After a long year of bloodletting in 2009, the financial industry is now poised to start making money again!

Looking over the year's figures for CommonWealth Magazine's Top 100 Financial Enterprises, they are awash with confidence-stirring good news: Total after-tax profit across the entire financial industry has moved out of the red and into the black, topping out at NT$150.56 billion, with average profit margins among the top 100 financial concerns rising from negative 1.2 percent in 2008 to three percent last year. Among the 88 firms providing figures, the percentage of those posting after-tax profits rose to 80 percent in 2009 from less than half in 2008.

With capital increases widespread throughout the insurance industry and blessed with a continuing recovery in the value of financial assets, the total value of assets throughout the financial industry increased by NT$2.38 trillion last year, 2.8 times greater than the amount it increased the previous year.

But upon closer inspection it becomes clear that the financial sector has relied on belt-tightening cutbacks to achieve this success.

Total operating revenues for the industry slid five percent and, furthermore, the number of institutions reporting negative growth in operating revenue remained at half, indicating that the overall environment for business operations remains rocky. Industry figures show a reduction in overall workforce but an increase in average employee productivity, clearly signifying that the financial sector has wrung its profits from cost-cutting measures.

The phenomenon of creating profit through cost savings has been particularly evident in the banking industry, which emerged from 2008 relatively unscathed.

Among the top 100 financial institutions are 35 banks, at least 25 of which reported negative growth in operating revenue. Among the ranked banks, average total operating revenue showed negative growth of 15.57 percent, yet average profit margins stood at 6.18 percent.

Compared with the banking industry's struggles to turn a profit, life insurance companies and securities institutions enjoyed a stellar year in 2009, with average operating revenues posting growth of 22.47 percent and 12.29 percent, respectively, largely shrugging off the frustration of the disastrous year that for them was 2008.

Why are life insurance companies and securities institutions doing so well while banks continue to struggle? The most direct cause has been the low interest rate policies to which various central banks around the world have adhered. While low interest rates have been the savior of insurance companies and securities institutions, they have been the bane of banks.

Insurers, Securities Firms Ramp Up Investment

An abundance of available capital at low interest rates has heated up the investment market, prompting life insurers and securities firms – businesses intimately connecting with investment – to ramp up investment activity.

The enormous financial assets of insurance companies have not only helped to boost the stock positions securities institutions hold, but the bull market has also proven a boon to their securities brokerage and derivatives businesses. It's hard to imagine that in 2008 it was precisely these businesses that were responsible for massive after-tax losses among more than 70 percent of insurance companies and securities firms.

Life insurers have been the biggest beneficiaries of the investment market. As Winnie Fang, partner and head of financial services at accountancy firm KPMG observes, given the massive investment positions life insurers hold, they gained the most from the recovery in the investment market. Broadly speaking, net income has been comparatively good at those financial holding companies that include life insurers. Earnings at Fubon Life, for example, accounted for half of the 2009 market-leading after-tax earnings per share at Fubon Financial.

The bills finance business was also a major beneficiary of low interest rates in 2009. Three bills finance institutions ranked as the top three in terms of profitability as they took advantage of continually broadening rate spreads on their instruments issued amid low interest rates.

But, similarly, what was a low interest rate banquet for some left only table scraps when it came to the banks.

The bull investment climate brought on through low interest rates did indeed spur the recovery of banks grievously damaged by the structured debt of their wealth management businesses but was insufficient to offset their declining fortunes amid the industry's average net interest rate spreads of just around one percent. Even a number of otherwise sound, old state-run institutions with niche markets saw major declines in operating revenues.

With little prospect of improvement in sight, banks virtually without exception focused their efforts on measures such as raising their weighting of demand deposits and improving non-performing loan ratios, thus eking out profits through cost savings.

But Susan Chu, vice president and chief rating officer of the Ratings Department at Taiwan Ratings Corporation, fears that despite the current official non-performing loan ratio posted at the 10-year low of just 1.14 percent, the real figures from 2009 could yet emerge as being as high as four percent. This is because in early 2009 banking consortia agreed, at the urging of the Taiwanese government, to offer new loans to a number of financially troubled companies, such as the Taiwan High Speed Rail Corp., so that those companies could continue to pay off their old loans. If they had not done so, those banks may well have already listed a huge amount of their loans as bad debt.

Life Insurers: Investment Success, Core Business Frustration

But for life insurers, on the surface the apparent big winner, low interest rates have not necessarily been a complete bonanza. Amid low interest rates, premiums have become more expensive, making conventional policies harder to sell, and revenues from investment policy first-year premiums declined precipitously in 2009. Thus, a number of insurers saw their investment success offset by frustrations in their core businesses.

As a result, last year many insurers introduced floating rate annuities offering interest rate returns higher than those of bank time deposits, to both reduce the cost of policy financing and satisfy the demands of the large pool of time depositors. Last year, Cathay Life and Fubon Life each earned upwards of NT$100 billion from first-year premiums tied to floating interest rate annuities.

While last year's low interest rate environment resulted in a boom in floating rate annuities, it also weakened insurance companies' core principle of "assurance," becoming instead a stand-in for banking products.

Sunny Lin, a 30-plus year veteran of Taiwan's life insurance industry and executive director of Taiwan Life, notes with regret that while the rate of coverage among Taiwanese exceeds 200 percent, the average cash value of those policies is just over NT$600,000. In other words, what Taiwanese are buying from life insurance companies isn't "insurance" but "time deposits."

"Diversification of insurance products isn't a problem, but the prerequisite should be to buy enough assurance," Lin says, urging an industry return to conventional assurance products.

But the impact of low interest rates on life insurers doesn't end there. Taiwan lacks long-term products that offer higher returns, so Taiwanese life insurers are forced to look to relatively higher-return overseas assets or real estate to offset the unfavorable interest rate spreads. The potential risks here lie not only in foreign exchange and hedging losses associated with transactions in the tens of billions of New Taiwan dollars, but also the problem of property market bubbles.

As Susan Chu reminds us, compared to the extent that life insurance companies have invested in high-risk assets, their capitalization remains insufficient, despite having returned to pre-financial meltdown levels.

The prescription of low interest rates has helped the insurance and securities industries to latch onto the investment locomotive and bring them back from the brink. But the upturn has only been on the surface, because problems stemming from cutthroat price competition, low interest rate spreads and negative spreads remain pervasive and serious. With investment markets now having returned to relatively high levels, hopes this year of matching last year's investment windfalls grow increasingly dim.

2010 Prospects Brighter for Banks

Jack Huang, chief economist and head of research for SinoPac Holdings, believes earnings in the securities industry this year may only reach 60 percent of last year's.

"For securities companies to make money this year, they'll have to rely on short-term plays, so the level of difficulty will be higher," he says.

Fubon Financial president Victor Kung thinks that with the big impact of the investment markets on the insurance industry, profit margins may not be up to last year's levels.

But an upturn in the banking industry can be reasonably expected. The central bank may raise interest rates in the second half of this year and as banks' lending and wealth management businesses continue to improve, earnings from interest and handling fees can be expected to recover to near pre-financial crisis levels.

In 2010 Taiwan's financial industry still faces uncertainties as to whether it will be included on the early harvest list for the pending Economic Cooperation Framework Agreement (ECFA) and other questions regarding entry into the China market. The challenges it faces, both at home and abroad, remain prodigious.

Translated from the Chinese by Brian Kennedy