Mid-sized banks most vulnerable to loan losses if pandemic persists: Moody's

Their exposure to SMEs and unsecured loans heightens the risks.

Hong Kong’s mid-sized banks are most exposed to higher-loan losses should the COVID-19 pandemic persist and economic disruptions continue, reports Moody’s Investors Service.

The city’s banking industry faces reduced clarity on recovery due to its high vulnerability to the global economic slowdown, according to Moody’s. The banks are expected to operate in an economic environment constrained by social distancing measures and tight travel restrictions, which will severely undermine a large portion of Hong Kong’s key services industries. Moody’s baseline scenario assumes that such conditions will continue through July.

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Of the banks, mid-sized lenders were noted to be at a precarious situation due to their large SME and unsecured lending portfolios. “Mid-sized banks are most vulnerable amid the coronavirus-led downturn, as their relatively high exposure to small and medium-sized enterprises and unsecured lending to individuals puts them at risk of higher loan losses," said Sonny Hsu, a Moody's vice president and senior credit officer.

"By contrast, larger Hong Kong banks are less affected given their lower exposure to the most-affected sectors relative to their total assets, with the performance of other major loan types—such as commercial real estate loans and residential mortgages—likely to remain resilient," he added

Banks are expected to report lower net interest margins and lower fee income. Further, fee income will drop because of lower sale of wealth management products. Fees on credit card and trade finance will also drop on the back of lower consumption and merchandise trade.

Meanwhile, credit costs are expected to rise as banks set aside more reserves amidst deteriorating loan quality from the economic downturn. However, capitalisation and liquidity will likely remain strong due to expected modest asset and loan growth. This will help Hong Kong banks retail good capitalisation, according to Moody’s.

“Monetary easing measures by major central banks will contribute to an improvement in liquidity condition in the banking system. Hong Kong banks mostly have strong liquidity profiles, which will allow them to weather even extreme funding volatility,” the report added.

Should the measures to contain the outbreak extend beyond July, a more pervasive recession is expected. Such a recession will see its effects extend into the financial and real estate industries, pushing unemployment past previous peaks, and could lead to the widening of credit pressure on more banks.

Under this downside scenario, real estate prices, which have risen greatly from their previous lows during the 2003 SARS outbreak, could enter a severe downturn and challenge Moody's view that the crisis will have relatively little impact on real estate-related loans, the report concluded.