Funds Stick With Bets Against Chinese Banks; Wagers that midsize lenders’ share prices will fall remain at high levels

July 19, 2013, 7:41 a.m. ET

Funds Stick With Bets Against Chinese Banks

Wagers that midsize lenders’ share prices will fall remain at high levels

MIA LAMAR

HONG KONG—Short-sellers are sticking to heavy bets against China’s banks a month after a cash crunch gripped the country’s banking system, reflecting their belief that there is more stress to come even as banking shares rebound.

The wagers by hedge funds and other alternative funds started building in Hong Kong in June as a sudden shortage of cash among mainland lenders spooked investors. Banks scrambled to raise money to meet a wide range of funding demands, dumping short-term bonds, pushing interbank rates up to as high as 30% and sending the Shanghai benchmark stock index to a four-year low.The distress is still readily apparent in valuations across the sector. Just three of China’s nine major banks are currently trading above book value—what the assets on their balance sheet are worth, according to FactSet Research.

Bearish bets against China’s biggest state-run banks have cooled after the central bank injected funds and sought to soothe fears over the nation’s financial system. But short positions—bets that a company’s share price will fall—against midsize banks remain at high levels. The belief is that they have far less cash at their disposal and could face further trouble after aggressive lending earlier in the year to boost profits in the face of slowing economic growth.

China Minsheng Banking Corp., 600016.SH -3.67% which is not state-owned, suffered the most during last month’s turmoil, falling 20%. While the stock has rebounded around 3% this month, bets on further declines remain at high levels. Analysts say the bank is most at risk because of heavy exposure to risky wealth management products. The company declined to comment.

Data from SunGard’s Astec Analytics shows that borrowing of shares in Hong Kong-listed China Minsheng currently stands at a record 930 million shares, more than triple the roughly 300 million shares that had been borrowed as of early June. The borrowing of shares is often used as a proxy measure of short-selling, in which a short-seller borrows shares owned by someone else and then sells them, hoping to buy them back when the price falls.

One other indicator shows heavy bearish bets. The percentage of China Minsheng’s shares available for lending that have been borrowed hit 100% last week and has held near there since, “suggesting this increased demand to borrow for short-selling has soaked up almost all the available Minsheng shares for loan,” said Karl Loomes, a market analyst with Astec.

Concerns are running high about the worsening quality of assets on banks’ balance sheets. Andrew Maynard, global head of trading and execution at Hong Kong-based brokerage CLSA, said that while some investors have closed their short positions on Chinese banks, “most remain with that position on.” Shorting has been accompanied by selling from long-only investors, he said.

Other banks are also in the crosshairs of market bears. Borrowing of shares of Bank of Communications—China’s fifth largest lender by assets–also remains unusual at 52 million shares after doubling over a three-week span in June, according to Astec data. Shares dropped to near a two-year low earlier this month. The company didn’t respond to a request for comment.

Bearish bets haven’t been exclusive to mainland banks. The borrowing of shares inBank of East Asia Ltd. 0023.HK -0.36% —one of Hong Kong’s largest local banks and one that has made a strong push for mainland business in recent years—also rose significantly last month and has yet to decline, according to Astec. A bank spokeswoman didn’t respond to a request for comment.

Bearish bets against China’s largest banks, though, declined when China’s central bank, the People’s Bank of China, stepped in to provide liquidity to the banking system. It was widely believed that the central bank allowed the squeeze to occur to teach the financial sector a painful lesson about the risks of too much lending.

Investors quickly cut their short exposure to China’s major lenders largely because their huge deposit bases provide ample liquidity and it is widely believed that the government would come to the aid of these banks before they faced serious trouble.

With the midsize banks, though, investors are worried about their smaller deposit base and dependence on interbank lending, though they are also confident the government will come to their aid.

“In terms of how the short-sellers like to trade—when there is a lack of clarity—I think that time has probably passed,” said Chris Weston, chief market strategist at IG Markets in Melbourne. “Right now, the damage has been done in the credit market and we know the PBOC is happy to add to liquidity.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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