2016 outlook: stay away from the banks (2884 TT) Buy...

See important disclosures, including any required research certifications, beginning on page 47

Taiwan Financials

What's new: Given the rising macro headwinds that we see for Taiwan in

2016, we are downgrading our sector rating to Negative from Neutral. We

are also cutting our TPs for all the stocks in our universe and downgrading

ratings for Fubon FHC (2881 TT, TWD39.65, Outperform [2], from Buy [1]),

E.Sun FHC (2884 TT, TWD18.40, Underperform [4], from Outperform [2])

and First Financial (2892 TT, TWD14.85, Sell [5], from Underperform [4]).

What's the impact: Downside risks don't appear fully priced in yet,

given the ongoing share price corrections, which we see as being driven

mainly by concerns about the weakening CNY, rising default risks on high-

yield bonds and Taiwan’s sluggish 2016 GDP growth outlook. But

compared with Daiwa’s economics forecasts, the market still looks

optimistic on the Taiwan macro indicators for the year – it expects the

USD:CNY rate and Taiwan’s GDP growth to settle at 6.7 by end-2016 and

2.2% YoY for 2016, respectively, vs. our forecasts of 7.5 and 1.6% YoY. We

also believe that the impact of 2 likely CBC rate cuts this year, and the

banks’ rising NPLs/credit costs, are not yet fully priced in.

Banks are more fragile than the insurers. We expect excess liquidity

conditions in the system to intensify in 2016, putting pressure on bank

NIMs. Also, the depreciating CNY should continue to cap CNY deposit

growth and loan growth, while leading to a greater default risk on the

banks’ Treasury Market Unit (TMU) business. And lower loan recoveries

and higher NPLs could drive up credit costs further. Meanwhile, fee income

growth should hold up better, but it could only be a drop in the bucket.

Insurers: a light in the dark. A weaker TWD:USD exchange rate and

steepening yield curve as a result of the Fed’s rate hike cycle should lend

some support to the insurers’ earnings. Worries about the volatile global

equity market and the rising risk of defaults on high-yield bonds and the

resulting impact on earnings growth are justified but priced in, in our view.

What we recommend: We don’t think the time has come to revisit the

sector, as we see more downside risks looming. Our EPS forecasts are

now 5-20% below the street for all the stocks that we cover except for

Cathay FHC (2882 TT, TWD39.95, Buy [1]), given its shorter asset

duration, which will allow it to benefit more from further Fed rate hikes, its

large USD position and its lower exposure to high-yield bonds. The main

upside sector risks: lower-than-expected credit costs and higher-than-

expected loan growth, investment returns, and policy rate. How we differ

: We are more bearish than the market on the banks as a result of our

below-consensus 2016 macro forecasts for Taiwan and China.

11 January 2016

Taiwan Financial Sector

2016 outlook: stay away from the banks

Given the concerns about Taiwan’s increasing macro headwinds, we downgrade our rating on the sector to Negative from Neutral

Compared to the Taiwan insurers, the banks are more sensitive to macro downgrades. Downside risks for banks don’t seem fully priced in

Investors should keep away from the banks and take shelter in the insurers, particularly Cathay FHC, which is our top sector pick

Key stock calls

Source: Daiwa forecasts

Christie Chien(886) 2 8758 6257

[email protected]

New Prev.

Cathay Financial Holdings (2882 TT)Rating Buy Buy

Target 53.60 62.20

Upside p 34.2%

Fubon Financial Holding (2881 TT)Rating Outperform Buy

Target 44.30 61.00

Upside p 11.7%

E.Sun Financial (2884 TT)Rating Underperform Outperform

Target 16.40 20.80

Downside q 10.9%

CTBC Financial (2891 TT)Rating Underperform Underperform

Target 14.30 18.20

Downside q 10.6%

First Financial (2892 TT)Rating Sell Underperform

Target 11.70 15.20

Downside q 21.2%

2

Taiwan Financial Sector: 11 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Taiwan Financial Sector: ROAE

The ROAEs for Taiwan’s financial holding companies

(FHCs) are likely to fall from 12.2% for 2015E to 10.5% for

2016E and pick up modestly to 11.3% for 2017E. For the

stocks under our coverage, we forecast the average ROAE

for the bank-centric FHCs to drop from 11% for 2015E to

9.6% for 2016E, while that for the insurance-centric FHCs

to fall from 14.8% for 2015E to 12.3% for 2016E. The

Central Bank of China’s (CBC) likely rate cuts, dim GDP

outlook, impact of China’s economic slowdown and CNY

depreciation, lower investment returns on the back of

volatile market conditions and rising default risks on bonds

all paint a gloomy 2016 growth outlook for the sector. The

upward trend in the USD and the Fed’s tightening cycle are

positive factors, but may not be able to offset the drags.

Source: Bloomberg, Daiwa forecasts

Valuation Taiwan Financial Sector: 12-month rolling PBR

The Taiwan FHCs are trading currently at 1.0x 12-month

rolling PBR, lower than the past-10-year average of 1.3x.

Among the stocks that we cover, Mega FHC has the lowest

absolute 12-month rolling PBR of 0.9x. Given our lower

ROE forecasts for the sector for 2016E, we are also cutting

our target PBRs for the sector. For the bank-centric FHCs,

our target PBRs come in at 0.8-1.0x, while those for the

insurance-centric FHCs are 1.3-1.5x (down from 1.0-1.3x

and 1.4-1.7x, respectively, from our previous target

forecasts).

Source: Bloomberg, Daiwa

Earnings revisions Taiwan Financial Sector: revisions to consensus 2016 net profit forecasts

The Bloomberg consensus 2016E earnings for Fubon FHC

and Cathay FHC are 16-34% higher now compared to the

beginning of 2015. On the other hand, the forecasts for

Mega and First Financial are 5.1% and 7.2% lower,

respectively, compared to the forecasts made in early-

2015. Meanwhile, the forecasts for E.Sun and CTBC have

remained fairly stable.

For the sector as a whole, consensus expectations favour

the insurance-centric FHCs over the bank-centric FHCs, in

line with our view that the insurers are likely to hold up

better than the banks given macro headwinds. For the

bank-centric FHCs, however, we see risks of further

downward forecast revisions.

Source: Bloomberg, Daiwa

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Fubon Cathay MegaCTBC First E.Sun

(2015/01/01=100)

3


Sector stocks: key indicators

Source: Bloomberg, Daiwa forecasts

Daiwa’s: key forecast changes for 2016 (banks and insurers)

Old forecast New forecast Reason for the change

NIM expansion 2 to 7bps -3 to 2bps The CBC is now likely to deliver 2 additional 12.5bps rate cuts in 2016, versus no rate cuts under Daiwa's previous forecasts.

Loan growth 0 to 10% -2 to 7.5% TWD loan growth could come in lower, in the range of -3% to 3% (down from 0-5%), except for E. Sun Bank, on the back of likely lacklustre GDP growth for 2016.

Deposit growth 3 to 5% 4 to 8% Many companies/individuals would rather sit on heavy cash positions than take the risk of investing amid the gloomy economic outlook. The upward trend in the USD also encourages more USD savings.

Fee income 0 to 10% 5 to 15% Lower loan growth, higher deposit growth implies that the banks will be flooded with excess savings. This could create a good environment for the banks to promote their wealth management products.

NPL ratio

After hedged investment yield

Hedging cost

0.2 to 1%

4.5%

60-90bps

0.2 to 1%

4.0-4.2%

50-60bps

We still see a risk of NPLs rising amid sluggish economic growth, despite the NPL ratio for 2015 coming in lower than expected. As such, we keep our 2016 NPL forecasts unchanged.

We revise down our investment yield forecasts on concern of more volatile market conditions and rising default risks on high-yield bonds.

Better hedging performance on the back of a weaker TWD:USD exchange rate.

Source: Daiwa’s forecasts

Taiwan Financial Sector: key assumptions and valuation changes

Beta value Cost of equity 2016E ROE Implied 2016E P/B Target price Rating Share price as of 8 Jan

old new old new old new changes old New

Cathay FHC 1.04 11.3 12.2 11.1 1.7 1.5 62.2 53.6 -13.8 Buy Buy 39.95

Fubon FHC 1.15 12.2 15.3 13.5 1.4 1.3 61.0 44.3 -27.4 Buy Outperform 39.65

Mega FHC 0.84 9.7 11.6 10.1 1.2 1.0 26.7 21.0 -21.3 Hold Hold 20.25

E.Sun FHC 0.87 10.0 12.1 10.3 1.3 1.0 20.8 16.4 -21.2 Outperform Underperform 18.40

CTBC FHC 0.92 10.3 11.1 10.1 1.1 0.9 18.2 14.3 -21.4 Underperform Underperform 16.00

First FHC 0.86 9.9 9.1 7.5 1.0 0.8 15.2 11.7 -23.0 Underperform Sell 14.85


Taiwan Financial Sector: rating summary

Rating Target price (TWD) Rationale for making changes in rating and/or target price

New Prev. New Prev.

Cathay FHC Buy Buy 53.6 62.20 Fed’s rate hike cycle and the upward trend in the USD should continue to support Cathay FHC's earnings; reiterate Buy (1) rating.

Fubon FHC Outperform Buy 44.3 61.00 Cutting our TP and downgrading Fubon FHC to Outperform (2) over concerns in the market about its higher exposure to high-yield bonds vs. Cathay. But the recent sell-off looks overdone to us and we still like this stock on valuation grounds.

Mega FHC Hold Hold 21.00 26.67 Tighter USD liquidity in 2016 should lend some support to Mega FHC's earnings given its large exposure to USD. Accordingly, we maintain our Hold (3) rating but cut our TP on the back of Taiwan’s current gloomy macro environment.

E.Sun FHC Underperform Outperform 16.4 20.80 High earnings growth rate for E.Sun FHC is unlikely to be sustainable in 2016, amid the rising macro headwinds. Accordingly, we are downgrading the stock to Underperform (4) and cutting our TP.

CTBC FHC Underperform Underperform 14.30 18.20 CTBC FHC’s expansion plan seems inappropriate to us. We also see a lack of growth momentum for its core earnings amid the increasing macro risks. As such, we are cutting our TP and reiterate our Underperform (4) rating on the stock.

First FHC Sell Underperform 11.70 15.20 We think First FHC will not benefit at all from any of the CBC rate cuts that we see in 2016 and we see no other short-term positive catalysts for the stock. Accordingly, we downgrade the stock to Sell (5) from Underperform (4) and cut our TP.


Share

Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg

Cathay Financial Holdings 2882 TT 39.95 Buy Buy 53.60 62.20 (13.8%) 4.678 4.415 6.0% 3.924 4.433 (11.5%)

CTBC Financial 2891 TT 16.00 Underperform Underperform 14.30 18.20 (21.4%) 1.757 1.685 4.3% 1.648 1.852 (11.0%)

E.Sun Financial 2884 TT 18.40 Underperform Outperform 16.40 20.80 (21.2%) 1.641 1.649 (0.5%) 1.674 1.938 (13.6%)

First Financial 2892 TT 14.85 Sell Underperform 11.70 15.20 (23.0%) 1.437 1.196 20.1% 1.190 1.330 (10.5%)

Fubon Financial Holding 2881 TT 39.65 Outperform Buy 44.30 61.00 (27.4%) 6.223 6.363 (2.2%) 4.802 6.083 (21.1%)

Mega Financial 2886 TT 20.25 Hold Hold 21.00 26.67 (21.3%) 2.419 2.302 5.1% 2.195 2.459 (10.7%)

Rating Target price (local curr.) FY1

EPS (local curr.)

FY2

4


Table of contents

Executive summary: stay away from banks ........................................................... 5

Increasing macro headwinds are a challenge ....................................................................5

Coping with uncertain macro environments .......................................................... 7

Interest rates: a diverging trend .........................................................................................7

Exchange rates: USD rally, a depreciating TWD and CNY .............................................. 11

GDP growth: lingering at a low level ................................................................................ 14

Valuations ................................................................................................................18

Sector trading below its past-10-year average PBR ......................................................... 18

Lower PBR for the sector ................................................................................................. 18

Risks to our investment case .................................................................................20

Changeable macro environment ...................................................................................... 20

Company Section

Cathay Financial Holdings ............................................................................................... 21

Fubon Financial Holding .................................................................................................. 25

Mega Financial ................................................................................................................ 29

E.Sun Financial................................................................................................................ 33

CTBC Financial................................................................................................................ 37

First Financial .................................................................................................................. 41

5


Executive summary: stay away from banks

Increasing macro headwinds are a challenge

Daiwa’s economics team expects Taiwan’s GDP growth to settle, uninspiringly, at 1.6%

YoY for 2016E. The Central Bank of China (CBC) could deliver two more 12.5bps rate cuts

in 2016, and the TWD could depreciate to 34.7 against the USD by end 2016 (see

“Outlook for 2016-17: coping with hard times”, and “CBC’s second rate cut bodes ill for

Taiwan” for the further details). In this report, we discuss how the impact of current macro

conditions, including the diverging interest rate trend (ie, the Fed is likely to deliver rates

hike while the CBC is cutting the policy rate), weak GDP growth and exchange rate

environment will affect Taiwan’s financial sector.

Banks: being hit with a harsh dose of reality We expect lower loan growth for 2016 given the dimmer economic outlook. Deposit

growth, on the other hand, could hold up better as firms/individuals could prefer to hold

heavy cash positions rather than taking a risk and investing amid such a gloomy economic

outlook. The banks will be once again forced to sit on excess liquidity this year, which

undermines the efficiency of their earnings, in our view. Even worse, potential CBC rate

cuts should exacerbate the problem of excess liquidity. We were expecting the banks’

NIMs to expand by 2-7 bps, but now see this number at -3 to 2bps. On the bright side,

excess liquidity in the system should help banks promote their wealth management

products. We foresee fee income growth holding up better than we previously expected.

