The change in Cathay Life's outlook to stable from negative reflects Moody's expectation that Cathay Life's profitability and capitalization have improved as capital market volatilities subsided and it will continue to maintain solid profitability and stable capitalization over the next 12-18 months despite low interest rates.
Cathay Life's proactive product and investment management helped mitigate profitability strain even when interest rates remain relatively low. The insurer has reduced its crediting rates offered to policyholders in response to lower bond yields. This has quickened the decline in the cost of liabilities and will alleviate negative spread risks.
Declining hedging costs also benefits Cathay Life in mitigating strain on its recurring yield. In addition, the insurer continues to realize gains on its equity and bond holdings to supplement its investment income. Driven by strong disposal gains, the insurer's net income grew strongly and it reported positive investment spreads in 2020 and the first half of 2021.
Cathay Life capitalization has also improved, mainly reflecting higher unrealized gains on equities as the equity market rebounds. The insurer's disciplined dividend policy to retain earnings and its slowing new business growth will also support its capitalization. Moody's expects the insurer's local risk-based capital (RBC) ratio, which stood at above 370% as of the end of June 2021, to stay well above the regulatory minimum of 200% in the next 12 months.
In addition, Cathay Life's business and financial performance has not been affected much by the surge in the number of coronavirus cases between May and July 2021.
The affirmation of Cathay Life's A3 IFSR reflects the insurer's strong business profile as the largest life insurer in the domestic market. It also has strong channel control because its products are mainly distributed by its tied agency with good productivity. However, the insurer holds significant overseas investments and equity investments, which expose its earnings and capitalization to higher volatility than global peers.
The change in Cathay Financial's outlook to stable is in line with the outlook change at the group's main subsidiary, Cathay Life. The affirmation of the group's Baa1 issuer rating reflects the strong domestic franchises of the group's life insurance, property and casualty (P&C) insurance and banking subsidiaries.
Cathay Financial maintains stable capitalization and earnings, supported by solid capitalization and strong earnings at both Cathay Life and Cathay United Bank. The liquidity at Cathay Financial and its major subsidiaries is also adequate because of committed bank credit lines from major local banks and a large liquid investment portfolio at Cathay Life.
Cathay Financial's issuer rating continues to reflect the aggregate weighted average financial strength of its main subsidiaries and the structural subordination of the holding company to its operating subsidiaries. The group also benefits from the diversification of its earnings sources through its various subsidiaries across the financial services industry.
Its rating also incorporates a certain degree of government support for its banking subsidiaries, which have well-established franchises and a decent market share of loans and deposits in the domestic market.
The affirmation of Cathay Century's A2 IFSR reflects its strong brand, market position and distribution support from Cathay Financial. In addition, the insurer has strong profitability and solid capitalization. These strengths are partially offset by its significant gross catastrophe risks and reserve volatility.
Cathay Century's strong market position as the second-largest P&C insurer in the domestic market benefits from Cathay Financial's strong brand and franchise. The insurer's strong distribution support from its affiliates, notably via Cathay Life, is also a competitive strength and fosters high channel control.
Cathay Century's profitability is strong, thanks to its good underwriting profitability and investment income. The insurer's gradual shift towards the personal-line business with granular risk exposure has improved its underwriting profitability.
Cathay Century's capitalization is also solid with a RBC ratio of 317% at the end of June 2021. The insurer's strong earnings will continue to support its business growth and dividend payments to Cathay Financial.
However, Cathay Century is exposed to significant gross catastrophe risks, primarily from earthquakes and typhoons. Potential large losses stemming from its commercial fire business could also increase earnings volatilities. That said, the insurer has entered into comprehensive reinsurance programs to lower its net catastrophe exposure to a manageable level relative to capital.
In addition, tail risk stemming from some of the insurer's liability and commercial fire policies could increase its reserve volatility. That said, the insurer has improved its reserve adequacy, underpinned by its favorable reserve development since 2018.
Cathay Century's outlook remains stable, reflecting Moody's expectation that the insurer will maintain strong profitability and solid capitalization while delivering a more stable loss development trend over the next 12-18 months.
Cathay United Bank
The upgrade of Cathay United Bank's long-term ratings and assessments and its BCA reflects the bank's stable and strong financial fundamentals, supported by its track record of sound asset quality, improving capitalization, adequate profitability and strong liquidity. Its financial profile is strongly positioned relative to its previous baa2 BCA.
Cathay United Bank's capitalization has improved over the past few years. Its Common Equity Tier 1 (CET1) ratio has improved to 12.0% as of the end of 2020 from 10.5% as of the end of 2019. We expect the bank to continue to maintain a good level of capitalization as the bank is designated as a domestically systemically important bank (D-SIB) and will need to meet a minimum CET1 ratio of 11% by 2025.
