Taiwan Financial Industry- Challenges and Opportunities December 2006 Sophia Cheng >> Research Analyst Merrill Lynch (Taiwan) +886 2 2376 3732 [email protected]

Taiwan Financial Industry- Challenges and Opportunities December 2006

Sophia Cheng >>Research AnalystMerrill Lynch (Taiwan)+886 2 2376 [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.

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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.

2Refer to important disclosures on pages 32

Taiwanese banks: low valuation in the region

Source: Merrill Lynch estimates

1. Still recovering from consumer debt problem

2. Gradual profit improvement in 2007

3. Need to find next areas of growth

• Follow your clients

• Management clients’ wealth

Dah SingBk of EAUOB SBI

NAB

DBS

CBA

Hang Seng Bk

ANZ

Chinatrust

SinoPacTaishin

Yuanta

Cathay

Fubon Kooknim

Wex bac

Woori

ESUNShinKong

CL

Bk of China

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0%

07E RoE (%)

07 P/B (x )How to improve?


GDP growth: Taiwan lags other emerging Asian markets


2005 2006 2007F 2008F 2005 2006 2007F 2008FGlobal 4.7 5.2 4.5 4.6 3.2 3.2 3.0 3.0United States 3.2 3.2 1.7 2.5 3.4 3.2 1.5 1.8Euro Area 1.5 2.7 2.2 2.2 2.2 2.2 2.2 2.0Japan 2.7 2.9 2.6 2.0 (0.5) 0.1 0.3 0.9Taiwan 4.0 4.3 3.5 3.9 2.3 0.8 1.8 2.3Hong Kong 7.3 5.1 3.5 4.5 0.9 2.2 3.1 3.2China 10.2 10.5 9.6 9.3 1.8 1.5 2.5 2.2Philippines 5.6 5.3 5.5 5.5 6.6 6.0 5.1 5.0Thanland 4.5 4.5 4.4 5.0 4.5 4.5 2.9 2.6India 7.5 8.4 8.0 7.6 4.0 5.7 5.9 6.1

Real GDP Growth (%) CPI Inflation (%)


Credit Penetration: Total Loans as a Percentage of GDP (%)

Source: Central Bank Data, Merrill Lynch estimatesNote: Most data end-2005, some end 2004, some ML estimates

132%

150%

162%

111%

44%

40%

57%

53%

112%

38%

27%

23%

24%

65%

27% 34

%

12%

32%

73%

23%

17%

107%

44%

26%

106%

73% 75%

140%

77%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

Ger

man

y

Japa

n

UK

USA

Bulg

aria

Cze

ch

Egyp

t

Hun

gary

Isra

el

Kaza

khst

an

Pola

nd

Rom

ania

Rus

sia

S Af

rica

Turk

ey

Ukr

aine

Arge

ntin

a

Braz

il

Chi

le

Col

ombi

a

Mex

ico

Chi

na

Indi

a

Indo

nesi

a

Mal

aysi

a

Philip

pine

s

S Ko

rea

Taiw

an

Thai

land

DEVELOPED EMERGING EUROPE AND SOUTH AFRICA LATIN AMERICA EMERGING ASIA


Deposit Penetration: Total Deposits as a Percentage of GDP (%)

114%

98%

131%

46%

43%

67%

97%

42%

126%

24% 34

%

27%

18%

76%

33%

32%

27% 30%

59%

28%

27%

158%

62%

40%

129%

64% 69

%

169%

89%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

Ger

man

y

Japa

n

UK

USA

Bulg

aria

Cze

ch

Egyp

t

Hun

gary

Isra

el

Kaza

khst

an

Pola

nd

Rom

ania

Rus

sia

S Af

rica

Turk

ey

Ukr

aine

Arge

ntin

a

Braz

il

Chi

le

Col

ombi

a

Mex

ico

Chi

na

Indi

a

Indo

nesi

a

Mal

aysi

a

Philip

pine

s

S Ko

rea

Taiw

an

Thai

land

DEVELOPED EMERGING EUROPE AND SOUTH AFRICA LATIN AMERICA EMERGING ASIA

Source: Central Bank Data, Merrill Lynch estimatesNote: Most data end-2005, some end 2004, some ML estimates


