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Asia-PacificApril 2 2006

Tough targets for transformation

Taiwan’s financial reform programme is addressing not only issues about China but the problems of a highly fragmented banking sector. Stephen Timewell reports from Taipei.
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Taiwan is facing a significant structural transformation. This is not just because of the offshore migration of manufacturing production to China but because the government’s second financial reform package is intent on making the fiercely competitive and highly fragmented banking sector both more robust and better placed for the future.

While gross domestic product (GDP) growth rates of about 4% auger well and Taiwan is untroubled by debt or liquidity issues, cross-strait relations are a key concern. These relations impact heavily on the prospects for the banks, which are still forbidden from establishing branches in China and, as a result, are increasingly inefficient and at a disadvantage there.

The financial reform programme promulgated by Taiwan president Chen Shui-bian over the past two years has aimed to reduce significantly the number of Taiwan banks from the current 47 while pushing ahead with the privatisation of state-controlled banks and reducing government stakes. Although the consolidation of the banking sector began in 2002, the pace has been slow and government-controlled banks still account for 50% of loans and nearly 70% of deposits.

Change of structure

Mr Chen’s reforms have tried to change a highly fragmented banking structure where few banks, if any, have strong market shares and no bank can claim any genuine regional strength. As Kong Jaw-sheng, chairperson of the newly created Financial Supervisory Commission (FSC), explained to The Banker recently: “The main purpose [of the reforms] is to enhance international competitiveness. We have many banks but the market is global and we need the banks to be bigger and stronger.” He added: “Our top five banks only account for a 38% market share. That is too low, it should be up to 60%. And among our 47 banks, 26 have a market share of less than 1%.” Mr Kong believes that Taiwan has a lot of small banks because it did not privatise before 1990 and that failure then is making it more difficult now.

Policy goals

The government announced in 2004 four clear policy goals for which the FSC acts as a catalyst in removing obstacles for mergers and acquisitions. The goals were:

  • Halve the number of government-controlled banks from 12 to six by end-2005.
  • Establish three banks with market shares of 10% or more by end-2005 and one with 20% market share within three years.
  • Reduce the number of financial holding companies from 14 to seven by end-2006.
  • Have one financial institution managed by foreign investors or listed on an overseas stock exchange by end-2006.

While the government may be clear on what it wants, achieving its goals is another matter. “We want Taiwan to be a regional financial centre,” says Mr Kong. “We are encouraging foreign banks to come here; there is no discrimination against foreigners and we allow up to 100% foreign ownership.” Merger hurdles

The regulator may be encouraging but a number of key factors are working against mergers and are slowing down the consolidation process. First, the weak Democratic Progressive Party (DPP) government is under heavy pressure in the legislature and is extremely sensitive to criticism over pricing in any privatisation. Second, unions represent a major obstacle to any deals being done and regulation to enable the mergers envisaged could be stronger. Also, the important role of key families and ‘losing face’ cannot be ignored in arranging any sales. And, with many small banks, the prospect of building a sizeable market share may require a domestic or foreign bank to make a number of acquisitions, which is a daunting task in such a tough market. And then there is the China factor.

Nevertheless, there are some optimists. Paul Leech, CEO of HSBC in Taiwan, which has less than 1% market share, says: “I think there will be quite a few deals in 2006. We will see some movement. It will be good for investment banks.” And, despite political and risk management concerns, rating agency Moody’s recently takes a positive view. It says: “The financial strengths of Taiwan’s banks have generally improved, thanks to the recovering economy and efforts to diversify revenue. Therefore, over the past year, banks have seen double-digit loan growth, continued declines in non-performing loans (NPLs), and improvements in profitability and capital strength.”

The FSC notes that key ratios for the banking system have improved in recent years. For example, the BIS capital ratio, which has remained above 10% for the past five years, had risen to 10.7% in June 2005 and the NPL ratio, which peaked at 11.8% in April 2002, had dropped sharply to 2.2% at the end of 2005. After the huge bad debt write-offs and negative returns in 2002, the banks have recovered in terms of profitability, producing an overall return on assets and return on equity in 2005 of 0.3% and 4.8% respectively. As for assets, banks have been growing steadily at a 5% annual rate, bringing total assets at the end of 2005 to $797bn, making Taiwan the third largest banking market in Asia (excluding Japan).

Will industry consolidation take place? Merrill Lynch analyst Sophia Cheng believes the government’s reaction to opposing forces is critical. “If resistance from the public or labour unions is minimal, hence no political intervention, it would be positive to industry consolidation.” But the government is often seen to buckle under pressure and, examining Chinatrust’s plans announced on February 9 to buy up to 10% of another holding company, Mega, over the next year through the open market, Ms Cheng notes: “We view the government’s reaction to potential resistance from labour unions of Mega and Taiwan Business Bank as the critical factor to further industry consolidation.”

M&A forges ahead

Despite the uncertainties and recent public concerns over the high levels of credit card debt at banks, mergers and acquisitions have taken place (see table download) and more are in the pipeline. Foreign investors are also moving in to the market. On March 14, the US’s Newbridge Capital and Japan’s Nomura Group agreed to invest NT$27bn ($833m) and NT$4bn respectively in medium-sized Taishin Financial Holding Company in a private placement. This would allow Taishin to restore financial health, to normalise earnings and to pursue new growth opportunities.

