At least 1,331 companies have halted trading on China’s mainland exchanges, freezing $2.6 trillion of shares, or about 40 percent of the country’s market value, Bloomberg News reports today.
The Shanghai Composite Index has fallen 5.9 percent on Wednesday, July 8th, 2015. It was about 32 percent below the peak of 5,166 it reached on June 12. The unwinding of margin loans is adding fuel to the fire. Individual investors, we all know by now, have used generous margin financing terms to enter the stock market and then build up their portfolios. Less known is that Chinese companies have been doing the exact same thing by using their own corporate stock to secure loans from banks.
This means that they stood to lose a lot when those share prices start trending dramatically lower.
Says Nick Lawson at Deutsche Bank: “Stocks are being suspended by the companies themselves because many have bank loans backed by shares which the banks themselves may want to liquidate, joining the queues of margin sellers.”
Nomura analysts add that: “Some bank loans have been extended with shares of listed companies put up as collateral.”
Numbers here are sketchy, but the team at Nomura estimate that the total amount of such loans may be 500-600 billion yuan ($80 billion – $96 billion), which sounds like a lot but is equivalent to about 1 percent of total loans to Chinese enterprises.
Still, the dynamic now at play is reminiscent of the troubles encountered by U.S. energy firms thanks to the plunging price of oil. Many shale explorers have bank loans tied to the value of their oil and gas reserves. When the price of oil began sinking last year, those credit lines were generally reassessed at a lower value, limiting the amount of credit available to the energy companies and creating further pressure for firms that were already dealing with the fallout from dramatically lower crude prices.
The easiest way to stop a painful cycle of lower share prices leading to curbed corporate credit, further troubles for Chinese companies and then ever-increasing share price pressures is to halt stock trading altogether.
Speaking of which, the latest move from Chinese regulators announced on Wednesday bans corporate executives from selling stock for six months.
This vicious circle described above also explains why China’s central bank has quickly moved to support the market in an effort to limit its impact on the wider economy.