Why are Hong Kong banks cautious towards lending to mainland state-owned entities?

27% of SOEs are loss-making.

Analysts at BMI Research are seeing a pick up in the growth of mainland-related lending by Hong Kong banks since H216, coming in at 7.0% y-o-y in December 2016, which was slightly stronger than the headline loan growth figure of 6.5% y-o-y in the same period.

"That said, we maintain our view that Hong Kong banks will take a cautious approach towards lending to corporates operating in the mainland, and differentiate its lending between state-owned entities and private sector firms. We continue to expect loan growth to Chinese SOEs to be weaker than that of private firms," says the firm.

Here's more from BMI Research:

This is already being observed from the slowdown in lending by the territory's banks to SOEs, which declined to 2.7% y-o-y in December 2016 (versus 4.4% y-o-y in September 2016), despite the significant improvement in the industrial profitability of these companies. With respect to private entities, lending to these firms in the mainland accelerated further in December 2016, climbing to 26.5% y-o-y in December 2016, which also exceeded the peak seen in March 2015.

In our view, Hong Kong banks are taking a cautious approach as SOEs in the mainland (which are usually in the industrial sector) continue to be saddled with a significant amount of liabilities (relative to assets).

According to data from the National Bureau of Statistics (NBS), the liabilities-to-assets ratio of state-holding industrial enterprises has remained elevated at around 60% over the past six years, as compared with a noticeable decline in the ratio for private industrial enterprises since the start of 2011.

In addition, a significant number of the state-holding firms are loss-making, at around 27%, versus less than 9.0% for private companies. These factors suggest that there are increasing risks that these SOEs will be unable to repay their debt due to their weak financial positions, particularly if the Chinese government does not step in to provide support.