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### Viewing cable 05TAIPEI2875, TAIWAN BANK M&A MAY PICK UP STEAM

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
05TAIPEI2875 | 2005-07-01 08:57 | 2011-08-23 00:00 | UNCLASSIFIED | American Institute Taiwan, Taipei

`

    This record is a partial extract of the original cable. The full text of the original cable is not available.

` `

    UNCLAS SECTION 01 OF 04 TAIPEI 002875

    SIPDIS

    STATE PASS AIT/W AND USTR
    STATE FOR EAP/RSP/TC, EAP/EP, EB/IFD/OMA
    USTR FOR FREEMAN, WINTER AND WINELAND
    USDOC FOR 4420/USFCS/OCEA/EAP/LDROKER
    USDOC FOR 3132/USFCS/OIO/EAP/ADAVENPORT
    TREASURY FOR OASIA/LMOGHTADER
    TREASURY PASS TO OCC/AMCMAHON
    TREASURY ALSO PASS TO FEDERAL RESERVE BOARD OF GOVERNORS,
    AND SAN FRANCISCO FRB/TCURRAN

    E.O. 12958: N/A
    TAGS: ECON EFIN PINR TW
    SUBJECT: TAIWAN BANK M&A MAY PICK UP STEAM

    REF: A. TAIPEI 2131
         ¶B. TAIPEI 1878

    ¶1.  Summary:  Following the failure to privatize Changhwa
    bank, Taiwan authorities are making measured moves to
    encourage bank consolidation and proceed with the
    second-stage of financial reform.  While it appears unlikely
    that the reform plan will achieve its stated benchmarks
    established in October 2004, progress is being made and there
    is increasing pressure for banks to actively seek merger and
    acquisition partners.  End Summary.

    Second Stage of Financial Reform
    --------------------------------
    ¶2.  Ref A reports on the failure to consummate the
    privatization of Changhwa bank.  The planned privatization
    was to be the trigger point to start bank consolidation for
    the financial reform plan announced by President Chen
    Shui-bian on October 20, 2004.  The plan, referred to as the
    second-stage of financial reform in banking circles, was
    developed by the Presidential Economic Advisory Team.  Its
    goal is to increase efficiency in the banking sector and the
    utilization of banking assets.  Currently, the banking
    industry's rate of return on assets is less than one percent,
    and the return on equity, according to figures from the first
    quarter of 2005, has risen to a modest 3.7 percent.  The
    strategy calls for introducing international banking
    standards into the market and decreasing the number of banks
    and financial holding companies.  The plan established some
    quite specific benchmarks:

    a.    Having a state-owned bank sold to and operated by a
    foreign one by the end of 2005;
    b.    Reducing state-owned banks from 12 to 6 by the end of
    this year; and
    c.    Cutting financial holding companies from 14 to 7 by the
    end of 2006.

    Environment for Banking M&A
    ---------------------------
    ¶3.  The American Chamber of Commerce held a seminar on May 18
    featuring international (Goldman Sachs, Jones & Day and HSBC)
    and local firms (ChinaTrust Bank) discussing the prospects
    for banking mergers and acquisitions in Taiwan.  The
    participants noted that there is no shortage of political
    will at senior levels of the Taiwan government for bank
    consolidation and that the government wants to see
    consolidation take place quickly.  One banker also suggested
    that the government's desire for rapid consolidation runs
    counter to industry preference.  He said that merging a weak
    bank with a sound one would take at least a year and that
    merging two sound banks would take considerably longer,
    perhaps three years.  While the industry as a whole agrees
    that consolidation is good for the banking sector and for
    Taiwan's economy, few, if any, senior bank executives want to
    be the first one to sell or merge their bank.

