Hong Kong banks tough enough, says Fitch

Fitch Ratings believes Hong Kong banks will withstand potential losses resulting from a new global economic slowdown.

A Fitch stress test showed that growing links between Hong Kong and China and the expansion by Hong Kong banks in the mainland could have a more marked effect that will be far different from the downturns in 1997 and the “Great Recession of 2008-09.”

Fitch's severe downturn scenario in China may lead to negative rating actions in isolated cases. Its central case sees a mild stress reflecting a somewhat slower operating environment. This environment will be distinguished by continued volatile capital markets, slower but still healthy growth in China, a weaker domestic property sector and moderating global trade.

Fitch's stress-loss assumptions in the severe scenario result in average expected impairment charges of 4.3% of exposures over a three-year period, ranging from 3.5%-5.1% for individual banks. Pre-tax losses in such a scenario could on average reach 14% of Fitch Core Capital, spanning a pre-tax gain of 1.6% to losses of 30.2% in the absence of banks taking sufficiently mitigating actions.

Domestic property exposures remain mild as long as single-name concentrations are not prevalent and a conservative approach to risk remains the norm. A mitigating factor is the Hong Kong Monetary Authority's tight regulation for property lending and low loan-to-value ratios.

Fitch's three-year stress-loss assumption for mortgages is 1.6% in the severe scenario, based on data derived from historical peak losses for the industry in 2000-2002. For secured commercial property loans, Fitch assumes a 4% stress loss.

Fitch considers that future losses on corporate loans could reach 6% over a three-year horizon. This is likely to exceed most banks' internal assumptions, and reflects an increasing portion of loans related either directly or indirectly to China, a market for which losses have been limited so far.

Loans specifically identified for use outside of Hong Kong—the majority being direct lending to China—are subject to up to 10% stress-losses.

Minority stakes in Chinese financial institutions are a concentration risk for The Hongkong and Shanghai Banking Corporation Limited ('AA'/Negative), Hang Seng Bank Limited ('A+'/Stable), Standard Chartered Bank (Hong Kong) Limited and Dah Sing Bank ('BBB+'/Stable). Fitch's stress scenarios assume that the value of these stakes could decline by up to 65%, a steep decline which is, however, not inconsistent with the historical performance of comparable listed companies.

"Impairment charges are likely to rise from current low and unsustainable levels but Hong Kong banks are well-positioned to withstand the headwinds," says Sabine Bauer, Director in Fitch's Financial Institutions Team.

"This is despite conservative loss assumptions to reflect rising risks from an increasing portion of banks' exposure directly and indirectly related to China."