The protracted property downturn in Hong Kong and mainland China could weaken credit strength of banks in Hong Kong, a Moody’s report said.

With over half of their total loan portfolios tied to real estate, Hong Kong banks are heavily exposed to the property sector through lending for property development, investment, and residential mortgages, the report said.

“Hong Kong banks’ loans to property development and investment, which include those to Hong Kong and Chinese property developers, are most at risk,” said Sean Hung, a Moody’s vice president and senior credit officer.

“Borrowers in these segments are under strain from the high interest rate environment, rising office vacancies, reduced retail foot traffic, weak operating environment and weak property sales,” said Hung.

China’s property sector, accounting for nearly a quarter of the economy, has been engulfed by a debt crisis since 2021 after a regulatory crackdown on high leverage among developers triggered a liquidity crunch. The crisis has left many companies in default and homes uncompleted.

Despite a series of stimulus and easing measures from policymakers, the downturn has persisted, with home sales remaining sluggish and developers’ liquidity tight.

Meanwhile, Hong Kong’s housing market has experienced a steep decline from its 2021 peak amid economic and political headwinds. A national security clampdown sparked an emigration wave from the city, while a slowing Chinese economy dampened demand from potential Chinese home buyers – a key driver of the market historically.

Additionally, smaller and mid-sized banks in Hong Kong are more vulnerable to asset risks from the property downturn compared to their larger counterparts, as the lenders have higher concentration exposures to small and medium-sized developers, the report said. Any significant spike in credit costs could erode their profitability, it said.