Oliver's Twist

HK$1m at 1pc APR: should you take the challenge?

PUBLISHED : Monday, 23 December, 2013, 8:37am
UPDATED : Tuesday, 24 December, 2013, 10:44pm

That’s the question faced by one local Hong Kong resident Thursday who opened her e-mail inbox to find a jaw-dropping offer from a local bank.

The bank, who will remain nameless although it’s possible to recognise it among Hang Seng Index constituents, offered to lend the retail client HK$1 million at 1 per cent interest for one year.

The offer stipulated that the annualized HK$10,000 interest charge had to be paid upfront in the first month. There were no other strings, or handling charges, attached.

Now, you might think the pitch was made to some high-roller, a tycoon, or a financial industry worker such as a fund manager with experience managing risk. Nope. The recipient has a good credit rating but she’s no Mensa-club member when it comes to investing.

That aside, the offer begs the question of why are banks ringing up Hong Kong’s middle class in an effort to shovel money at them? Didn't these institutions hear the recent caution from the Hong Kong Monetary Authority, and separately, Financial Secretary John Tsang, about elevated risk and volatility in the financial markets as the United States scales back its monthly stimulus injections in the economy? The HKMA’s acting chief executive Eddie Yue on Thursday even went as far as to warn against individuals ramping up borrowing, highlighting a sudden outflow of funds as one risk as the easy money taps are slowly closed.

One explanation for the cognitive dissonance is that local banks are sitting on a pile of money that they can’t lend out. Mortgage issuance has dried up as a lending channel thanks to dwindling home sales on the secondary market – a testament to the effectiveness of the government’s effort to rein in prices via taxes and tighter lending rules. The “shutdown” of the secondary market, as described by one industry expert, is evident in data that show sales this year are the lowest since modern records began in 1996. Don't expect things to improve much next year, as one London-based property group is forecasting just 45,000 secondary transactions, down from an estimated 52,000 in 2013.

Another explanation also has roots in the idea that inflation has reached the tipping point. In seeking to issue more loans, could local banks be acting in a rational manner ahead of some sort of change to the city’s colonial-era currency regime? An unwind of the US dollar peg have been muted before and the idea that it’s now upon our doorstep looks like a stretch, according to currency analysts. Still, it’s hard to imagine that the abandoning the US dollar peg in favour of one that tracks the Chinese yuan hasn’t been looked at as a solution the city’s growing inflation problem. Moreover, local banks ramping up their Hong Kong dollar loans is consistent with the idea that change is brewing. Financial institutions stand to gain by transferring the liability of a rising currency to a hapless borrower who must pay back in future with a Hong Kong currency worth more relative to the US dollar. 

Putting all the theorising aside, if you receive a marketing email, should you take up the million-dollar challenge? 

Financial advisers say the 1 per cent “hurdle rate” looks insanely cheap when considering the low-risk investment alternatives on offer.

One idea would be to pile in to yuan-denominated Dim Sum corporate bonds issued in Hong Kong by companies like Caterpillar and Volkswagen. These offer yields of around 2 per cent to 2.5 per cent. Chinese government bond are another option. They yield around the same level. Factor in yuan appreciation of around 1 per cent to 2 per cent annually against the US dollar and the gross annual return on either option is around 3 per cent to 4.5 per cent.  

If the past is any guide, during periods of turmoil China’s currency has tended to hold its own rather than decline against the US dollar, which means there shouldn’t be too much risk of the currency losing ground in anything but a major crisis. Still, one of the predictions making the rounds is that the US dollar be stronger next year against major currencies, which means it wouldn’t be unusual to see the yuan tread water for a while.

Another idea is to head for corporate bonds issued by companies such as Hutchinson Whampoa. Denominated in US dollars, these bonds are as “good as gold” according to one advisor. Hong Kong stocks are another possible bet. Some advisers think another positive year is likely, with Hong Kong even set to regain its shine after a year when the spotlight shifted to US stocks. The Tracker Fund of Hong Kong is indicated to pay a dividend of 3.17 per cent in the financial year 2014, according to Bloomberg.

Banks seeking to hand money away at ultra-low rates could be an anomaly at the end of long period of easy money. Whether it's laying ground for future problems is likely to be revisited. But for now best grab the offer before it disappears.