S&P: Cathay Financial Holding Co. Ltd. And Cathay Life Insurance Ratings Affirmed On Sustained Capitalization; Outlook Stable
"The rating affirmation reflects Cathay FHC group's extremely strong competitive position underpinned by Cathay Life's well-established franchise and leading market position in Taiwan's life insurance industry," said S&P Global Ratings credit analyst Serene Hsieh. "It also reflects the group and the life insurer's average capitalization, which we expect to remain in the lower adequate range for the next two to three years."
The group's manageable investment diversification and foreign exchange risk exposures support an adequate risk position, which we consider to be a neutral rating factor. In our view, the Cathay FHC group credit profile mainly reflects the risk profile of its flagship subsidiary, Cathay Life. The ratings on the holding company also reflect its subordination to the group's core entities.
We expect Cathay Life's capital and earnings to remain in the lower adequate range for the ratings for the next two to three years. Cathay Life's capital adequacy has weakened in recent quarters. This is given the high level of goodwill from the acquisitions of Global Life Insurance Co. Ltd. and Singfor Life Insurance Co. Ltd. in 2015, and the sizable unrealized loss from its equities booking as available-for-sale at the end of 2015. We expect the insurer's capital adequacy to gradually recover over the next few quarters supported by the group's prudent capital management with effective capital-raising initiatives and reasonable cash dividend payout. Moreover, unrealized loss on its investment book has recovered gradually during 2016. The group announced on Sept. 9, 2016, that Cathay Life will issue an upper limit of New Taiwan dollar (NT$) 35 billion perpetual noncumulative subordinated corporate bonds at the end of 2016. The holding company will be the sole investor for this bond issuance, and will issue perpetual noncumulative preferred stocks at the same time to support Cathay Life's hybrid raising by end-2016. We view these bonds issued by Cathay Life as having long sustainability based on the group's prudent capital policies. The bonds therefore qualify as capital with intermediate equity content, as defined by our criteria. Over the longer term, we expect Cathay Life's capitalization to remain at a similar level, supported by the group's more prudent capital policy, which will require lower cash dividend payout than what we have observed in the past two years.
We also expect the group's consolidated capital adequacy to remain at the lower adequate range for the next two to three years. In addition to Cathay Life, the group's capital adequacy is also supported by our assessment of stronger capitalization at Cathay United Bank Co. Ltd. and Cathay Century Insurance Co. Ltd. Moreover, we factor in the potentially lower cash dividend payout in 2016-2018 as the group pursues more prudent capital policies. We expect the holding company to complete its plan to issue noncumulative preferred stock at the end of 2016. The proposed amount is up to NT$35 billion-NT$50 billion with an aim to support Cathay Life's business growth and group's growth strategy for the next few years. Similar to Cathay Life, we also classify the holding companies' proposed preferred stocks as having intermediate equity content, under our hybrid capital criteria. We include such issuance up to a maximum of 25% in our calculation of the group's total adjusted capital, which forms the basis of our consolidated risk-based capital analysis of the insurance group. We understand the proposed issuance amount does not exceed our threshold. The inclusion is based on our understanding that the issuance will be considered eligible for regulatory capital. The preferred stocks are callable after seven years, and we expect the group to remain strongly committed to managing its regulatory capital level in a stable manner. We also anticipate that the group's financial flexibility will remain strong despite slightly weaker financial leverage and fixed-charge coverage ratios.
In our view, Cathay Life and accordingly Cathay FHC group's risk position is a neutral rating factor. Compared to domestic life insurers, Cathay Life has satisfactory investment diversification and manageable foreign exchange (forex) risk exposures, though these are rising. In contrast, we view the insurer's ratio of investment leverage in high-risk assets to total adjusted capital as high as most of its domestic peers'. We believe the insurer's forex risk exposures are manageable, supported by Cathay Life's proactive hedging strategy and availability of foreign exchange volatility reserve to withstand a moderate level of market volatility. This is despite the fact that the insurer has widened its unhedged position in recent quarters. We expect Cathay Life to control the ratio of forex risk exposure to total liability (including shareholders' equity), as defined by our criteria, to remain below 10%.
"The stable outlook reflects our view that Cathay Life will remain the flagship core member of the Cathay FHC group," said Ms. Hsieh.
We expect the group's capital adequacy to remain in the lower-adequate range over the next two years. This is mainly supported by the group's prudent capital management, including supportive dividend policy and capital raising initiatives via the issuance of perpetual noncumulative preferred stocks at the holding company and subordinated corporate bonds at Cathay Life. We also expect Cathay Life to maintain its investment asset allocation strategy, an operating performance consistent with our base-case assumptions of expected return on average assets at least 0.3%-0.4%, and an extremely strong competitive position in Taiwan's life insurance sector. Moreover, we believe the insurer will maintain its risk control mechanism at a sound level to mitigate potential volatilities in its financial risk profile associated with fluctuations in the capital market and forex rates.
We could lower the ratings on Cathay Life and Cathay FHC if any of the following occurs:
Cathay Life's capitalization weakens to less than adequate due to: (1) unexpected financial market volatilities with sizable losses on the insurer's investment portfolio; (2) overly aggressive business growth or growth of value in-force materially lower than our current forecast; or (3) failure to complete capital-raising initiatives at both the holding company and Cathay Life as planned. The effectiveness of Cathay Life's hedging mechanism materially weakens or hedging policies become more aggressive, resulting in higher forex risks, as indicated by a ratio of forex risk exposure to total liability (including shareholders' equity), as defined by our criteria, consistently exceeding 10% in a material and consistent manner. Significantly heightened concentration risks in financial sector investments result in weaker investment diversification. Capital and earnings at the group's core banking entity Cathay United Bank Co. Ltd. weaken. We view the likelihood of an upgrade to be remote over the next two years. Such action would require a significant increase in capital to raise Cathay Life's capital adequacy to a strong level. This would also have to be accompanied by a superior operating performance compared to its peers with stable credit profiles for the other core entities of the Cathay FHC group.