The banks’ NPL ratio for 2015 is likely to come in lower than we expected. However, we

have decided to keep our NPL numbers for 2016 unchanged despite a lower base for

2015, as we believe weak GDP growth for Taiwan will continue to put pressure on asset

quality. Given that the overseas branches of the Taiwan banks are mostly concentrated in

developing Asia, with just a few located in the developed markets, the banks’ asset quality

is also likely to be exposed to the economic slowdown in the emerging markets this year.

Taiwan Banks: Daiwa’s key forecast changes for 2016

Old forecast New forecast Reason for the change

NIM expansion 2 to 7bps -3 to 2bps CBC is now likely to deliver two additional 12.5bps rate cuts in 2016, versus no rate cuts under Daiwa's previous forecasts

Loan growth 0 to 10% -2 to 7.5% TWD loan growth could come in lower, in the range of -3% to 3% (down from 0-5%) on the back of likely lacklustre GDP growth for 2016

Deposit growth 3 to 5% 4 to 8% Many companies/individuals would rather sit on heavy cash positions than take the risk of investing amid the gloomy economic outlook. The USD rally trend also encourages more USD savings

Fee income 0 to 10% 5 to 15% Lower loan growth, higher deposit growth implies that the banks will be flooded with excess savings. This could create a good environment for the banks to promote their wealth management products

NPL ratio 0.2 to 1% 0.2 to 1% We still see risk of NPLs rising amid sluggish economic growth, despite the NPL ratio for 2015 now coming in lower than expected. As such, we have decided to leave our 2016 NPL forecasts unchanged

Source: Daiwa’s forecasts

Insurers: a light in the dark

The key macro trends that have benefitted the insurers, including the Fed’s rate hike cycle,

the upward trend in the USD and regulatory easing, are not affected by Taiwan’s weak

GDP outlook. Although the CBC’s potential rate cuts will push down the yield on domestic

bonds, we believe any losses could be offset by higher FX gains on the back of a weaker

TWD:USD exchange rate. The insurers could also cut their domestic bond positions and

switch to overseas assets to avoid being hit by the CBC rate cuts. We believe Cathay

should continue to do well in 2016 and reiterate our Buy (1) call on the stock. While

Fubon’s core business looks likely to remain solid in 2016, its larger risk appetite could

lead to higher volatility risks amid the increasing macro uncertainty. As such, we are

downgrading the stock from Buy (1) to Outperform (2).

Sell the banks; take

shelter in the insurers

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/Taiwan_Economy-_151130.pdf#page=1

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/20151217tw_Taiwan_Economy-.pdf#page=1

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/20151217tw_Taiwan_Economy-.pdf#page=1

6


Switch from the bank-centric FHCs to insurance-centric FHCs

Most of the bank-centric FHCs that we cover are trading in line with their past-10-year

average PBRs now. However, we still think it is not yet time to revisit the banks. We

suggest investors switch from the banks to the insurers. And our top sector pick is Cathay

FHC, for which we again reiterate our Buy (1) call, although we cut our target price for the

stock from TWD62.2 to TWD53.6, as we are revising down our investment yield forecast

from 4.5% to 4.2% for 2016.

7


Coping with uncertain macro environments

Interest rates: a diverging trend

The Fed’s funds rate is rising on the back of ongoing tightening moves. However, at the

same time, CBC looks more likely to deliver additional rate cuts (Daiwa’s economics team

looks for two 12.5bp rate cuts in 2016E) as Taiwan’s GDP growth is likely to remain

lacklustre in 2016. Diverging domestic and overseas interest rate trends are likely to have

a different impact on the banks and insurers.

Banks: drags outweigh the benefits

Diverging interest rate trends in the US and Taiwan will allow the Taiwan banks to enjoy

wider spreads on their USD lending, especially on the back of the Fed’s next round of

tightening, but they could suffer from a narrower spread on domestic lending and a

shortfall in investment gains. The net impact on bank NIMs, on our estimates, is tilted to

the downside. Our previous model expected bank NIMs to expand by 2-7 bps, but we now

expect changes of -3 to 2 bps for 2016.

Diverging lending spreads: lower spread for TWD loans to be a larger drag

The USD lending spread has gradually improved on the back of the tighter USD liquidity,

as we expected (see “favour insurance-centric FHCs”, published on 16 April 2015), and we

believe this trend will be sustained in the future. For the banks that we cover, the foreign

lending spread has continued to improve since 1Q15. And foreign currency loans (mostly

in USD) account for a notable share of the total lending for Taiwan’s banks (15-40%), an

important contributor to their interest income. Thus, the banks that have a higher share of

foreign currency lending are in a better position to gain from the trend. For the banks that

we cover, Mega Bank has the highest share of USD loans, while Cathay United Bank has

the lowest.

Taiwan Financial Sector: Lending spread

Source: Company, Daiwa

However, earnings downside has emerged since the CBC made 2 policy rate cuts in

September and December 2015. Daiwa now expects the CBC to deliver two more 12.5bps

rate cuts in 2016, on the back of the sluggish Taiwan GDP growth outlook for 2016,

implying that the TWD lending spread should deteriorate further. The table below

summarises the impact of the change in the lending spread (assuming the foreign currency

lending spread expands by 10bps while the TWD lending spread narrows by 10bps).

1.5

1.6

1.7

1.8

1.9

2.0

3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15

Foreign currency lending spread Overall lending spread

(%)

NIMs will come under

pressure if the CBC cuts

rates in 2016

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/20150416tw_Taiwan_Financial_Sector.pdf#page=1

8


Taiwan Financial Sector: FX loans as a % of total loans (as at end 3Q15)

Taiwan Financial Sector: scenario analysis: the impact of changes in the lending spread

TWDm

FX lending spread up by

10bps

TWD lending spread down by

10bps Net

impact FHC's PPOP

for 2016E

% of 2016E PPOP for the FHC

CUB 155 -987 -832 67,119 -1.2

TFB 245 -919 -674 68,483 -1.0

E.Sun 169 -827 -658 18,965 -3.5

Mega 645 -1151 -506 41,729 -1.2

First 335 -1169 -834 21,677 -3.8

CTBC 461 -1135 -674 39,579 -1.7

Source: Company, Daiwa Note: CTBC Bank had the highest foreign currency loan share of 46.6% as at end 3Q15, but

mostly comprised JPY loans from the Tokyo Star Bank it acquired in 2014, rather than USD loans.

Source: Daiwa forecasts Note: Based on the figures for end-9M15. CUB= Cathay United Bank. TFB= Taipei Fubon Bank

A lower return from NCDs

Unlike the insurers that are long-term investors, the investments made by the banks in

general are short term in nature and comprise a larger domestic proportion. One popular

investment tool for the banks are certificates of deposit (including negotiable certificates of

deposit, or so-called NCDs) issued by the CBC. As at the end of 3Q15, the outstanding

amount of these NCDs issued accounted for 11.2% of the total assets held by Taiwan’s

financial institutions. For the banks that we cover, the number is smaller, ranging from 0-

9% of total assets, as at the end of 9M15.

Given that excess liquidity has long been an embedded structural problem for Taiwan, the

interest rate on NCDs has been low. And conditions have deteriorated further on the back

of the CBC’s surprise rate cuts in September and December. The average interest rate for

91- to 180-day NCDs dropped from 55bps for August to 43 bps for November 2015.

Facing the challenge of a lower return on NCDs, a direct solution for the banks would be to

switch their investments elsewhere or simply cut their positions. However, given the excess

liquidity backdrop, in addition to the capital requirement limit on holding risker assets, the

banks may have to succumb and accept a lower return on NCDs going forward. On our

estimates, a 10bps drop in the NCD interest rate could drag earnings down by TWD0-

310m, which would be equivalent to 0-0.8% of the FHC’s 2016E PPOP, all else being

equal.

Taiwan Banks: NCDs as a % of the banks’ total assets NCD interest rate: 91 to 180-day products

Source: Companies Source: CEIC, Daiwa

46.6

40.4

22.4 21.5

17.013.6

0

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50

CTBC Bank Mega Bank First Bank Taipei FubonBank

E.SUN Bank Cathay UnitedBank

(%)

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9

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(%)

Banks will earn a lower

interest rate from NCDs

as the policy rate falls

9


Insurers: benefits outweigh the risks

We think that future interest rate trends will affect the insurers in 4 main ways, namely: 1)

uninspiring returns on domestic bond investments, 2) greater returns on overseas bond

investments, 3) a moderate increase in hedging costs, and 4) a higher default risk on high-

yield bonds. We believe the benefits of a rising overseas bond yield should outweigh any

earnings downside that the insurers might face in 2016.

Gains on overseas bond yield should outweigh the downside

Based on the insurers’ investment portfolios and asset durations as at the end of 3Q15 (8.8

years for Cathay and 13 years for Fubon), we estimate that a 10bp decrease in the

domestic bond yield would result in a respective loss of TWD45m for Cathay Life and

TWD43m for Fubon Life. On the other hand, a 10bp increase in the overseas bond yield

would lead to a respective gain of TWD256m for Cathay Life and TWD101m for Fubon Life.

The Taiwan Government 10-year bond yield hit a record low of 0.98% on 24 December

2015, after the CBC announced a rate cut on 17 December. Since the bond yield has

already hit a record low level, any further downside looks limited for the domestic bond

yield, in our opinion, despite 2 more likely policy rate cuts of 12.5bps each in 2016. We

only see a 15bps decline in the domestic bond yield in 2016.

On the other hand, the current US 10-year Treasury yield of 2.3% remains far below its

past 10-year average of 3.2%, implying that there is a lot of room for the yield to go higher.

Our US chief economist, Mike Moran, expects the Fed to deliver three 25bps rate hikes in

2016. And we have factored in a 70bps increase in the US 10-year Treasury yield for 2016.

On our estimates, the net gain from this would be TWD1,721m for Cathay Life (2.5% of

Cathay FHC’s PPOP) and TWD640m for Fubon Life (0.8% of its PPOP).

Taiwan Government bond and US Treasury yields (10-year) Taiwan Insurers: investment portfolio as at end-3Q15

Cathay Life Fubon Life

TWDbn % TWDbn %

Cash & cash equivalent 86.3 1.9 172.5 6.3

Equity- domestic 352.4 7.7 213.0 7.8

Equity- international 256.3 5.6 172.0 6.3

Bond- domestic 394.0 8.6 564.3 20.5

Bond- international 2240.3 49.0 1304.0 47.5

Mortgage & secured loans 488.5 10.7 82.9 3.0

Real estate 489.1 10.7 185.7 6.8

Others 268.5 5.9 53.3 1.9

Total 4575.4 100.0 2747.7 100.0

Source: CEIC, Daiwa Source: Company, Daiwa

A rise in the interest rate would push up the insurers’ earnings, but it would also result in

mark-to-market losses on their balance sheets, as an increase in the bond yield would lead

to a drop in the bond price. While we agree that bonds categorised as available-for-sale

(AFS) are likely to record some mark-to-market losses, we note that most of the bonds that

the insurers own (60-80%) are in the held-to-maturity (HTM) category, and are not subject to

market price changes. As such, we believe that any AFS-related losses would still be

manageable for the insurers. For the insurers that we cover, Cathay Life is relatively more

insulated to the risk of having large mark-to-market losses, given that a smaller proportion of

its assets are categorised as being in the AFS category (26.5% vs. 53.2% for Fubon Life).

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Dec

-15

Taiwan government 10-yr bond yield US 10-yr treasury yield

(%)

Downside for the

domestic bond yield to

drop further should be

limited while it seems

like there is plenty of

room for the overseas

bond yield to rise

10


Taiwan insurers: AFS assets as a % of total assets


Moderate increase in hedging costs should remain manageable Having a diverging interest rate trend could also lead to a higher hedging cost, as the price

of cross currency swaps (CCS) is highly correlated to the difference between US and

Taiwan bond yields. However, we believe the risk to the insurers remains manageable at

this stage, given that the scale of the Fed’s rate hikes are likely to be small. Daiwa’s

economist Mike Moran expects the Fed funds target rate to reach 1.13% by end-2016, only

1pp higher than the current level.

The overall hedging environment still looks more benign than in the past (see the following

chart) given the build-up of FX reserves (TWD17.6bn for Cathay Life and TWD6.4bn for

Fubon Life, as at the end of 3Q15) and the ongoing rally in the USD. We expect the

hedging cost to come in at 50bps for Cathay Life and 60bps for Fubon Life in 2016.

Taiwan insurers: Hedging costs


(Note: since 2012, the Financial Supervisory Commission [FSC] has allowed the Taiwan

life insurers to build up FX reserves under liabilities to absorb 50% of their FX losses rather

than directly hitting the P&L, which gives the insurers more flexibility in managing their FX

risks and reducing their hedging cost.)

Concerns about rising default risks on high-yield bonds could be overdone

In early December 2015, before the Fed delivered its first rate hike on 17 December, the

share price for Cathay and Fubon started correcting, due mainly to concerns in the market

about their high-yield bond investment positions. These concerns are justified in our view,

as the higher US interest rate means that investors are likely to have started pulling some

money out of the emerging markets, making it harder for businesses in general in these

markets to get finance and increasing the risk of these companies defaulting on their bonds.

