Moody's: Taiwan banking system stable, despite subdued domestic operating environment

Moody's Investors Service says that the outlook for Taiwan's banking system over the next 12-18 months is stable, reflecting Moody's expectations that the credit metrics of Taiwanese banks rated by Moody's will remain mostly steady, despite the subdued domestic operating environment and weak demand for key electronics exports.

"We expect a modest deterioration in the banks' asset quality over the next 12-18 months, even though the banks maintained good asset quality metrics in the first six months of 2016 and also in 2015, amid the challenging operating environment in Taiwan," says Sonny Hsu, a Moody's Vice President and Senior Analyst.

"Profitability will deteriorate, because of tighter net interest margins and a decline in fee-based income, but credit costs will remain low and capitalization should improve moderately, against the backdrop of modest loan and asset growth," adds Hsu.

The banks' sound liquidity profiles remain a key credit strength, and Moody's says that Taiwanese banks will continue to benefit from strong government support, if needed.

Moody's conclusions were contained in its just-released report on the outlook for Taiwan banking system titled, "Banking System Outlook - Taiwan: Credit Metrics Largely Hold Steady in Subdued Operating Environment".

The stable outlook is based on Moody's assessment of five drivers: Operating Environment (deteriorating); Asset Risk and Capital (stable); Funding and Liquidity (stable); Profitability (deteriorating); and Government Support (stable).

On the operating environment, Moody's says that Taiwan should achieve a GDP growth of 1.2% in 2016 and 1.8% in 2017. Weak external demand, which weighed on overall economic growth in 2015, will likely persist, given the low growth in major advanced markets and the slowdown in the Mainland Chinese economy.

Resilient domestic consumption and stable labor market conditions, on the other hand, should underpin overall economic growth.

As for loan growth, the report says Moody's-rated banks should record growth only in the mid-single digits, despite the central bank's cut of the policy interest rate by half a percentage point since September 2015. Moody's assessment is based on the weak demand for Taiwan's exports -- which has depressed corporate capital expenditures -- and the fall in new home purchases, which curtails demand for retail loans.

Moody's points out that Taiwan's housing market has been cooling since 2014, following a strong run-up in prices earlier in the decade.

Moody's explains that low interest rates and resilient labor market conditions have helped keep the problem loan ratio for Moody's-rated Taiwanese banks low, at 1.1% at end-2015.

Small- and medium-sized borrowers in the export sector will contribute to a deterioration in asset quality over the next 12-18 months, because these businesses are the most sensitive to weaknesses in external demand. The banks' exposures to property developers and the container shipping industry also pose risks.

The asset quality of personal lending -- which accounts for close to half of overall lending -- should hold up relatively well, given supportive labor market conditions.

As for the banks' capital levels, Moody's says such levels will improve modestly over the next 12-18 months, based on Moody's expectation of moderate loan growth.

Moody's also says that the banks' profitability will deteriorate in 2016, ending six years of steady increases. The central bank's cumulative 0.5 percentage point interest rate cut will weigh on the banks' net interest margins. Meanwhile, fee and commission income will decline, owing to lower mutual fund sales and the regulator's cap on life insurance agency fees.

On the issue of government support, Moody's expects that such support will remain strong. The Government of Taiwan (Aa3 stable) has not allowed any bank creditors to bear any losses over the past two decades.

Moody's rates 11 of the 39 locally incorporated commercial banks in Taiwan, which together accounted for 60% of total system loans at 31 March 2016.