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Taiwan Banks FINANCIAL MARKETS the Seven Fat Years

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Taiwan Banks FINANCIAL MARKETS the Seven Fat Years Taiwan banks FINANCIAL MARKETS The seven fat years Seven lean years are over. Taiwan’s banking and finance shares Banks rose to a peak in early 1997, before starting a long slide that would consume most of the next seven years. In biblical fashion, we now see Taiwan those seven lean years giving way to what will be, if not seven years of prosperity, at least significantly better times ahead. Sector analysis 22 October 2003 Raising market weighting to Overweight. We are raising our weighting of the Taiwanese financial sector to Overweight from Underweight within a regional financials context. In addition, from a country perspective, our Taiwan strategist also considers financials an Overweighted sector. Initiating coverage on six banks. With this report, we are initiating coverage of six Taiwanese banks: Chinatrust; First FHC; Taishin; SinoPac; E.Sun; and Cosmos. Our top picks are Chinatrust and Cosmos, both rated BUY, and we also see substantial upside in Taishin and E.Sun, also initiated with BUY ratings. Systemic health is on an upswing. A half-decade of fears that Taiwan’s banking system would implode under the weight of bad debts Paul Sheehan are starting to fade. Massive write-offs, a return to growth, and resumed Head of Asia-Pacific Financials access to the capital markets are setting off a virtuous cycle for the health Hong Kong (852) 2848-8580 of the system. [email protected] Nora Hou Getting closer to China. The chances of meaningful economic Taipei (8862) 2734-7522 integration with mainland China are increasingly likely, in our view, with [email protected] politics and the March 2004 election as likely catalysts. Taiwanese banks have a built-in client base on the mainland—all they need is access. Asian Financials Research Team Paul Sheehan Head of Asia-Pacific Trust the consumer. After an appalling record for consumer lending in +852 2848-8580 [email protected] Hong Kong and Korea, investors are justifiably wary of credit card businesses and consumer debt. Nevertheless, Taiwan’s households are Tay Chin Seng Singapore, Malaysia +65 6539 6694 [email protected] wealthy, liquid, and undergeared, with only 3% of disposable income going to pay interest, and debt to income actually lower than in 1998. Young Chung Mok Korea—Banks +82 2 3171 519 [email protected] Don’t forget the macro. In addition to favourable drivers for the Mark Barclay Korea—Brokers, Insurance banking industry and for our individual picks in isolation, Taiwan has a +82 2 3171 528 [email protected] very supportive macro environment, including an undervalued currency, Ned Akov Japan increasing GDP growth, and low interest rates. These are catalysts for an +81 3 5210 1615 [email protected] overall bull market—one in which the banks will uncharacteristically lead. Andrew Stotz Thailand—Banks +662 694 7722 [email protected] Taiwan banks – Forecasts and ratings Price 12-month PER (x) PBV (X) Marc Lavoie Thailand—Finance Cos. Ticker Rating 16/10 (NT$) Target (NT$) 03F 04F 04F +662 694 7749 [email protected] Chinatrust 2891 TT BUY 32.30 50.00 15.0 10.2 1.6 Liny Halim Indonesia [b] Taishin 2887 TT BUY 21.80 29.65 10.8 8.0 1.3 +6221 515 7343 [email protected] First FHC 2892 TT SELL 21.70 18.28 NM 15.8 1.4 SinoPac 2890 TT HOLD 17.90 19.36 14.1 12.6 1.3 Gilbert Lopez Philippines E.Sun 2884 TT BUY 18.70 24.64 10.7 12.2 1.6 +63 2 840 8937 [email protected] Cosmos 2837 TT BUY 15.50 24.77 8.9 7.3 1.1 Source: Company data, ING estimates Nora Hou Taiwan _ +8862 2734 7522 [email protected] Peter Williamson Regional Exchanges +65 6539 6620 [email protected] PLEASE SEE THE IMPORTANT DISCLAIMER, COMPANY DISCLOSURES AND ANALYST CERTIFICATION ON THE LAST PAGE OF THIS REPORT Taiwan Banks October 2003 Contents Summary 1 Key themes and picks 2 Systemic risk: Off the table 5 Credit cards: Impending doom or continued boom? 8 Economic integration – The shape of things to come 18 M&A 20 Valuation 23 Loan portfolios and growth 27 Asset quality 34 Reserve adequacy 38 Rates and margins 39 Company section 41 Chinatrust: Local hero............................................................................................. 42 Taishin: #2 tries harder........................................................................................... 57 First FHC: Still distressed ....................................................................................... 67 SinoPac: Waiting for love........................................................................................ 83 E.Sun FHC: Prodigal sun........................................................................................ 92 Cosmos: A universe of consumers ....................................................................... 