But we believe the risk to the insurers remains manageable, however, as high-yield bonds

account for a limited proportion of their investment portfolios. For Cathay Life, high-yield

bonds (including energy-related bonds that have a higher default risk on the back of falling oil

20

25

30

35

40

45

50

55

60

65

1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15


(% of total assets)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

E

2016

E

2017

E

Fubon Cathay

Implementation of FX reserves

(%)

We expect hedging

costs to increase

modestly in 2016, but

remain lower than the

level seen before 2012

Cathay Life is less

exposed to high-yield

bonds

11


prices) account for just less than 2% of its total investments, while for Fubon Life, the number

is around 7%, on our estimates. But this level remains manageable for both, in our view.

Exchange rates: USD rally, a depreciating TWD and CNY

Daiwa’s economics team expects the TWD to keep sliding against the USD going forward

and settle at 34.70 against the USD by end-2016 and at 35.50 by end-2017, implying 4.8%

and 2.3% depreciation for 2016 and 2017, respectively (see “Coping with hard times”,

published on 30 November 2015). Meanwhile, the CNY is also under pressure on the back

of the upward trend in the USD. Daiwa’s Asia ex-Japan chief economist, Kevin Lai (who

assumes that China will end up muddling through debt deflation and a currency crisis, with

some impact on its Asia peers) expects the USD:CNY exchange rate to reach 7.50 as at

end-2016 (see “Crowded entry, jammed exit”, published on 9 September 2015). The

market seems to be hoping for a weaker TWD to boost the earnings of the financial sector,

but worries about the falling CNY are having a negative impact. We see a depreciating

TWD and CNY as having a different impact on the banks and insurers.

Banks: not all rosy

The value of banks’ USD assets has been lifted on the back of the USD rally over the past

year. But a potential drop in USD loan growth, lacklustre CNY loan growth, and the drag

from their Treasury Market Unit (TMU) businesses are concerns for the Taiwanese banks.

USD rally: mixed picture for the banks

The upward trend in the USD implies that the interest income earned by the Taiwan banks

in USD dollar terms will immediately be valued higher, given that the TWD is the reporting

currency for the Taiwanese banks. Likewise, the value of their investment returns

denominated in USD will be lifted. But unlike the insurers, where more than half of their

investment assets are allocated overseas (mostly in the USD), banks in general hold a

relatively smaller share of overseas assets, limiting the upside from which the banks can

benefit as a result of the upward trend in the USD.

Taiwan Banks: USD assets as a % of total assets


The USD rally is not all roses for the banks, however. It hits the public’s willingness to

borrow in USD while encourages the public to save more in USD terms. Over the past few

years as the USD has continued to weaken, a popular speculative trade is to borrow in

USD and exchange it into other appreciating currency, such as CNY, to take advantage of

the exchange rate divergence. Given that the currency trends have now reversed, the

above carry trade is becoming unpopular, especially after the PBOC devalued the currency

on 19 August 2015.

We were expecting USD supply and demand to somehow strike a balance as tighter global

USD liquidity and a gradually improved G3 economy somewhat filled the loan demand gap

(see “Favour insurance-centric FHCs”, published on 16 April 2015). But over the past few

months, it seems that the balance has tilted toward the supply side, with the supply of USD

outweighing USD loan demand. Mega Bank, the sole USD clearing bank and a major USD

33.5

24.8

19.316.6 15.8

9.5

0

5

10

15

20

25

30

35

40

Mega Bank CTBC Bank E.Sun Bank First Bank Taipei Fubon Bank Cathay United Bank

(% of total assets)

Banks are often less

exposed to USD

compared to insurers

Banks are now flooded

with excess USD

liquidity


http://asiaresearch.daiwacm.com/eg/cgi-bin/files/China%20Economy-Crowded_150909.pdf#page=1

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/20150416tw_Taiwan_Financial_Sector.pdf#page=1

12


lender in Taiwan, has seen its USD deposit growth outweigh its USD loan growth to a large

extent (36.2% and 6.9% YoY, respectively, for 3Q15), dragging down its USD loan-to-

deposit ratio (LDR) from 96.1% for 3Q14 to 75.4% for 3Q15 (note: the LDR ratio we use

here excludes inter-banking activities). A lower LDR ratio implies lower efficiency in utilising

the assets it holds, putting its margins under pressure.

Mega Bank: USD loan and deposit growth

Source: Company, Daiwa Note: Inter-banking related activities are excluded from the statistics.

To make better use of the excess USD liquidity, banks can offer a lower lending rate to

bolster loan demand, channel the liquidity to the inter-banking market, promote the sale of

wealth management (WM) products, and become more involved in USD denominated

investments. The first 2 actions would narrow the scale of margin improvement amid a

rising USD interest-rate trend. The third choice, engaging in more overseas investment,

could be both good and bad, as it would largely depend on how a bank manages its

portfolio. It could lead to the “trading & other income” account in the P&L statement

becoming more volatile going forward.

In our view, promoting the sale of wealth management products is the best option for the

banks, ie, using higher fee income to fill the earnings gap left by margin deterioration. But

depending on WM sales to digest all excess liquidity is not practical, however, as global

markets could face more uncertainty in 2016, which would discourage depositors from

buying WM products. We believe banks would try to sell their WM products first when

dealing with excess liquidity, but would still have to use the other 3 tools and succumb to

some margin deterioration.

As the sole USD clearing bank in Taiwan, Mega Bank is more exposed to the risk of

excess USD liquidity. Our previous model called for a 4bps expansion in the NIM for Mega,

but now we see its NIM expanding by 2bps instead for 2016.

CNY depreciation

Following our discussion in the previous section, the speculative trade of borrowing in USD

and exchanging into CNY is becoming unpopular as the USD regains its strength. But

since the CNY is now weakening, can the banks not benefit from higher CNY loan growth?

Our answer to the above question is yes, but only to a limited extent, given that banks do

not hold as many CNY positions as they do USD positions (around 3-6.5% of total assets).

Banks’ CNY lending ability is also capped by slower growth of CNY deposits due to CNY

depreciation.

(10)

0

10

20

30

40

1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15

USD deposit USD Loan

(% YoY)

To digest the excess

liquidity, banks may

have to succumb to

lower NIMs

13


CNY deposits saved in Taiwan

Source: CEIC, Daiwa

CNY depreciation should continue to hit TMU business growth as most of the speculating

demand on one-way CNY appreciation declines. CNY depreciation also raises the risk of

banks increasing their provisions. Taiwanese banks usually position themselves as a

market intermediary rather than trade counterpart when selling these TMU products. A

merit of this strategy is that they don’t have to bear the risk of capital loss from the trade

itself, but can earn stable fee incomes by finding trade counterparts (usually larger global

investment banks) for their customers. However, the guarantee deposit requested by the

trade counterparts is often paid by the Taiwanese bank in advance. And when the trades

turn out to be money-losing, there is a high risk of customers just walking away and not

returning the guarantee deposit paid by the bank earlier, creating losses for the banks.

According to the Commercial Times, the PBOC’s decision to devalue the CNY by 1.9% on

11 August forced Taiwanese banks to increase their provisions by TWD190bn in total for

August to cover potential losses from the target redemption forward (TRF) deal, which is

one of a major products sold for the TMU business. Given that Daiwa’s forecast for a

continued weakening of the CNY, to 7.50 by end-2016, Taiwanese banks could be at risk of

having to raise their provisions further going forward. Most banks don’t disclose the

provision set aside for the TMU business, and thus we are unable to precisely factor in the

risk to our model. However, we believe it is a risk that cannot be ignored and see it as one

of the factors (besides a weak economic outlook) that could drive up NPL ratios in 2016.

Insurers: what matters the most is the USD/TWD rate

Insurers are a major beneficiary of the USD rally, as their unhedged USD positions will

increase in value when translated into TWD, adding FX gains and increases in the FX

reserves they hold. Having a higher amount of FX reserves will afford insurers more

flexibility to set up hedging strategies in the future. Cathay Life’s FX reserves increased

from TWD11.6bn for 2Q15 to TWD17.6bn for 3Q15, while for Fubon Life they rose from

TWD1.2bn to TWD6.4bn.

Meanwhile, we see the depreciation of the CNY having a limited impact on the insurers, as

their overseas assets are mostly denominated in USD. CNY-denominated assets usually

account for less than 10% of the overseas assets the insurers hold.

0

50

100

150

200

250

300

350

Nov

-11

Feb

-12

May

-12

Aug

-12

Nov

-12

Feb

-13

May

-13

Aug

-13

Nov

-13

Feb

-14

May

-14

Aug

-14

Nov

-14

Feb

-15

May

-15

Aug

-15

Nov

-15

(CNY bn)

CNY depreciation not

only hit on TMU

business growth, but

also raises the risk for

banks to increase their

provisions

CNY depreciation is not

a major issue for

insurers, given their

limited exposure to the

currency

14


USD rally is pushing up the FX gains for the insurers

Since most of the life insurers’ unhedged overseas assets are dominated in USD (more

than 80%, on our estimates), a stronger USD implies an immediate lift to the value of these

assets, which are calculated in TWD on the balance sheet. Some 24.8% of the FX assets

for Fubon are not fully hedged, while the figure for Cathay is higher at 40%, as at end-

3Q15. On our estimates, Cathay Life could recognise an FX gain of TWD25.4bn in 2016E,

while Fubon Life posts a gain of TWD13bn. Our calculation is based on their investment

portfolios and hedging strategies as at end-3Q15.The gains for both companies are higher

than our precious forecasts (TWD9bn for Cathay and TWD5.9 for Fubon), when we

expected the TWD to weaken to 33.00 against the USD by the end of 2016, versus our

new forecast of 34.70.

Life insurers: FX strategies Life insurers: FX reserves set aside

Source: Source: CEIC, Daiwa

Not much impact from CNY depreciation

Daiwa’s economics team forecasts the CNY to depreciate by 13.6% against the USD by

end-2016, which would reduce the value of insurers’ CNY assets. However, since the CNY

only accounts for less than 10% of the overseas assets of Cathay Life and Fubon Life, the

impact is likely to be limited. In addition, since the TWD is also depreciating against the

USD, the absolute impact of CNY depreciation should be smaller (the CNY could

depreciate against the TWD by 4.6% in 2016 in average, based on Daiwa economic team’s

forecasts).

On our estimates, Cathay Life will recognise a TWD8.2bn FX loss in 2016E while the

number for Fubon Life is TWD7.1bn, assuming that 10% of their foreign assets are held in

unhedged CNY positions. We believe the actual FX loss on CNY weakness will be smaller

than the above numbers suggest, as insurers can avoid the risk by reducing their CNY

exposure. For example, according to management, Cathay Life has already cut its CNY

exposure to 7% of its foreign assets as at end-3Q15.

GDP growth: lingering at a low level

One of the major conclusions we made in our recent report, “Outlook for 2016-17: coping

with hard time”, published on 30 November 2015, is that Taiwan is likely entering a low

GDP growth era now, in contrast to the strong rebound seen after the Asia financial crisis

(AFC) and the global financial crisis (GFC). Daiwa’s economics team foresees Taiwan’s

GDP settling at 1.6% YoY for 2016 and 2.1% YoY for 2017, which are both far from

exciting. In addition, we believe that emerging markets (EMs), including China, will endure

the challenge of money outflows. On the other hand, developed markets are expected to

post better economic growth in 2016-17.

0

20

40

60

80

100


Fully hedged Not fully hedged

(%)

11.6

1.2

17.6

6.4

0

5

10

15

20


2Q15 3Q15

(TWD bn)

We see FX gains

increasing as the TWD

weakens further against

the USD



15


Banks: dealing with a heavy blow

Lower loan growth, falling LDR and a potential rise in NPLs

Banks are relatively more exposed to the risk of lacklustre GDP growth in Taiwan, as loan

growth is highly correlated to the overall economic background. We note that both Taiwan’s

investment and consumption demand are unlikely to rebound strongly in 2016. We have

been more cautious on banks since April 2015, and expect low- to middle-single-digit TWD

credit growth for 2016 (versus middle to high single digit growth, according to most

managements). Given our dimmer GDP outlook for 2016, we now expect TWD loan growth

to come in at a range of -3% to 3% for most of the banks under our coverage for 2016. The

only exception will be E.Sun Bank, as solid home equity loan demand should continue to

bolster its TWD loan growth.

However, foreign currency loan growth could exceed TWD credit growth, as many banks

are continuing to increase their overseas exposure by increasing the number of their

overseas branches. But, given that banks’ current operating branches are mostly located in

developing regions such as Asia, the economic slowdown in the Asia region, especially in

China, would likely have an impact on foreign currency loan growth as well, in our view.

Another main channel for lending in foreign currency terms is offshore banking units

(OBUs). OBU activities have expanded since 2013 on the back of the FSC’s easing of

regulations (accounting for 5-20% of total loans in Taiwan as at end-3Q15). But after years

of development, the comparison base has been pushed up, with limited upside for further

easing of regulations. In addition, a large portion OBU customers for Taiwanese banks are

Taiwanese companies registered in a foreign country. Essentially, they are still Taiwanese

enterprises, with many involved in export-driven businesses, but with factories built outside

the island (mainly in China or other developing countries in Asia). With global trade flows

likely to stay sluggish going forward, we do not expect OBU lending to record meaningful

growth in 2016-17.

