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Taiwan Financial IndustryChallenges and Opportunities December 2006 Sophia Cheng >> Research Analyst Merrill Lynch (Taiwan) +886 2 2376 3732 [email protected] No part of this report may be used or reproduced or quoted in any manner whatsoever in Taiwan by the press or other persons. Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on pages 32. Global Securities Research & Economics Group Global Fundamental Equity Research Department >> Employed by a non-US affiliate of MLPF&S and is not registered/qualified as a research analyst under the NYSE/NASD rules. Taiwanese banks: low valuation in the region 1. 2. 3. Still recovering from consumer debt problem Gradual profit improvement in 2007 Need to find next areas of growth 07 P/B (x ) 5.00 How to improve? 4.50 Hang Seng Bk 4.00 3.50 Cathay 3.00 Bk of China 2.50 Follow your clients 1.50 • Management clients’ wealth 1.00 CBA Wex bac ANZ ShinKong UOB Bk of EA SBI Dah Sing CL Yuanta Fubon DBS Chinatrust Kooknim Woori Taishin SinoPac 2.00 • NAB ESUN 0.50 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 07E RoE (%) Source: Merrill Lynch estimates Refer to important disclosures on pages 32 2 GDP growth: Taiwan lags other emerging Asian markets Global United States Euro Area Japan Taiwan Hong Kong China Philippines Thanland India 2005 4.7 3.2 1.5 2.7 4.0 7.3 10.2 5.6 4.5 7.5 Real GDP Growth (%) 2006 2007F 5.2 4.5 3.2 1.7 2.7 2.2 2.9 2.6 4.3 3.5 5.1 3.5 10.5 9.6 5.3 5.5 4.5 4.4 8.4 8.0 2008F 4.6 2.5 2.2 2.0 3.9 4.5 9.3 5.5 5.0 7.6 2005 3.2 3.4 2.2 (0.5) 2.3 0.9 1.8 6.6 4.5 4.0 CPI Inflation (%) 2006 2007F 3.2 3.0 3.2 1.5 2.2 2.2 0.1 0.3 0.8 1.8 2.2 3.1 1.5 2.5 6.0 5.1 4.5 2.9 5.7 5.9 2008F 3.0 1.8 2.0 0.9 2.3 3.2 2.2 5.0 2.6 6.1 Source: Merrill Lynch estimates Refer to important disclosures on pages 32 3 106% 120% 107% 112% 111% 140% 132% 160% 140% 150% 180% 162% Credit Penetration: Total Loans as a Percentage of GDP (%) 75% S Korea 77% 73% 26% 44% 17% 12% 23% 32% 34% 27% 24% Russia 20% Philippines 65% 23% Romania 27% 38% 40% 53% 44% 60% 40% 57% 80% 73% 100% DEVELOPED EMERGING EUROPE AND SOUTH AFRICA LATIN AMERICA Thailand Taiwan Malaysia Indonesia India China Mexico Colombia Chile Brazil Argentina Ukraine Turkey S Africa Poland Kazakhstan Israel Hungary Egypt Czech Bulgaria USA UK Japan Germany 0% EMERGING ASIA Source: Central Bank Data, Merrill Lynch estimates Note: Most data end-2005, some end 2004, some ML estimates Refer to important disclosures on pages 32 4 169% Deposit Penetration: Total Deposits as a Percentage of GDP (%) 158% 180% 129% 89% 28% 27% Colombia Mexico 40% 69% 64% 62% 59% 30% 32% Ukraine 27% 33% Turkey 20% 18% 27% 24% 40% 34% 43% Bulgaria 42% 46% 60% USA 67% 80% 76% 100% 97% 98% 120% 114% 140% 126% 131% 160% DEVELOPED EMERGING EUROPE AND SOUTH AFRICA LATIN AMERICA Thailand Taiwan S Korea Philippines Malaysia Indonesia India China Chile Brazil Argentina S Africa Russia Romania Poland Kazakhstan Israel Hungary Egypt Czech UK Japan Germany 0% EMERGING ASIA Source: Central Bank Data, Merrill Lynch estimates Note: Most data end-2005, some