    ¶4.  Seminar participants said that it is not hard for the
    government to realize its goal of bank consolidation because
    it can quickly merge a number of existing state-owned banks.
    This process may have already begun with banking circles and
    press speculation on the expected merger of the International
    Commercial Bank of China (ICBC) with Chiao Tung Bank.  Both
    of which are operated by state-owned Financial Holding
    Company Mega Holdings.  Other indications of M&A activity
    include a June 30 resolution by the Taipei Commercial Bank to
    merge with SinoPac Financial Holding Company; Yuan Da
    Business Group acquiring Fuhua Financial Holding Company; and
    Cathay Financial Holding Company announcing June 30 its
    acquisition of Lucky Bank.  (Note:  Reftel B reports on
    another ongoing merger in April of Macoto Bank with Shin
    Kong.  End Note.)  The M&A experts, however, called on the
    government to respect market forces and realize that foreign
    banks will place a lower value on local M&A targets than will
    domestic banks.  Foreign banks will be unwilling to pay the
    same price that local banks will, largely because local banks
    have an unmet need for additional branch offices.  One
    seminar participant called on the government to make a
    &good8 bank available for sale to all bidders, suggesting
    that this would serve as a catalyst for increased M&A in the
    banking sector.  This comment reflected the market's view
    that the Changhwa sale was flawed because it limited the
    potential buyers to foreign banks and that Changhwa was not a
    particularly sound bank.

    ¶5.  Market participants and news reports indicate that
    Changhwa bank is moving forward to try and recover from the
    bungled sale to a foreign bank.  Current plans call for
    several sound local banks, as well as private placement
    funds, to join together and propose a takeover mechanism.
    Cathay, Fubon and ChinaTrust are reportedly in discussions on
    how to solve the Changhwa problem.

    Background on the Banking Reform Measures
    -----------------------------------------
    ¶6.  Motivated by a sharp rise in the rate of nonperforming
    loans in 2000, Taiwan launched a major effort to improve the
    quality of its banks in 2001.  The NPL rate in 2001 was
    double the rate in 1997 when the Asian Financial crises
    erupted.  Taiwan Authorities established the Financial
    Reconstruction Fund (FRF) with a capital base of NT$140
    billion to address insolvent financial institutions.  The
    FRF, similar to the Resolution Trust Corporation in the US,
    has taken over 47 insolvent financial institutions and,
    eventually, sold them to sound banks.  The 47 institutions
    included the credit departments of 36 farmers associations,
    nine credit cooperative associations and two banks.  In
    addition, Taiwan authorities offered incentives for financial
    institutions that lowered NPL ratios below 7% by December
    2002 and below 5% by December 2003.  Institutions failing to
    meet the targets would be subject to penalties.  Similar
    carrot and stick measures have been adopted for credit
    departments of farmers associations and credit cooperative
    associations.  Officials hope that the combination of
    incentives and penalties will encourage financial
    institutions to consolidate.

    ¶7.  Taiwan banks, responding to the government's measures,
    cut their NPL rates by writing off bad debt and selling
    problem assets to asset management companies.  By December
    2004, the quantity of non-performing loans fell 64.5% to
    NT$590.7 billion (US$19 billion) from a peak of NT$1,661.9
    billion (US$53.6 billion in March 2002.  Average NPL ratios
    dropped from 11.7% to 3.8%.  The rapid write-offs eroded bank
    profitability, causing banks to post a combined pre-tax loss
    of NT$104.6 billion (US$3.8 billion) in 2002.  By 2004,
    though, banks returned to profitability and reported combined
    profits of NT$153.3 billion (US$5 billion).

    ¶8.  Reducing NPLs also eroded capital adequacy rates.  Banks
    compensated for the capital losses by issuing debt
    (convertible into equity), resulting in total bank debt
    reaching NT$676.4 billion (US$21.8 billion) in December 2004,
    four times the level in 2001.  The average capital adequacy
    ratio reached 9.5%, higher than the existing requirement of
    8%.

    Current Banking Environment
    ---------------------------
    ¶9.  The current banking environment consists of 48 banks, all
    with less than a ten percent market share.  This number is
    down from the 53 banks operating in Taiwan at this time last
    year.  Senior officials routinely decry the &overbanking8
    situation and call for bank consolidation.  Financial
    Supervisory Commission Chairman Kong Jaw-sheng told AIT/T
    that his goal is to change Taiwan's banking environment from
    one of lots of little banks into one of several large banks
    capable of effectively operating in the regional market.

    More Reform Needed & Delivered in 2005
    --------------------------------------
    ¶10.  Even while citing figures indicating that nonperforming
    loan ratios continue to decline significantly, the FSC's
    Bureau of Monetary Affairs has been enacting a variety of new
    rules in 2005 to encourage banks to improve their operations.
     BOMA has set targets for all banks to meet on rate of NPLs,
    coverage of bad debts and capital adequacy.  As of February
    2005 all banks are required to lower NPL rates below 5%, to
    increase the level of reserves to cover bad loans above 40%
    and to achieve capital adequacy rates above 10%.  Even while
    the average rates achieved by banks in these three categories
    are quite good, it is a different story when one looks at
    individual banks.  According to AIT/T analysis of data on
    bank operations, some 60 percent of banks do not now meet all
    three of BOMA's basic guidelines listed above.  While most
    banks probably meet one or two of the targets, fewer than
    half meet all three of the targets.

