CITIC Securities to gain from higher underwriting volumes

Thanks to domestic IPO market opening up again.

It has been noted that among 117 securities companies in China, CITIC Securities (CITICS) is the largest in terms of total assets and net capital. It is more diversified than most Chinese securities companies, having expanded beyond its traditional cash stockbrokerage business into securities underwriting, stock margin lending, and asset management.

According to a research note from Moody's Investors Service, in line with this, over the next 12-18 months, it expects CITICS to benefit from higher underwriting volumes resulting from the gradual re-opening of the domestic IPO market, growing asset management business from a low base, and the new Shanghai-Hong Kong Stock Connect.

The report noted that the Shanghai-Hong Kong Stock Connect, which was announced in April 2014 and is expected to launch shortly, will generate growth in cross-border brokerage volumes.

In addition to so-called “southbound” crossborder trades, CITICS is also well positioned to capture “northbound” trades through its CLSA unit.

Here's more from Moody's Investors Service:

When the firm has been diversifying its revenue sources, CITICS has been cutting back its proprietary-trading activity to limit associated risks.

As at end-2013, proprietary trading assets accounted for RMB3.5 billion, about 1% of total assets and 4% of equity, down from RMB20 billion in 2011. According to CITICS, its proprietary-trading operations are much smaller than the industry average of around 11% of equity, and are mainly focused on market-neutral equity arbitrage trading strategies that aim to hedge against market volatility.

In July 2013, CITICS made CLSA a wholly owned unit by purchasing the remaining 80.1% stake of the Hong Kong-based specialist institutional securities firm from Credit Agricole for $841.68 million.

The presence of an international subsidiary with an established franchise like CLSA should allow CITICS to benefit from cross-border liberalisation of China's capital markets, of which the Shanghai-Hong Kong Stock Connect is a key example.

In addition to CITICS, Haitong Securities (unrated) and China Merchants Securities (unrated) have established operations in Hong Kong that will help them benefit from northbound trading activity, although these firms' businesses in Hong Kong are not as established as CLSA's.

We note that CITICS’ large distribution network and customer base across China can allow it to scale up new businesses more quickly than peers. CITICS' cost-to-income ratio was 56% in 2013, lower than the peer average of

58%.

Among the securities companies globally rated by Moody's, CITICS' expense ratio is among the lowest, reflecting lower staff-compensation costs than for many of these firms. About 50% of CITICS' costs are variable depending on company revenue performance.

Despite these strengths in the domestic market, CITICS is nonetheless exposed to industrywide pressures, including margin compression in brokerage commissions, new regulatory initiatives, and execution challenges related to international expansion.

CITICS' brokerage commission rates were on a downward trend between 2008 and 2011, in line with the industry in China. CITICS' top market share in brokerage commissions does not shield it significantly from such price competition.

To better differentiate its product from those of peers, CITICS has been focusing on providing quality research and other services to high-net-worth clients, for whom price alone may better less of a deciding factor than it is for mass-market customers.

Focusing on high-net-worth clients also provides opportunities for CITICS to cross-sell wealth management products, and only individual investors with minimum account balances of at least RMB500,000 are initially authorized to buy Hong Kong securities under the Shanghai-Hong Kong Stock Connect.

Chinese regulators are active in efforts to liberalize the securities industry in order to drive the development of the domestic capital markets. In addition to the plans for the Shanghai-Hong Kong Stock Connect, a moratorium on domestic initial public offerings (IPOs) that had been instituted in late 2012 was lifted early this year. Subsequently, A-share stock turnover has increased and IPOs have resumed, albeit haltingly.