Taiwan Banks' performance remained resilient despite ongoing threat from COVID-19 pandemic. (6 min read)

Taiwan Banks' earnings performance remained resilient despite threat ongoing threat from COVID-19 pandemic. Outlook is stable.?

• Taiwan is in the sweet spot with its Tech-centric economy driving corporate earnings. Resilience of Taiwan Banking earnings affirms the Taiwanese economy’s growth prospects as an unexpected beneficiary of the pandemic and success of its strategy against COVID-19.? GDP grew by 6.45% in 2021 and is expected to continue its above average growth of 4.42% into end-2022. ?Coupled with the benefits of its early responses to COVID-19 and continuing vaccination efforts with full vaccination rate of 77.6%, the banking system has benefited from these factors in addition to having stable earnings’ results of corporates, good asset underwriting and low credit provisioning.??
• The economy and banking system are expected to be stable with manageable inflation of 1.5% and lowering unemployment rate 3.63% by end of 2022.? While profitability remains modest, healthy asset quality and capitalization and strong compliance and risk underwriting of banks offsets strong competition from the operating environment. Liquidity continues to be ample across TWD and USD, as evidenced by continuing downward trend of funding costs in the market. Banks continue to operate at 60% efficiency. The recent inversion of dollar duration does not materially impact banks.

MODEST PROFITABILITY

• Return on equity of Taiwanese banks have been below 10%, which is modest by international standards.?Earnings quality remains sound driven largely interest from customer loans, fixed income, and structured investments.?Overseas income from its foreign branches and overseas banking units have contributed 15-20% of total operating income; similar level of income from overseas is expected.?Its volatile earnings – mainly FX and capital gains – comprised less than 20% over the past 5 years.??Cost-to-income has been stable at 60% levels.

ADEQUATE CAPITALIZATION

• Taiwan Banks' capitalization continues to remain adequate in view of the regulatory minimums across CET1, T1 and Total CAR requirements (regulatory min.: 6%, 8% and 10.5%, respectively). Quality of capital is strong comprising of mostly common equity capital and tier-1 eligible capital instruments.

THE ISSUE ON ABUNDANCE OF LIQUIDITY AND THE LOVE-HATE RELATIONSHIP WITH FUNDING

• Leverage (liabilities/equity) is low by global standards at 13.9x. Loan-to-deposit ratio has remained good at below 70% at end-2021. While this reflects abundant liquidity of banks with more deposits in the system than loans, this also signals inefficiencies in credit lending and lack of further domestic growth particularly on infrastructure and capital expenditure. Extending loans to green financing on offshore wind may somewhat help curve this lack of domestic growth.
• Nevertheless, with abundance of liquidity, funding cost is also low. CASA deposits accounted for 78% of total funding. Normally, CASA deposits are cheap sources of funding. However, this is not entirely the case for Taiwan where financial institutions are flooded with liquidity and wholesale deposits from corporates are charged with negative rates! The inefficiency of Taiwan's economy and financial system to digest liquidity have created a cheaper and more stable wholesale funding market. (Caveat emptor! This statement is not always true; there were times in which either TWD or USD funding market were tight and treasurers are scrambling to find spot for swaps!)

REGULATORS' EXPECTATION: LESS DEPENDENCE OF OFFSHORE BRANCHES FROM HEADQUARTERS' CAPITAL INJECTION TO SUPPORT ITS OVERSEAS BRANCHES

• The issue of liquidity is a different story for offshore branches. Many regulators offshore require localized offshore branches to source its liquidity independent of its headquarters. This means that offshore branches can no longer just rely on its parent for funding and liquidity, but have to have solid relationships with fellow foreign branches and domestic banks. They can also issue certificate of deposits and raise local currency debt locally; these are highly encouraged by local regulators to add spice and activity to the local capital markets.
• In many cases, these offshore branches operate in restricted markets, where contingency funding through direct capital injection is not immediate and might even require prior approval from regulators and central bank. Furthermore, from a risk capital and pricing perspective, borrowing from related parties are required to have higher capital charges and are more expensive due to "arms length" requirements for the avoidance of market riggering. Thus, having good and solid relationship with regulators and viewing them as partners in maintaining the sanctity and integrity of the financial system is certainly a must. FYI. Pari Passu, Taiwan, as a restricted market with restricted forex, is no different and employs heads-up or greenlighting of capital injections.

