Hong Kong’s smaller developers become US$22 billion risk for banks

[HONG KONG] While New World Development’s mounting debt has captured market attention and shaken one of Asia’s wealthiest families, Hong Kong’s smaller property firms have lenders on even higher alert.

Banks are tightening the screws on mid-sized developers that have at least US$22 billion in debt. They are demanding stricter refinancing terms, asking for credit enhancements such as collateral or guarantees, and increasingly, halting new lending altogether, according to people familiar with the matter. 

Local developer Lai Sun Development is facing extra bank scrutiny as it seeks to refinance an October loan, said sources, who requested not to be named because the matter is private. Wang On Properties was forced to offer credit enhancements to banks because of cash flow concerns, other people added. 

The shift underscores growing caution in a sector long regarded as a cornerstone of Hong Kong’s economy. Smaller and mid-sized developers are being squeezed by a mix of high interest rates and plunging asset values, the result of Hong Kong’s deepest property downturn in decades.

As these firms slash spending and rush to offload assets, the fallout is beginning to reverberate beyond their balance sheets. The pressure threatens to erode bank margins, weigh on the local job sector, and send ripples through overseas markets where Hong Kong developers have long been active players. What was once a reliable engine of growth is now a source of growing financial fragility.

The lenders are taking extra steps to minimise fallout that is already mounting. Just in the past days, several Hong Kong lenders were called out by Moody’s for risks in their lending to commercial real estate in the city. The credit assessor downgraded Dah Sing Bank’s rating and also emphasised asset quality challenges posed by loans to the sector at Bank of East Asia, whose outlook it held at “negative”.

In another sign of growing stress, about HK$46 billion (S$7.5 billion) in short-term debt of 11 publicly-traded smaller developers in the Asia financial hub is at “risky” levels in the next 12 months, according to a Jefferies Financial Group report in February. 

The Hong Kong Monetary Authority (HKMA) and banks are handling developers’ financing needs on a case-by-case basis, Hong Kong Financial Secretary Paul Chan said in an interview with local media on Monday (Jun 23).

When Wang On Properties sought to refinance a loan earlier this year, it was told to go the extra mile by agreeing to repay with residual proceeds from several joint venture projects in Hong Kong, including its developments in Ap Lei Chau, according to people familiar with the matter. 

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Wang On received a HK$1.02 billion facility in March, downsizing from HK$1.45 billion, the people said.

The company didn’t respond to requests for comment. 

Meanwhile, lenders are taking longer to assess Lai Sun’s asset quality, wary of its financial health and property revaluation, other people said. The company did not comment. 

Hong Kong’s listed second-tier developers, including Lai Sun, Far East Consortium International and CSI Properties, have racked up at least HK$173 billion in debt, according to the Jefferies report. That accounts for about 12 per cent of the HK$1.4 trillion loans for property development and investment in Hong Kong by the end of March, according to data from HKMA.

“Smaller banks typically have a weaker client base and are likely to be more exposed to second-tier developers and non-prime properties,” said Phyllis Liu, director at S&P Global Ratings, who estimated such lenders have about 5 per cent more property loan exposure compared with the three largest lenders in Hong Kong. “They will face more volatility in their asset quality.”

While New World’s net debt to shareholders’ equity ratio stood at 95.5 per cent as of December, Kowloon Development reached 104 per cent and Road King Infrastructure surpassed 172 per cent, perpetual bonds included, according to Bloomberg Intelligence. 

Road King warned of default risk if investors do not accept its proposals to buy some bonds back at discounts. It stopped paying coupons for all of its perpetual notes from November, a sign of worsening liquidity.

Some banks have stopped renewing financing terms with a number of small to mid-sized real estate firms altogether, pushing the city’s rich property families to turn to private credit lenders. 

“For more vulnerable borrowers, banks would closely monitor them under a ‘watch-list’,” said Matt Choi, director of financial institutions at Fitch Hong Kong. They would take “appropriate measures” to reduce exposure and secure additional collateral to minimise potential credit losses, Choi said.

That is affecting companies beyond listed ones. Parkview, known for its namesake luxury residential development in Hong Kong, obtained a HK$300 million bridge loan from investment firm PAG last month, after banks were reluctant to extend funds, according to people familiar with the matter. 

Tai Hung Fai Enterprises, the property business run by billionaire Edwin Leong, also tapped a security agent firm ran by Dignari Capital Partners‘s Grace Tan for a HK$300 million loan in March, putting up its head office units as collateral, according to filings.

The companies did not respond to requests for comment. 

During the property boom era, Hong Kong’s mid-sized real estate families took on debt more aggressively to fund expansion. But that left them more vulnerable to a downturn than deep-pocketed conglomerates like Sun Hung Kai Properties and Swire Properties.

The financial hub’s residential values are still hovering around an eight-year low. The city’s skyscrapers are struggling to find tenants, with grade-A office vacancy rates at a record high of 17.5 per cent in the first quarter and rents expected to drop as much as 10 per cent this year, according to CBRE Group.

Companies are rushing to conduct firesales. Far East Consortium, which owns residences and offices from Singapore to Australia and the UK, is offering new apartment units for its Pavilia Forest project at below break-even price. 

It is experiencing “one loss at a time” when selling each unit, chairman David Chiu said in November. The company pledged to cut debt by HK$6 billion in the next 18 months, he added.

More disposals will hit the market. CSI Properties said in February it planned to offload HK$9 billion of assets in four years. A month later, Lai Sun Development announced plans to sell HK$8 billion in two years.

While the sales are unlikely to shake global markets, they will add pressure in places with oversupply. Overseas assets often are non-core for smaller Hong Kong developers, hence a first resource of cash. Emperor International Holdings is planning to sell a building in London’s Soho district. Chinese Estates Holdings sold an office at US$217 million at breakeven in December to repay loans. It is also looking for a buyer for the flagship Zara store on London’s Oxford Street.

“For some asset classes, like office towers in Canary Wharf in the UK, where there’s a lack of market depth, some of those transactions might require a steeper discount,” said Jefferies’s Wong.

The more immediate impact is being felt among Hong Kong’s home owners and the construction industry, which accounted for almost a 10th of the workforce. 

By the end of March, the city recorded the highest number of households in negative equity since 2003, meaning their properties were worth less than the loans they took out. Private sector expenditure also contracted by 9.3 per cent in the fourth quarter from a year ago, reflecting cautionary sentiment, according to consultancy Rider Levett Bucknall. 

“The deterioration in Hong Kong smaller developers’ financial health can fuel a domino effect on the economy,” said Natixis senior economist Gary Ng. He added that risks include a repricing in collateral, and a collapse in construction activities that would pinch income for the local workforce in a worst-case scenario.