Real Estate

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

The mortgage war in Hong Kong, the world's most unaffordable housing market, is getting intense. But instead of panicking, investors in HSBC Holdings Plc should be looking to uncork the champagne.

Frequent attempts by the government to cool an overheated market have brought transactions in pre-owned homes to a standstill. New launches, though, are still abundant as developers clear inventory. And to help hapless buyers suspend their disbelief as they write million-dollar checks for shoebox-sized apartments, lenders are coming up with what look like giveaway rates.

At least 10 banks, including HSBC, Standard Chartered Plc, Bank of China Hong Kong Ltd. and Hang Seng Bank Ltd., have cut their mortgage rates to a spread of 1.3 percent to 1.32 percent over Hibor, the city's interbank rate, the Hong Kong Economic Times reported. The same home loan last year cost Hibor plus 1.7 percent.

Conventional thinking suggests bank shareholders should worry about this squeeze. After all, it isn't just new customers who'll be less profitable. Existing homeowners will want to refinance at lower rates, too. But the Hong Kong dollar's peg to the U.S. currency means borrowing costs in the city will rise as the Federal Reserve tightens monetary policy. Defaults could surge if stratospheric home prices start returning toward terra firma.

Up, Up and Away
Home prices in Hong Kong remain elevated, making the city one of the world's least affordable
Source: Centaline Property Centa-City Leading Index

Yet, investors can afford to shrug off the mortgage rivalry, at least for now. Banks in Hong Kong are well capitalized and sitting on cheap liquidity. About 72 percent of Hang Seng Bank's and 65 percent of BOC Hong Kong's funding comes from equity and current or savings accounts, according to Morgan Stanley, which estimates a similarly high figure for HSBC. Putting this money -- on which the banks pay practically no interest -- to work at a rising Hibor will give lenders plenty of cushioning to absorb any hit from less profitable home loans.

Besides, Hong Kong lenders are experiencing a mini-boom thanks to trapped China cash. Multinationals operating in the People's Republic have been wrong-footed by Beijing's clampdown on outflows so they're turning to the territory to get new financing as well as manage the risk on their existing China exposure, Bloomberg News reported Friday.

Happy Days Again
The interest-rate spread of Hong Kong lenders over their funding costs is the highest since the financial crisis
Source: Bloomberg
* The composite interest rate is what banks pay for funds. Hibor is the benchmark for the rate at which they deploy those funds.

Even then, bread-and-butter banking in Hong Kong is all about the city's biggest obsession: real estate.

Supporting a large mortgage book takes only a sliver of shareholder funds, and profits are phenomenal. Notwithstanding current low spreads, the mortgage business can earn a return on equity of 26 percent.

Higher loan losses can as easily make those fat profits disappear. If Hong Kong home prices do collapse, lenders will definitely feel the pain. Provisions for loan losses are running at 0.12 percent at BOC Hong Kong. Between 2000 and 2003, when the property market was in free fall, those provisions averaged 1.5 percent.

It Pays to Lend
Banks in Hong Kong have outperformed the benchmark Hang Seng Index since the U.S. election even as mortgage curbs tighten
Source: Bloomberg

A stamp-duty hike in November to 15 percent for all but first-time home buyers and as much as 30 percent for foreigners could ultimately take a toll on prices that have picked up following a slump early last year. Still, they'd need to fall a lot for banks to start feeling the pinch. Home buyers can only count on lenders to advance them 50 percent of the value of a property over HK$10 million ($1.3 million). Strict down-payment rules cover most residential real estate in the city.

For now, HSBC shareholders may have more to gain from rising U.S. interest rates than they have to worry about stiff competition and shrinking spreads in the mortgage market. The threat of a collapse in Hong Kong home prices is more real, but also more distant.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net
Andy Mukherjee in Singapore at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net