Cambodian banks have a case of long COVID. Asset quality will likely deteriorate further over the next two years even as the country's headline economic growth picks up and stays above 5%. This is because the sectors that were hit hardest by the pandemic are lagging the broad economy. And these are the same sectors to which banks are most exposed.

S&P Global Ratings does not expect Cambodia's nonperforming loans (NPLs) to peak until 2026. One key issue is highly concentrated lending to tourism-related and property sectors. The latter sector in particular could take years to heal. As one example, high-end condo prices have slumped to 2013 prices after a price runup pre-pandemic. Big buyers of these units are Chinese investors--many of whom are suffering from China's own property downturn and slow economic recovery.

The tough lessons of this episode could, however, lead to structural improvements in the sector. Slower lending growth, less concentrated loan books, and better provisioning could, over time, improve the risk-reward scenario for Cambodian banks.

Cambodia's Bad Loan Problem Will Need Time To Fix

By our forecasts, NPLs in Cambodia's broader financial system will continue to increase over 2024-2025, peaking at 7.7% of total loans in 2026 (see table 1). This reflects significant exposures to sectors that are lagging the broad recovery, delays in recognition, and cautious loan growth magnifying NPL ratios.

For example, the tourism sector accounted for the largest portion of restructured loans since 2020. Cambodian authorities have given banks more time to classify tourism-related restructuring loans into problem loans. The extension in recognizing problem tourist-related loans might only kick the can down the road, however, further delaying recovery. Real estate-related lending makes up about a fifth of lending and we expect the sector's downturn to persist.

Loan growth has hit a wall after growing at double the pace of nominal GDP growth in the pre-COVID years. This is due to low credit demand, funding tightness and caution on the banks' side. Credit losses of around 179 basis points in 2023 reflect the extremely high credit risks in the economy.

Table 1

Why The Slow Repair?

China's slow recovery is one issue that weighs. Cambodia has high reliance on high spending Chinese tourists and real estate investors. We note that overall visitor tourist arrivals in Cambodia have recovered well to 83% of pre-COVID levels and are now less reliant on China (see chart 1). But the incoming tourists are spending much lesser than before the pandemic. This is dragging on tourism-related sectors e.g., retail trade, which account for a significant 17% of bank loans.

Chart 1

Chinese investors and business travelers also have an outsized impact on Cambodia's property markets. In particular, the condo market. High-end condos are under pressure, in part because of a mismatch between demand and supply. Local buyers prefer more affordable, stand-alone houses for themselves, while most of condos in the past were aimed at overseas investors (especially from China).

Supply Overhang Continues To Haunt The Real Estate Sector

Strains on property prices and sales will persist, given a mismatch between supply and demand. Existing inventory is not clearing because of weak overseas demand. For example, high-end condo prices have corrected some 42% from an all-time high in 2018, bringing it back to 2013 levels. As per estimates by real estate consultancy CBRE Cambodia, over one-third of the landed property projects scheduled for completion in 2023 were either delayed or deferred.

Chart 2

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Real estate will thus continue to be a source of economic imbalances for the banks, in our view, directly and indirectly. Direct exposure of banks to construction and real estate is sizable amounting to one-fifth of bank loans. A big part of properties was often financed and built with foreign money. But there are local developers that have over recent years become involved in property development especially for landed houses.

The weak sales together with tightening funding have exacerbated developers' issues. Some of these developers are reliant on bank financing or sales. Developer financing is also prevalent, wherein developers are facing delinquencies from stressed buyers whose incomes are impacted. Banks are also affected by rising delinquencies via spillover effects to other real estate dependent industries e.g., cement, glass, and paint.

High Leverage And Low Buffers To Absorb Stress

Cambodia is also taking longer to heal due to rapid loan growth in the past, which pushed private credit to 180% of GDP. That is higher than most peers, e.g., Vietnam, Thailand, and Mongolia. This is compounded by high sectoral concentration. As such, the banks have low buffers to absorb stress.

Provisioning coverage ratio (PCR) is also low for the industry. The PCR for largest six banks (by assets) was 43% as of December 2023, significantly lower than most other banks in Southeast Asia, which maintain over 100% provision coverage. In our view, provisioning is inadequate for the level of stress in the system.

We believe banks are stuck between a rock and a hard place. Rising NPLs necessitate higher provisioning levels, but challenging conditions have crimped their profitability, which limits their ability to ramp up the provisions.

It's Not All Bad News…

We note a pipeline in free-trade deals could broaden manufacturing sector in the country, and this would in turn help relieve imbalances in the financial sector. We also expect increased offshoring of China-based manufacturing to benefit Cambodia.

The Cambodian government is investing more deeply in building out and improving its logistical infrastructure to narrow the gap with competitors like Vietnam. It's trying to move Cambodia up the value chain e.g., in electrical products and solar products. The efforts are showing results, including by attracting investments in manufacturing.

Tourism will, in our view, remain a structural driver, and continue to grow less dependent on China. Diversification plans are afoot to work with airlines on more direct flights to markets including Russia, India, and the Middle East. Garment sector exports, the largest contributor to Cambodian exports, have shown signs of recovery after a sharp contraction in 2023.

…But Cambodia's Risk-Reward Scenario Is Weaker Than Peers'

Given the high risk for the Cambodian economy and extremely high credit risk, the risk-return perspective is weaker for Cambodia's banking system compared with peers. We assess Cambodia's Banking Industry Country Risk Assessment as '9', which is on the lower end our BICRA scale (1-10). This reflects the economy's low-income levels, small size, and lack of diversification. It also reflects the fragmented and very competitive banking industry and weak supervision, the high leverage of the private sector, and risk management practices.

At this juncture, the country's returns on assets are low and look even more menial on a risk-return basis.

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Table 2

Editor: Cathy Holcombe

Digital design: Halie Mustow