Highly-lever­aged bets lure in­vestors with 15% yields


China’s wealthy are flock­ing to in­vest­ment prod­ucts that buy bank-is­sued se­cu­ri­ties and soup up re­turns us­ing lever­age. That is, they use bor­rowed funds to buy ad­di­tional se­cu­ri­ties. If the se­cu­ri­ties end up with a higher rate of re­turn than the bor­rowed funds, then the in­vest­ment prod­uct can make high re­turns.

Elm BV, a spe­cial-pur­pose ve­hi­cle used by UBS Group AG, has sold 3.7 bil­lion yuan ($555 mil­lion) of struc­tured notes in 18 of­fer­ings since 2015 with yields as high as 15 per­cent, data com­piled by Bloomberg show. Gold­man Sachs Group Inc, So­ci­ete Gen­erale SA and Guo­tai Ju­nan Se­cu­ri­ties Hong Kong Ltd have also de­signed such prod­ucts, which of­ten use lever­age to in­vest in US cur­rency cap­i­tal se­cu­ri­ties. Chi­nese banks sold at least $27.7 bil­lion of Basel III notes off­shore since the first is­suance in 2014.

“I ex­pect de­mand for such struc­tured notes to con­tinue grow­ing as the Chi­nese are still look­ing for bet­ter yields given the cur­rent low re­turns on Asian bonds,” said Richard Zhang, as­sis­tant chief ex­ec­u­tive of­fi­cer at Huarong In­vest­ment Stock Corp, an in­ter­na­tional unit of one of four State-owned as­set man­agers. Richard Zhang, He warned that in a cri­sis, struc­tured notes us­ing lever­age would suf­fer greater losses.

China Citic Bank In­ter­na­tional Ltd and China Cinda As­set Man­age­ment Co are among Chi­nese fi­nance com­pa­nies tap­ping the mar­ket for cap­i­tal se­cu­ri­ties fol­low­ing a lull, just as ane­mic eco­nomic growth erodes their prof­itabil­ity. The Basel-based Bank for In­ter­na­tional Set­tle­ments said ear­lier this month that a warn­ing in­di­ca­tor for the na­tion’s bank­ing stress had risen to a record, while CLSA Ltd es­ti­mated shadow bank­ing ac­tiv­i­ties may be hid­ing po­ten­tial losses of $375 bil­lion. China’s money-mar­ket rates are fore­cast to re­main el­e­vated in the com­ing quar­ter, as the cen­tral bank seeks to rein in lever­age.

UBS helped Elm is­sue 332 mil­lion yuan of three-year notes in Jan­uary linked to lenders’ contin­gent con­vert­ible notes, or CoCos, pay­ing a 15.1 per­cent coupon. Yields on CoCos from In­dus­trial & Com­mer­cial Bank of China Ltd dropped to a record low 3.7 per­cent last month as global in­ter­est rates slumped. The av­er­age yield on wealth man­age­ment prod­ucts sold by China’s do­mes­tic banks de­clined 71 ba­sis points in the first half to 3.98 per­cent.

The rally in China’s CoCos has faded in re­cent weeks as the largest five lenders re­ported the small­est in­crease in trail­ing 12-month prof­its in at least a dozen years. The yield pre­mium for ICBC’s 6 per­cent ad­di­tional Tier 1 se­cu­ri­ties widened 36 ba­sis points to 312 ba­sis points from the year’s low on Aug 16.

In­vestors in struc­tured notes can’t af­ford ma­jor mar­ket cor­rec­tions be­cause the se­cu­ri­ties have delever­age trig­gers, forc­ing the sale of un­der­ly­ing CoCos should their prices fall too far.

as­sis­tant chief ex­ec­u­tive of­fi­cer at Huarong In­vest­ment Stock Corp

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