On the other hand, we expect deposit growth to stay firm, as many companies/individuals

would rather be in a cash-heavy position than take a risk and invest amid a gloomy

economic outlook. Deposits in all Taiwanese banks on average rose from 5.7% YoY for

2014 to 6.7% YoY for 10M15, while loan growth was down from 4.4% YoY to 3.1% YoY

over the same period. In our previous model, we were expecting deposits to grow at

around 3-5% for banks, but we now expect deposit growth to reach 4-8% for 2016. A

divergence between loan and deposit growth could lead to a lower LDR ratio, which

implies lower efficiency in profit earning. This is one of the important factors that has led to

us lowering our NIM expansion forecast to -3 to 2 bps for 2016, down from 2-7bps

previously.

As of 9M15, NPL for the banks under our coverage came in lower than we expected, at

0.25% on average, versus our 2015 forecast of 0.36%. Nevertheless, the potential rise in

the NPL ratio is still a concern for banks amid sluggish economic growth and we believe

the pace of asset quality deterioration could be sharp. Cross-strait ties and industry links

have become closer and closer over the past few years, meaning that chain effects can

occur if a firm (Taiwanese or Chinese) starts to face financing problems. As such, we are

not changing our NPL forecast for 2016 (0.41%), despite a likely lower-than-expected NPL

ratio for 2015. Likewise, given the larger asset-quality pressure, banks will likely be forced

to set aside more reserve that could push up their credit cost. We expect gross credit cost

to increase by 10-30bps in 2016. While we still think a potential rise in NPL and credit cost

will be manageable for Taiwanese banks (ie will not cause any financial breakdown in the

system), given the large excess liquidity buffer and the low level of NPL currently, investors

should be aware of the risks.

We are lowering our loan

growth forecast for 2016

Banks could be trapped

in the excessive liquidity

problem again in 2016

16


The NPL ratio of Taiwanese banks has stayed at a low level since 2010, after the economy

recovered from the global financial crisis (GFC). Low NPL ratio for banks is good news, but

also implies lower loan recovery in the future. For the past few years, Taiwanese banks

have been recording loan recoveries from bad debts accumulated during the 2005-06

credit card crises and the GFC, which has led to an extremely low net credit cost for banks

over the past few years. Net credit cost for the banks we cover was mostly under 30bps as

at end-3Q15. With fewer outstanding NPLs prevailing, we expect lower loan recovery for

banks in 2016-17, leading to a normalisation of the net credit cost. We expect the net credit

cost to increase by 10-30bps in 2016 for the banks under our coverage.

Taiwan banks: LDR ratio Taiwan banks: NPL ratio

Source: Company, Daiwa Source: Company, Daiwa

Fee income: excess liquidity in the system to bolster fee income growth

Fee income growth has been a major earnings growth driver for the banks over the past

few years. In particular, wealth management fee income growth has been the strongest.

For the banks we cover, most management expect fee income growth to hit 10-20% YoY

for 2016 on the back of strong sales of wealth management products.

We agree with the views of the managements’ of the banks that the fee income still has

room to grow. Taiwan is a country with excess savings, which makes it a good market for

wealth management products. In addition, the latest FSC policy direction is to conduct an

“import-substitution strategy” via regulatory easing. For example, easing regulations for

domestic banks’ bond issuances via the OTC board. This should help the domestic banks

gain market share from the foreign banks.

Nevertheless, we still have concerns that the sluggish economic/trade outlooks for

Taiwan/Asia for 2016 will affect demand for: 1) FX settlements, 2) syndicated loans by

corporates, and 3) consumption and thus credit card use. A depreciating CNY has also hit

the TMU business, as mentioned in the “CNY depreciation” section above. We expect fee

income growth to settle at 5-15% YoY for most of the banks under our coverage for 2016, a

tad lower than managements’ forecasts of 10-20% YoY growth. But our current forecast of

5-15% growth is higher than our previous forecast of 0-10% YoY, as we now see fee

income growth being bolstered by excess liquidity in the system on the back of the CBC’s

easing measures. Daiwa’s economics team now expects the CBC to deliver two 12.5bps

rate cuts in 2016, versus its previous forecast of no rate cuts.

70

75

80

85

90

95

Nov

-01

May

-02

Nov

-02

May

-03

Nov

-03

May

-04

Nov

-04

May

-05

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

Nov

-11

May

-12

Nov

-12

May

-13

Nov

-13

May

-14

Nov

-14

May

-15

Nov

-15

(%)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Oct

-04

Apr

-05

Oct

-05

Apr

-06

Oct

-06

Apr

-07

Oct

-07

Apr

-08

Oct

-08

Apr

-09

Oct

-09

Apr

-10

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

(%)

We expect net credit

cost to increase as loans

looks to fall in 2016

We are more cautious

than the banks’

managements on fee

income forecasts

17


Insurers: more defensive to domestic lacklustre growth

The insurers have more flexibility relative to the banks in allocating their funds to overseas

markets, especially after the FSC’s regulatory easing on overseas investments. This

flexibility means the insurers should be less affected by the lacklustre domestic economic

growth that we see for 2016-17. Likewise, the insurers can avoid being hit by the slowdown

in the EM economies by cutting their EM exposure while adding positions in the developed

markets where the economies are doing better.

Nevertheless, sluggish domestic GDP growth could put a drag on the insurer’s 2016

premium growth. We are not too concerned about the impact on the sector, however, due

to: 1) VNB looking as if it will remain on a growth trajectory on the back of their improving

product mixes, 2) first year premiums (FYP) are relatively small compared to the total

amount of investment assets held by the insurers (the figure was 3.6% for Cathay Life and

5.2% for Fubon Life for 9M15). The key for the Taiwan insurers to improve their profit is to

better use their investment assets on hand rather than increasing them, in our view. 3) The

changing macro environment and innovations in addition to regulatory changes could help

the insurers attract customers. For example, according to the insurers’ managements,

since the beginning of 2015, USD-denominated insurance policies have been very popular

in the market, on the back of the USD’s extended strength.

Taiwan Insurers: VNB margin (VNB/FYP) Taiwan Insurers: FYP collected as a % of total investment assets


5

10

15

20

25

30

2010 2011 2012 2013 2014 9M15


(%)

4.9

6.5

3.6

5.2

0

1

2

3

4

5

6

7

8


9M14 9M15

(%)

Insurers can allocate

their funds overseas and

be less affected by weak

domestic GDP growth

18


Valuations

Sector trading below its past-10-year average PBR

The ROAE for the Taiwan FHCs is likely to fall from 12.2% for 2015E to 10.5% for 2016E,

before picking up modestly to 11.3% for 2017E, on our estimates. For the stocks under our

coverage, we forecast the average ROAE for the bank-centric FHCs to drop from 11% for

2015E to 9.6% for 2016E, and that for the insurance-centric FHCs to fall from 14.8% for

2015E to 12.3 for 2016E.

On the Bloomberg consensus forecasts, the 12-month rolling PBR for the sector is

currently trading at 1.0x, which is lower than its past-10-year average of 1.3x. Given our

lower ROE forecast for 2016E, we are cutting our target PBR for the sector. For the bank-

centric FHCs, our target PBRs come in at 0.8-1.0x, while those for the insurance-centric

FHCs are between 1.3x and 1.5x (down from our previous forecasts of 1.0-1.3x and 1.4-

1.7x, respectively).

Taiwan Financial Sector: ROAE trend Taiwan Financial Sector: 12-month rolling PBR

Source: Bloomberg, Daiwa (table\sum) Source: Bloomberg, Daiwa

Lower PBR for the sector

In light of the increasing macro headwinds, we are seeing bank valuations being taken

down by the market in 2016, and we expect their PBRs to trade below the past-10-year

average throughout 2016. On the other hand, we believe valuations for the insurers will

hold up relatively better, as the fundamentals of their core businesses continue to improve

this year.

We use Gordon Growth Model to derive a justified PBR for the banks under our coverage.

For the insurers, we use an adjusted EV methodology to derive the valuation. Our models

are based on our 2016 GDP forecast of 1.6% YoY for Taiwan, in which we factor in two

12.5bps rate cuts by the CBC for the same period. We also assume a 3% risk free rate and

an 8% equity risk premium. We calculate the cost of equity for each company based on its

historical average beta value (see the following table below for details).

Taiwan Financial Sector: summary of valuation changes

Beta value Cost of equity 2016E ROE Implied 2016E P/B Target price Rating Share price as of 8 Jan

old new old new old new changes old New

Cathay FHC 1.04 11.3 12.2 11.1 1.7 1.5 62.2 53.6 -13.8 Buy Buy 39.95

Fubon FHC 1.15 12.2 15.3 13.5 1.4 1.3 61.0 44.3 -27.4 Buy Outperform 39.65

Mega FHC 0.84 9.7 11.6 10.1 1.2 1.0 26.7 21.0 -21.3 Hold Hold 20.25

E.Sun FHC 0.87 10.0 12.1 10.3 1.3 1.0 20.8 16.4 -21.2 Outperform Underperform 18.40

CTBC FHC 0.92 10.3 11.1 10.1 1.1 0.9 18.2 14.3 -21.4 Underperform Underperform 16.00

First FHC 0.86 9.9 9.1 7.5 1.0 0.8 15.2 11.7 -23.0 Underperform Sell 14.85


7

8

9

10

11

12

13

2011

2012

2013

2014

2015

E

2016

E

2017

E

(%)

0.6

0.9

1.2

1.5

1.8

2.1Ja

n-06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

(x)

Ave. +1SD

Ave. -1SD

Ave.

19


Cathay FHC: 12-month rolling PBR Fubon FHC: 12-month rolling PBR

Source: Bloomberg, Daiwa Source: Bloomberg, Daiwa

E.Sun FHC: 12-month rolling PBR Mega FHC: 12-month rolling PBR


First FHC: 12-month rolling PBR CTBC FHC: 12-month rolling PBR


0.5

1.0

1.5

2.0

2.5

3.0

3.5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

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0.8

0.9

1.0

1.1

1.2

1.3

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1.6

1.7

Jan-

06

Jul-0

6

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07

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(x)

Ave. +1SD

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Ave.

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

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Jul-0

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(x)

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0.8

1.0

1.2

1.4

1.6

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06

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(x)

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6

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0.5

0.7

0.9

1.1

1.3

1.5

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1.9

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06

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Ave.

20


Risks to our investment case

Changeable macro environment

Our investment case for the Taiwan Financial Sector is premised on our assumption of

1.6% YoY and 2.1% YoY GDP growth for Taiwan for 2016 and 2017, respectively. Daiwa

also assumes that the Fed will deliver three more 25bp rate hikes, and that the CBC will

cut its policy rate by 25bps (two 12.5bps rate cuts) in 2016. Changes to our macro

forecasts, both domestically and internationally, would have implications for our investment

case. Some of these risks are discussed below:

Stronger GDP growth for the G3 economies and Taiwan

Daiwa’s economic team currently looks for 2016 GDP growth to come in at 2.6% YoY for

the US and 1.4% for the Euro area. These are used as the assumptions for both our

Taiwan GDP forecast (1.6% YoY for 2016) and our investment case for the Taiwan

Financial Sector. Stronger growth in the G3 economies would likely lift Taiwan’s GDP via

higher exports and support loan growth for the banks. Also, the banks’ NPLs and credit

costs would also trend lower on the back of better economic growth globally.

CBC’s policy rate hikes

The CBC’s policy rate decisions are getting harder to predict, as it looks to be stuck

between low GDP growth and loose monetary conditions. We see a higher chance of the

CBC delivering the two 12.5bps rate cuts because it aims to protect GDP growth. But if it

were to decide to hold rates or even deliver rate hikes in 2016, the banks’ margins would

be protected, which would ease the pressure of excess liquidity in the system. For the

insurers, a CBC rate hike would lead to a higher yield on their domestic bond investments,

which would be a positive for them.

If the emerging markets resume their economic growth momentum

We are concerned that the ongoing liquidity pullback in emerging markets (including

China) as a result of the Fed’s tightening would significantly damage their economies. Our

base case is that these markets will muddle through the Fed’s tightening cycle, but suffer

from a further slowdown in GDP growth. If the emerging markets are able to shrug off the

impact of capital outflows and resume their growth rate, not only would it lend support to

Taiwan’s exports/ GDP, it would also enhance the banks’ overseas business.

On the other hand, if a widespread breakdown in emerging-market financial markets were

to occur, and we see a higher chance of this happening after the PBOC’s CNY rate

adjustment on 19 August, this could lead to defaults on their bonds, which would hit the

insurers hard.

Flatter-than-expected yield curve

The major downside risk for the insurers, in our view, would be if the yield curve were to

stay flat in 2016-17. In this case, Fed rate hikes would steepen the yield curve, but

disinflation pressure globally could still flatten it. In addition, bond yields could come under

stress if there were a sudden rise in bond demand. Rising geo-political risks and further

terrorist attacks could be triggers prompting investors to turn from risky assets to safer

ones, pushing down bond yields.

Risks to our investment

case are mainly macro-

driven


Taiwan Financials

What's new: Despite Daiwa’s lacklustre GDP growth outlook for Taiwan for

2016-17, we expect Cathay FHC’s fundamentals to continue to improve as

it benefits from macro tailwinds. We reiterate our Buy (1) call on the stock.

What's the impact: Cathay Life’s core business continues to improve.

The negative investment spread has narrowed over the past few quarters

on the back of a higher recurrent yield and faster-than-expected fall in

liability costs. We expect this trend to continue as the Fed’s rate-hike cycle

raises the recurring yield further. Having a short asset duration (8.8 years

as of end-3Q15) allows Cathay Life to benefit from Fed rate hike cycles.

