Even a modest increase in non-performing loans would have a
significant impact on Hong Kong bank profits, suggesting the sector
will be a sensitive indicator of China's debt markets in the year
A landmark domestic bond default earlier this month and headlines of
bankruptcies — highlighted last week by Zhejiang Xingrun Real Estate
Co — have underscored concerns that an unprecedented surge in
company debt in China is now showing signs of unraveling.
"The quality of these loans extended by Hong Kong banks to Chinese
companies has not been tested," said Mirza Baig, head of foreign
exchange and interest rate strategy at BNP Paribas in Singapore.
"That is a concern in the backdrop of the rapid rise in exposure."
Foreign bank claims on China hit $1 trillion last year, up from
nearly zero 10 years ago, and the biggest portion was provided by
Hong Kong, Bank of International Settlements data shows. The $430
billion in loans outstanding represents 165 percent of Hong Kong's
GDP, BIS figures show.
Data from the Hong Kong Monetary Authority (HKMA), the city's
de-facto central bank, showed a similar astonishing rise. By the end
of 2013, Hong Kong banks' net claims on China as a percentage of
their total loan book was nearing 40 percent, compared with zero by
The rival financial center of Singapore has also ramped up its China
loans as well, but its exposure is the equivalent of 15 percent of
its GDP, figures from its monetary authority show.
Local banks in both these centers have taken over lending that
foreign banks once dominated, drawn by cheap funding rates following
the global financial crisis, a voracious appetite from Chinese
borrowers and healthy growth in the world's second-biggest economy.
"Hong Kong banks have pounced on arbitrage opportunities between
on-and offshore renminbi funding rates," said Cathy Holcombe, a
strategist at Gavekal Dragonomics in Hong Kong.
There is no breakdown of the type of loans behind the $430 billion
figure. But Stephen Long, managing director of financial
institutions at Moody's Investor Services, said "a substantial part"
is in lower-risk categories such as trade finance. This would
include loans to Hong Kong blue-chip companies operating on the
mainland or loans supported by guarantees from Chinese banks.
However, trade finance may also hide speculative flows that bet on a
rise in the yuan — a popular trade encouraged by the currency's 2.9
percent rise against the dollar last year. In this trade, investors
and companies falsify trade receipts to convert foreign currency
into yuan and avoid capital controls.
This year's slide in the yuan may also pinch debtors' ability to
service their loans. The yuan has dropped nearly 3 percent, wiping
out its 2013 gains, putting it on track for its worst March quarter
"Most of these loans are not hedged completely on a currency basis
even if they are collateralized and the currency volatility means
some of these banks may be sitting on large currency losses," said a
trade banker at a large European Bank. He declined to be identified
because he was not authorized to speak openly to the media.
Stock and credit analysts also say a big chunk of the loans has
ended up in China's property and financial sectors, as well as
industries with surplus production capacity, such as steel — all
areas where regulators are trying to control lending.
To be sure, capital buffers at Hong Kong banks are much higher than
minimum international standards and the central bank has not shown
any alarm about the lending.
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The HKMA said it has been "closely monitoring" the sector's credit
exposure and it expects banks "to maintain sufficiently robust
system of controls to manage the specific risks that they are
Investors are showing more concern though. An index of financial
stocks <.HSCIF> in the main Hong Kong bourse had fallen by more than
13 percent this year through to the end of last week. It perked up
on Monday on hopes for government stimulus to support the Chinese
Analysts said Bank of East Asia <0023.HK> and Bank of China (Hong
Kong) <2388.HK> have the biggest exposure to China among the lenders
based in the territory, at 46 percent and 27 percent of their loan
books, respectively. The latter is also the clearing bank for all
yuan-related transactions appointed by the China's central bank. The
banks did not return calls seeking comment.
Hong Kong's non-performing loans (NPLs) ratio is currently a record
low of 0.5 percent. But if it returned to the long-term average of
3.5 percent, it would cut nearly 20 percent off current expectations
for local bank pretax profits for the financial year starting this
April, Barclays Capital said.
Larger global banks in Hong Kong, such as Standard Chartered Bank <STAN.L>
and HSBC <HSBA.L> are less at risk because of their big balance
Under a scenario whereby NPLs return to 3.5 percent, Bank of East
Asia would take a 10 percent hit to its pretax profit, while Dah
Sing Financial Group <0440.HK> and Wing Hang Bank <0302.HK> could
lose nearly a sixth, Barclays says. Dah Sing and Wing Hang did not
return calls seeking comment.
Sharnie Wong, a banking analyst at Barclays, said the two biggest
risks to asset quality of Hong Kong banks are a sharp downturn in
China's economy and a rise in U.S. interest rates. The first factor
could reduce the ability of borrowers to service their loans and the
second point would raise bank funding costs, squeezing profit
Although China's official NPL ratio is 1.0 percent, bankers estimate
the real figure is anywhere between 5 percent and 10 percent.
Wong and other analysts argue that interest rates, and with them
NPLs, are set to rise as rates globally increase, partly in response
to healthier U.S. and European economies.
That means Hong Kong banks will have to put more aside to offset
debt risks and so readings on their NPLs and provisions against bad
debt will provide a window on the state of China's credit market.
(Additional reporting by Michelle Chen;
editing by Michael Flaherty
and Neil Fullick)
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