    Carrots...
    ----------
    ¶11.  Along with announcing the new requirements, BOMA offered
    some incentives for banks to hit the targets.  Among the
    incentives for banks that bring NPL ratios below 5% and
    increase bad debt coverage above 40% are:  the ability to
    introduce new financial products and services; relocate
    branch offices (except for moving to Taipei and Kaohsiung);
    install automatic service facilities outside banking offices,
    and travel to China without applying for a permit.
    Additional incentives for banks that bring their NPL below
    2.5% include establishing offices overseas (including China);
    replacing a full-service branch office with four
    limited-service branches; and the ability to offer the
    following services without going through and application and
    approval process: investment below statutory ceiling limits,
    introduction of collective management services for trust
    funds and introducing mutual funds.

    ¶12.  FSC offers extra incentives in the case of banks that
    meet the bad debt coverage and capital requirements and bring
    their NPL rates below 2.5%.  Such banks do not need prior
    permission from BOMA to introduce specified new banking
    services.  This benefit will help sound banks to quickly
    offer new services in the marketplace.  Foreign banks enjoy
    this benefit as well as local ones.

    ¶13.  The FRF has helped eight credit coops transform
    themselves into banks.  BOMA allows these eight new banks and
    community-level financial institutions to relocate branch
    offices provided their NPL rate is below 5%.

    Credit Coop Incentives
    -----------------------
    ¶14.  BOMA is also trying to encourage community-level Credit
    Cooperative Associations (CCA) to improve their quality.
    CCAs may only operate in a county or city where no other CCAs
    exist.  An existing CCA may expand to two neighboring
    counties or cities if its capital adequacy exceeds 12%, its
    NPL rate is below 1%, and its bad debt coverage is 100%.  A
    CCA may expand to a single neighboring county or city if is
    capital adequacy is 10%, its NPL is 2% and its bad debt
    coverage exceeds 40%.

    And Sticks
    ----------
    ¶15.  BOMA also has some penalties in hand for banks which
    fail to meet the new targets.  If a bank's NPL ratio exceeds
    5%, it will be subject to the following:

    -- Restrictions on establishing branches;
    -- Limits on compensation paid to Board Members;
    -- Limits on dividend payouts to shareholders;
    -- Restrictions on investments in non-financial firms; and
    -- Limits on loans or loan guaranties to related persons.

    If the NPL ratio exceeds 15%, a bank faces the following
    penalties:

    -- Restrictions on providing banking services to high-risk
    clients;
    -- Restrictions on offering high interest rates for deposits;
    -- BOMA may reduce the number of branches; and
    -- BOMA may require removal of Board members and/or bank
    managers.  (Note:  On June 26, the FSC announced that it has
    ordered the Hualien Business Bank to dismiss the majority of
    its Board Members for making improper loans to business and
    personal associates.  End Note.)

    Comment
    -------
    ¶16.  In the wake of the failure to sell off Changhwa bank as
    originally planned, the government continues to make measured
    moves to encourage bank consolidation.  The market is
    evaluating a wealth of M&A opportunities.  It seems highly
    unlikely that the first benchmark of the financial reform
    plan -- a foreign bank operating a state-owned bank this year
    -- will be met.  Foreign banks are unwilling to pay domestic
    prices for a financial institution.  The second benchmark --
    cutting back to 6 state-owned banks this year -- is clearly
    within reach.  Changhwa Bank will probably be taken over by a
    consortium of domestic banks in the near future and, as
    suggested by the AmCham seminar participants, the government
    is moving to merge ICBC and Chiao Tung Bank.  Over the next
    several months Taiwan's smaller and weaker banks will come
    under increasing pressure to consolidate with other
    institutions.  It may not happen as quickly as some in the
    government would like, but some bank consolidation appears to
    be a real possibility in 2005.  The third benchmark --
    halving the number of Financial Holding Companies -- is not
    due until next year and is unlikely to be addressed until
    then.
    KEEGAN

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