Barclays expects Hong Kong dollar liquidity conditions to remain tight and deposit growth to stay under pressure leading to the increase in corporate lending rates. This is due to the rapid development of the offshore renminbi market, and macro indicators like the slowing down in gross domestic product (GDP).
According to a report released by yesterday (February 13), banks – whose margins have declined in the second half of 2011 – are expected to re-price credit more aggressively due to rising pricing power as their European peers exit the region, and growing credit risk given the macro headwinds.
Barclays foresees corporate lending rates surging 200-300 basis points (bp) over the next two years from current levels.
“The biggest implication [of liquidity tightening conditions] is the rising cost of borrowing for corporates,” said Sharnie Wong, a Hong Kong-based analyst at Barclays Capital in an email reply to questions yesterday. “This may exacerbate asset quality deterioration if it is more expensive for corporates to borrow, especially when economic growth is expected to slow.”
The fact that US’ interest rates are to remain unchanged until 2014 increases the likelihood of tighter liquidity conditions occurring locally and rising borrowing costs. This is anticipated to hinder growth, said the report.
Real gross domestic product (GDP) growth is expected to slow from 4.8% in 2011 to 3% this year, said the bank.
Barclays also anticipates deposit competition to remain fierce across all major currencies as the pace of growth slows. Loan growth is estimated to decline from 20% last year to 6% in 2012 on slowing deposit growth, which is forecasted to drop from 11% in 2011 to 5% this year.
Despite higher lending rates in the future as shown in Figure 1, the bank believes that corporates in Hong Kong will still have the capacity to refinance their maturing debt through loans. These entities will also have the capability to tap the bond market directly.
“Corporates can refinance their maturing debt, albeit at higher rates,” added Wong. “[They also can] tap the bond market if they fail to secure bank funding at reasonable rates.”
In a scenario where rising costs of borrowing will naturally lead to a potential increase in bad debts, Barclays has not yet witnessed a systemic increase in the non-performing loans (NPLs) of banks but has seen “pockets of weakness”.
“[We can see NPL weakness for] Dah Sing Bank whose NPLs for China-related small to medium enterprise exposure rose significantly,” said Wong. “But the NPL ratio is at an all time low, so the only way it can go is up.”
Barclays expect lackluster earnings in 2012 as margins remain under pressure and loan growth slows. As a result, the economic slowdown is likely to fuel a rise in NPLs in 2012, albeit from a low base.
The Hong Kong Monetary Authority (HKMA) is also asking banks to be more prudent in setting aside additional regulatory reserves to prepare for a potential pick-up in bad debts, said the report.