Hong Kong banks' profits and asset quality face further pressure from their exposures to commercial real estate (CRE). Banks, particularly the larger players, should be able to manage the strains and maintain resilient credit profiles. This is due to their diversified loan portfolio, adequate collateral, and reasonable underwriting standards.
Small and midsize banks are likely to experience greater strain due to their higher exposure to CRE investment loans and, potentially, to smaller and leveraged developers and investors.
Chart 1
What's Happening
We believe that nonperforming loans (NPLs) for commercial real estate have not peaked for Hong Kong banks. Recent results showed that the impaired loan ratio of Hongkong and Shanghai Banking Corp. Ltd. increased to 2.79% at end-2024 from 1.75% at end-2023. And Hang Seng Bank reported a jump to 6.12% at-end-2024 from 2.83% at end-2023.
Why It Matters
The underlying property pain is not going away yet.
- With soft demand for offices and retail space, Hong Kong banks will likely see increasing asset quality pressure when their CRE loans come due for refinancing over the next few years (see "Hong Kong's Commercial Real Estate Downturn Is Spreading To Banks," published on RatingsDirect on Oct. 31, 2024).
- A higher-for-longer interest rate scenario would add to the strain on asset quality.
- Property development and investment loans in Hong Kong make up about 14%-15% of total outstanding loans in the system as of end 2024. Out of this, we estimate about 60% (or 8%-9% of total loans) are related to CRE.
Small banks are more vulnerable.
- Given elevated downside risks, CRE exposure could push Hong Kong banking sector's ratio of credit losses up from our estimate of 0.5%. Nonetheless, we expect any excess pain, beyond our base case, to be manageable.
- For the large players [1], pressure on rising credit loss are likely to remain manageable, due to their diversification, risk selection and control, exposure management and collateral management.
- Small and midsize banks [2] will face heightened volatility in their asset quality and credit losses, especially those with heavier CRE exposures. They are likely to be more exposed to leveraged second-tier property developers and investors with higher concentration of nonprime properties exposure.
What Comes Next
In our base case, we expect Hong Kong banking sector to weather this storm with some scratches on profitability.
Strong defenses. We expect the sector's strong profitability to be a solid first line of defense to absorb credit losses. Hong Kong retail banks' annualized operating profit before impairment charges over average assets stood at 1.36% for first half of 2024, similar to the full-year 2023 performance, while the impairment charge to average assets stood at 0.18% for first half of 2024 and 0.26% for 2023. This gives the sector a buffer to take on more provisioning without reporting a loss or eating into capital.
The dents on profit for smaller banks with large property development and investment loans exposures are likely to be deeper.
Capitalization is another line of protection. Hong Kong banks capitalization is also strong; average common equity tier-1 capital ratio was 18.0% and the tier-1 ratio was 19.7% at the end of September 2024. These are well above the regulatory requirements.
Hong Kong's newspapers have reported concerns that even some large developers in the city face default risks. Even in a strained scenario where two or three developers failing to honor their obligations, we think no bank will fail because regulatory oversight in Hong Kong limits banks' exposures to a single group and banks also have ample of liquidity.
However, this type of situation would hit profitability very hard for some banks.
Background Brief: Collateral Buffers Weaken In Downcycles
Hong Kong banks normally make property investment loans at loan-to-value (LTV) ratio of 50% or below. This gives the institutions good protection.
However, this LTV ratio at 50% is at loan origination. In a weak market with very low investment appetite on property, repossessing the collateral is a tougher proposition than in a normal market. Banks would likely have to sell it at steep discounts and take losses.
Given such dynamics, banks have incentives to work with certain types of distressed borrowers rather than taking procession of collateral; e.g., if borrowers have a viable business, a decent property portfolio or other assets to post additional collateral, and/or a willing and financially strong shareholder.
Notes
[1] Large banks refer to the Hong Kong and Shanghai Banking Corp. Ltd. and its subsidiary Hang Seng Bank Ltd.; the Bank of China (Hong Kong) Ltd., and Standard Chartered Bank (Hong Kong) Ltd.
[2] Small and midsized banks refers to next largest 15 licensed banks, after the top three largest banks.
Related Research
- Hong Kong Retail Landlords: A Choice Between Lower Rents Or Higher Vacancy, Feb. 18, 2025
- Hong Kong's Office Market: With Rents Down, Valuations Will Follow, Feb. 12, 2025
- Hong Kong's Commercial Real Estate Downturn Is Spreading To Banks, Oct. 31, 204
This report does not constitute a rating action.
| Primary Credit Analyst: | Ryan Tsang, CFA, Hong Kong + 852 2533 3532; ryan.tsang@spglobal.com |
| Secondary Contacts: | Phyllis Liu, CFA, FRM, Hong Kong +852 2532 8036; phyllis.liu@spglobal.com |
| HongTaik Chung, CFA, Hong Kong + 852 2533 3597; hongtaik.chung@spglobal.com |
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