The value of new business (VNB) margin improved again (up from 23% for

9M14 to 27% for 9M15) as Cathay Life made more efforts to enhance its

product mix. The weaker TWD (vs. the USD) also led to Cathay Life

posting FX gains and building up its FX reserves, offering more flexibility for

its FX hedging strategy (Daiwa now looks for the TWD to drop to 34.7

against the USD by end-2016, vs. 33 previously). We look for its hedging

cost to come in at 50bps for 2016E, vs. its past-10-year average of 150bps.

We lower our investment yield to 4.2% (from 4.5%) for Cathay Life for

2016E despite its rising recurrent rate and prudent investment strategies

(eg, high-yield bond exposure accounts for less than 2% of investment

assets vs. 7% for Fubon Life) given the rising macro uncertainties.

Slight drag from the bank business. Cathay United Bank (CUB) is

unlikely to be spared from the rising macro risks that are discussed in the

sector portion of this report. But having a strong insurance wing should help

bolster its fee income growth for 2016-17.

What we recommend: We reiterate our Buy (1) call but cut our SOTP-

based 12-month TP from TWD62.2 to TWD53.6. The stock is trading at a

12-month rolling PBR of 1.1x. Our target PBR is now 1.5x vs. 1.7x

previously, given our new ROE forecast of 11.1% for 2016E (previous:

12.2%). We agree with the general market view that the volatile equity

market and rising default risk for high-yield bonds should add more

variation to Cathay FHC’s earnings in 2016 (as a result, we cut our 2015-

16E EPS by 11.5% and 8.6% respectively), but see the recent sell-off as

overdone, especially when the fundamentals of its life business continue to

improve. Key risk to our call: lower investment returns over our forecast

horizon.

How we differ: Our 2016-17E EPS are 2.3% and 0.5% lower than consensus

forecasts, respectively, on our lower investment return forecasts.

11 January 2016

Cathay Financial H ol dings

Enjoying macro tailwinds

Favourably positioned to combat risks seen across the sector

We expect a higher recurrent yield and VNB margin in 2016

Reiterate Buy (1); cut TP to TWD53.6 on rising macro uncertainty


Source: FactSet, Daiwa forecasts

Cathay Financial Holdings (2882 TT)

Target price: TWD53.60 (from TWD62.20)

Share price (8 Jan): TWD39.95 | Up/downside: +34.1%


[email protected]

Forecast revisions (%)

Year to 31 Dec 15E 16E 17E

PPOP change 4.5 (7.7) (5.4)

Net profit change 5.8 (11.5) (8.5)

Core EPS (FD) change 6.0 (11.5) (8.6)

95

103

110

118

125

35

41

48

54

60

Jan-15 Apr-15 Jul-15 Oct-15 Jan-16

Share price performance

Cathay Fin (LHS)Relative to TWSE Index (RHS)

(TWD) (%)

12-month range 39.65-55.80

Market cap (USDbn) 15.07

3m avg daily turnover (USDm) 24.25

Shares outstanding (m) 12,563

Major shareholder Wan Pao Development Co. (17.8%)

Financial summary (TWD)


Total operating income (m) 137,568 134,324 147,087

Pre-provision operating profit(m) 69,877 62,351 69,166

Net profit (m) 60,027 49,284 55,231

Core EPS (fully-diluted) 4.678 3.924 4.295

EPS change (%) 18.7 (16.1) 9.5

Daiwa vs Cons. EPS (%) 0.6 (2.3) (0.5)

PER (x) 8.5 10.2 9.3

Dividend yield (%) 5.5 5.5 5.4

DPS 2.2 2.2 2.1

PBR (x) 1.1 1.1 1.1

ROE (%) 13.4 11.1 11.8

22

Cathay Financial Holdings (2882 TT): 11 January 2016

Financial summary

Key assumptions

Profit and loss (TWDm)

Change (YoY %)

Source: FactSet, Daiwa forecasts Note: Net insurance income, which equates to the retained earned premium minus retained claims payment and net changes in the insurance

reserve, is included in non-interest income. Interest income earned from investments made by the life insurance business, however, is categorised into net interest income. For a life insurer with a long operating history such as Cathay, retained claims payment and net changes in the insurance reserve usually surpass the premium collected for the year, dragging total non-interest income down to a negative number. As such, YoY changes for non-interest income are shown as “n.a.” in the table above.

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

FYP growth (%) – Life Insurance 26.2 (22.6) 4.6 (25.0) 16.5 (15.0) 10.0 10.0

Value of New Business – Life Insurance

(local. Curr. bn)43.0 44.0 50.0 52.5 55.5 56.1 56.6 57.2

Embedded Value – Life Insurance

(local. Curr. Bn)449.0 475.0 565.0 635.0 709.0 731.3 722.8 741.0

Recurrent Yield, pre-hedge (%) – Life

Insurance3.5 3.6 3.6 3.4 3.2 3.4 3.8 3.9

Net-interest margin (%) – Bank 1.1 1.2 1.3 1.3 1.3 1.2 1.2 1.3

Loan Growth (%) – Bank 9.8 11.2 0.1 2.8 8.6 2.0 3.5 3.8

Tier-1 BIS (%) – Bank 9.7 9.4 9.2 10.0 11.4 11.5 11.6 11.6

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Net-interest income 92,741 105,055 112,727 114,558 125,083 138,095 154,006 169,288

Net fees & commission 185 920 2,207 791 369 (992) 1,235 3,136

Trading and other income 18,663 10,005 35,285 63,480 79,465 87,682 70,340 76,198

Net insurance income (65,281) (57,411) (79,559) (80,268) (88,342) (87,217) (91,257) (101,535)

Total operating income 46,308 58,569 70,659 98,560 116,576 137,568 134,324 147,087

Personnel expenses (28,140) (30,938) (32,724) (34,298) (35,106) (39,976) (41,683) (43,667)

Other expenses (15,604) (16,951) (19,048) (19,979) (22,244) (27,715) (30,291) (34,255)

Total expenses (43,744) (47,889) (51,772) (54,277) (57,350) (67,690) (71,973) (77,921)

Pre-provision operating profit 2,565 10,681 18,887 44,283 59,225 69,877 62,351 69,166

Total provision 0 (1,063) (3,173) (1,484) (2,982) (2,829) (5,420) (6,086)

Operating profit after prov. 2,565 9,618 15,715 42,799 56,243 67,048 56,930 63,080

Non-operating income 1,283 956 1,025 1,237 1,573 1,253 1,260 1,269

Profit before tax 3,848 10,574 16,740 44,036 57,815 68,301 58,190 64,348

Tax 1,718 1,667 457 (4,779) (6,458) (8,275) (8,906) (9,117)

Min. int./pref. div./other items 0 0 0 0 0 0 0 0

Net profit 5,566 12,241 17,197 39,257 51,357 60,027 49,284 55,231

Adjusted net profit 5,566 12,241 17,197 39,257 51,357 60,027 49,284 55,231

EPS (TWD) 0.410 1.040 1.410 3.120 3.940 4.678 3.924 4.295

EPS (adjusted) (TWD) 0.410 1.040 1.410 3.120 3.940 4.678 3.924 4.295

EPS (adjusted fully-diluted) (TWD) 0.410 1.040 1.410 3.120 3.940 4.678 3.924 4.295

DPS (TWD) 0.600 0.500 0.700 1.500 2.000 2.200 2.200 2.148

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Net-interest income 5.5 13.3 7.3 1.6 9.2 10.4 11.5 9.9

Non-interest income n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Total operating income (34.3) 26.5 20.6 39.5 18.3 18.0 (2.4) 9.5

Total expenses (19.2) 9.5 8.1 4.8 5.7 18.0 6.3 8.3

Pre-provision operating profit (84.3) 316.4 76.8 134.5 33.7 18.0 (10.8) 10.9

Total provisions n.a. n.a. 198.6 (53.2) 101.0 (5.1) 91.6 12.3

Operating profit after provisions (84.3) 275.0 63.4 172.4 31.4 19.2 (15.1) 10.8

Profit before tax (76.4) 174.8 58.3 163.1 31.3 18.1 (14.8) 10.6

Net profit (adjusted) (48.6) 119.9 40.5 128.3 30.8 16.9 (17.9) 12.1

EPS (adjusted, FD) (61.7) 153.7 35.6 121.3 26.3 18.7 (16.1) 9.5

Gross loans 4.1 7.9 2.0 9.6 8.7 (0.6) 3.3 5.1

Deposits 3.2 6.4 3.1 8.7 7.4 11.5 7.0 5.0

Total assets 9.2 6.7 10.1 12.1 12.4 9.0 7.4 7.1

Total liabilities 9.5 7.2 9.9 10.2 12.2 9.6 7.7 7.3

Shareholders' equity 3.0 (2.2) 14.4 53.6 15.5 0.7 2.2 3.8

Avg interest-earning assets 11.5 8.5 (6.9) (6.1) 10.1 11.5 12.0 10.1

Avg risk-weighted assets 2.5 8.7 8.0 9.4 13.2 12.1 10.0 10.0

23


Financial summary continued …

Balance sheet (TWDm)

Key ratios (%)


As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Cash & equivalent 742,594 814,156 422,667 483,611 586,296 432,277 495,317 537,536

Investment securities 833,000 1,421,277 1,449,490 1,601,130 1,628,307 1,676,800 1,655,029 1,699,076

Net loans and advances 1,383,122 1,492,075 1,521,712 1,667,392 1,812,774 1,801,966 1,860,587 1,955,017

Fixed assets 37,941 38,606 114,634 103,394 92,878 53,807 53,985 54,301

Goodwill 8,391 9,693 9,393 9,223 9,283 54,830 45,229 37,528

Other assets 1,684,142 1,229,595 1,993,057 2,312,522 2,815,299 3,549,097 4,018,703 4,424,889

Total assets 4,689,190 5,005,403 5,510,953 6,177,273 6,944,837 7,568,778 8,128,850 8,708,348

Customers deposits 1,329,507 1,414,422 1,458,393 1,585,031 1,702,302 1,897,710 2,030,507 2,132,032

Borrowing 87,462 101,612 89,524 148,174 230,710 320,290 307,575 313,895

Debentures 65,105 84,744 95,371 102,467 134,404 67,438 47,810 38,208

Other liabilities 2,984,609 3,186,913 3,619,516 3,962,090 4,438,300 4,845,214 5,295,382 5,759,711

Total liabilities 4,466,683 4,787,691 5,262,804 5,797,762 6,505,717 7,130,652 7,681,273 8,243,846

Share capital 101,544 103,575 108,654 119,650 125,632 125,632 125,632 125,632

Reserves & others 117,032 110,086 135,744 255,680 307,849 310,920 320,687 337,851

Shareholders' equity 218,576 213,661 244,398 375,330 433,481 436,552 446,319 463,483

Minority interests 3,931 4,051 3,752 4,180 5,640 1,573 1,259 1,019

Total equity & liabilities 4,689,190 5,005,403 5,510,953 6,177,273 6,944,837 7,568,778 8,128,850 8,708,348

Avg interest-earning assets 3,826,116 4,150,101 3,862,132 3,627,032 3,992,807 4,453,835 4,990,009 5,496,062

Avg risk-weighted assets 854,194 928,921 1,003,420 1,098,228 1,243,186 1,393,684 1,533,053 1,686,358

BVPS (TWD) 21.912 21.020 22.839 31.718 34.953 34.874 35.626 36.973

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Loan/deposit 67.1 67.5 65.2 63.8 64.4 60.3 58.3 57.6

Tier-1 CAR 9.7 9.4 9.2 10.0 11.4 11.5 11.6 11.6

Total CAR 11.4 12.0 12.6 13.5 16.2 16.3 16.4 16.4

NPLs/gross loans 0.3 0.3 0.3 0.3 0.3 0.2 0.3 0.4

Total loan-loss prov./NPLs 269.6 324.9 379.4 468.1 528.2 887.3 657.0 624.0

ROAA 0.1 0.2 0.3 0.7 0.8 0.8 0.6 0.6

ROAE 2.0 5.1 6.9 12.1 12.2 13.4 11.1 11.8

Net-interest margin 2.4 2.5 2.9 3.2 3.1 3.1 3.1 3.1

Gross yield 2.7 2.8 3.3 3.5 3.5 3.5 3.5 3.5

Cost of funds 0.7 0.8 0.8 0.8 0.8 0.8 0.8 0.9

Net-interest spread 2.0 2.0 2.4 2.7 2.7 2.7 2.6 2.6

Total cost/total income 94.5 81.8 73.3 55.1 49.2 49.2 53.6 53.0

Effective tax (67.0) (17.3) (2.9) 11.2 11.5 12.3 15.6 14.5

Dividend-payout 146.3 48.1 49.6 48.1 50.8 47.0 56.1 50.0

Company profile

Cathay Financial is ranked the largest financial-holding company in Taiwan by assets, and its major

subsidiaries include Cathay Life (Taiwan’s largest life insurer), and Cathay Bank (Taiwan’s second-

largest private bank). In Mainland China, Cathay has been building up its life business since 2004,

and has been operating its bank business since 2010. The Tsai family controls more than 37% of

Cathay Financial.