103 See back of report for important disclosures and disclaimer 2 Taiwan Banks October 2003 Summary Raising Taiwan financials weighting We have re-initiated coverage of the Taiwanese financial sector and raised our weighting of the Taiwan banks from Underweight to Overweight versus our regional portfolio of financials. We are reducing our weightings in both Korea and Thailand, and looking to these markets as a source of funds for Taiwan. Initiating coverage on six banks With this report we are also initiating coverage of six banks: Chinatrust, Taishin, First Financial, SinoPac, E.Sun, and Cosmos. Our preferred plays in the sector are Chinatrust and Cosmos, with significant upside present in Taishin and E.Sun as well. Politics drives rapprochement Our research and polling shows that the central theme of next year’s elections will be closer economic integration with mainland China. We believe that a new administration will be highly motivated to secure better cross-straits relations and will lift restrictions on Taiwanese banks’ ability to operate in China. This will be rapidly transformational for the banks—in effect or actuality a second CEPA for Taiwan. Reversing corporate hollowing-out Over the past decade, more and more Taiwanese corporates have relocated their operations to the mainland—where their banks have not been able to follow. As this changes, banks will gain access to a ready-made pool of business, which we estimate will increase loan growth by 1.5% to 2.5% per annum over the next decade. Systemic risk fades The failure of the Legislative Yuan to pass a meaningful RTC program notwithstanding, we believe that the systemic risk of the Taiwanese financial system has receded and continues to fall. We still believe that a number of major institutions are unviable and need to be resolved, but we no longer see a danger that doing so will pull otherwise healthy banks over the cliff. Liquidity deployment will bolster margins Lending spreads in Taiwan will remain compressed until rates turn around, which we don’t foresee until 2005. Expect shrinkage to be especially likely in richly-priced credit and cash card margins. However, resumed loan growth in key categories and the redeployment of excess liquidity will start to boost real net interest margins from 2Q04 onwards. Credit cards set for a cycle – not a crash Although increasing competition will reduce rates, Taiwan’s credit card lending can safely continue with a 15-25% growth rate over the next five years, due to robust credit information sharing, no personal bankruptcy, and low household leverage. Even in a depressed economy with near-record unemployment, interest payments on debt account for only 3% of average household disposable income—with net savings still at close to 20%. See back of report for important disclosures and disclaimer 1 Taiwan Banks October 2003 Key themes and picks Recommendations and coverage initiations We are initiating coverage on six bank groups: First, Chinatrust, Taishin, SinoPac, E.Sun, and Cosmos. Of these, our top picks are Chinatrust and Cosmos, both rated BUY, and we have also initiated BUY ratings on Taishin and E.Sun with lesser upside. We believe that the underlying business prospects of SinoPac are already fully valued, and we hence rate the shares as a HOLD in line with our regional practice of not setting price targets based on M&A. That said, we believe it is highly likely that SinoPac will be sold; we believe that a domestic acquiror would pay NT$21-23 per share and a foreign acquisitor potentially more. We continue to believe that First FHC is deeply troubled both operationally and in terms of asset quality despite having raised capital this summer. We initiate coverage on the shares with a SELL rating. Fig 1 Recommendation summary ING Price Px NT$ Rating 10/16/03 target Up/downside Chinatrust BUY 32.30 50.00 54.8% Taishin BUY 21.80 29.65 36.0% First FHC SELL 21.70 18.28 -15.7% SinoPac HOLD 17.90 19.36 8.2% E.Sun BUY 18.70 24.64 31.8% Cosmos BUY 15.50 24.77 59.8% Source: Company data, ING estimates _ Key themes The four key themes we believe are critical to assessing the prospects for Taiwan’s banking sector are as follows: • Systemic risk of troubled institutions and bad debts to the rest of the sector; • Credit card debt and personal lending; • Economic integration with mainland China and its banking impact; and • Consolidation of the Taiwanese banking industry We explore each of these themes in detail in the pages which follow. Macro catalysts Multi-year upcycle for TWD We believe that the NT$ is significantly undervalued—in particular against the US dollar. Evidence for this can be found in Taiwan’s large balance of payments (BoP) surplus—which last year reached a record US$33.6bn, or just under 12% of GDP on a reported basis; we think this understates the case.1 The NT$ also appears undervalued in terms of its real effective exchange rate (REER), which is currently 7% and 14% below its five-year and 10-year averages, respectively.
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