09/03 信義(9940)

• Cross-strait financial deregulation provides new opportunities. We believe cross-strait deregulation will benefit Taiwanese banks and FHCs in two ways. First, it will provide new growth opportunities for such firms given that Taiwan’s market is saturated while there is a more favorable lending environment in China (average spread is 3.1% compared to only 1.2% in Taiwan). Secondly, business alliances through cross-equity investment and possible M&A activity may provide a share price re-rating theme for the domestic financial sector as a whole, where Taiwan financials are trading at 1.2x PB, compared to 2.3x PB among their counterparts in China.
• ECFA to favor banks; equity investment the next step. The signing of an Economic Cooperation Framework Agreement (ECFA) with China on June 29 paved the way towards more favorable market access to Taiwanese banks, compared to Closer Economic Partnership Arrangement (CEPA) and WTO guidelines, by allowing them to extend RMB lending to Taiwanese firms in China after just one year of branch operation while proven profitable. The duration required to apply for branch upgrade has also been shortened from two years of representative office establishment to one year, a condition in line with CEPA rules. While the next round of cross-strait talks is expected to be held within the next six months, we believe the relaxation of investment restrictions will be the next topic for negotiations. Any further developments regarding possible business alliances and cross-equity investment may trigger a new round of re-rating for Taiwan financials, in our view.
• Fundamental recovery well under way. We see the current macro-environment as providing good earnings turnaround opportunities for Taiwan financials, mainly on the back of the sector’s well maintained asset quality which is at a historically low credit cost level, and steady loan growth and fee income recovery attributed to a revival in the economy and equity markets. The unexpected re-discount rate hike of 12.5 bps by the CBC on June 25 has initiated a new interest rate up-cycle, in our view, which may benefit NIM among banks and enhance asset returns while narrowing the duration mismatch gap for insurers. We believe that in the preliminary stage of the rate hike banks stand to benefit more than insurers, while FX risk is still regarded as the swing factor for insurers. With that said, a strong earnings recovery may lead to enhancement among Taiwanese banks’ ROE (1H10 annualized ROE at 9.1% compared to 4.5% in FY09) while providing strong fundamentals to further push up Taiwan financials’ PB valuation (currently at 1.2x PB, compared to average of 1.3x PB since FY01).
• Banks preferred over insurers; watch for election rally in 2H10. In general, we stand overweight on Taiwan financial sector as a whole, while prefer banks over insurers as we continue to see banks leading an earnings recovery moving into 2H10, while cross-strait deregulation also favors banks. Within the banking sector we prefer state-owned banks to private banks, given their consistent earnings performance while spearheading China banking deployment progress. We favor Mega FHC (2886 TT/NR/NT$19.70) and Taiwan Cooperative Bank (5854 TT/NR/NT$19.85), given their robust earnings outlook, faster China deployment progress and undemanding valuations (both are trading at 1.0x PB compared to peers’ average of 1.2X PB). We also hold a long-term positive view on First FHC (2892 TT/NR/NT$18.45), as we see its prudent credit lending policies and good earnings capability may prove it to be a long-term survivor. While we hold a neutral view on domestic insurers’ outlooks, however, we like Fubon FHC (2881 TT/NR/NT$37.25), given its robust earnings capability, its “double engine” business model (banks and insurance), and flexible China deployment strategy. We also suggest investors watch for an election rally in 2H10, as Taiwan’s financial index typically reacts positively to election events.