Larger Taiwan banks expected recipients of projected margin uplift

Partly because of their mainland China exposure.

Taiwanese bank profitability is expected to rise over the medium term, and larger banks such as Mega International, Cathay United and First Commercial are likely to be the primary beneficiaries of margin uplift.

According to a release from Fitch Ratings, this is owed to their greater exposure to mainland China, and better deployment of their Chinese yuan deposit bases.

However, the sustainability of higher profitability has yet to be established, and there is the potential for increased risk-taking as some Taiwanese banks rapidly build Chinese exposures.

Here's more from Fitch Ratings:

Earnings data from 1H14 confirmed strong growth in Taiwan's banking sector, with pre-tax profit rising by 27% yoy (versus 6% in 1H13).

As a result, Fitch has revised up its profitability forecasts for the banking sector, and now expects return on assets to be 0.66% for both 2014 and 2015.

Strong growth in offshore (primarily China) exposures, including yuan deposit placements and foreign-currency loans, was the principle factor driving the boost in margins and, by extension, accelerating profit growth.

Offshore lending has been a major source of growth for several large Taiwanese banks, and has significantly outstripped the growth of local lending over the past several years.

From 2010-1Q14, offshore lending grew at a compound annual growth rate of 25% compared with just 6% for overall bank lending.

This lending has the potential to improve Taiwanese bank margins, but aggressive extension of Chinese exposures could change bank risk appetites and lead to additional risk taking.

We expect the rate of growth of offshore exposures to remain high relative to overall sector loan growth over the next few years, though it will slow down.