Is Hong Kong’s New World too big to fail?

Shuli Ren, Bloomberg

New World Development Co.’s financial distress is creating angst just as Hong Kong is starting to regain its feet.

The real estate developer’s systemic importance is of great concern to residents, policymakers and investors alike. Property fire sales at New World could drag down home prices further, while a potential default will impair banks’ loan books. But for the company’s $4.5 billion perpetual bond holders, there’s a possible happy ending if the builder is deemed too big to fail: An equity injection from Chinese state-owned enterprises or the Hong Kong government would make their day.

New World is nearly twice as important to Hong Kong’s economy and financial system as China Evergrande Group was to mainland China’s, even though the latter was by far the world’s most indebted developer, according to Barclays Plc analyst Wilson Ho.

Here is the most glaring statistic: As of last June, New World accounted for 7% of Hong Kong banks’ total commercial real estate loan book. To make matters worse, unlike Evergrande, nearly 70% of its borrowings were unsecured. By comparison, Chinese lenders’ exposure to Evergrande was much smaller at 1.9%, which perhaps explains why Beijing chose not to bail out the builder after its spectacular default in 2021.

But it would be a mistake to expect a Lehman-like collapse in Hong Kong if New World crumbles. Local lenders are well-capitalized. For instance, Hang Seng Bank Ltd. has already impaired 15% of its Hong Kong commercial real estate loans, which accounted for just 16.4% of its tier-one capital. As such, it’s not hard to see that the lender can easily absorb more losses if another 7% becomes non-performing.

BOC Hong Kong Holdings Ltd. is perhaps the most vulnerable among the listed lenders, because more than 60% of its commercial real estate loans were unsecured, as opposed to Hang Seng’s one-third or Bank of East Asia Ltd.’s 16%. But a similar sensitivity analysis translates into only 1.1 percentage point increase in the non-performing loan ratio, which can easily be covered by BOC Hong Kong’s 20% tier-one capital ratio.

That said, one needs to ask how policymakers define too-big-to-fail these days, and whether Hong Kong is becoming more strategically important now that the US and China are entering a second trade war.

Another factor to consider is whether New World’s woes will spill over to the rest of the billionaire Cheng family’s empire, such as Chow Tai Fook Jewellery Group Ltd., or toll roads operator CTF Services Ltd. The Chengs might have to do more self-rescue should their ring-fencing measures fail.

There is some evidence that New World poses reputational risk to its sister companies. CTF Services withdrew a planned $111 million three-year panda bond last month. As for the jewelry retailer, even though Chow Tai Fook’s shares have finally caught up to gold’s spectacular rally, more than doubling in value this year, the stock price is still below the initial public offering more than a decade ago. It’s seeking to raise $1 billion through convertible bond sales.

Looking back, it’s interesting to ask why Beijing allowed Evergrande and Country Garden Holdings Co. to go bust, but decided to bail out China Vanke Co. How New World plays out will only add another fascinating chapter to the ever-shifting narrative of what’s deemed too-big-to-fail in real estate. [Abridged]

Courtesy Bloomberg/Shuli Ren