24


Cathay FHC: key quarterly data Cathay FHC: forecast changes

TWDm 9M14 9M15 % YoY 2Q15 3Q15 % QoQ

Cathay FHC

Total income 92,805 109,519 18.0% 43,865 31,865 -27.4%

Total expense (42,560) (46,235) 8.6% (14,693) (17,659) 20.2%

Net income 44,666 54,885 22.9% 23,125 13,651 -41.0%

EPS (TWD) 3.53 4.33 22.7% 1.83 1.07 -41.5%

Cathay Life

Net earned premium 327,065 376,690 15.2% 129,963 137,284 5.6%

Net investment income 131,770 149,219 13.2% 59,899 41,700 -30.4%

Other income 110,657 10,760 -90.3% 2,326 536 -77.0%

Total cost and expense (537,489) (493,625) -8.2% (169,858) (171,871) 1.2%

Net income 29,273 37,402 27.8% 16,879 8,022 -52.5%

Cathay United Bank

Net interest income 19,046 20,295 6.6% 6,729 6,921 2.9%

Fee income 8,664 11,222 29.5% 3,863 3,789 -1.9%

Investment income 6,315 4,565 -27.7% 1,399 1,690 20.8%

Operating expense (16,523) (18,174) 10.0% (6,024) (6,549) 8.7%

Pre-prevision profit 18,385 18,994 3.3% 6,245 6,161 -1.3%

9M15(A) 2015E 2016E 2017E

Old New Old New

Cathay Life

FYP growth (%) -15 -10 -15 10 10 10

Hedging cost (bps) 53 50 50 60 50 60

After hedged investment yield (%) 4.6 4.4 4.5 4.5 4.2 4.5

Pre-hedging recurrent yield (%) 3.40 3.40 3.40 3.75 3.75 3.90

Cost of liability (%) 4.34 4.39 4.33 4.35 4.28 4.21

Cathay United Bank

NIM expansion (bps) -13 -6 -12 7 0 3

Loan growth (%) 1.0 4.3 2.0 4.0 3.5 3.8

Fee income growth (%) 25.0 20.0 25.0 20.0 20.0 15.0

NPL ratio (%) 0.16 0.33 0.20 0.20 0.30 0.35

Net credit cost (bps) 2 20 12 25 33 37

Source: Company, Daiwa Source: Company, Daiwa forecasts

Cathay Life: investment yield and cost of liability Cathay Life: investment portfolio

(TWDbn) 4Q12 4Q13 4Q14 9M15

Total investments (TWDbn) 3,283.7 3,785.1 4,169.1 4,575.4

Weight (%)

Cash & Cash equivalents 8.2% 3.7% 3.2% 1.9%

Equity- Domestic 8.1% 8.9% 8.4% 7.7%

Equity- International 4.3% 4.9% 5.0% 5.6%

Bond- Domestic 16.6% 14.4% 11.0% 8.6%

Bond- International 39.6% 38.9% 43.6% 49.0%

Mortgage & Secured loans 10.3% 12.2% 12.7% 10.7%

Policy loans 5.5% 4.7% 4.0% 3.7%

Real estate 5.6% 10.6% 10.5% 10.7%

Others 1.8% 1.7% 1.6% 2.2%


Cathay Bank: NIM and coverage ratio Cathay Bank: coverage and NPL ratio


Cathay FHC: 12-month rolling PBR Cathay FHC: Bloomberg-consensus EPS forecasts


3.2

3.7

4.2

4.7

5.2

2010 2011 2012 2013 1Q14 1H14 9M14 2014 1Q15 1H15 9M15

Cost of liability After-hedged investment yield

(%)The negative investment gap is closed since 1Q15

1.51

1.67 1.701.79 1.79 1.79 1.81 1.84 1.84 1.83 1.84

1.07

1.171.26 1.26

1.42 1.39 1.36 1.331.24 1.23 1.23

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2010 2011 2012 2013 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15

Interest spread NIM

(%)

0.15

0.20

0.25

0.30

0.35

0.40

200

300

400

500

600

700

800

900

1,000

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

Coverage ratio (LHS) NPL ratio (RHS)

(%) (%)

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

(x)

Ave. +1SD

Ave. -1SD

Ave.

2.8

3.0

3.2

3.4

3.6

3.8

4.0

4.2

4.4

4.6

4.8

Jan-

15

Feb

-15

Mar

-15

Apr

-15

May

-15

Jun-

15

Jul-1

5

Aug

-15

Sep

-15

Oct

-15

Nov

-15

Dec

-15

Jan-

16

2016E EPS 2017E EPS

(TWD)


Taiwan Financials

What's new: While Fubon Life’s core business looks on track to improve

over 2016-17, rising risks of default for its high-yield bond and equity

positions are a concern to us. We also lower our earnings forecast for the

bank business for 2016. But even using bearish assumptions and cutting our

EPS forecast for 2016 by 21%, we see 11.7% upside to our TP from the

current share price level, as the recent sell-off looks overdone, in our view.

What's the impact: Fubon Life has higher-than-peers’ exposure to

high-yield bonds, the default risks for which have been rising after the Fed

kicked off its rate-hike cycle in December 2015. We estimate that its total

exposure to high-yield bonds is around 7% of its total investment portfolio

(vs. 2% for Cathay Life). The Fubon Life investment team has a bright track

record, and we believe it can manage such a risk. However, given the

higher exposure to high-yield bonds, the risk-reward profile now looks less

attractive to us vs. 3 months ago. We cut our total 2016E investment yield

from 4.5% to 4% and cut our 2016E BVPS from TWD42.3 to TWD34.9.

Core life business likely to remain solid in 2016. We expect the

recurrent yield to be bolstered by the Fed’s ongoing rate-hike cycle. The

VNB margin should continue to improve as Fubon Life has placed more

emphasis on improving its product mix over the past 2 years. We also

expect its hedging cost to be 60bps for 2016, lower than our previous

expectation of 90bps, as the TWD looks set to weaken further vs. the USD.

Earnings drag from the bank business. We believe the challenging

macro environment will hit Taipei Fubon Bank (TFB), dragging down loan

growth and NIM. We believe Fubon Bank’s China earnings will also be hit

by the slowdown in China. We expect TFB’s 2016E net income to be 21%

lower than it was in 2015.

What we recommend: We downgrade the stock to Outperform (2) from

Buy (1) and cut our 2016-17E EPS by 18-21%, as we factor in lower

earnings for TFB and a lower investment yield for Fubon Life (from 4.5% to

4%). We cut our SOTP-based 12-month target price to TWD44.3 (from

TWD61.0), on our lower 2016 EPS forecasts. The stock is trading at a 12-

month rolling PBR of 1.1x, lower than its past-10-year average PBR of

1.2x. Our target multiple is 1.3x (vs. 1.4x previously, as we lower our 2016E

ROE from 15.3% to 13.5%). Despite our EPS cuts, we still think the recent

market sell-off has been overdone. Key risks to our call: lower-than-

expected investment returns and a further slowdown in China.

How we differ: Our 2016-17 EPS forecasts are 13.9% and 7.8% lower than

consensus, respectively, on our lower investment yield forecast.

11 January 2016

Fubon Fi nancial Hol ding

Less attractive risk-reward profile, but sell-off overdone

Life business remains solid; high-yield bond exposure is a concern

We expect the bank business to put a drag on earnings in 2016

Downgrading to Outperform (2); cut TP to TWD44.30



Fubon Financial Holding (2881 TT)




[email protected]



PPOP change (2.9) (14.2) (10.3)

Net profit change (2.2) (20.7) (17.5)

Core EPS (FD) change (2.2) (21.1) (17.8)

90

100

110

120

130

35

44

53

61

70



Fubon Fin (LHS)Relative to TWSE Index (RHS)

(TWD) (%)

12-month range 39.65-68.20




Major shareholder City of Taipei, Taiwan (13.1%)





Net profit (m) 64,538 50,076 54,814


EPS change (%) 5.7 (22.8) 9.5

Daiwa vs Cons. EPS (%) (3.8) (13.9) (7.8)

PER (x) 6.4 8.3 7.5


DPS 3.0 3.0 3.0

PBR (x) 1.1 1.1 1.0

ROE (%) 16.1 13.5 14.3

26

Fubon Financial Holding (2881 TT): 11 January 2016

Financial summary

Key assumptions


Change (YoY %)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

FYP growth (%) – Life Insurance 50.8 (28.2) 12.1 (14.8) (10.3) (10.0) 10.0 10.0

Value of New Business (NTD bn) – Life

Insurance24.8 28.0 31.7 31.8 34.8 35.5 36.2 36.9

Embedded Value (NTD bn) – Life

Insurance155.5 176.0 217.8 295.7 396.0 351.0 318.9 356.5

Recurrent Yield, pre-hedge (%) – Life

Insurance3.5 3.6 3.6 3.7 3.8 4.0 4.1 4.2

Net-interest margin (%) – Bank 1.6 1.0 1.0 1.1 1.1 1.2 1.2 1.3

Loan Growth (%) – Bank 3.1 11.3 7.7 7.4 18.3 4.5 3.0 4.6

Tier-1 BIS (%) – Bank 9.2 9.3 9.9 10.4 9.7 10.5 10.6 10.6

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E


Net fees & commission (744) (5,811) (6,875) (4,481) (6,770) (4,473) (4,602) (4,902)


Net insurance income (6,980) (4,473) (11,599) (22,115) (26,661) (32,442) (24,171) (23,604)



Other expenses (18,678) (18,327) (20,459) (19,519) (22,865) (20,131) (21,523) (23,235)

Total expenses (39,262) (39,966) (43,129) (43,539) (49,299) (57,520) (60,708) (64,345)


Total provision (1,099) (902) 512 (4,083) (2,989) (3,210) (6,902) (8,155)


Non-operating income 0 0 0 0 0 0 0 0


Tax (2,428) (5,122) (4,348) (5,735) (11,466) (5,343) (6,227) (6,692)


Net profit 20,719 30,687 29,149 38,464 60,483 64,538 50,076 54,814


EPS (TWD) 2.330 3.390 3.070 3.310 5.887 6.223 4.802 5.256

EPS (adjusted) (TWD) 2.330 3.390 3.070 3.310 5.887 6.223 4.802 5.256


DPS (TWD) 1.000 1.000 1.000 1.500 3.000 3.000 3.000 3.000

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E


Non-interest income (42.0) 52.6 (34.8) 81.5 88.6 8.9 (30.4) 9.3

Total operating income 0.5 20.7 (0.7) 20.6 35.3 5.1 (5.1) 8.1

Total expenses 12.3 1.8 7.9 1.0 13.2 16.7 5.5 6.0

Pre-provision operating profit (14.1) 51.4 (10.2) 46.4 55.2 (2.5) (13.5) 10.2

Total provisions (81.7) (17.9) n.a. n.a. (26.8) 7.4 115.0 18.1

Operating profit after provisions 4.1 54.7 (6.5) 31.9 62.8 (2.9) (19.4) 9.2

Profit before tax 4.1 54.7 (6.5) 31.9 62.8 (2.9) (19.4) 9.2

Net profit (adjusted) 4.8 48.1 (5.0) 32.0 57.2 6.7 (22.4) 9.5

EPS (adjusted, FD) (5.7) 45.5 (9.4) 7.8 77.9 5.7 (22.8) 9.5

Gross loans 1.6 10.6 6.1 10.1 18.2 16.4 5.1 6.6

Deposits 2.7 (0.1) 7.0 8.3 20.1 25.3 8.0 5.5

Total assets 12.8 4.9 13.3 12.0 18.3 14.4 7.7 8.0


Shareholders' equity 4.3 7.5 31.1 11.5 19.4 (5.7) (7.1) 14.1

Avg interest-earning assets 19.5 (4.1) (8.5) 5.1 12.5 37.2 26.9 8.0


27




Key ratios (%)


As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Cash & equivalent 268,447 297,263 244,372 298,729 335,037 504,132 572,069 622,178

Investment securities 888,103 968,478 1,528,881 1,725,183 1,994,815 1,757,434 1,901,471 2,119,167


Fixed assets 27,211 32,517 33,821 34,452 43,580 34,653 37,400 40,394

Goodwill 13,824 13,805 13,462 13,455 30,997 19,428 19,086 18,759

Other assets 1,207,941 1,152,459 1,056,296 1,172,270 1,434,732 2,044,675 2,212,923 2,351,481

Total assets 3,452,775 3,622,863 4,105,866 4,596,972 5,438,361 6,222,131 6,700,604 7,239,124


Borrowing 147,395 136,662 137,961 184,815 321,663 358,436 386,475 436,497

Debentures 97,107 102,576 106,287 118,728 151,842 137,246 123,971 97,669

Other liabilities 1,686,476 1,851,794 2,166,287 2,447,077 2,741,592 3,078,054 3,387,443 3,718,319


Share capital 85,584 90,137 95,269 102,336 102,336 102,336 102,336 102,336

Reserves & others 131,806 143,545 211,160 239,342 305,707 282,525 255,201 305,576


Minority interests 4,884 0 0 222 8,104 0 0 0



Avg risk-weighted assets 810,201 891,201 967,282 1,087,767 1,340,222 1,586,007 1,744,607 1,919,068

BVPS (TWD) 25.401 25.925 32.165 33.388 39.873 37.608 34.938 39.860

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Loan/deposit 73.9 80.5 82.3 81.6 81.2 76.8 73.6 72.7

