Hong Kong's US$25 billion pile of soured debt spurs talks to form ‘bad bank'

Business Times

17-07-2025

[HONG KONG] The pile of non-performing loans (NPLs) at Hong Kong lenders has grown so large that some in the industry have discussed the creation of a 'bad bank' to soak up the financial hub's soured debt.
The talks between some of the city's biggest banks, described by sources familiar with the matter, have been preliminary in nature and lenders would face significant hurdles before putting the idea into action.
Yet the discussions underline growing concern among industry insiders over a bad loan buildup. Soured loans increased to US$25 billion at the end of March, or 2 per cent of the total and a two-decade high, Fitch Ratings estimates, based on Hong Kong Monetary Authority (HKMA) figures. That may climb to 2.3 per cent by year end, the biggest jump in Asia Pacific, and loan quality is likely to deteriorate further to 2026, according to the ratings company.
Hong Kong's banks are coming under increasing pressure to offload loans backed by real estate assets after rolling them over or amending the original terms in the past to avoid writedowns. The delay by some banks in recognising impairments has helped mask even weaker underlying asset quality.
'We should be seeing more distressed sales – it's a little alarming that we are not,' said Jason Bedford, a former UBS Group analyst who made a name for predicting the troubles that hit Chinese regional banks in 2019.
Lenders, including Hang Seng Bank and Bank of Communications, recently engaged with advisory firms and held early-stage discussions about setting up a special vehicle to take their bad debt, sources familiar with the matter said, asking not to be named discussing private information.
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One of the proposed entities is modelled after China's distressed asset managers and could allow banks to recoup at least a portion of the loans, said the sources, asking not to be identified as the matter is private. It's unclear how much traction the proposal has received among banks and Hong Kong regulators.
Hang Seng and Bank of Communications were not immediately available to comment.
Hong Kong also narrowly averted a deeper crisis last month as banks after tense negotiations, agreed to a record US$11 billion refinancing for troubled developer New World Development. Political and economic turmoil over the past few years have shook the city's real estate sector, where office vacancies are surging to a record.
'There's too much supply of commercial real estate, particularly office space, hence we continue to see Hong Kong banks' asset quality deterioration stemming from the sector this year,' said Savio Fan, an analyst at Fitch.
Still, the HKMA said the banking sector's overall asset quality 'is manageable and provisions remain sufficient' even as its bad loan ratio edged up. The total capital ratio of locally-incorporated banks stood at 24.2 per cent at the end of March 2025, while the average liquidity coverage ratio of the major banks was 182.5 per cent, far above international minimum requirements, according to the HKMA.
While Fitch predicts loan quality will continue to deteriorate, it has said the situation is manageable given that lenders have large buffers.
Citigroup analysts this week upgraded Hang Seng to 'buy', saying credit costs from 2025 to 2027 are largely factored in, while dividends look sustainable and on the outlook for share buybacks. The US bank also has a buy rating on Bank of China (HK).
Hang Seng's credit impaired gross loans surged to HK$19.8 billion at the end of last year, up from HK$1.08 billion at the end of 2023. Impairments at Dah Sing Banking Group, whose unit was downgraded by Moody's Investors Service in June, more than doubled to HK$1.79 billion in 2024.
The city's largest bank, HSBC Holdings, had US$33.2 billion of exposure to Hong Kong commercial real estate at December 2024, of which about US$4.6 billion was credit impaired.
While the valuation of commercial real estate in Hong Kong has likely fallen more than 50 per cent in the last few years, they have not 'really declined a lot' on property companies and bank books since there have been few transactions, according to Cusson Leung, chief investment officer at KGI Asia.
'It's a big dilemma for both the developers and the banks,' said Leung. 'If a bank forces the sale of a commercial property at a 50 per cent discount, it would have implications on the valuations of other buildings and collateral and, under the current poor market sentiment towards commercial real state, this could have undesirable consequences.'
In the first half of 2025, HK$2.9 billion, or 20 per cent, out of a total of HK$14.8 billion in transactions of mortgage sales and assets were sold at a capital loss, according to data from Colliers International.
The HKMA said it monitors that banks have 'appropriate and timely loan classification and provisioning at all times' and subjects them to independent validation by external auditors.
The lenders are now at risk of taking a hit on their lending income as well as the Hong Kong interbank offered rate, a benchmark for loan rates, has collapsed. One-month Hibor has slumped to 1.1 per cent from 4.6 per cent end last year, according to Bloomberg-compiled data. Corporate lending has also been weak.
Fan at Fitch said he 'definitely sees some pressure' on net interest margins due to the drop in Hibor but at the same time, fee income looks 'quite strong' from wealth management.
For Bedford, the situation for Hong Kong lenders is different from the troubled regional Chinese banks, which were using special-purpose vehicles to intentionally hide bad loans. Financial disclosures in Hong Kong have always been very 'market-based', he said.
Ultimately, though, banks are trying to maintain the mark-to-market value of their property so they do not take huge impairment losses, he said, adding that there is a 'structural incentive' not to do anything that will create an immediate change to valuations.
'Hong Kong banks are going through a very textbook credit cycle,' said Bedford. 'NPLs are going up, loan growth stalls, banks start to increase risk scoring standards and the economy slows.' BLOOMBERG