Fitch Assesses Taiwan's First Basel III Tier 1 Instrument

Tue Apr 22, 2014 9:00pm EDT

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(The following statement was released by the rating agency) TAIPEI, April 22 (Fitch) Fitch Ratings will generally rate Basel III-compliant Tier 1 instruments issued in Taiwan, such as Taishin International Bank's (BBB+/AA-(twn)/Stable) recently launched perpetual non-cumulative subordinated debt, four notches down from the banks' anchor rating. The notching, typically from the banks' Viability Rating (VR), comprises two notches for non-performance risk, based on standard and less-easily triggered profit and capital thresholds for coupon omission and deferral, and two notches for poor recovery prospects. For Taishin International Bank, its VR is 'bbb+', which would result in a rating of 'BB'/'BBB+(twn)' for its subordinated debt, if Fitch were to rate the issue. Taiwanese Basel III Tier 1 instruments exhibit lower non-performance risk than those in other jurisdictions, such as Singapore and Hong Kong, where cancellation of any periodic distributions is fully discretionary and Fitch would notch similar instruments at least three times from their anchor rating for non-performance risk. In limited Taiwanese cases where Fitch considers profit and capital thresholds to be more easily triggered, Fitch will apply wider notching (that is, three notches or more) for non-performance risk. These cases include those with additional terms imposing a high capital ratio trigger for coupon deferral and situations where a bank's retained earnings can barely cover interest payments. Also unlike Basel III Tier 1 instruments in other jurisdictions, Taiwanese Basel III Tier 1 instruments typically do not accord full discretion to the issuer on coupon payments, which limits their loss absorption flexibility to support the issuer's viability. Fitch does not ascribe equity credit to such hybrid instruments so that they are excluded from Fitch's calculation of Fitch Eligible Capital when considering an issuer's VR. Notching for typical Basel III Tier 1 instruments is wider than the two notches for Fitch-rated Basel III Tier 2 instruments in Taiwan, reflecting additional and higher non-performance risk built in the profit and capital tests for Tier 1 securities, compared with the absence of terms for coupon omission and deferral for Tier 2 instruments. Both types of instruments include two notches for loss severity, reflecting poor recovery prospects at the point of non-viability (PONV) or government receivership. Fitch believes Taiwan's authorities would only move a bank into insolvency administration when it reaches a very low capital level or a 2% capital adequacy ratio (CAR), thereby reducing recovery prospects. Fitch's approach to rating Tier 1 securities differs slightly from its approach in rating Tier 2 securities. Fitch-rated subordinated and hybrid securities are still notched down from the financial institution's anchor rating, which is usually the issuer's VR, but in cases of high state ownership or institutional support, the support-driven Issuer Default Rating may act as the anchor rating for the ratings of Tier 2 securities because Fitch views the state/parent as having a stronger interest in supporting a state bank/subsidiary to prevent it from hitting points where loss-absorption features kick in. Fitch observes that market pricing for Basel III-compliant Tier 2 instruments have not been meaningfully different from the legacy Tier 2 ones despite the former's higher risk stemming from the addition of a non-viability trigger. Fitch attributes the peculiar market pricing behaviour to the persistent and abundant market liquidity and, to some extent, the market's lack of familiarity in assessing the risks. As such, the market may start to price in additional risk for Basel III instruments, especially when market liquidity thins and market participants become more familiar with additional risk associated with the non-viability trigger. More details on how Fitch assesses bank subordinated and hybrid securities are in "Assessing and Rating Bank Subordinated and Hybrid Securities Criteria", dated 31 January 2014. For Taiwanese banks' Basel III instruments in particular, refer to "Taiwan Banks: Basel III Capital Rules and Instruments", dated 30 May 2013. Both reports are available at www.fitchratings.com. Contact: Jonathan Lee Senior Director +886 2 81757601 Fitch Ratings Limited, Taiwan Branch Suite 1306, 13F, 205, Tun Hwa N. Rd., Taipei Cherry Huang Director +886 2 81757603 Sophia Chen Director +886 2 81757604 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria and Related Research: Assessing and Rating Bank Subordinated and Hybrid Securities Criteria here Taiwan Banks: Basel III Capital Rules and Instruments here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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