BREAKINGVIEWS-HK property woes lob banks real-world stress test

Reuters
09/29
BREAKINGVIEWS-HK property woes lob banks real-world stress test

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Ka Sing Chan

HONG KONG, Sept 30 (Reuters Breakingviews) - Ever since the 2008 crisis, regulators around the world have conducted regular stress tests to ensure that banks can survive a hypothetical shock. Lenders in Hong Kong, however, have been facing a stiff real-world examination. A deep slump in real estate prices is not only testing the industry's resilience, but also whether the financial hub's main watchdog has done enough to protect the banking system from its overheated property market. The final results of this appraisal will resonate far beyond the former British colony.

Hong Kong has long been one of the world’s most expensive cities in which to buy a home. Amazingly, that is still the case, even after property prices dropped more than 30% since 2021 following the Covid pandemic, a sharp increase in U.S. interest rates, and escalating trade tensions between China and the United States.

The slump has scorched even astute investors in the property-obsessed city who have long sought their fortunes by borrowing to buy bricks and mortar. Now this once-lucrative strategy has soured, even in the commercial real estate $(CRE)$ sector. For example, in 2017 a group of investors banded together to buy The Center, a prime office building overlooking Hong Kong's harbour, for $5.2 billion from Li Ka-shing, Hong Kong’s richest man. Most of them are now losing their shirts. One had his home seized by banks this year after failing to service his debt. Meanwhile, British fund manager Schroders SDR.L could lose control of a second property from its Hong Kong portfolio to creditors in just over a month, real estate intelligence provider Mingtiandi reported in August.

The gloomy situation invokes unpleasant comparisons with the much larger crisis in mainland China where nearly all major developers, including former giants like Country Garden 2007.HK and Evergrande, have defaulted or even vanished. Hong Kong narrowly escaped its own "Evergrande moment" in July when the blue-chip New World Development 0017.HK pulled off a $11.1 billion refinancing. Several smaller firms have defaulted, with more facing repayment and restructuring pressure.

Bankers are feeling the strain. Take Hang Seng Bank 0011.HK, a 63%-owned HSBC HSBA.L subsidiary which is traditionally one of the most conservative lenders in town. When CEO Diana Cesar took charge of the $29 billion lender in 2021 only 1.04% of its loans were classed as non-performing. That figure has since soared to 6.69% due to souring credits in its HK$123 billion ($15.8 billion) commercial real estate portfolio, more than two-thirds of which is classified as having a "significant increase in credit risk" or worse. The slump has prompted murmurs that Hang Seng and others were contemplating setting up a bad bank to absorb some of their soured assets. However, the Hong Kong Monetary Authority (HKMA) was quick to dismiss the idea.

The city's top financial watchdog has good reasons to squash talk of drastic intervention. It has spent much of the past decade and a half taking steps to protect Hong Kong's banking sector from the property bubble. Between 2009 and 2020 the HKMA implemented no fewer than eight rounds of measures to limit lenders' exposure to rapidly rising house prices, a spokesperson told Reuters Breakingviews. The regulator repeatedly lowered the maximum loan-to-value ratio for residential properties, limiting the proportion that buyers could borrow. Those seeking a second home faced even tougher constraints. The HKMA also forced lenders to check that buyers applying for a mortgage could afford a 300-basis point increase in interest rates.

Hong Kong regulators were guided by vivid memories of a previous property crash following the Asian financial crisis, which started in 1997. House prices dropped by 70% in six years, the economy shrank by 8.7% in five quarters while unemployment spiked fourfold to 8.5%. Confidence in the banking system wobbled and several smaller banks suffered runs.

When Norman Chan took charge of the HKMA in late 2009, he had repeatedly warned of risks from another asset-price bubble. Liquidity was pouring into Hong Kong as a result of the U.S. Federal Reserve’s quantitative easing. As an open economy with a currency pegged to the greenback, the HKMA could not hike interest rates. Instead it forcefully tried to dampen demand for residential mortgages, which accounted for 36% of banks’ total loans.

These measures have helped Hong Kong's banks weather the slump. At the end of March, the total capital ratio for the sector stood at 24.2%, well above the international minimum requirement of 8%, while provisions for loan losses were almost 1.5 times the stock of bad credits. Moreover, Hong Kong’s banks have remained profitable. The sector has recorded profit growth in the last three consecutive years, even after deducting bad debt provisions.

Indeed, the HKMA has been unwinding some of its mortgage restrictions since 2020, echoing the Hong Kong government's efforts to shore up the local real estate market. The implication is that banks have weathered their real-life test. Yet they could face new headaches if property prices dip deeper. This is plausible for commercial properties, where the HKMA took a less restrictive approach.

Office buildings and shops around the world are under pressure from remote work and the rise of e-commerce. Hong Kong developers face additional challenges. The proportion of the city’s prime office buildings that are vacant will rise to 18.9% this year, consultancy CBRE predicts, thanks to new supply that was planned when the market was more buoyant. About two decades ago, the influx of mainland Chinese tourists was crucial in turning around a six-year property slump. This time, however, the forces are working in reverse as more Hong Kong locals travel to the mainland and shop on Chinese e-commerce platforms.

Lower U.S. interest rates would give Hong Kong property developers and investors some breathing space, but it's too early to rule out further declines. Nevertheless, bank regulators in the developed world, many of which are facing political pressure to ease post-2008 regulations, can point to Hong Kong as an example of how to prepare for a real-world stress test.

CONTEXT NEWS

Hong Kong real estate prices have dropped more than 30% after reaching a peak in 2021, according to data from Hong Kong's Rating and Valuation Department.

The Hong Kong Monetary Authority has rolled out at least eight rounds of measures to contain the banking system's risk exposure to the property market between 2009 and 2020, a spokesman told Reuters Breakingviews.

Hong Kong property prices are suffering from an extended slump https://www.reuters.com/graphics/BRV-BRV/zgpozdrjxvd/chart.png

Hang Seng Bank's bad loan ratio has spiked https://www.reuters.com/graphics/BRV-BRV/egpbqgmqkvq/chart.png

Hong Kong has worked hard to prevent a leveraged property bubble https://www.reuters.com/graphics/BRV-BRV/zjpqoleowpx/chart.png

(Editing by Peter Thal Larsen; Production by Aditya Srivastav)

((For previous columns by the author, Reuters customers can click on CHAN/ KaSing.Chan@thomsonreuters.com))

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