Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDRs) of China-based GF Securities Co., Ltd. and wholly owned principal subsidiary GF Holdings (Hong Kong) Corporation Limited at 'BBB'.
The Outlook is Stable. Fitch has also affirmed the subsidiary's Shareholder Support Rating (SSR) at 'bbb'.
GF Securities is a leading fully licensed securities firm in China with industry-leading market rankings in securities brokerage, equity research and fund management. The company is headquartered in Guangzhou, the capital of Guangdong province. It is under close provincial supervision because of its important strategic role in the province but the provincial government's investment stake is limited.
The company has a diversified shareholding structure. Jilin Aodong Pharmaceutical Group Co., Ltd., Liaoning Chengda Co., Ltd., and Zhongshan Public Utilities Group Co., Ltd. are the three largest shareholders in GF Securities as of end-2023 with ownership of around 20%, 18% and 10%, respectively.
The Stable Outlook reflects our view that its Standalone Credit Profile (SCP), together with our expectation of modest potential support, will remain unchanged in the medium term.
Key Rating Drivers
Notching-Up Approach: GF Securities' Long-Term IDR is underpinned by a combination of its SCP of 'bbb-' and a one-notch rating uplift from its SCP. The uplift reflects Fitch's expectation of a modest degree of support likelihood from the Guangdong provincial and Guangzhou municipal governments. We apply the notching-up approach, instead of top-down, due mainly to the limited shareholding control.
The one-notch uplift reflects its important strategic role working closely with the local government to maintain the province's financial and social stability. It has a record of supporting financing activities for local state-owned enterprises (SOEs) and facilitating the rehabilitation of local companies under liquidity stress. The notching-up also reflects funding and liquidity support from the local government, as stated in letters of support from the provincial and municipal authorities. We expect any support GF Securities requires would be immaterial relative to the government's ability to provide it.
Stable SROE: The sector risk operating environment (SROE) score remains at 'bbb-'/ Stable, supported by a strengthening regulatory framework that enhances capital market growth and development in the longer term. This is despite potential business volatility arising from evolving capital market development and macroeconomic growth headwinds.
The operating environment score is above the implied 'bb' category, as we believe China's solid external finance and a record of stable economic performance will provide greater financial and economic stability than the implied operating environment score indicates.
Capital Market Faces Near-Term Challenges: Equity market turnover has gradually stabilised, but regulatory tightening to improve the quality of listed companies and restrictions on local government refinancing have disrupted investment banking operations. This has led to a decline in IPO deals and put pressure on debt issuance activities. However, these measures are expected to yield long-term benefits by reducing credit risks from lower-quality issuers and enhancing regulatory oversight through improved data transparency and disclosures, thereby contributing to the financial system's overall stability.
Adequate Franchise: GF Securities' IDR reflects its leading market position across China, especially in the Guangdong-Hong Kong-Macao Greater Bay Area, supported by its established franchise strength in equity research and fund management. In addition, GF Securities' long-standing cooperative relationships with local governments and local SOEs, as well as its services to the provincial government's policy designation and social initiatives benefit the company's business profile.
Risk Control Strengthening: Fitch views GF Securities' internal risk infrastructure as acceptable with internal control policies in place. However, they are weaker than those of higher-rated sector peers, as evidenced by the regulatory penalties in 2019 and 2020 that resulted in the regulator suspending its underwriting business for 12 months. We believe that risk control has been strengthened since then by the company's remedial measures, with better-controlled operational risk and an improved external assessments of risk control in recent years.
Earnings Under Near-Term Pressure: GF Securities' profitability, measured by operating income to average equity, declined to 5.2% in 1Q24 and 6.1% in 2023, from 8.1% in 2022. Proprietary trading income recovered from distressed conditions in 2022, but 2023 profit was pressured by weaker fee income from brokerage and fund management operations amid weak market sentiment. The pressure continues into 2024 with regulatory tightening on listing requirements and local government leverage denting GF Securities' investment-banking operations and overall returns.
