent drinking lots of beer?

new game's picture

all alone? you got zh to comfort you, ha...

behind the curtain's picture

Definitely Sum Ting Wong ...

SheepDog-One's picture

China can of course just announce NIRP and enjoy great stawk gains and then all is well.

xrxs's picture

“Some companies that had pledged shares as collateral for loans are now faced with a stark choice - dump them under pressure from impatient brokers and banks and book a loss and get disappeared, or stump up fresh cash or other assets to make up for the difference in value,” Reuters writes.

Fixed that for Reuters

khnum's picture

3 trillion yuan maybe if they devalue to vietnamese dong levels then pay it off in us dollars

RadioFlyer's picture

Thats a lot of Dong, can the market take it?

CHoward's picture

They'll have it all figured out by Sunday evening - not a problem.

lester1's picture

Print

 

Devalue

 

Buy stocks

 

Repeat

ifishivote's picture

once again yawn....these rigged markets are only going higher.

Mark Mywords's picture

Yep. It'll all matter. Someday. Sometime. Soon.

But not today. Likely not tomorrow either. But someday.

Someday.

Kirk2NCC1701's picture

The only way out for China at this point, is to dump all the USTs in one fell swoop, and go to a gold standard. 

That way, rather than going down alone, they force the Fed to do a universal currency reset.

[tick, tock] China.

Jacksons Ghost's picture

We, the west, will kill every Chink on the planet before that is allowed to happen. So please, stop with the pipe dream of honest money. Global thermonuclear war before that fantasy is realized.

nathan1234's picture

We, the West, have been killing people all over Asia, Africa & Latin America for a long long LONG time .That's home truth.

 

sun tzu's picture

The only problem is they have plenty of nukes

buzzsaw99's picture

the perfect scam. borrow against notional value and get the heck out of dodge.

Baldrick's picture

buy a home on the west coast of na.

Soul Glow's picture

And move yuan to dollars to gold.

Yen Cross's picture

Move yuan to GBP, then hedge it with $usd.

 Cable is oversold, so if you park yuan on GBP, knowing $usd is overbought, especially after Kuroda, you get MOAR bang for the buck.

 Plus gold is overbought on the daily chart, so you can take those profits and buy some real stuff.

Flatchestynerdette's picture

I was waiting for you Yen.

Glad to see you post.

newworldorder's picture

China has learned from the US and the West. When debt repaiment goes against you, one can simply suspend debt repaiment if backed up in shares, bonds, oli or other "things" that have lost value. Easy as pie.

T-NUTZ's picture

Would you like to play a game?

22winmag's picture

They'll press the button before they allow mankind to be free of his collective financial chains.

pitz's picture

But margin debt is at a significant medium-term low, per the chart.  So what's the big deal?  If it was at a peak, then we might have a problem.  But as I see the chart, plenty of room for it to rise.

If high P/E ratios were a problem, the US market would have imploded many times over by now.  Yet Amazon remains at a P/E of close to 4 digits.

 

abyssinian's picture

Cracked fortune cookies! 

RadioFlyer's picture

I wonder what Yellen is up to tonight? Perhaps she's having a nice bottle of 1929 Domaines Barons de Rothschild Chateau Lafite Rothschild? Just to have a taste of the crash, the terroir or terror...

Muse minus Time's picture

ZHers colletively warmed her classic 1929 to vinegar so instead of eating cake, it'll be salad.

Herdee's picture

And there goes over $3 trillion of Treasuries.Who will finance U.S. debt? Nobody left that's big enough.

bid the soldiers shoot's picture

Thank God for ZH.  Without it how many of its writers would be working for the National Enquirer, writing stories about the infamous scary bug in the jungle that can swim up a man's stream of urine and distort his brain into thinking that Toria Nuland is a desirable babe to fuck? 

This article is about PBoC crawling into your urethra and making you change your will, naming Xi as the beneficiary.