While the Taiwanese banking system's key credit constraint has been weak profitability compared to other banking systems globally, the low for longer rate environment has narrowed this gap. Furthermore, amongst the Taiwanese banks, the bank has maintained relatively strong and stable profitability, supported by its fee and commission income growth.
Moody's also expects Cathay United Bank to maintain satisfactory asset quality over the next 12-18 months, although uncertainties remain amid the coronavirus pandemic. This is supported by 1) government's effective measures to contain the pandemic and alleviate the financial burden on the corporates and individuals; and 2) Cathay United Bank's prudent risk management and built up of a strong loan loss buffer. The bank's impaired loan ratio (not including credit card receivables) was 0.68% as of 31 March 2021, down from 0.72% as of the end of 2020.
The bank has high exposures to the real estate sector, which leaves the bank's asset quality sensitive to the risk of potential corrections in the property market. However, this risk is mitigated by the bank's conservative loan-to-value ratio for mortgage lending and the relatively stable labor and housing market conditions.
Cathay United Bank has maintained a strong funding profile compared with its global peers and has limited reliance on wholesale funding, supported by the bank's good deposit franchise. The bank's liquidity is strong amid its prudent liquidity management and ample liquidity conditions in the Taiwanese banking system.
Cathay United Bank's Adjusted BCA is at the same level as its BCA of baa1, indicating no uplift attributable to affiliate support. Moody's assesses a very high level of support from Cathay Financial Holding Co., Ltd, the bank's sole parent. Nevertheless, the parent holding company's intrinsic ability to provide support is limited compared with the bank's baa1 BCA.
Moody's does not consider Cathay United Bank to operate in an operational resolution regime. Therefore, Moody's applies a basic Loss Given Failure analysis in rating Cathay United Bank's liabilities. The Preliminary Rating (PR) Assessment of the bank's deposit is the same as its baa1 Adjusted BCA. The PR Assessments of the bank's CRRs and CR Assessment are at a3/a3(cr), one notch above the bank's Adjusted BCA.
Cathay United Bank's A1 deposit ratings, Aa3 CRRs and Aa3(cr) CR Assessment incorporate a three-notch uplift based on Moody's expectation of a very high level of government support. Moody's assessment of government support stems from the bank's position as one of the largest privately-owned banks in its domicile, with a 5% and 6% market share of loans and deposits, respectively, as of the end of 2020, and its designation as a D-SIB.
The outlook is stable, reflecting Moody's expectation that the bank will maintain a sound financial profile over the next 12-18 months, supported by good economic fundamentals of its domicile.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Moody's could upgrade Cathay Life's rating if (1) the insurer significantly reduces its equity and unhedged overseas investments while sustaining its high-risk assets at below 150% of shareholders' equity; (2) its capitalization improves, with its local risk-based capital (RBC) ratio remaining above 350% or its adjusted capital/total assets remaining above 8.0% (8.5%, excluding separate account assets); (3) its profitability improves meaningfully, with its return on capital (ROC) remaining above 12%; and/or (4) its average cost of liabilities declines further while the insurer continues to shift toward less-spread-dependent products.
On the other hand, Moody's could downgrade the insurer's rating if (1) the insurer's profitability declines, with its ROC remaining below 6% or its investment spread staying negative; (2) its capitalization weakens, with its local RBC ratio remaining below 250% and its adjusted capital/total assets remaining below 4% (4.5%, excluding separate account assets) on a sustained basis; (3) the insurer significantly increases its holdings of risky assets, including equity and unhedged overseas investments; and/or (4) Cathay Financial's adjusted financial leverage increases above 30% and its earnings coverage drops below 8.0x, both on a sustained basis.
A rating upgrade of Cathay Financial's key operating subsidiaries, mainly Cathay Life and Cathay United Bank, could lead to an upgrade of the group's rating.
On the other hand, Moody's could downgrade Cathay Financial's rating if (1) the group's key operating subsidiaries, namely Cathay Life and Cathay United Bank, are downgraded; (2) the group's double leverage increases significantly or its financial leverage rises above 30% and earnings coverage falls below 8x, all on a sustained basis; (3) it undertakes significant acquisitions or expansions that exert significant pressure on its financial profile; and/or (4) there is a decrease in the diversification of the group's business mix of life and non-life insurance and banking operations.
Moody's could upgrade Cathay Century's rating if (1) its profitability remains high with its ROC consistently above 12% with its franchise and market position further strengthened; (2) it delivers a more stable and consistently favorable loss development trend; and/or (3) its gross underwriting leverage declines and remains consistently below 2x.