end 2004, some ML estimates Refer to important disclosures on pages 32 5 Too much surplus liquidity 4,500 NCD Outstanding vs Deposit Ratio NT$bn CBC CD Outstanding (L) 4,000 % 6.00 1-year Deposit Rate (R) 5.00 3,500 3,000 4.00 2,500 3.00 2,000 1,500 2.00 1,000 1.00 500 2006/07 2006/01 Jul-05 Jan-05 Jul-04 Jan-04 Jul-03 Jan-03 Jul-02 Jan-02 Jul-01 Jan-01 Jul-00 Jan-00 Jul-99 Jan-99 0 Source: CBC, TEJ Refer to important disclosures on pages 32 6 Consumer credit outgrow corporate loans Loan growth 2006/08 2006/01 2005/06 2004/11 2004/04 2003/09 2003/02 Total 2002/07 2001/12 2001/05 2000/10 2000/03 1999/08 Individuals 1999/01 1998/06 1997/11 1997/04 1996/09 1996/02 1995/07 1994/12 2006/09 2006/02 2005/07 2004/12 2004/05 2003/10 2003/03 2002/08 2002/01 2001/06 2000/11 2000/04 1999/09 1999/02 1998/07 1997/12 Corp Loan car Loan Unsecured personal loan Mortgage 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% 1994/05 Corporate NT$bn 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Source: Central Bank Data, Merrill Lynch estimates Refer to important disclosures on pages 32 7 Margins remain thin 3.4 Benchmark rate gap between TW and US 12 % % Interest Spread (L) New Loan Rate (R) 10.0 9.0 3.2 8.0 10 3 8 2.8 7.0 6.0 5.0 6 2.6 4 2 2.4 0 2.2 4.0 3.0 2 3Q00 1Q01 3Q01 1Q02 3Q02 1Q03 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 2006 2005 2004 2003 2002 2001 2000 1999 US Fed Funds Rate 1.0 3Q94 1Q95 3Q95 1Q96 3Q96 1Q97 3Q97 1Q98 3Q98 1Q99 3Q99 1Q00 Taiwan CBC Rediscount Rate 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 2.0 Source: CBC, Merrill Lynch Refer to important disclosures on pages 32 8 Three areas to grow •Wealth management •Treasury products •Overseas operations Non-loan income to operating revenue 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% Indonesia South Korea Taiwan Thailand Philippines India Singapore Malaysia Australia Hong Kong 0% Source: Company reports, Merrill Lynch Refer to important disclosures on pages 32 9 Non-loan business gaining importance TW Bank: Net Fee/Op Revenue 20% 16% 12% 8% 4% Refer to important disclosures on pages 32 3M06 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 0% % Chinatrust FEIB Taipei Fubon Hsinchu Bank Cathay United Taishin Bank IBTAIPEI Bank SinoPac ICBC TBB C.H.B First Bank E.Sun Bank 1997 31% 8% 8% 8% 6% 17% 5% 10% 15% 7% 8% 9% 9% 2000 25% 13% 9% 8% 7% 24% 8% 13% 17% 7% 8% 10% 12% 2003 24% 21% 34% 13% 15% 22% 12% 15% 19% 14% 11% 12% 16% 2005 29% 29% 34% 25% 20% 20% 22% 23% 18% 20% 13% 15% 18% 10 Taiwan households hold US$1.3tn assets Asset allocation in cash & deposit Others, 9% Taiwan: 41% Bond, 1% USA: 30% Life insurance, 11% Cash, 41% Mutual/Trust fund, 7% Stock, 31% Source: Central Bank, CEIC Refer to important disclosures on pages 32 11 Wealth Management & FX/Derivatives 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Trust Assets (NT$bn) Chinatrust First Bank Citibank N.A. CTC ICBC (Mega FHC) Taishin Bank Taipei Fubon Bank Cathay United Bank HNCB Bank SinoPac C.H.B IBTAIPEI TC Bank E.Sun Bank Asia Trust 2000/12 41 57 92 53 25 17 1 1 9 15 11 1 5 7 