S&P: Taiwan Business Bank Assigned 'BBB/A-2' Ratings; Outlook Positive
"The ratings on TBB reflect the bank's stable market share and franchise in Taiwan, as well as its adequate funding and liquidity profile," said S&P Global Ratings credit analyst Yuhan Lan. "The ratings also reflect TBB's government ownership and the bank's moderate systemic importance with a moderately high likelihood of extraordinary government support in times of financial distress. The bank's slim earning capacity, slightly below-average asset quality, and bad debt coverage partly offset these strengths."
Our bank criteria use our Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating (ICR). The anchor for a bank operating only in Taiwan is 'bbb'. The BICRA score is based on our evaluation of economic risk; we view Taiwan as a middle-income, moderately stable economy with a dynamic private sector and strong household net financial positions. These factors partially offset the somewhat high level of private sector indebtedness and property price growth in recent years, in our view.
We characterize Taiwan's banking sector as highly competitive and fragmented. This results in low earning capacity to cushion against potential credit costs during economic downturns. Nonetheless, very strong and stable system-wide funding partly offset these weaknesses.
"TBB's adequate business position is supported by its good market position in small and midsize enterprise (SME) lending business as the third-largest lender in Taiwan with an 8% market share," added Ms. Lan. "This ensures the bank's franchise value in attracting new business, which underpins its business stability."
We expect TBB to remain strategically focused on promoting this sector while maintaining its top-three market position. However, the bank's business and geographical diversification is only about the industry average with a major focus on traditional banking businesses. This is despite the bank's recent efforts to increase overseas lending through the establishment of new foreign branches and finance subsidiaries, and through its offshore banking unit, with growing revenue contributions.
We expect TBB's capital and earnings to remain moderate with a forecasted risk-adjusted capital (RAC) ratio at the borderline of 7% over the next 18-24 months under our base-case scenario. The drop in the bank's RAC ratio by the end of 2014 was in line with our downward trending expectation, given the bank's growth strategy in SME lending and higher-risk overseas countries. However, the improvement in TBB's RAC ratio to 7.9% as of the end of September 2015 exceeded our expectation, supported by the bank's earnings retention and below-average loan growth in the first nine months of 2015.
TBB's pursuit of better margin SME lending, as well as the reduction in its large corporate and government lending resulted in lower overall loan growth in the first nine months of 2015 than we expected previously. TBB has also slowly increased its overseas exposure through its various branches with better net interest margins. Moreover, the bank's strategy to grow its fee income through bancassurance business has supported the improved earnings results.
Nonetheless, we expect TBB's capital ratio to drop back to the lower borderline of 7% for moderate capitalization in the coming one to two years. This will be driven by the bank's potential growth in higher-risk exposures and likely credit costs arising from SME exposure. We view SME lending as more susceptible to economic slowdowns, and such business now accounts for over 40% of the bank's loan portfolio. In addition, likely growth in TBB's exposure in countries with higher economic risk, such as China and Cambodia, provides some risk of additional credit costs and could pressure the bank's already thin earnings.
We believe TBB's moderate risk position reflects the bank's slightly above average growth in risk assets, concentration in SME lending, as well as its moderate loss experiences. We expect TBB to have above-average growth in loans and risk assets in the coming one to two years. The bank's concentration in SME lending and focus on overseas exposure, particularly in China, could expose it to higher credit costs during economy downturns.
In addition, the bank recorded several losses in the past 10 years due to substantial corporate credit provisioning, which we attribute to TBB's weaker asset quality and provision coverage compared to peers'. This is despite the bank's efforts to clean its asset book and increase its coverage over the past years. It is also in spite of TBB's focus on traditional commercial banking business with low complexity, and the bank's relatively diversified risks, given that a large part of its loans are spread over different enterprise sectors.
Our assessment of TBB's funding as average is based on our view of the bank's good funding profile under its majority-government-shareholding status and franchise. TBB's access to a stable and diversified deposit base and interbank funding resources further support its adequate liquidity, in our view. The bank's balance sheet comprises highly liquid assets, with its broad liquid assets standing over 3x its short-term wholesale funding over the past five years. TBB has maintained a stable, though slightly above-average, loan-to-deposit ratio over the past five years.
The issuer credit rating on TBB also reflects the bank's moderate systemic importance to Taiwan's banking system where it holds a 3.5% deposit market share, and our belief that the Taiwan government is likely to provide implicit support to TBB in times of need, given the government's majority shareholding.
"The positive outlook on TBB reflects our view of the likelihood that TBB will maintain its capital and earnings at an adequate level over the next one to two years, as represented by a RAC ratio sustainably above 7.25%," said Ms. Lan. "In our base case, we expect the bank's capitalization to remain moderate, with a RAC ratio at the borderline of 7% in the coming one to two years."
We also expect the bank's earnings and asset quality to remain slightly below average. Nonetheless, we believe TBB should be able to maintain its government ownership and market position in deposits and the SME business, and hence sustain the bank's moderate systemic importance in Taiwan's financial sector over the next one to two years.
We may raise the rating if TBB further enhances its capital and earnings with a RAC ratio above 7.25% for a sustainable period. This could happen if the bank initiates a new capital raising plan, and improves its earning capability to the domestic industry average through diversification. At the same time, TBB would need to maintain prudent risk management to avoid rising credit costs and retain a good portion of its earnings on book.
We may revise the outlook to stable if the bank's moderate systemic importance weakens to low systemic importance due to a drop in government indirect ownership and an apparent weakening of the bank's position in the domestic deposit market.