Daniel Tabbush has covered banks in Asia for more than 20 years, most recently as head of Asian bank research at CLSA. The following does not constitute investment advice, and the views and opinions expressed are those of the author and do not necessarily represent the views of S&P Global Market Intelligence.
While much attention in the financial sector throughout 2016 has been on the impact of the slowdown in China's economy on the asset quality at mainland banks, it is worth keeping an eye now on the spillover effect in Hong Kong. There is ample evidence of a weakening in Hong Kong economic growth, which is in part due to China.
We can already see some signs of the spillover of China's economic decline on Hong Kong's wider economy. Consider tourism. Over recent months, according to Hong Kong tourism authorities, the number of tourists coming from China to Hong Kong has been falling. Ominous signs can also be seen in the retail sector. Hong Kong's Census and Statistics Department data showed 7.5% year-over-year drop in Hong Kong retail business receipts the third quarter. Overall, Hong Kong's real GDP growth is declining from a peak of 6.8% in 2010 to 1.6% in 2016, according to an Economist Intelligence Unit forecast.
For sure, banks in Hong Kong face worsening credit quality and growth prospects. Bank of East Asia Ltd. reports a decline in its Hong Kong loans over in the past year, to HK$186.60 billion in the first half of this year from HK$193.90 billion as at the first half of 2015. At the same time, the lender is seeing a deterioration of credit quality. It reported impaired loans in Hong Kong of HK$1.09 billion as at the end of the first half, up from HK$471 million in the year-ago period and HK$643 million at year-end 2015. Bank of East Asia's domestic impaired loans is growing fast, and serves as a warning sign about the weakness of the domestic economy.
Hang Seng Bank Ltd. may not be showing the same sort of loan contraction in Hong Kong as at Bank of East Asia, but its domestic impaired loan profile is similarly poor. Over the period from the first half of 2015 to the first half of 2016, Hang Seng Bank's impaired loans in Hong Kong rose 28%. Moreover, its overdue loans and advances in Hong Kong jumped 77% over the same period.
There is more to worry about, in the form of mainland China lending. Bank of East Asia reported that 45.8% of its total loans as at the end of the first half are for China-based clients. While Bank of East Asia's impaired loans in China have not been rising aggressively over the past 12 months, its overdue loans in the country have been. These are up 34%. With a continued weakening of China's economy, more of these overdue loans will need to be impaired and require more credit costs from Bank of East Asia.
Hang Seng Bank is less exposed to China than Bank of East Asia. Only 11.7% of Hang Seng Bank's loans are based on the mainland. The bank has been experiencing a nearly comparable rise of its China-based impaired loans compared with its China-based overdue loans. I believe this is due to loan migration, where overdue loans are weakening and moving to an impaired loan status. As such, Hang Seng Bank's impaired loans from China rose 30% year over year in the first half of 2016.
For Bank of East Asia, the result of worsening loan quality in Hong Kong and China has been a steady and meaningful rise of its provisions-to-loans at amortized cost ratio. The figure was as low as 0.06% in 2012, but has since risen to 0.52% in the first half.
At Hang Seng Bank, it too has seen its worsening domestic and China loan quality adding to its credit costs. Its provisions-to-loans at amortized cost ratio rose from 0.08% to 0.21% over the same period. Perhaps the figure is far lower than Bank of East Asia, due to a smaller China exposure, but I would expect both banks to see higher credit costs from Hong Kong and China lending to weigh on earnings in the second half of 2016 and during 2017.