33 2002/12 96 122 152 102 91 51 17 13 26 41 22 5 19 12 31 2004/12 511 205 153 135 122 120 49 82 67 59 45 44 35 28 30 2005/12 619 226 176 157 156 138 122 120 77 61 51 66 36 38 30 Share 2000/12 6.5% 9.0% 14.7% 8.5% 4.0% 2.7% 0.2% 0.2% 1.4% 2.3% 1.8% 0.2% 0.8% 1.1% 5.3% Share 2002/12 7.9% 10.1% 12.5% 8.4% 7.5% 4.2% 1.4% 1.1% 2.1% 3.4% 1.8% 0.4% 1.6% 1.0% 2.6% Share 2004/12 22.3% 8.9% 6.7% 5.9% 5.3% 5.3% 2.1% 3.6% 2.9% 2.6% 2.0% 1.9% 1.5% 1.2% 1.3% Share 2005/12 22.4% 8.2% 6.4% 5.7% 5.7% 5.0% 4.4% 4.4% 2.8% 2.2% 1.9% 2.4% 1.3% 1.4% 1.1% Sources: Company Data, Merrill Lynch estimates Refer to important disclosures on pages 32 12 FX – With Customers FX-with Customers (NT$bn) 1 Chinatrust 2 ICBC (Mega FHC) 3 HNCB 4 Taishin Bank 5 First Bank 6 C.H.B 7 Taipei Fubon Bank 8 Bank Of Taiwan 9 Taipei Fubon Bank 10 Bank SinoPac 11 E.Sun Bank 12 CTC 13 CTB 14 TBB 15 IBTAIPEI 2000 24 28 26 5 24 21 8 19 8 9 3 8 9 11 3 2002 28 29 24 17 22 17 8 16 8 15 3 7 8 8 4 2004 118 61 45 41 29 26 17 23 17 37 18 15 16 13 8 2005 152 89 51 37 32 28 30 25 30 22 26 20 18 14 11 Share 2000 4.5% 5.2% 4.9% 0.9% 4.5% 3.9% 1.6% 3.5% 1.6% 1.7% 0.5% 1.4% 1.8% 2.0% 0.6% Share 2002 3.7% 3.9% 3.2% 2.2% 2.9% 2.3% 1.1% 2.1% 1.1% 2.0% 0.4% 0.9% 1.1% 1.1% 0.6% Share 2004 8.6% 4.5% 3.3% 3.0% 2.1% 1.9% 1.2% 1.7% 1.2% 2.7% 1.3% 1.1% 1.2% 1.0% 0.6% Share 2005 12.4% 7.2% 4.1% 3.0% 2.6% 2.3% 2.5% 2.1% 2.5% 1.8% 2.1% 1.6% 1.5% 1.2% 0.9% Sources: Company Data, Merrill Lynch estimates Refer to important disclosures on pages 32 13 OBU growing fast NT$mn 30,000 30% 25% 25,000 20% 15% 20,000 10% 5% 15,000 0% 10,000 -5% -10% 5,000 -15% 0 -20% 1998 1999 2000 2001 OBU pretax profit 2002 2003 2004 2005 % to banks prtax earnings Note: OBU contribution in 2005 increased was mainly because of more provisioning in 2005. if taking out the extra provisioning, the contribution from OBU was < 20% Sources: Company Data, Merrill Lynch estimates Refer to important disclosures on pages 32 14 Taiwan corporate investing the most to China (HK + China already 41%) TW-China supervision MoU not signed Taiwan export amounts US$bn 200 180 160 140 120 100 80 60 40 20 USA Refer to important disclosures on pages 32 Japan HK China Korea Europe 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 0 Other 15 Taiwan is the biggest FDI in Vietnam 13% of Vietnam foreign direct investment comes from Taiwan in 2002-Aug06 Refer to important disclosures on pages 32 16 Taiwan financial institutions landscape Banks Life Insurance 2005 Premium Income NT$ bn 400 Asset Managers Foreign competition increasing Currently overpriced No single company big enough to deliver transforming transaction Life Insurance dominated by Cathay Group Larger banks are largely government controlled AIG-owned $461 591 3.4x 3.1x 350 Market Share of AUM (1) Mid-sized private banks likely to lead to consolidation Remaining life insurers are small and some are capital constrained 300 250 Total Assets NT$ bn 141 $62 2.2x 1.9x 200 8% 6% Reported NPLs (%) 3,000 1.38 2.59 0.5 216 $270 1.4x 1.9x 100 $12 1.5x 50 2.4 2.15 1.65 1.94 1.87 2.08 2.59 2.9 2.36 1.04 1.34 2.68 2.6 2.38 