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Top 2000 Survey: Financial Industry

Investment Losses Bode Ill for Economy


Investment Losses Bode Ill for Economy


The financial industry, which caught a profit tailwind 2014, found itself sailing against strong headwinds in 2015. As the Chinese economy slows down and financial markets remain volatile, making money is getting harder.



Investment Losses Bode Ill for Economy

By Pei-hua Lu
From CommonWealth Magazine (vol. 597 )

For the finance industry the good days came to an end last year.

According to CommonWealth Magazine's 2016 rankings of the top 16 financial holding companies and top 100 financial firms, the era of high growth is over.

Last year, the top 100 financial enterprises posted a combined revenue worth NT$4.84 trillion, a year-on-year increase of less than one percent. As many as 34 financial firms saw their revenue shrink.

The top 100 of the industry recorded combined profits of NT$466.51 billion, up four percent from 2014. Profit growth slowed dramatically given that profits had posted a 30 percent gain in 2014.

The 16 financial holdings posted after-tax net profits of NT$304.1 billion, a year-on-year increase of just two percent. The figure looks even more dismal if one considers that after-tax net profits posted 40 percent growth in 2014.

External factors are mainly to blame for the financial industry's poor performance in 2015.015. Domestic banks generate overseas profits with their overseas banking units (OBU) as well as bank branches in China and other foreign markets. However, shrinking profits were reported across the board last year, with bank branches in China registering the steepest decline with 48.1 percent.

Bad Chinese Loans on the Rise

Fubon Bank (China) Co. Ltd. President Dennis Chan told the Q4 investor conference last year that the overall bad loan ratio is creeping up in China's banking sector.

The business of domestic banks' branches in China is plummeting due to the economic slowdown in China as well as their overzealous expansion in the Chinese market during the past four years. These two factors have been negatively reinforcing each other. Just as domestic banks reaped their greatest profits during China's boom years, their China operations are now bleeding money as the economy heads downhill.

Fitch Ratings Taiwan said in a recent report that the compound annual loan growth rate of Taiwanese banks in Asia reached up to 20 percent between 2010 and 2014, five times higher than Taiwan's domestic loan growth, and China accounted for the highest share of loans during that period.

Taiwan Academy of Banking and Finance Executive Vice President Lu Yang-cheng indicates that Taiwanese banks have brought the problem on themselves. Many Chinese state-owned enterprises participated in real estate development projects initiated by local governments in 2012 and 2013, Lu says, and they turned to Chinese banks for loans. Since the Chinese banks lacked liquidity, they issued guarantees to the developers, who used them to apply for loans with foreign-funded banks. "Back then the Taiwanese banks were scrambling for it," Lu says.

Now that the Chinese growth engine is stalling, the Chinese branches of Taiwanese banks are saddled with a non-performing loan ratio of 0.21 percent, seven times as high as two years ago, according to Financial Supervisory Commission (FSC) statistics.

RMB-linked Structured Products Turn Sour

Aside from their bank branches in China, OBUs used to be the golden geese of Taiwanese banks. As trade using RMB as transaction currency increased and many expected the Chinese currency to strengthen against the U.S. dollar, RMB-linked financial derivatives, known as target redemption forward or TRF, became their most popular products.

However, when the RMB weakened last year, TRF sales took a hit and the OBUs' exposure to possible customer defaults negatively affected the profits of Taiwanese banks.

TRF buyers bet on the direction of the RMB exchange rate. Small- and medium-sized companies, in particular, had anticipated a stronger RMB. When the RMB began to depreciate in the latter half of 2014, banks began to call in collateral to cover potential losses.

When clients are not able to top up collateral, defaulting on their contracts, the banks are forced to absorb the losses.

The FSC has found that the sudden RMB depreciation of August 11 last year caused the deposited reserve of Taiwanese banks for a single month to skyrocket to NT$190 billion. Total exposure to RMB-linked derivatives and financial products is close to NT$300 billion.

Cherry Huang, a vice president with Fitch Ratings Taiwan, warns that TRF derivative risk could continue to burn banks and investors this year. Once losses from TRF operations affect companies' cash flow in their core business, banks will have a much higher bad loan risk.

Investment Setbacks Plague Life Insurers

The life insurance industry posted record profits in 2015, but Shin Kong Financial Holding, Mercuries Life Insurance, and the major shareholders of Nan Shan Life Insurance – Ruentex Development and Ruentex Group – all announced that they would not distribute dividends. Fubon Financial Holdings is paying a smaller dividend than last year. All point to "possible investment losses" to justify their conservative dividend policy.

Life insurers collect premiums from their customers, premiums which they then invest in stocks, bonds and other financial instruments. Since volatility remains high in the financial markets and life insurance firms do not want losses from financial investments to drag down profits, they report these investments as financial assets "available-for-sale" or "held to maturity" in their balance sheets.

Should these financial assets incur losses for the life insurer they will not affect profits but become "unrealized losses".

The decline of the Taiwanese stock market in the second half of 2015 ate away at life insurance sector's investment profits. Four of the five major life insurers – Cathay Life, Fubon Life, Nan Shan Life, and Shin Kong Life - reported unrealized losses totaling NT$91.8 billion. This is the main reason why the life insurers are reluctant to pay out dividends, even though they keep making a great deal of money.

Overall, highly volatile financial markets affected the financial industry's commercial loan and investment performance in 2015.

Unfortunately, these headwinds have just begun to blow through the financial industry and are not likely to abate soon. If the financial sector wants to get through this year safely, it needs prudent risk management capability and a very precise eye for asset allocation.

Translated from the Chinese by Susanne Ganz

Financial Holding Company Performance

Taiwan’s Top 10 Financial Institutions--Shareholders’ Equity

Taiwan’s Top 10 Financial Institutions--Net Profit After Tax

Taiwan’s Top 10 Financial Institutions--Profit Margin

Taiwan’s Top 10 Financial Institutions--Revenue Growth