Too much surplus liquidity

Source: CBC, TEJ

NCD Outstanding vs Deposit Ratio

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Jan-

99

Jul-9

9

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

2006

/01

2006

/07

NT$bn

-

1.00

2.00

3.00

4.00

5.00

6.00%

CBC CD Outstanding (L) 1-year Deposit Rate (R)


Consumer credit outgrow corporate loans

Source: Central Bank Data, Merrill Lynch estimates

Loan growth

-15%-10%-5%0%5%

10%15%20%25%30%

1994

/0519

94/12

1995

/0719

96/02

1996

/0919

97/04

1997

/1119

98/06

1999

/0119

99/08

2000

/0320

00/10

2001

/0520

01/12

2002

/0720

03/02

2003

/0920

04/04

2004

/1120

05/06

2006

/0120

06/08

Corporate Individuals Total

0 2,000 4,000 6,000 8,000

10,000 12,000 14,000

1997/1

2199

8/07

1999/0

2199

9/09

2000/0

4200

0/11

2001/0

6200

2/01

2002/0

8200

3/03

2003/1

0

2004/0

5200

4/12

2005/0

7200

6/02

2006/0

9

NT$bn

Corp Loan car Loan Unsecured personal loan Mortgage


Margins remain thin

Source: CBC, Merrill Lynch

0

2

4

6

8

10

12

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Taiw an CBC Rediscount Rate US Fed Funds Rate

Benchmark rate gap between TW and US

2

2.2

2.4

2.6

2.8

3

3.2

3.4

3Q94

1Q95

3Q95

1Q96

3Q96

1Q97

3Q97

1Q98

3Q98

1Q99

3Q99

1Q00

3Q00

1Q01

3Q01

1Q02

3Q02

1Q03

3Q03

1Q04

3Q04

1Q05

3Q05

1Q06

3Q06

%

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0%

Interest Spread (L) New Loan Rate (R)


Three areas to grow•Wealth management

•Treasury products

•Overseas operations

Non-loan income to operating revenue

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Hon

g K

ong

Aus

tral

ia

Mal

aysi

a

Sin

gapo

re

Indi

a

Phi

lippi

nes

Tha

iland

Tai

wan

Sou

th K

orea

Indo

nesi

a

Source: Company reports, Merrill Lynch


Non-loan business gaining importance

TW Bank: Net Fee/Op Revenue

0%

4%

8%

12%

16%

20%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

3M06

% 1997 2000 2003 2005Chinatrust 31% 25% 24% 29%FEIB 8% 13% 21% 29%Taipei Fubon 8% 9% 34% 34%Hsinchu Bank 8% 8% 13% 25%Cathay United 6% 7% 15% 20%Taishin Bank 17% 24% 22% 20%IBTAIPEI 5% 8% 12% 22%Bank SinoPac 10% 13% 15% 23%ICBC 15% 17% 19% 18%TBB 7% 7% 14% 20%C.H.B 8% 8% 11% 13%First Bank 9% 10% 12% 15%E.Sun Bank 9% 12% 16% 18%


Taiwan households hold US$1.3tn assets

Cash, 41%

Stock, 31%

Mutual/Trust fund,7%

Life insurance, 11%

Bond, 1%

Others, 9%Asset allocation in cash & deposit

Taiwan: 41%

USA: 30%

Source: Central Bank, CEIC


Wealth Management & FX/Derivatives

Sources: Company Data, Merrill Lynch estimates

Trust Assets Share Share Share Share(NT$bn) 2000/12 2002/12 2004/12 2005/12 2000/12 2002/12 2004/12 2005/12