One of the important deals in the pipeline is the acquisition by Bank of Taiwan (BoT), the country’s biggest bank, of the relatively small Central Trust of China (CTC), a bank with 22 branches. Announced last November, Lii Sheng-yann, president of Bank of Taiwan, explained to The Banker that the effective merger of the two 100% state-owned entities would be completed by July 2007. With no union problems expected, Mr Lii believes that the merger will proceed smoothly and help to boost BoT’s market share, bringing the share of deposits up to 11.3%, maintaining first place, and helping to become the leading lender with 9.3%.

The government’s effort to create a national champion may take an extra turn, however. Mr Lii notes that after the CTC merger is completed next year, the specialist Land Bank of Taiwan may become a possible target. The country’s fifth largest bank with the leading market share for loans at 8.1%, the 100% state-owned Land Bank could complement BoT very well and help to create the megabank that the government has been seeking. With Land Bank included, BoT would become an institution with a market share approaching 20% and enough capital to move into the world’s Top 100 banks, up from its current position of 117th.

This three-way merger could happen even sooner. Goldman Sachs is understood to have recently won a mandate to review the possibilities for Land Bank and is expected to give its report in May. As Mr Lii notes: “We are at a very exciting time for banking reform.” He says that it is possible that the government’s stake in BoT could be reduced in line with the overall privatisation goal, with perhaps 20%-30% being sold to the public in a privatisation in July 2008.

Consolidation challenge

No bank can ignore the consolidation challenge, even though Moody’s concludes that the process “will be long and slow”. Fubon Financial Holding, the country’s second largest financial institution, acquired Taipei Bank in 2002 and now Taipei Fubon Bank has 121 branches but is looking for more.

TABLE:TOP 20 BANKS IN TAIWAN: DECEMBER 31 2004,( $ MILLIONS)

A potential target is Hsinchu International Bank with 83 branches mainly in the south, which would bring Fubon closer to the supposed optimal branch level of 200 to 250.

Fubon president Victor Kung stresses the uncertainties and difficulties in buying banks but is pleased to note that Fubon is the only Taiwan bank that owns a Hong Kong bank with a branch network. It bought Hong Kong-based International Bank of Asia two years ago and renamed it Fubon Bank Hong Kong last April. The bank, jointly supervised in Hong Kong, has important access to clients in China’s Pearl Delta region.

Other large financial holding firms such as Cathay (which has the largest life insurer in Taiwan) are stuffed full of liquidity and looking to buy. Shihchen Joseph Jao, senior executive vice-president at Cathay United Bank, explains how Cathay last year bought Lucky Bank, a small operation with 32 branches, which increased Cathay’s network to 140. Given the tight domestic market Mr Jao also wants to expand overseas and is looking closely at Vietnam and India.

Done deals

Some deals have been completed. Ambitious E.Sun Bank, in which the UK’s Prudential has taken a 5% stake, bought Kaohsiung Business Bank in 2004 in a deal that gave it another 20 branches and boosted its network to 114. Last July, Taishin attempted to acquire the larger Chang Hwa Commercial Bank and eventually bought a 22.6% stake that gave it control on the board and, with Chang Hwa’s 168 branches, boosted its branch network to 270. Taishin had outbid Singapore’s Temasek to win Chang Hwa.

In a more recent arrangement, Mega Financial Holding (which includes International Commercial Bank of China and Chiao Tung Bank) has started to buy up shares of middle-ranked Taiwan Business Bank (TBB), which is 38% government owned. Under this complex process, explains ministry of finance director-general Teng-Cheng Liu, Mega will go into the market if TBB shares drop below NT$9. “Deals take a long time because TBB is a limited company and we do not want to impact on the market,” he says. If Mega succeeds with TBB it will almost double its branch network to 230.

The ministry of finance, while keen to complete deals and build banks that have genuine size and regional clout, is also very sensitive to public criticism of selling off state assets too cheaply, hence the slow and difficult balancing act. Nevertheless, Mr Liu is adamant that the government is reducing its market share from the current 50%. “Our target figure for the market share of government-controlled banks in five years is around 30%,” he says.

Foreign interest

In recent developments, foreign investors are beginning to emerge. In February, US giant GE Consumer Finance bought a 24.9% stake in the relatively small Cosmos Bank, which Cosmos president C C Hu says has 63 branches and a 1.2% and 1.5% market share in loans and deposits respectively. Under the terms of the deal, GE is to pay NT$2.6bn cash for an initial 10% in April and NT$7.2bn for the remaining 14.9% in the form of convertible bonds in three years time.

“GE has bought us to have a strategic view of the market. It doesn’t have a banking licence; it cannot do lending. It sees Cosmos as potential for developing consumer finance as a way of expansion and we can still develop auto loans and mortgages,” Mr Hu explains.

The Cosmos chairman also has a Japanese car business so, with GE’s auto expertise, Cosmos is expected to expand in the auto finance area.

Meanwhile, SinoPac Holdings is expected to complete its takeover of International Bank of Taipei by July this year, resulting in a group with a 4% market share, 129 branches and 8000 staff (1000 overseas). SinoPac CEO Paul Lo expects 30% of income to be from overseas by 2008 from operations in the US (California’s Far East National Bank), HongKong, Macau and elsewhere, following a traditional Citibank international expansion strategy.

Just as domestic politics and unions dictate the pace of banking consolidation, cross-strait relations dictate banking progress in China. Although Taiwan banks have seven representative offices in China, there are no Chinese bank offices in Taiwan, and no Taiwan bank branch can be established in China until joint supervision terms are agreed – and that is a political, not a banking issue. In short, political relations with China cast a long shadow over Taiwanese banks’ activity there and, with recently increased tensions, no early solution is in sight.

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