By Chao Deng
New warnings are emerging over a surge in risky bets by
mom-and-pop investors who are using borrowed cash from brokers to
pile into and fuel China's booming stock market.
Margin lending has more than tripled in the past year to a
record 1.7 trillion yuan ($274.6 billion), according to database
WIND Info, echoing past investment crazes among Chinese
speculators. Such investors have long shown a penchant for rushing
into whatever is yielding the highest returns, from real-estate and
wealth-management products, to bitcoin and online money-market
funds.
The practice isn't unique to China, where margin debt equals
3.2% of total market capitalization, compared with 2.3% in the U.S.
But when looked at compared with the number of shares that are
freely traded, the percentage for China rises because the country's
state entities own more than half of the market.
Research by Macquarie Securities Group shows China's margin-debt
ratio at 8.2% of the free float, a measure the securities house
prefers, and a level that easily tops the peak levels in Taiwan
during the late 1990s, and far exceeds levels in the U.S. during
the dot-com frenzy when the market rose and then quickly fell.
"There's a huge amount of leverage built in," said Matthew
Smith, Shanghai-based senior analyst at Macquarie. The worry is
"more about volatility than a pending collapse," but the comparison
to the size of the market that retail investors can actually access
is "a reality check."
Along with several rounds of monetary easing from China's
central bank that has pumped billions of yuan into the financial
system in recent months, margin lending has helped stoke an
explosive market--the Shanghai Composite Index rose 53% last year
and another 36% this year.
"It's definitely not sustainable for us to trade up the market,"
said Yuming Ying, fund manager at Hong Kong-based China Eagle Asset
Management Ltd. "There's quite a lot of local reports pointing to
high levels of margin trading. It is quite dangerous. You really
don't know when it will stop."
Local investors have leveraged up their bets on smaller stocks
on the mainland in particular, adding risk to an already volatile
portion of the market.
The turnover from margin financing accounts for 25% of daily
trading volumes on the ChiNext, the market in Shenzhen where small
Chinese startups trade, according to estimates from UBS AG. There,
local investors have rushed to buy firms purported to have huge
growth potential, pushing the ChiNext benchmark up nearly 80% this
year to record-high valuations.
By comparison, the turnover from margin-financing accounts makes
up 15% of daily trading volume in the total mainland market.
But strategists and investors say the triggering of margin
calls, when brokerages force their investors to sell to recover
their original loan, isn't likely. Assuming a Chinese investor had
invested the minimum 500,000 yuan needed to start a margin-trading
account and borrowed the same account at the beginning of the year,
the market would have to fall roughly 50% from its current level
for the coverage ratio, that is, the ratio of invested money to
borrowed money, to fall to a level where the broker would force
selling.
"[It's] not particularly likely especially given the 10% [daily]
down-limit" on stocks by Chinese authorities and investors would
begin selling before, said Macquarie's Mr. Smith.
One danger is that those who bought early on, seeing their
stocks surge, would take on even more loans to invest further.
Brokerages ask their investors to add collateral when their
coverage ratio reaches around 1.5 times, and unwind positions
automatically at around 1.3 times. Macquarie estimates the average
coverage ratio of margin traders in China is currently 2.6 times,
up from this year's low of 2.3 in early February. Margin loans can
increase to 9.4 trillion yuan from the current 1.7 trillion, before
the average coverage ratio would hit 1.3 times.
Authorities have stepped in numerous times since December to
rein in borrowing practices at brokerages, from issuing verbal
warnings to suspending the opening of new margin-trading accounts
at select firms.
"If there was a lot of aggressive business practice amongst
brokerages, regulators would be likely to step in again," said UBS
China strategist Wenjie Lu.
Investors also say increased cash in the system provides support
to the market. The daily trading volume on the Shanghai Stock
Exchange surpassed 1 trillion yuan for the first time on
Monday.
Still, Mr. Ying said he started selling out of his investments
in mainland stocks in December because margin trading by local
investors had been a big reason behind Shanghai's steep rally. The
firm continued to unload stocks even after authorities stepped in
to curb margin lending in January.
Mr. Ying admits that he sold early, but he said that trying to
predict and time changes in mainland investor behavior is tricky.
"Chinese investors are probably too optimistic--reforms can't make
a difference too quickly. While Western investors are too
pessimistic--the market won't crash with the amount of foreign
reserves authorities have."
Gregor Stuart Hunter contributed to this article.
Write to Chao Deng at Chao.Deng@wsj.com