1 Chinatrust 41 96 511 619 6.5% 7.9% 22.3% 22.4%2 First Bank 57 122 205 226 9.0% 10.1% 8.9% 8.2%3 Citibank N.A. 92 152 153 176 14.7% 12.5% 6.7% 6.4%4 CTC 53 102 135 157 8.5% 8.4% 5.9% 5.7%5 ICBC (Mega FHC) 25 91 122 156 4.0% 7.5% 5.3% 5.7%6 Taishin Bank 17 51 120 138 2.7% 4.2% 5.3% 5.0%7 Taipei Fubon Bank 1 17 49 122 0.2% 1.4% 2.1% 4.4%8 Cathay United Bank 1 13 82 120 0.2% 1.1% 3.6% 4.4%9 HNCB 9 26 67 77 1.4% 2.1% 2.9% 2.8%

10 Bank SinoPac 15 41 59 61 2.3% 3.4% 2.6% 2.2%11 C.H.B 11 22 45 51 1.8% 1.8% 2.0% 1.9%12 IBTAIPEI 1 5 44 66 0.2% 0.4% 1.9% 2.4%13 TC Bank 5 19 35 36 0.8% 1.6% 1.5% 1.3%14 E.Sun Bank 7 12 28 38 1.1% 1.0% 1.2% 1.4%15 Asia Trust 33 31 30 30 5.3% 2.6% 1.3% 1.1%


FX – With Customers


FX-with Customers Share Share Share Share(NT$bn) 2000 2002 2004 2005 2000 2002 2004 2005

1 Chinatrust 24 28 118 152 4.5% 3.7% 8.6% 12.4%2 ICBC (Mega FHC) 28 29 61 89 5.2% 3.9% 4.5% 7.2%3 HNCB 26 24 45 51 4.9% 3.2% 3.3% 4.1%4 Taishin Bank 5 17 41 37 0.9% 2.2% 3.0% 3.0%5 First Bank 24 22 29 32 4.5% 2.9% 2.1% 2.6%6 C.H.B 21 17 26 28 3.9% 2.3% 1.9% 2.3%7 Taipei Fubon Bank 8 8 17 30 1.6% 1.1% 1.2% 2.5%8 Bank Of Taiwan 19 16 23 25 3.5% 2.1% 1.7% 2.1%9 Taipei Fubon Bank 8 8 17 30 1.6% 1.1% 1.2% 2.5%

10 Bank SinoPac 9 15 37 22 1.7% 2.0% 2.7% 1.8%11 E.Sun Bank 3 3 18 26 0.5% 0.4% 1.3% 2.1%12 CTC 8 7 15 20 1.4% 0.9% 1.1% 1.6%13 CTB 9 8 16 18 1.8% 1.1% 1.2% 1.5%14 TBB 11 8 13 14 2.0% 1.1% 1.0% 1.2%15 IBTAIPEI 3 4 8 11 0.6% 0.6% 0.6% 0.9%


OBU growing fast


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%

0

5,000

10,000

15,000

20,000

25,000

30,000

1998 1999 2000 2001 2002 2003 2004 2005

NT$mn

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

OBU pretax profit % to banks prtax earnings


Taiwan corporate investing the most to China (HK + China already 41%)

TW-China supervision MoU not signed

Taiwan export amounts

0

20

40

60

80

100

120

140

160

180

200

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

US$bn

USA Japan HK China Korea Europe Other


Taiwan is the biggest FDI in Vietnam

0

50

100

150

200

250

300

350

400

450

2002 2003 2004 2005 8M2006

US$mn

Taiwan direct investment in Vietnam

13% of Vietnam foreign direct investment comes from Taiwan in 2002-Aug06

17Refer to important disclosures on pages 32 1

Taiwan financial institutions landscape

____________________Non-classified financial institutions (e.g. China Development, Waterland FHC) not includedFigures 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

0

500

1,000

1,500

2,000

2,500

3,000

Total AssetsNT$ bn

Life Insurance

Market Share of AUM

Banks

0%

2%

4%

6%

8%

10%

% of TotalTrading Volume

Securities

Increasing consolidation expected; led by Yuanta and Fubon

$751.2x

$1111.2x $22

1.1x$250.8x

$441.1x

$244.5x $16

1.0x

$911.3x

$2161.4x

$170.9x

0%

2%

4%

6%

8%

Asset Managers

Foreign competition increasingCurrently overpricedNo single company big enough to deliver transforming transaction