3.23 3.42 2.51 4.86 2.38 5.76 1.21 2.98 3.21 1.76 2.31 9.61 1.48 9.69 18.8 1.79 2,500 0 2,000 $258 1.4x $127$127 1.5x 1.4x $198 2x 1,500 $96 1.2x$591 $27 $216 3.1x 0.9x 1.4x 1,000 $91 1.3x 500 P&C Insurance 22 $132 2.0x $4 3.2 1.6x 0.5x $10 $24 0.9x 1.2x $9 $3 $138 5x 0.2x 0.9x Securities $6 0.6x 0 P&C Insurance dominated by Fubon Remaining P&C insurers are small and some are capital constrained $270 $216 1.9x 1.4x $26 $141 $17 $15 $14 1.5x 1.6x 1.2x0.8x $44 0.7x $21 $24 1.1x 1.0x 1.6x % of Total (2) Trading Volum e of Ta Ta iw iwa an n M Coo eg p La a F HC Hu nd a Ba Na nk n Ch Fir FH s C Ch i na t F an tru HC g st F Hw H a C Ta Ca Ba iw tha nk an y Bu FH C s Fu Ba b nk Ta on F is h H Fa C rm in F er HC E. s Ba S n Si un k In noP FH tl . C a Bk c F Hs o HC in f T c h aip Sh u I e i i n nt T k l. Un a C ong Bk i o ho F H n Bk ng C o Ba Fu f T nk a En h H iwa Fa T w n r E ie a F as Co H te m. C rn Ba In Ba n J ih tl. B k nk O S a S f O ha u n nk n v e g FH rs ha ea i B C s a Co Ch nk s m i ne os se Ta C ic h en B un tra ank l g C Tr Ch om us t . Ch i nes Ban in e B k a D an Ch B ev. k i n ow FH fo n aB C Bk Co an of m. k Ka B a oh nk si u ng 45 $111 $65 1.2x 1.6x Bk 2005 Direct Written Premium NT$bn 4% 2% 0% Ca Fu pi t bo al n FH C JF AM Na AB ti o na N Fu -A M l h R Hw O a FH C Po l Pr aris ud en tia l Fi rs t HS BC 150 10% 8% 6% $4615.8 $6 3.4x0.9x 1.4x 258 $246 1.4x 1.6x Government-related Banks Old Private Banks New Private Banks FHC 4% Increasing consolidation expected; led by Yuanta and Fubon $75 1.2x $216 1.4x $91 1.3x $111 1.2x $17 0.9x $24 4.5x $22 1.1x $25 0.8x $44 1.1x $16 1.0x 2% 0 Yu Fu a nt bo a Ta n F is h HC Si in F no H Pa C c FH C C J ih ap Su i tal n FH C Po la ris Fu K hw GI a FH Pr C es ide nt 0% ____________________ Non-classified financial institutions (e.g. China Development, Waterland FHC) not included Figures in blue represent market cap in NT$ bn. Figures in green represent price-to- 1H06 book value ratios. Figures in grey represent FHC market cap in NT$ bn and FHC price-to-1H06 book ratio. Figures in red represent reported NPLs (%) Source: BOMA, Bloomberg, CBC, Taiwan Stock Exchange, SITCA. Assets and NPL ratios as of Sep 2003 and Dec 2003, respectively. Market cap data as of March 26, 2004 (1) As of January 2004 (2) Year 2005 Refer to important disclosures on pages 32 17 1 Mortgage loan market share Mortgage Loan Share (NT$mn) 1 Land Bank 2 Chinatrust 3 TCB Bank 4 Cathay United Bank 5 Taipei Fubon Bank 6 First Bank 7 HNCB 8 Taishin Bank 9 Bank Of Taiwan 10 Bank SinoPac 2000/12 14.9% 3.9% 11.1% 3.4% 4.5% 4.6% 4.1% 2.4% 5.5% 2.5% 2002/12 13.4% 6.2% 9.5% 3.0% 3.9% 4.7% 5.4% 4.1% 4.9% 3.3% 2004/12 11.4% 7.4% 7.0% 5.6% 2.9% 5.0% 5.1% 4.7% 4.1% 3.6% 2005/12 10.9% 7.8% 6.7% 6.1% 4.8% 4.6% 4.7% 4.6% 4.3% 4.1% Sources: Company Data, Merrill Lynch estimates Refer to important disclosures on pages 32 18 Taiwan vs Korea: top 5 market share Taiwan Land Bank Bank Of Taiwan Taiwan Cooperative Bank Hua Nan Bank Chang Hwa Bank Top 5 market share Loans 8% 8% 8% 6% 5% 34% Assets 6.2% 8.9% 6.9% 5.8% 4.6% 32% South Korea Assets Loans KB 