Still not saved: Negative outlook persists for Hong Kong banks

No end in sight for year-long drought.

The outlook remains negative for Hong Kong’s banks on the back of increasing mainland exposure and deteriorating local economic conditions.

According to Moodys, outlook for Hong Kong’s banking system remains negative, as it has been since June 2013.

“The key risks that underpin the negative outlook are the banks’ growing exposures to Mainland China, deteriorating credit conditions in the Mainland, asset market imbalances in Hong Kong’s economy, high levels of private sector debt, and the implications on support for creditors from the impending new resolution regime,” noted the report.

Here’s more from Moody’s:

Some recent developments, such as stable property prices and benign credit market conditions, have made these threats appear less imminent.

However, we anticipate a more challenging environment for the economy and Hong Kong banks, as interest rates start to rise in 2015 following a long period of extremely easy monetary conditions and a significant rise in credit.

Hong Kong banks will likely further expand their Mainland-related exposures in the coming 12-18 months following years of strong growth.

Such expansion poses credit challenges as it increases the banks’ exposures to China’s economic and financial vulnerabilities, and pressures some of the banks’ liquidity profiles and capitalization levels.

The banks’ Mainland exposures grew 29% in 2013, and accounted for 20% of their total assets at end-2013 versus 16% at end-2012.

The key drivers behind the strong growth are Mainland and overseas corporates’ expanding cross-border trade and investment activities, relatively low funding costs in Hong Kong compared to China, and credit demand diverted to Hong Kong from China, due to tighter liquidity conditions and higher funding costs in the Mainland.

Hong Kong banks have so far maintained conservative credit standards on their Mainland-related lending and report good asset quality metrics.

However, the rapid growth in their Mainland-related business and the transformation in their financial profile entail risks, as the banking system evolves into an important offshore financial conduit for Mainland China.

In addition, we expect asset quality trends in China to remain under pressure in the next one to two years from the country’s economic rebalancing and slowing growth.