Taiwan Financial Industry- Challenges and Opportunities

1. December 2006 Sophia Cheng >> Research AnalystMerrill Lynch (Taiwan) +886 2 2376 3732 sophia_cheng@ml.com Taiwan Financial Industry- Challenges and Opportunities No part of this report may be used or reproduced or quoted in any manner whatsoever in Taiwan by the press or other persons. Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on pages 32. Global Securities Research & Economics Group Global Fundamental Equity Research Department

2. Taiwanese banks: low valuation in the region • Still recovering from consumer debt problem • Gradual profit improvement in 2007 • Need to find next areas of growth • Follow your clients • Management clients’ wealth How to improve? Source: Merrill Lynch estimates

3. GDP growth: Taiwan lags other emerging Asian markets Source: Merrill Lynch estimates

4. Credit Penetration: Total Loans as a Percentage of GDP (%) Source: Central Bank Data, Merrill Lynch estimates Note: Most data end-2005, some end 2004, some ML estimates

5. Deposit Penetration: Total Deposits as a Percentage of GDP (%) Source: Central Bank Data, Merrill Lynch estimates Note: Most data end-2005, some end 2004, some ML estimates

6. Too much surplus liquidity Source: CBC, TEJ

7. Consumer credit outgrow corporate loans Source: Central Bank Data, Merrill Lynch estimates

8. Margins remain thin Benchmark rate gapbetween TW and US Source: CBC, Merrill Lynch

9. Three areas to grow • Wealth management • Treasury products • Overseas operations Source: Company reports, Merrill Lynch

10. Non-loan business gaining importance

11. Taiwan households hold US$1.3tn assets Asset allocation in cash & deposit Taiwan: 41% USA: 30% Source: Central Bank, CEIC

12. Wealth Management & FX/Derivatives Sources: Company Data, Merrill Lynch estimates

13. FX – With Customers Sources: Company Data, Merrill Lynch estimates

14. 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% Sources: Company Data, Merrill Lynch estimates

15. Taiwan corporate investing the most to China (HK + China already 41%) TW-China supervision MoU not signed

16. Taiwan is the biggest FDI in Vietnam 13% of Vietnam foreign direct investment comes from Taiwan in 2002-Aug06

17. 2005 Premium Income NT$ bn $461 400 3.4x 350 300 $62 250 2.2x 200 150 $12 1.5x 100 $270 1.9x 50 0 $258 $127 Nan Shan Prudential ING Aetna China Life Fubon FHC Cathay FHC 1.5x 1.4x Shin Kong FHC $27 Mercuries Life China Post Office President Alliance 0.9x $127 $198 $96 $216 1.4x $65 2x 1.2x 1.4x 1.6x $91 $591 1.3x 3.1x $141 $26 $17 $111 $15 $14 $44 1.6x $21 $24 $10 $24 $138 1.5x 1.2x 1.2x 0.8x $9 $6 $3 1.1x 0.7x 1.2x 1.6x 0.9x 0.9x 1.0x 0.2x 5x 0.6x 2005 Direct Written $75 Premium NT$bn 1.2x $270 $132 2.0x 1.9x $216 1.4x 45 $91 $111 $17 1.3x $24 1.2x $16 $25 $22 $44 0.9x 4.5x 1.0x 0.8x 1.1x 3.4x 1.4x 1.6x 1.1x $4 1.6x $461 $6 $246 22 Government-related Banks New Private Banks FHC Old Private Banks 0 Taian Union Newa Central Zurich Ming Tai Mega FHC Fubon FHC Cathay FHC Taiwan financial institutions landscape Banks Life Insurance Asset Managers Foreign competition increasing Currently overpriced No single company big enough to deliver transforming transaction Life Insurance dominated by Cathay Group Larger banks are largely government controlled AIG-owned 591 3.1x Market Share of AUM Mid-sized private banks likely to lead to consolidation (1) Remaining life insurers are small and some are capital constrained Reported NPLs (%) 141 1.9x 216 1.4x Securities P&C Insurance P&C Insurance dominated by Fubon Increasing consolidation expected; led by Yuanta and Fubon (2) Remaining P&C insurers are small and some are capital constrained $216 1.4x 3.2 0.5x 5.8 0.9x 258 1.4x ____________________ Non-classified financial institutions (e.g. China Development, Waterland FHC) not included Figures in blue represent market cap in NT$ bn. Figures in greenrepresent 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 1

18. Mortgage loan market share Sources: Company Data, Merrill Lynch estimates

19. Taiwan vs Korea: top 5 market share Taiwan South Korea Source: Merrill Lynch estimates

20. Private banks growing fast but still small 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 Source: TEJ, Merrill Lynch

21. Government initiatives Product 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 betterIncentive for money and talents to stay - tax reform - incentive and compensation program - friendly environment Follow clients overseas - Vietnam: Taiwan banks expanding - China: indirect