The talk of the town might be Hong Kong’s budget for 2016 and 2017, but a little press release by Moody’s recently dropped. Their findings were concerning.
An announcement by Moody’s entitled “Chinese banks face higher risks and loan delinquencies” indicated, “Banks that are more involved in extending stock loans, distributing stock-related wealth management products and providing custody services to stock funds could see pressure on their asset quality and profitability if stock market weakness persists.”
The impact from market weakness is expected to be small for large banks, but smaller and mid sized institutions and clients could feel a pinch. Year-to-date, Chinese stocks are down 15%, as measured by the iShares China Large-Cap ETF (FXI), following a -13% year in 2015.
Such volatility is getting a lot of press; exposing how “green” Chinese institutions and regulators are. From a quantitative point of view, the 3yr standard deviation for the FXI is just under 22%. This displays that investors, institutions and regulators should expect disperse returns around the average. The way regulators are handling this recent volatility shows a pullback was not expected, despite what annualized volatility has been suggesting. Many professionals forget volatility cuts both ways. For context, developed indices like America’s S&P 500 has a 3yr standard deviation of 11%, nearly half of China.
On a related note, Hong Kong equities are down 9% this year thus far, as per the iShares MSCI Hong Kong ETF (EWH). Fundamentals, however, in Hong Kong are much stronger than the backdrop in China. The capital markets sector, from real estate to IPO’s, posted record breaking numbers in 2015. While on the other hand, China ended 2015 banning IPO’s and limiting its institutions. Similar to policy efforts, Hong Kong equities have also proved to be less volatile. The 3yr standard deviation for the iShares MSCI Hong Kong ETF (EWH) is currently at 16.7%.
From a macro point of view, this research proves a few points. Policy volatility leads to equity volatility, which then bleeds into the banking and lending system.
Moreover, the stock loan market is extremely selective. Institutions that focus on a variety of lending solutions are not aware of the nuances in the stock loan market. Large banks do provide a competitive service, but the structure and experience behind that service is key. Squadron Lending has a keen focus on the stock loan market. So much so, that Squadron’s global operation focuses only on stock loans (or cash for stock transactions) for their high-net-worth clients.