Tier-1 CAR 9.2 9.3 9.9 10.4 9.7 10.5 10.6 10.6

Total CAR 13.0 13.5 13.9 13.5 12.9 13.3 13.4 13.4

NPLs/gross loans 0.3 0.3 0.1 0.1 0.2 0.2 0.3 0.3

Total loan-loss prov./NPLs 260.5 388.4 778.5 1,076.3 937.0 1,166.4 650.3 715.1

ROAA 0.6 0.9 0.8 0.9 1.2 1.1 0.8 0.8

ROAE 9.5 13.5 10.8 11.9 16.0 16.1 13.5 14.3


Gross yield 3.1 3.8 4.5 4.7 5.6 4.1 3.4 3.5

Cost of funds 0.6 0.8 0.9 0.9 1.3 1.2 1.1 1.2



Effective tax 10.5 14.3 13.0 13.0 15.9 7.6 11.1 10.9

Dividend-payout 42.9 29.5 32.6 45.3 51.0 48.2 62.5 57.1

Company profile

Fubon Financial Holding (Fubon) is one of the largest financial holding companies in Taiwan. Its

major subsidiaries include a bank, life insurance, P&C insurance, and securities companies. Fubon

integrated Fubon Bank and Taipei Bank in 2005 and consolidated seven brokers into Fubon

Securities in 2000. In addition, the company acquired Fubon Bank Hong Kong in 2004, ING Taiwan

in 2009, a 20% stake in China's Xaimen Bank in 2008 and a 80% stake in First Sino Bank

28


Fubon FHC: key quarterly data Fubon FHC: forecast changes

TWD mn 9M14 9M15 % YoY 2Q15 3Q15 % QoQ

Fubon FHC

Total income 99,341 108,699 9.4% 38,654 32,901 -14.9%

Total expense -36,665 -38,413 4.8% -12,500 -13,453 7.6%

Net income 53,772 58,347 8.5% 22,027 16,177 -26.6%

EPS (TWD) 5.24 5.68 8.4% 2.15 1.57 -27.0%

Fubon Life

Net earned premium 299,383 317,418 6.0% 99,205 125,791 26.8%

Net investment income 85,588 103,874 21.4% 36,376 32,907 -9.5%

Other income 1,785 1,888 5.8% 549 827 50.6%

Total cost and expense -350,237 -376,211 7.4% -118,440 -147,336 24.4%

Net income 31,253 38,849 24.3% 15,827 9,770 -38.3%

Taipei Fubon Bank


Fee income 8,625 8,919 3.4% 2,963 2,890 -2.5%

Other income 9,029 6,074 -32.7% 2,128 2,003 -5.9%

Operating expense -13,843 -15,153 9.5% -5,084 -5,166 1.6%

Pre-prevision profit 20,435 17,049 -16.6% 5,816 5,803 -0.2%

9M15(A) 2015E 2016E 2017E

Old New Old New

Fubon Life

FYP growth (%) -10.6 -15.0 -10 10 10 10

Hedging cost (bps) 28 70 40 90 60 70

After hedged investment yield (%) 5.36 4.35 4.60 4.5 4.0 4.5

Pre-hedging recurrent yield (%) 3.92 4.02 3.85 4.10 4.10 4.20

Cost of liability (%) 3.86 3.84 3.84 3.81 3.81 3.78

Taipei Fubon Bank

NIM expansion (bps) -2 5 -2 6 0 3

Loan growth (%) 2.8 4.5 4.5 5.0 3.1 4.6


NPL ratio (%) 0.12 0.23 0.15 0.30 0.30 0.30

Net credit cost (bps) -8.1 10 12 20 37 49


Fubon Life: cost of liability Fubon Life: investment portfolio

4Q14 1Q15 2Q15 3Q15

Deposit and cash equivalent 3.4% 5.1% 6.0% 6.3%

Domestic fixed income 23.3% 21.8% 21.7% 20.5%

Overseas fixed income 45.5% 42.6% 43.1% 47.5%

Domestic equity 10.4% 11.0% 9.9% 7.8%

Overseas equity 6.9% 8.4% 8.1% 6.3%

Mortgage loans 2.7% 2.9% 3.0% 3.0%

Policy loans 2.0% 1.9% 1.9% 1.9%

Real estate 5.9% 6.3% 6.3% 6.8%


Taipei Fubon Bank: NIM and coverage ratio Taipei Fubon Bank: NPL and coverage ratio


Fubon FHC: 12-month rolling PBR Fubon FHC: Bloomberg-consensus EPS forecasts


4.56

4.16

4.16

4.07 4.06 4.04 4.01 3.98 3.95 3.933.89 3.88 3.88 3.87 3.86

3.7

3.8

3.9

4.0

4.1

4.2

4.3

4.4

4.5

4.6

2009

2010

2011

2012

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

(%)

1.31.34 1.33 1.33

1.29 1.281.24

1.27 1.241.28

1.31

0.940.99 1.01

1.051.10 1.10 1.09 1.10

1.071.1 1.08

0.8

0.9

1.0

1.1

1.2

1.3

1.4

2010 2011 2012 2013 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15

Interest spread NIM

(%)

0

200

400

600

800

1000

1200

1400

0.1

0.1

0.2

0.2

0.3

0.3

Dec

-11

Mar

-12

Jun-

12

Sep

-12

Dec

-12

Mar

-13

Jun-

13

Sep

-13

Dec

-13

Mar

-14

Jun-

14

Sep

-14

Dec

-14

Mar

-15

Jun-

15

Sep

-15

NPL ratio (LHS) Coverage ratio (RHS)

(%) (%)

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

(x)

Ave. +1SD

Ave. -1SD

Ave.

4.5

5.0

5.5

6.0

6.5

Jan-

15

Feb

-15

Mar

-15

Apr

-15

May

-15

Jun-

15

Jul-1

5

Aug

-15

Sep

-15

Oct

-15

Nov

-15

Dec

-15

Jan-

16

2016E EPS 2017E EPS

(TWD)


Taiwan Financials

What's new: Mega Financial (Mega) should be able to benefit from the

ongoing tighter USD liquidity trend, but we think it will take longer than we

had previously expected for any gains to materialise (now likely to be 2017

vs. 2016 before). As such, we are cutting our TP but maintain our Hold (3)

rating on the stock as we believe most of the downside has been priced in.

What's the impact: Any gains from tighter global USD liquidity trend

taking longer than expected to materialise. We were expecting the tighter

global USD liquidity to bolster Mega Bank’s loan growth and offer a better

lending spread. Mega Bank’s FX loans grew by a decent 6.5% YoY for 9M15.

And to our surprise, its FX deposit growth was even stronger, up by 14.1% YoY

for 9M15. As such, its loan-to-deposit ratio (LDR) fell, undermining the

profitability of the bank. The LDR for USDs (exclude inter-banking activities) fell

from 96.1% for 3Q14 to 75.4% for 3Q15. The bank’s USD deposit growth

should remain firm as the USD continues to strengthen, but USD loan growth

could pick up more slowly as global economic growth remains lacklustre. We

see the pressure on its LDR remaining throughout 2016, and would expect

likely better global economic growth in 2017 to ease the pressure.

Cutting its China exposure. Concerns in the market about Mega Bank’s

high China exposure, at 87% of the bank’s shareholder equity as at end-

2014 (sector average: 68%), has been one of the main reasons for the

share price decline over the past few months, on the back of China’s

slowing economy. That number though had, fortunately, dropped to 75% as

at end-3Q15 and should continue to fall as management has promised to

cut its China exposure going forward. To reflect the concerns on Mega’s

high China exposure, we raise our 2016 net credit cost forecast from 25bps

to 35bps. The downside to earnings of having such China exposure,

however, is priced in after the recent correction, in our view.

What we recommend: Mega is a defensive pick amid Taiwan’s lacklustre

GDP growth environment (see “Coping with hard times”) given its high

overseas earnings proportion. We cut our SOPT-based 12-month TP to

TWD21.0 (from TWD26.7) given the lack of near-term positive share price

catalysts and the potential rise that we see in its credit cost. The stock is

trading at a 0.9x 12-month rolling PBR, lower than its past-10-year average

of 1.1x. Our target price implies an end-2016 PBR of 1.0x. Being a

defensive name while offering a high dividend yield (6.9% for 2015E)

makes Mega FHC a good stock to hold, in our view.

How we differ: Our 16-17E EPS are 5.4% and 4.3% lower than

consensus, respectively, as we see Mega taking longer to benefit from

tighter USD liquidity.

11 January 2016

Mega Fi nanci al

Lacking near-term positive share-price catalysts

Benefits from tighter USD liquidity are taking time to materialise

Concerns on high China exposure are priced in, in our view

Maintain Hold (3); cutting TP to TWD21.0 (HKD26.67)



Mega Financial (2886 TT)




[email protected]



PPOP change 1.0 (1.9) (4.2)



95

103

110

118

125

20

22

24

26

29



Mega Fin (LHS)Relative to TWSE Index (RHS)

(TWD) (%)

12-month range 20.00-28.00




Major shareholder Ministry of Finance (9.2%)





Net profit (m) 34,905 29,858 31,668


EPS change (%) (0.4) (9.3) 6.1

Daiwa vs Cons. EPS (%) 7.4 (5.4) (4.3)

PER (x) 8.4 9.2 8.7


DPS 1.4 1.4 1.4

PBR (x) 0.9 0.9 0.9

ROE (%) 11.7 10.1 10.7


30

Mega Financial (2886 TT): 11 January 2016

Financial summary

Key assumptions


Change (YoY %)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Net-interest margin (%) - bank 1.1 1.2 1.2 1.2 1.3 1.2 1.3 1.3

Loan growth (%) - bank 4.3 9.4 4.1 10.1 4.8 4.1 3.0 5.0

Loan to deposit ratio (%) - bank 85.3 91.5 87.4 85.4 85.1 78.8 75.2 74.6

Provision coverage (%) 310.1 462.0 700.2 772.9 778.5 985.2 525.9 472.3

Fee to income ratio (%) 22.8 20.1 17.7 18.8 18.3 19.1 18.3 18.1

Expense to income ratio (%) 50.1 45.8 42.8 41.5 39.2 37.8 37.8 37.1

Tier-1 CAR (%) 9.5 9.3 9.6 9.4 9.8 10.5 10.6 10.7

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E


Net fees & commission 9,544 9,204 9,147 10,367 11,121 12,209 12,292 12,810


Net insurance income 1,027 1,380 1,216 1,664 1,737 2,421 2,588 2,767



Other expenses (6,525) (7,075) (6,971) (7,226) (8,044) (7,613) (8,007) (8,277)

Total expenses (20,993) (20,973) (22,150) (22,916) (23,795) (24,141) (25,391) (26,248)


Total provision (2,234) (3,714) (4,342) (5,276) (1,588) (1,586) (6,115) (6,565)




Tax (3,490) (3,430) (4,479) (4,506) (5,089) (5,284) (5,745) (6,255)


Net profit 15,150 17,686 20,795 22,495 30,240 32,905 29,858 31,668


EPS (TWD) 1.340 1.540 1.820 1.960 2.430 2.419 2.195 2.329

EPS (adjusted) (TWD) 1.340 1.540 1.820 1.960 2.430 2.419 2.195 2.329


DPS (TWD) 0.900 0.850 1.100 1.110 1.400 1.400 1.400 1.400

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Net-interest income (5.3) 12.8 4.6 5.8 17.3 6.1 7.0 6.2

Non-interest income (15.7) 4.3 26.6 7.8 0.5 4.1 1.9 4.1

Total operating income (9.8) 9.4 13.0 6.6 10.0 5.3 5.0 5.4

Total expenses 4.7 (0.1) 5.6 3.5 3.8 1.5 5.2 3.4

Pre-provision operating profit (20.8) 19.0 19.3 9.0 14.4 7.7 4.9 6.6

Total provisions (69.4) 66.3 16.9 21.5 (69.9) (0.2) 285.6 7.4

Operating profit after provisions (2.2) 13.3 19.7 6.8 30.8 8.1 (6.8) 6.5

Profit before tax (2.2) 13.3 19.7 6.8 30.8 8.1 (6.8) 6.5

Net profit (adjusted) 5.6 16.7 17.6 8.2 34.4 15.4 (14.5) 6.1

EPS (adjusted, FD) 3.1 14.9 18.2 7.7 24.0 (0.4) (9.3) 6.1

Gross loans 4.3 9.4 2.8 10.1 4.8 4.2 2.9 4.9

Deposits 5.0 1.9 8.1 12.6 5.3 12.6 7.8 5.8

Total assets 0.5 4.3 4.1 14.2 5.0 6.8 4.7 5.4


Shareholders' equity 2.7 1.0 3.6 14.8 8.1 15.4 (3.4) 2.7

Avg interest-earning assets 1.7 3.0 4.8 8.3 8.8 6.4 6.2 5.3


31




Key ratios (%)


As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Cash & equivalent 398,186 503,392 458,490 551,247 634,546 743,003 825,548 916,995

Investment securities 566,058 481,593 569,241 653,156 625,778 666,200 686,701 696,429


Fixed assets 21,139 21,417 22,331 22,150 22,126 4,577 4,551 4,525

Goodwill 237 297 304 318 308 100 101 102

Other assets 187,393 149,649 173,902 232,177 253,825 273,405 283,136 289,601

Total assets 2,509,848 2,618,402 2,726,969 3,113,626 3,270,577 3,493,322 3,658,011 3,857,308


Borrowing 584,277 665,745 622,337 763,283 785,849 727,743 733,072 780,062

Debentures 61,912 63,150 64,330 60,292 71,563 62,670 52,670 53,097

Other liabilities 103,844 97,766 111,832 114,738 115,581 108,230 109,132 110,171


Share capital 110,594 112,806 114,498 124,498 124,498 135,998 135,998 135,998

Reserves & others 90,277 90,075 95,701 116,907 136,523 165,188 154,926 162,735


Minority interests 370 297 281 187 162 200 200 200



Avg risk-weighted assets 1,488,189 1,585,718 1,707,021 1,900,590 2,075,281 2,162,258 2,239,366 2,329,465

BVPS (TWD) 18.163 17.985 18.358 19.390 20.966 22.146 21.392 21.966

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Loan/deposit 85.3 91.5 87.4 85.4 85.1 78.8 75.2 74.6

Tier-1 CAR 9.5 9.3 9.6 9.4 9.8 10.5 10.6 10.7

Total CAR 11.4 11.7 12.0 11.3 11.9 12.6 12.7 12.8

NPLs/gross loans 0.4 0.3 0.2 0.2 0.2 0.2 0.3 0.4


ROAA 0.6 0.7 0.8 0.8 1.0 1.0 0.8 0.8

ROAE 7.6 8.7 10.1 10.0 12.5 11.7 10.1 10.7


Gross yield 1.6 1.7 1.7 1.7 1.9 1.9 2.0 2.0

Cost of funds 0.5 0.6 0.6 0.6 0.7 0.7 0.7 0.8



Effective tax 18.7 16.2 17.7 16.7 14.4 13.8 16.1 16.5

Dividend-payout 67.2 55.2 60.4 56.6 57.6 57.9 63.8 60.1

Company profile

Established in February 2002 and more than 22% owned by the government, Mega Financial is a

holding company composed of four main operating subsidiaries, namely, banks, bills, securities,

and general insurance and securities investment trust enterprises (SITE).

