DOMESTIC brokerages are directing large amounts of capital fleeing China’s tumbling stock market into high-yielding private debt, aiding embattled corporates but also raising risks for buyers including mutual funds, trusts and ultimately retail investors.

    Global investors are increasing worried about debt levels in China’s financial system, particularly borrowing by companies in the hard-to-assess shadow banking sector, fearing a shock could destabilize the world’s second-largest economy.

    Newly announced private placements — high-yielding bonds sold directly to institutional investors in one-to-one deals — were more than 60 billion yuan (US$9.12 billion) in November on the Shanghai Stock Exchange alone, more than the total new corporate debt issued in both Shanghai and Shenzhen as recently as April.

    Shanghai-listed placements were up 450 percent on the year in October and November and accounted for a third of all bond listings.

    “[Private placements] have attracted liquidity exiting the equity market, mainly from asset managers such as investment pools at insurance companies, trust companies, mutual funds,” said Nicholas Zhu, a senior analyst at the ratings agency Moody’s in Beijing.

    “After the summer equity downturn, a lot of that money had limited investment options and they found this new growth area.”

    Worryingly, many of these placements, which are risky because their pricing is not subject to market scrutiny, are from sectors such as energy and heavy industry, which accounted for most of the rise in corporate defaults in 2015.

    Regulators eased corporate issuance rules in 2015, hoping to boost credit access for productive small enterprises. But much of the new debt appears to originate with sectors responsible for China’s existing debt overhang.

    Ratings agency Standard and Poor’s said in a report in July that the size of China’s corporate debt had risen to 160 percent of gross domestic product in 2014, from 120 percent in 2013.

    Analysts express particular concern at the poor quality of some issuers because they are raising debt at a time when retail investors are also piling into debt-backed wealth management products.

    Of 58 private placements listed in Shanghai in November, a full 48 were real estate, energy, steel or local government construction and investment firms, all indebted sectors partly locked out of public lending markets and key clients of the murky shadow banking system.

    Shandong Honghe Mining Group, a coal miner in China’s northeast rust belt, highlights the often risky nature of debt issued outside public markets.

    The firm placed a 500 million yuan, 8.2 percent coupon private note in Shanghai last October. Honghe has also received “shadow bank” trust financing ultimately sourced from retail investors, trust firm statements show.

    But Shanghai exchange filings show the firm’s 2014 operating income, before depreciation and other line items, was only 1.4 times interest due that year, while cash and other liquid assets were barely sufficient to cover maturing obligations.

    In the meantime, China’s benchmark coal prices have fallen 40 percent.

    “Many trust loans were issued two years ago when commodity prices were still sky high,” said Oliver Barron, analyst at the economic consultancy NSBO Research in Beijing.

    “And any products that sent funds to those parts of the industrial sector may have repayment difficulties at the old high rates.”

    In early January, bond and bank regulators held a “training session” asking banks to lower yields and boost risk management in the wealth management sector. (SD-Agencies)