Moody's: Hong Kong banks face rising private sector debt and high property prices; outlook negative

Moody's Investors Service says material imbalances in Hong Kong's (Aa2 stable) economy, including accommodative monetary conditions, rising corporate and household debt, and inflated property prices are weighing on banks' credit profiles.

These factors underpin Moody's negative outlook for the Hong Kong banking system over the next 12-18 months.

"Despite a pick-up in economic growth since the second half of 2016, modest productivity increases and the prospect of higher interest rates will weigh on Hong Kong's medium term economic growth," says Sherry Zhang, a Moody's Analyst.

"Very accommodative monetary conditions have spurred property price increases and rising private sector leverage, which pose latent risks to the system. Meanwhile, the banks' growing mainland exposures also pose risks to their credit profiles," adds Zhang.

Moody's conclusions were contained in its just-released report "Banking System Outlook -- Hong Kong: Rising private sector indebtedness and high property prices keep outlook negative". The outlook expresses Moody's expectation of how bank creditworthiness will evolve in the system over the next 12-18 months.

The negative outlook is based on Moody's assessment of five drivers: Operating Environment (deteriorating); Asset Quality and Capital (deteriorating/stable); Funding and Liquidity (stable); Profitability and Efficiency (stable); and Government Support (deteriorating).

Moody's baseline scenario assumes subdued GDP growth of 2.5% in 2017 and 2.0% in 2018. Credit growth will pick up to a mid-teens percentage rate in 2017, from 6.5% in 2016.

Asset quality indicators should remain stable. Most rated banks' problem loan ratios remain very low by global standards and should remain stable despite a gradual increase in interest rates. Nevertheless, medium term risks remain amid high property prices and rising private sector leverage.

Hong Kong banks have bolstered their capitalization through retained earnings due to more stringent regulatory requirements. Moody's stress test suggests that rated banks would maintain sufficient capital even in a stressed scenario.

With a loan-to-deposit ratio of 68% at end-2016, the system is well funded to support the expected faster credit growth. Liquidity conditions will tighten only marginally as HKD interest rates rise along with the US monetary policy cycle.

Profitability will also remain stable as rising interest rates support lending income. Nevertheless, loan impairment charges will rise in 2018 as banks adopt IFRS 9, with banks assessing their credit impairment charges on an expected basis rather than on an incurred-loss basis.

Finally, Moody's expects government support in the event of a shock will become less forthcoming, reflecting Hong Kong's implementation of a revised resolution regime to minimize the cost of bank resolution and protect public funds. The new statutory framework vests broad new resolution powers with the bank regulator, including the ability to bail-in creditors.

Moody's rates 17 banks in Hong Kong that together accounted for 70% of total domestic loans at end-2016.