On the other hand, Moody's could downgrade the insurer's rating if (1) its capitalization weakens possibly as a result of catastrophe losses, with its gross underwriting leverage consistently above 3x; (2) its profitability deteriorates, with the combined ratio of its domestic business consistently above 95% or its ROC falls consistently below 10%; (3) there are significant adverse loss developments; and/or (4) the ratings of the group's other subsidiaries are downgraded, because a weakening in the credit profiles of the insurer's affiliates could expose it to contagion risk.
Cathay United Bank
Moody's could upgrade Cathay United Bank's ratings if the government's capacity to support the bank strengthens and the bank's BCA is upgraded.
Moody's could upgrade the bank's BCA if the bank continues to maintain sound asset quality; strengthens its capitalization, with its tangible common equity (TCE)/RWA ratio above 13.5% on a sustained basis; improves its profitability, with its return on tangible assets sustained above 0.85%; and maintains its strong liquidity profile.
Moody's could downgrade Cathay United Bank's ratings if the government's capacity or willingness to support the bank weakens; or if the BCA is downgraded.
Moody's could downgrade the bank's BCA if the bank's asset quality deteriorates, with its impaired loans increasing above 3.0% of gross loans; capitalization weakens, with its TCE/RWA ratio falling below 11.0%; or profitability declines, with its return on tangible assets falling below 0.5%.
The principal methodology used in rating Cathay Life Insurance Co., Ltd was Life Insurers Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1187348 . The principal methodology used in rating Cathay Century Insurance Co Ltd was Property and Casualty Insurers Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1187352 . The principal methodologies used in rating Cathay Financial Holding Co., Ltd were Life Insurers Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1187348 , Property and Casualty Insurers Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1187352 , and Banks Methodology published in July 2021 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1269625. The principal methodology used in rating Cathay United Bank Co., Ltd was Banks Methodology published in July 2021 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1269625 . Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
Cathay Life Insurance Co., Ltd offers life insurance, health insurance, accident insurance, annuity insurance and investment-linked insurance. It is a wholly owned subsidiary of Cathay Financial. At the end of 2020, its total assets and shareholders' equity totaled TWD7.7 trillion and TWD721.1 billion, respectively.
Cathay Financial Holding Co., Ltd offers life insurance, non-life insurance and banking services through its wholly owned operating subsidiaries. At the end of 2020, its total assets and shareholders' equity totaled TWD11.0 trillion and TWD904.8 billion, respectively.
Cathay Century Insurance Co Ltd offers motor, fire, accident and health, and marine insurance and is a wholly-owned subsidiary of Cathay Financial. As of 31 December 2020, Cathay Century reported total assets of TWD44.3 billion and shareholders' equity of TWD13.1 billion.
Headquartered in Taipei, Cathay United Bank Co., Ltd reported total assets of TWD3.2 trillion at the end of 2020.
LIST OF AFFECTED RATINGS/ ASSESSMENTS
..Issuer: Cathay Life Insurance Co., Ltd (Lead Analyst: Kelvin Kwok)
....Long-term Insurance Financial Strength Rating (Foreign Currency), Affirmed A3
....Outlook, Changed to Stable from Negative
..Issuer: Cathay Century Insurance Co Ltd (Lead Analyst: Kelvin Kwok)
....Long-term Insurance Financial Strength Rating (Foreign Currency), Affirmed A2
....Outlook, Remains Stable
..Issuer: Cathay Financial Holding Co., Ltd (Lead Analyst: Kelvin Kwok)
....Long-term Issuer Rating (Foreign Currency), Affirmed Baa1
....Outlook, Changed to Stable from Negative
..Issuer: Cathay United Bank Co., Ltd (Lead Analyst: Helen Zhang)
....Baseline Credit Assessment, Upgraded to baa1 from baa2
....Adjusted Baseline Credit Assessment, Upgraded to baa1 from baa2
....Long-term Counterparty Risk Assessment, Upgraded to Aa3(cr) from A1(cr)
....Short-term Counterparty Risk Assessment, Affirmed P-1(cr)
....Long-term Bank Deposit Rating (Foreign and Local Currency), Upgraded to A1 from A2; Outlook Remains Stable
....Short-term Bank Deposit Rating (Foreign and Local Currency), Affirmed P-1
....Long-term Counterparty Risk Rating (Foreign and Local Currency), Upgraded to Aa3 from A1
....Short-term Counterparty Risk Rating (Foreign and Local Currency), Affirmed P-1
....Outlook, Remains Stable