Taiwan banking system's pressure points in asset quality to be offset by ample liquidity

Outlook for the system remains stable.

Moody's Investors Service says that the outlook for the Taiwan banking system remains stable.

"The stable outlook reflects our expectation that Taiwan's economy will improve in the next 12 to 18 months, allowing the banks to maintain their credit metrics," says Ginger Kao, a Moody's Analyst.

"While there are some pressure points in relation to asset quality, these negative factors will be offset by the banks' ample liquidity, adequate capital positions and improved profitability," adds Kao.

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Besides, Moody's believes the willingness and capacity of the Taiwan government (Aa3 stable) to provide support in a stress situation will remain strong.

Kao was speaking on a just-released Moody's report titled, "Banking System Outlook: Taiwan," which outlines Moody's expectations for the fundamental credit conditions of Taiwan's banking system over the next 12 to 18 months.

According to the report, Moody's main concern in terms of the asset quality of the banks stems from weaker profits of Taiwanese corporates last year, which fell to their lowest levels since the global financial crisis in 2008-09, owing to the tepid annual GDP growth rate for the domestic economy of 1.3%, and despite the companies' sound balance sheets.

In addition, Moody's report points out that 28% of publicly traded companies had interest coverage ratios below 1x in 2012, versus 23% in 2011 and 15% in 2010. A prolonged period of weak interest coverage will expose the banks to asset quality deterioration if a recovery of profitability among these companies fails to materialize.

"Nonetheless, we believe the banks will maintain their credit profiles because their capitalization and profitability levels are at multi-year highs, as a result of generally stable operating conditions and the tightening regulatory requirements," says Kao.

However, Moody's report highlights that a key risk to its stable rating outlook is the weaker-than-expected recovery of external demand, given Moody's view of the strong correlation between export orders and the asset quality of the banks.

The report also says that another risk is the increasing imbalance in the domestic property market, because since last year, higher real estate prices have spread beyond greater Taipei to areas such as Taoyuan and Kaohsiung.

Another factor affecting the operating environment of the banks is household debt levels, which climbed to 86% of GDP in 2012; the second-highest level since the global financial crisis.

Moody's report says that credit risks will be contained as long as interest rates remain low and employment rates are stable, but vulnerability to the first driver is increasing.

Moody's report also says that while the capitalization levels of banks in Taiwan are lower than the levels maintained by their regional peers, the improved capital levels will help them absorb a likely modest increase in credit costs.

Moody's also expects the parent holding companies of various banks in Taiwan to inject a considerable portion of their newly raised capital into their banking subsidiaries, in order to fund the banks' expansion plans. Such injections would help the banks maintain stable capital levels.

"Moreover, we expect continuing ample liquidity in the Taiwan banking system, given its large base of sticky and stable customer deposits, and the mild growth in loans," adds Kao.

The report concludes by saying that the stable outlook on Taiwan's banking system is consistent with the stable outlooks for the 10 Taiwanese banks that Moody's rates. It is also consistent with Moody's outlook on the Taiwan government's bond rating.

The 10 banks together accounted for about 60% of the total assets of all locally incorporated banks as of 30 June 2013.