Healthy Capital Position: GF Securities has maintained adequate leverage relative to the business risks it undertakes, retaining an adequate capital buffer against unexpected market shocks, despite potential earnings volatility. Its net adjusted tangible leverage remained in a 3.4x-4.3x range over 2020-1Q24.
Reliance on Wholesale Funding: GF Securities is exposed to credit market volatility, similar to peers, due to its reliance on wholesale funding and high use of repos for short-term funding. Even so, the risk is reduced by its adequate liquidity coverage buffers and holdings of quality underlying collateral against the repo transactions. Its strong relationship with the local government and financial institutions also increases funding flexibility and benefits its funding and liquidity profile.
Support-Driven Subsidiary Rating: GF Holdings (Hong Kong)'s rating is equalised with that of GF Securities, underpinned by our expectation that extraordinary shareholder support would be forthcoming from GF Securities, if needed, considering their strong linkages. The rating reflects the subsidiary's key role as a core holding platform providing comprehensive cross-border financial services to meet the overseas business needs of the group's clients, high integration with the parent, and the huge reputational risk to GF Securities if the subsidiary were to default.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
IDR - GF Securities
Deterioration of the SCP would lead to a rating downgrade. This could be driven by a significant weakening in the franchise with a worse recovery than Fitch expects in investment-banking operations; increased risk appetite evident from regulatory penalties or discipline, or unexpected expansion; a notably weakened capital and funding profile with withdrawal of ordinary liquidity support provided by the local government; or a material lapse in risk control, together with sustained weakening of profitability - measured by operating profit/average equity - to below 7%.
Negative rating action is also possible if Fitch believes GF Securities has a reduced strategic importance to the local government, such as underserving the local government and local SOEs in the capital markets for a sustained period.
IDR - GF Holdings (Hong Kong)
A downgrade of GF Securities' rating would lead to a downgrade of GF Holdings (Hong Kong)'s rating to the same magnitude.
A downgrade for GF Holdings (Hong Kong) could also be triggered by changes in the propensity of GF Securities to provide extraordinary support. This could occur due to weakening linkages, as evidenced by a large dilution of GF Securities' ownership stake or a significant reduction of the subsidiary's role in carrying out the parent's offshore businesses.
Any indication of GF Securities not providing timely capital and funding support to GF Holdings (Hong Kong), should it run into liquidity or refinancing issues, would also pressure on GF Holdings (Hong Kong)'s rating.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
IDR - GF Securities
Positive rating action for GF Securities could be possible through strengthening of its SCP, in particular successful strengthening of the company's franchise and market position by management. This could take the form of a recovery at its investment-banking franchise along with a sustained improvement in profitability at above 10% of operating profit/average equity and in earnings quality.
An upgrade may also be triggered if Fitch believes the strategic importance of GF Securities to the local government has been materially strengthened, although this seems less likely in light of the government's limited shareholding control of the company.
IDR - GF Holdings (Hong Kong)
GF Holdings (Hong Kong)'s rating is equalised with that on GF Securities, so an upgrade is unlikely without a similar rating action for GF Securities.
ADJUSTMENTS
GF Securities' SCP has been assigned in line with the implied SCP.
The SROE score has been assigned above the implied score due to the following adjustment reason: sovereign rating (positive).
The capitalisation and leverage score has been assigned below the implied score due to the following adjustment reason: risk profile and business model (negative).
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Public Ratings with Credit Linkage to other ratings
GF Holdings (Hong Kong)'s rating is directly linked to GF Securities' rating.
ESG Considerations
GF Securities has an ESG Relevance Score of '4' for Governance Structure, as evidenced by the regulatory penalties in 2019 and 2020 that resulted in the regulator suspending its underwriting business for 12 months, which has a negative impact on the credit profile, and is relevant to the Long-Term IDR in conjunction with other factors.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/topics/esg/products#esg-relevance-scores.