16% 21% SFG 13% 15% WFG 11% 14% Hana 10% 9% KEB 6% 6% Top 5 marekt share 56% 65% Source: Merrill Lynch estimates Refer to important disclosures on pages 32 19 Private banks growing fast but still small Loan Market Share MoF initial plan and rules 2) Open up to foreign financial groups 2000/12 2005/12 1997-2005 CAGR 8.2% 7.7% 7.9% 5.0% 11.2% 9.6% 7.9% 0.9% TCB Bank 9.1% 8.2% 7.5% 2.9% HNCB 5.5% 5.4% 5.6% 5.6% C.H.B 5.1% 5.2% 5.0% 5.1% First Bank 5.7% 5.7% 5.3% 4.5% Chinatrust 2.8% 3.3% 5.1% 13.4% TBB 5.0% 4.5% 4.3% 3.4% 2.5% 3.3% 3.9% 11.7% 2.6% 3.3% 3.6% 10.3% Cathay United Bank 2.6% 2.9% 3.7% 20.4% Taishin Bank 1.1% 1.3% 3.3% 7.0% Taipei Fubon Bank 2.9% 2.6% 3.3% 4.1% Farmers Bank 3.0% 2.4% 2.7% 3.6% Bank Of Taiwan Foreign interests in Taiwan 1) Reduce market share of government-controlled bank (in terms of assets) from 50% to 25%-30% 1997/12 Land Bank Valuation more reasonable: from ~2x book to ~1.4x book Loan grwoth ICBC SinoPac+IBT CTB 3.0% 2.9% 2.6% 15.7% Government Bank 58.1% 54.9% 52.7% 4.4% Private Bank 12.1% 13.5% 19.0% 10.4% 100.0% 100.0% 100.0% Total Source: TEJ, Merrill Lynch Refer to important disclosures on pages 32 20 Government initiatives Product competitiveness: - how to compete with HK and Singapore Encourage industry consolidation - why not copy a DBS model in Taiwan - friendly takeover vs. hostile takeover - transparency requirement - who should have independent boards - how to make privatization process better Incentive for money and talents to stay - tax reform - incentive and compensation program - friendly environment Follow clients overseas - Vietnam: Taiwan banks expanding - China: indirect Refer to important disclosures on pages 32 21 Important Disclosures Information relating to Non-U.S. affiliates of Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S): MLPF&S distributes research reports of the following non-US affiliates in the US (short name: legal name): Merrill Lynch (France): Merrill Lynch Capital Markets (France) SAS; Merrill Lynch Dublin (Frankfurt Branch): Merrill Lynch CMB Ltd, Dublin, Frankfurt Branch; Merrill Lynch (South Africa): Merrill Lynch South Africa (Pty) Ltd; Merrill Lynch (Milan): Merrill Lynch Capital Markets Bank Limited; MLPF&S (UK): Merrill Lynch, Pierce, Fenner & Smith Limited; Merrill Lynch (Australia): Merrill Lynch Equities (Australia) Limited; Merrill Lynch (Hong Kong): Merrill Lynch (Asia Pacific) Limited; Merrill Lynch (Singapore): Merrill Lynch (Singapore) Pte Ltd; Merrill Lynch (Canada): Merrill Lynch Canada Inc; Merrill Lynch (Mexico): Merrill Lynch Mexico, SA de CV, Casa de Bolsa; Merrill Lynch (Argentina): Merrill Lynch Argentina SA; Merrill Lynch (Brazil): Banco Merrill Lynch de Investimentos SA; Merrill Lynch (Japan): Merrill Lynch Japan Securities Co, Ltd; Merrill Lynch (Seoul): Merrill Lynch International Incorporated (Seoul Branch); Merrill Lynch (Taiwan): Merrill Lynch Taiwan Limited; DSP Merrill Lynch (India): DSP Merrill Lynch Limited; PT Merrill Lynch (Indonesia): PT Merrill Lynch Indonesia; Merrill Lynch (KL) Sdn. 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