Many central banks in restricted markets employ such strategy to be able to manage foreign exchange exposure on a seamless manner, and avoid any sudden fluctuations in its forex. This is one of the lessons learned in Asian Financial Crisis.

EARNINGS' DIVERSIFICATION

• To improve profitability, Taiwan Banks continue to expand overseas though are mostly concentrated in Greater China and ASEAN region. As a percentage of operating income, overseas earnings are relatively concentrated in Hong Kong and China. Taiwanese banks have had mixed results with its China strategy, with some banks having a number of defaults from Chinese borrowers given relatively poorer . As a result, FSC has cautioned banks on their China exposures, having raised credit provisioning requirements to 1.5% of gross loans for extending credit to Chinese borrowers. Similarly, provisioning requirements for mortgages and real estate loans have also been raised to 1.5%. This is the minimum provisioning requirement for special mention loans.

Raising of credit provisioning is an indirect way of the regulators telling banks to slow down or moderate their credit and asset expansion.

• Aside from overseas expansion strategies, Taiwan banks also continue to diversify their revenues on the island domestically. This includes driving its asset servicing & wealth management expertise and enhancing its capabilities and expertise in custody space. Local banks continue to dominate TWD asset servicing, while at the same time, partners with Global Custodians offshore to deliver seamless custody platforms. Domestic banks derive synergy with its retail banking platforms to provide a wide range of wealth management products that includes insurance policies and mutual funds. Net fee and commissions income of the industry was $7.1bn at end-2021, equivalent to 27% of its total recurring revenues.
• Taiwan banks also take principal risks by investing in fixed income securities. This allows banks to further derive additional earnings by 1) securitizing its assets and 2) selling them as structured notes and/or 3) by funding repurchases. The notes can have the principal fully or partially be guaranteed by the issuing bank. The amount of on-balance sheet securitizations, i.e. principal guaranteed/secured notes, has been stable at $10-12bn. Off-balance sheet entrusted liabilities grew significantly in 2019-2021.
• A potential new source of income will be on reviving Taiwan's MBS, REITs and REATs market.

HEALTHY ASSET QUALITY WITH MODERATELY INCREASING CONCENTRATION IN MORTGAGES AND MICRO-, SMALL-, MEDIUM ENTERPRISES (MSMEs)

• Asset quality remains to be healthy with low NPL ratio at 0.17%. Different asset quality metrics also point to improving quality of assets with declining special mention and non-accrual (i.e. no longer generating interest income) loans. Loans classified as Pass comprised 98.7% of total loans.

• Composition of loans is well balanced between retail and corporate banking. That said, there is increasing concentration risk on mortgages (31.3% of total loans) and MSMEs (25.1%). While quality of credit is expected to remain satisfactory in the short-run, these are certainly risks needing special attention in the medium- (>6 months and within one year) and long-term (>1 year) horizon.

• For mortgages, credit comfort is taken from the islands' strong income per active laborer of US$67,529 and tight regulatory loan-to-value ratios ("LTV", limit: 35% for investment purposes and 70% first-time home buyers).
• For corporates, medium term loans are mainly revolving lines of credit for working capital needs, while long term loans are mainly for capital expenditures. Furthermore, Taiwan's Joint Credit Information Center also provides information on total credit and derivatives exposure of both retail and corporates, not only disallowing banks from over-extending loans for arbitrage or leverage purposes, but also enabling banks to have stronger risk oversight over their clients' exposure.

TOP LENDERS

TOP DEPOSITARY INSTITUTIONS

MOST PROFITABLE BANK BY NET INCOME

MOST SIZEABLE REVENUE CONTRIBUTION BY ITS OVERSEAS NETWORK

APPENDIX: FINANCIAL SUMMARY

Sources: Individual company data, FSC Banking Bureau and Central Bank of Republic of China (Taiwan)