St Patrick, they say, expelled snakes from the Emerald Isle.  Well, soon the legend will be told how Xi Jinping expelled Goldman Sachs, JP Morgan, and all the other snakes from Wall Street, The City of London, France, Germany and die Schweitz from the Chinese markets.

Mainland markets are veritable casinos dominated by retail investors who until last summer, were enthralled with the prospect of easy riches in an environment where shares only seemed to know one direction: up.

 

All of that changed last June when a dramatic unwind in the half dozen backdoor margin lending channels that helped to fuel the rally triggered an epic rout that became self-fulfilling once the retail crowd (which accounts for 80% of the market) became rip sellers rather than dip buyers.

That sounds pretty scary until when you examine its meaning

retail investors who until last summer ....

environment where shares only seemed to know one direction: up ...

All of that changed last June

Look at the chart.  It Started in October 2014 and burst in June 2015

8 (EIGHT) MONTHS. That's how long it took for the PBoC to figure out that the famous phalanx of little jew boys was horsing around with the Chinese Markets. A bubble that only lasts 8 months is only considered flatulance.

Did I forget to tell you that China allowed foreign investment banks to finally buy "A" shares in October 2014 the very same moment that Shanghai margin loans sky rocketed and, coincidentally (s) the Shanghai Composite?

By now everyone knows (it's on the test for newbees to get a password at ZH)  that half of the companies on the Shanghai Exchange have suspended trading in their shares (another mashugana rule of the Chinese markets)  

 Instead of quoting Reuters and Bloomberg, why can't the writer tell us how many companies still have suspended trading?

Or better how much of Goldman Sachs' money is still tied up in suspended shares?  While the yuan is losing value.  

If you feel that vermin is metaphorically swimming up your urine stream, check with Thick Willy.  He'll tell you what to do.

Flying Aardvark's picture

+1, fair analysis and accurate in a sense.

I think you may be giving the prc's leaders a tad too much credit for becoming legends. Did st Patrick intentionally bankrupt and enslave his countrymen in conjunction with expelling the snakes. Xi ain't no saint, and won't be remembered as such. He's a punk, no different than the wall street "monsters" he's ostensibly opposing.

 

bid the soldiers shoot's picture

You say that there is no difference between the leaders of the PRC and the arch monsters of Wall Street (Lloyd, Jamie, et alia).

Some of us see a sliver of daylight (or more) between the two and wave our pom poms when the Chinese kick Wall Street in the butt.

For those of you who don't see any difference between the two and don't see that the success of the Chinese economy is indispensable to avoid the collapse of the global economy, sexual mania, alcoholism, and regular heroin usage ought to keep you gainfully occupied till the SHTF.

ISEEIT's picture

They got the gold.

It either ends up nuclear and we all die (or envy those who did), or they actually have a plan. In either case a population 'adjustment' is gunna happen.

The Last Bubble's picture

Tyler,

"BofA figures the  average loan-to-asset value is about 40%. Apply that to the CNY3.05 trillion pile of collateralized stocks and you've got the potential for a CNY1.22 trillion unwind."

 So let's see, a CNY1.22 trillion unwind would amount to about...$185 Billions.

It's a lot of money but not the end of the world, well China in this case...

(maybe you should convert things in Zimbabwean dollar this would make it look even more ominous...)

 

NeverForgetSilver's picture

It is a lot of money for you and me but not a lot for an economy of $10 trillion. It is around $120 per person.

Bobportlandor's picture

Somethings fishy

The Baltic Dry Index, on the other hand, is difficult to manipulate because it is driven by clear forces of supply and demand.

Then why is The BDI Average Higher then the Supermax Price?

http://www.lloydslistintelligence.com/llint/dry-bulk/baltic-dry-index.htm

The bulk of material (90%) is delivered by ships 80,000 tons and less

http://www.learningmarkets.com/understanding-the-baltic-dry-index/

http://www.stevesmaritime.com/bulk.html

Only thing I can assume is the BDI is a average extending back in time. (manipulate!)

So the true BDI is more probable like 275 not 325