Softening demand in Taiwan's property market could push up NPLs for banks over the next one to two years. Taiwan Ratings believes most lenders have good capital buffers and could withstand moderate volatility in the domestic property market.

We tested banks' sensitivity to stress scenarios. Residential property transactions are cooling after brisk price rises and a jump in mortgage lending last year. While house prices have stayed strong, a reversal is possible.

In our view, banks have good provisions and financial buffers. The banks have generally tightened their appetite for property-related lending under regulatory exposure limits in recent months. This should help to prevent further lending concentration in the sector amid less-certain market conditions.

Property-Related Lending Growth Will Likely Ease

We anticipate banks will slow their pace of mortgage lending growth to 3%-5% over the next two years. This comes after an unusually strong 10.4% expansion in mortgage lending in 2024 amid a booming housing market and a government-led preferential housing loan program for younger buyers. That level compares with an average of about 7.5% growth during 2019-2023.

Nonetheless, last year's mortgage lending was on par with total loan growth in 2024 (see chart 1a). Banks' property-related exposure (including home mortgages, housing-repair loans and real estate development and construction lending) remain at roughly a third of total loans (see chart 1b).

Chart 1a

Chart 1b

We do not expect the strong momentum of mortgage lending growth in 2024 will persist over the next few quarters. The government-led preferential housing loan program for younger buyers largely explained the boost in transactions, which drove growth in mortgage lending.

Under the program, eight state-owned banks offer quite flexible and favorable terms for qualified applicant including a lower lending rate subsidized by government, tenors of up to 40 years, and a grace period on the repayment of loan principal of up to five years.

The eight stated-owned banks collectively reported about 17% mortgage loan growth in 2024, compared with 10% growth for the whole banking sector in the same period. In our view, this pace will likely slow.

Property-Related Loan Performance Could See Some Slippage

Cooling transactions and banks' tightening lending capacity for property will likely cap upside in residential markets. By our forecasts, housing prices will be nearly flat over this year and the next (see chart 2). This would be a letdown for homeowners, after a 9%-10% gains in home prices in 2024 and average yearly gains of above 8% during 2021-2024.

Chart 2

Softening market conditions could push more mortgage loans to become overdue in the next two to three years.

Moreover, the gradual expiration of the grace period of three-five years on principal payment of some mortgage loans could add to the burden on borrowers. If residential prices start to fall, the pain could spread quickly. For example, in the event of a market downturn, some small property developers would have higher default risk on their loan obligations

Core Earnings, Capital Buffers Could Handle A Jump In Credit Costs

In our view, the potential credit losses associated with property market volatility could be absorbable by banks' core earnings. The loan-loss reserves applied to real estate loans would also act as a buffer.

The regulator has required banks to set aside a 1.5% credit loss reserve for mortgage and real estate lending, higher than the 1% general reserve for other loans. This is precautionary, given the 90-day delinquency rate for mortgage loans was a low 0.07% in June 2024, and the low level has been maintained since 2021 (see chart 3).

The strong gains in home prices in recent years have contributed to low delinquency rates for real estate development and construction loans.

In our base case, we think nonperforming loans (NPLs) for mortgages will stay below 0.2% of total loans, and real estate NPLs below 0.5% for the next two years.

Chart 3

We also tested more severe scenarios (see table 1). Even if mortgage NPLs surged to 2% and real estate NPLs to 6%, the combined credit losses would be under 25 basis points (0.12% plus 0.11%). That is still absorbable compared to banks' pre-provision return on assets of 80-90 basis points in recent years.

In addition, we believe banks' satisfactory capitalization can further provide a buffer against unexpected property market volatility. As of the end 2024, the sector's regulatory Tier-one capital ratio was about 13%. We believe most banks have adequate to strong capitalization based on our capital framework assessment.

Table 1

Adequate Credit Controls And Prudent Growth Appetites Limit The Impact Of Volatile Property Prices

In our view, Taiwan banks have adequate lending and provisioning practices. For example, their underwriting standards are prudent in terms of internal scoring, serviceability test, collateral appraisal and credit provisioning level. The average loan-to-value (LTV) ratio of all outstanding mortgage loans is low at 50%-60%; though some LTVs for newly extended mortgage loans could be at 75%-80% subject to the locations and borrowers' creditworthiness.

The LTV ratio for land lending is generally capped at 40%-50% by regulation, based on the construction stages. This provides good buffer to absorb potential market fluctuations even in a stress case of a 20%-30% price correction.

These defenses would in our view allow the sector to absorb moderate property market volatility. We also expect sector lending appetite to ease after the recent strong run; this too will add to defenses.

Should the property market start to correct, however, some smaller players with higher than average loan exposure to the property market could face earnings pain and capital stress. This would be transmitted through higher credit costs on rising NPLs.

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