Mid-sized private banks likely to lead to consolidation

Government-related Banks New Private Banks FHCOld Private Banks

Larger banks are largely government controlled

$441.1x

Reported NPLs (%)

$2581.4x

1.5x$26

1.6x$141

$961.2x

$1982x

$1271.4x

$651.6x

$2161.4x

$270.9x

1.0x$21 $24

1.2x$100.9x 5x

$9

$911.3x

0.2x$3

0.6x$6

Life Insurance dominated by Cathay Group

Remaining life insurers are small and some are capital constrained

AIG-owned

$2701.9x $12

1.5x

$622.2x

$4613.4x

$241.6x

$2701.9x

Remaining P&C insurers are small and some are capital constrained

P&C Insurance

1.6x$4

3.4x$461

1.4x$6

1.6x$246

P&C Insurance dominated by Fubon

(1)

$1271.5x

$5913.1x

1.38 2.59 0.5 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)

$1322.0x

0

50

100

150

200

250

300

350

400

Catha

y FHC

Nan S

han

Shin K

ong

FHC

China

Post O

ffice

ING A

etna

Fubon

FHC

Presid

ent A

llianc

e

Mer

curie

s Life

China

Life

Prude

ntial

2005 PremiumIncome NT$ bn

0

22

45

Fubon

FHC

Ming

Tai

Union

Catha

y FHC

Centra

l

Taian

Zurich

Meg

a FHC

Newa

2005 Direct WrittenPremium NT$bn

3.2 0.5x

$2161.4x

5.8 0.9x

258 1.4x

591 3.1x

141 1.9x

2161.4x

1.2x$111

1.2x$17

0.8x$15 $14

0.7x $1380.9x


Mortgage loan market share


Mortgage Loan Share(NT$mn) 2000/12 2002/12 2004/12 2005/12

1 Land Bank 14.9% 13.4% 11.4% 10.9%2 Chinatrust 3.9% 6.2% 7.4% 7.8%3 TCB Bank 11.1% 9.5% 7.0% 6.7%4 Cathay United Bank 3.4% 3.0% 5.6% 6.1%5 Taipei Fubon Bank 4.5% 3.9% 2.9% 4.8%6 First Bank 4.6% 4.7% 5.0% 4.6%7 HNCB 4.1% 5.4% 5.1% 4.7%8 Taishin Bank 2.4% 4.1% 4.7% 4.6%9 Bank Of Taiwan 5.5% 4.9% 4.1% 4.3%

10 Bank SinoPac 2.5% 3.3% 3.6% 4.1%


Taiwan vs Korea: top 5 market share


Assets Loans

KB 16% 21%

SFG 13% 15%

WFG 11% 14%

Hana 10% 9%

KEB 6% 6%

Top 5 marekt share 56% 65%

South KoreaTaiwan Loans AssetsLand Bank 8% 6.2%Bank Of Taiwan 8% 8.9%Taiwan Cooperative Bank 8% 6.9%Hua Nan Bank 6% 5.8%Chang Hwa Bank 5% 4.6%Top 5 market share 34% 32%


Private banks growing fast but still small

Loan Market Share Loan grwoth

1997/12 2000/12 2005/12 1997-2005 CAGR

Land Bank 8.2% 7.7% 7.9% 5.0%

Bank Of Taiwan 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%

ICBC 2.5% 3.3% 3.9% 11.7%SinoPac+IBT 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%

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%

Total 100.0% 100.0% 100.0%

Source: TEJ, Merrill Lynch

Valuation more reasonable: from ~2x book to ~1.4x book

Foreign interests in Taiwan

MoF initial plan and rules

1) Reduce market share of government-controlled bank (in terms of assets) from 50% to 25%-30%

2) Open up to foreign financial groups


Government initiativesProduct 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


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Documents

Taiwan Financial Industry- Challenges and Opportunities December 2006 Sophia Cheng >> Research Analyst Merrill Lynch (Taiwan) +886 2 2376 3732 [email protected]