32


Mega FHC: key quarterly data Mega Bank: forecast changes


Mega FHC

Total income 46,003 43,077 -6.4% 14,260 13,679 -4.1%

Total expense -17,942 -16,580 -7.6% -4,148 -6,662 60.6%

Income before tax 28,061 26,497 -5.6% 10,112 7,017 -30.6%

Net income 23,811 21,749 -8.7% 7,314 6,230 -14.8%

EPS (TWD) 1.91 1.75 -8.4% 0.59 0.50 -15.3%

Mega Bank


Fee income 6,039 6,375 5.6% 2,206 2,120 -3.9%

Investment income 4,659 1,316 -71.8% 842 -577 -168.5%

Other income 1,637 1,141 -30.3% 334 644 92.8%

Operating expense -13,044 -14,225 9.1% -4,882 -4,694 -3.9%

Pre-prevision profit 25,583 21,521 -15.9% 7,351 6,762 -8.0%

Net income 20,484 19,120 -6.7% 7,149 5,318 -25.6%

9M15(A) 2015E 2016E 2017E

Old New Old New


Loan growth (%) 5.0 4.5 4.1 4.5 3.0 5.0

Fee income growth (%) 6.0 -10.0 5.0 5.0 0.0 5.0

NPL ratio (%) 0.09 0.23 0.15 0.29 0.30 0.35



Mega Bank: NIM and interest rate spread Mega Bank: USD deposit and loan growth


Mega Bank: NPL and coverage ratio Mega Bank: China exposure

Source: Company, Daiwa Source: Bank Bureau, Daiwa Note: Figures represent the lending activities (including activities in the interbank market) and

investments made in China

Mega FHC: 12-month rolling PBR Mega FHC: Bloomberg-consensus EPS forecasts


1.461.42

1.461.44

1.391.42

1.441.41 1.42

1.44

1.51

1.20 1.19

1.251.27 1.28

1.32

1.27

1.18

1.11

1.221.26

1.05

1.15

1.25

1.35

1.45

1.55

1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15

Interest rate spread NIM

(%)

(10)

0

10

20

30

40

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

USD deposit USD Loan

(% YoY)

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

100

600

1,100

1,600

2,100

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15


(%) (%)

70

75

80

85

90

95

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

(% to the bank's shareholders' equity)

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

(x)

Ave. +1SD

Ave. -1SD

Ave.

2.1

2.2

2.3

2.4

2.5

2.6

2.7

2.8

2.9

Jan-

15

Feb

-15

Mar

-15

Apr

-15

May

-15

Jun-

15

Jul-1

5

Aug

-15

Sep

-15

Oct

-15

Nov

-15

Dec

-15

Jan-

16

FY16 EPS forecast FY17 EPS forecast

(TWD)


Taiwan Financials

What's new: While holding up relatively better than the other Taiwan banks

over the past 6 months, E.Sun FHC’s earnings growth momentum could

slow in 2016 on the back of the dim economic outlook we see for Taiwan.

What's the impact: Earnings growth held up well in 2015 mainly due to:

1) the bank being less exposed to the slowdown in investment demand and

China’s economic slowdown, 2) its loan growth being backed by robust

home equity loan growth, 3) a lower cost-income ratio likely for 2015-17,

and 4) fee income likely to continue to do well as it is using its advantage in

digital banking and making good use of Big Data to increase its customer

base and efficiency (see “Our top pick among bank-centric FHCs”). These

factors will remain in place for 2016-17, in our view.

But growth momentum could be undermined by increasing macro

headwinds. We are cutting our loan growth forecast and expect no NIM

expansion for 2016 on the back of the likely sluggish Taiwan GDP growth

and potential policy rate cuts. We expect the NPL ratio to rise modestly for

2016. We are also cutting our fee income forecast for 2016, due to rising

competition and a high base in 2015 (see table inside for forecasts).

Large third-party payment revenue growth potential but will take time

for the gains to materialise. E.Sun Bank brought Alipay, the largest

internet financial services platform in China, into Taiwan in 4Q15, focusing

on serving Mainland visitors in Taiwan initially. This is a business with great

potential, in our view, as it can easily expand its customer base to local

Taiwanese in the future given that the required infrastructure is mostly in

place. However, fee income from this service will be small initially, and we

don’t see it making a meaningful contribution until 2017.

What we recommend: E.Sun has held up well compared to the other

FHCs during the market correction over the past few weeks. However,

given the increasing macro risks, we are downgrading the stock to

Underperform (4) from Outperform (2) and cutting our SOTP-based 12

month TP to TWD16.4 (from TWD20.8). The stock is trading at a 1.2x 12-

month rolling forward PBR, vs. its past-10-year average and our target PBR

of 1.0x. Despite the downgrade, we note that E.Sun remains more

favourably positioned to combat the risks we have seen across the sector.

Higher-than-expected loan and fee income growth, and lower-than-

expected NPLs and credit costs would be the key risks to our forecasts.

How we differ: Our 2016-17E EPS forecasts are 10.8% and 7.5% lower

than the consensus, respectively, as a result of our below-consensus GDP

and other macro forecasts.

11 January 2016

E.Sun Fi nanci al

Can’t miss impact of macro shocks

High earnings growth rate unlikely to be sustainable in 2016

Time needed for 3rd-party payments to make meaningful contribution

Downgrading to Underperform (4); cutting TP to TWD16.40



E.Sun Financial (2884 TT)


Share price (8 Jan): TWD18.40 | Up/downside: -10.8%


[email protected]

Forecast revisions (%)Year to 31 Dec 15E 16E 17E

PPOP change (1.2) (8.6) (8.2)

Net profit change (0.5) (13.6) (11.9)

Core EPS (FD) change (0.5) (13.6) (11.9)

90

100

110

120

130

17.0

17.9

18.8

19.6

20.5



E.Sun Fin (LHS)Relative to TWSE Index (RHS)

(TWD) (%)

12-month range 17.34-20.25




Major shareholder Commonwealth Bank of AUS (4.9%)





Net profit (m) 12,989 13,253 15,414


EPS change (%) 5.2 2.0 16.3

Daiwa vs Cons. EPS (%) (2.1) (10.8) (7.5)

PER (x) 11.2 11.0 9.4


DPS 0.5 0.5 0.5

PBR (x) 1.2 1.1 1.1

ROE (%) 11.1 10.3 11.5

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/E.Sun_Financial_150707.pdf#page=1

34

E.Sun Financial (2884 TT): 11 January 2016

Financial summary

Key assumptions


Change (YoY %)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E


Loan growth (%) - bank 8.8 9.5 12.1 12.6 12.8 10.0 7.5 8.2


Provision coverage (%) 154.7 514.6 666.1 555.8 n.a. 564.0 461.7 434.4



Tier-1 CAR (%) 8.6 9.0 9.1 8.4 9.3 9.5 9.5 9.6

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E



Trading and other income 334 1,244 3,316 4,589 5,800 6,787 7,118 6,774

Net insurance income 0 0 0 0 0 0 0 0



Other expenses (5,384) (6,275) (6,725) (7,880) (9,593) (10,853) (11,573) (12,407)

Total expenses (10,211) (11,623) (12,993) (14,827) (17,950) (20,189) (22,020) (24,084)


Total provision (2,732) (4,540) (2,020) (1,707) (2,034) (2,364) (3,315) (3,588)




Tax (549) (558) (1,292) (1,798) (2,166) (2,179) (2,397) (2,744)


Net profit 3,923 3,484 7,045 8,416 10,605 12,989 13,253 15,414


EPS (TWD) 0.970 0.780 1.320 1.400 1.560 1.643 1.677 1.950

EPS (adjusted) (TWD) 0.970 0.780 1.320 1.400 1.560 1.641 1.674 1.947


DPS (TWD) 0.200 0.200 0.300 0.276 0.435 0.450 0.450 0.487

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Net-interest income 32.5 10.8 5.8 (2.9) 18.8 10.3 7.0 15.7

Non-interest income 29.2 26.0 32.1 38.1 25.9 19.5 10.0 8.7

Total operating income 31.3 16.0 15.6 14.6 22.5 15.2 8.7 11.8

Total expenses 12.7 13.8 11.8 14.1 21.1 12.5 9.1 9.4

Pre-provision operating profit 71.6 19.1 20.7 15.1 24.2 18.4 8.2 14.7

Total provisions 29.1 66.2 (55.5) (15.5) 19.2 16.3 40.2 8.2

Operating profit after provisions 114.8 (9.6) 106.2 22.5 25.0 18.8 3.2 16.0

Profit before tax 114.8 (9.6) 106.2 22.5 25.0 18.8 3.2 16.0

Net profit (adjusted) 103.4 (11.2) 102.2 19.5 26.0 22.5 2.0 16.3

EPS (adjusted, FD) 90.2 (19.6) 69.2 6.1 11.4 5.2 2.0 16.3

Gross loans 8.8 9.5 12.1 12.6 12.8 10.0 7.5 8.2

Deposits 16.6 6.4 7.2 12.4 11.3 12.6 8.6 8.1

Total assets 15.1 6.7 7.7 10.8 13.4 12.5 7.8 7.4


Shareholders' equity 6.4 18.0 14.6 10.6 29.3 18.1 4.0 3.6



35




Key ratios (%)


As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Cash & equivalent 57,914 65,021 79,029 79,252 89,638 113,403 121,459 130,230


Net loans and advances 599,161 656,009 735,407 828,238 934,614 1,028,014 1,105,138 1,196,144

Fixed assets 14,457 16,479 17,251 19,373 21,106 22,604 23,724 24,900

Goodwill 4,016 4,061 4,187 5,552 5,683 5,793 5,852 5,911

Other assets 50,565 56,035 60,840 84,370 130,563 143,375 150,304 157,575

Total assets 1,084,528 1,156,814 1,245,954 1,381,075 1,566,420 1,762,130 1,899,934 2,040,664

Customers deposits 897,264 954,994 1,023,820 1,150,791 1,280,692 1,442,525 1,566,714 1,693,866

Borrowing 74,648 64,449 64,080 66,432 97,779 123,426 129,969 136,713

Debentures 44,003 47,452 54,082 55,782 52,429 43,693 44,567 45,459



Share capital 38,033 45,750 50,107 55,243 70,530 79,153 79,153 79,153

Reserves & others 17,209 19,429 24,606 27,408 36,311 46,997 52,022 56,734




Avg interest-earning assets 946,750 1,048,600 1,122,078 1,217,833 1,340,500 1,499,869 1,655,370 1,786,339

Avg risk-weighted assets 554,709 626,378 726,323 854,722 1,000,042 1,127,370 1,225,322 1,321,899

BVPS (TWD) 14.525 14.247 14.911 14.961 15.148 15.937 16.572 17.168

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Loan/deposit 66.2 68.1 71.4 71.6 72.7 71.3 70.5 70.6

Tier-1 CAR 8.6 9.0 9.1 8.4 9.3 9.0 9.2 9.4

Total CAR 11.5 12.3 13.2 12.2 12.7 12.7 13.0 13.2

NPLs/gross loans 0.4 0.2 0.2 0.2 0.2 0.2 0.3 0.3

Total loan-loss prov./NPLs 154.7 514.6 666.1 555.8 n.a. 564.0 461.7 434.4

ROAA 0.4 0.3 0.6 0.6 0.7 0.8 0.7 0.8

ROAE 7.3 5.8 10.1 10.7 11.1 11.1 10.3 11.5


Gross yield 1.9 2.0 2.0 1.9 2.0 2.0 2.0 2.1

Cost of funds 0.7 0.8 0.8 0.8 0.9 0.9 0.9 0.9



Effective tax 12.3 13.8 15.5 17.6 17.0 14.3 15.3 15.1

Dividend-payout 20.6 25.6 22.7 19.7 27.9 27.4 26.8 25.0

Company profile

E.Sun Financial Holding Co., Ltd. was established in 2002, operating as a bank-centric financial

institution with an asset size of TWD1,730bn as of 30 September 2015. Its primary subsidiary E.Sun

Bank offers integrated banking services, with relative strength in retail services, credit cards and SME

banking.

36


E.Sun FHC: key quarterly data E.Sun Bank: forecast changes

TWDm 9M14 9M15 % YoY 2Q15 3Q15 % QoQ

E.SUN FHC

Total income 24,504 29,327 19.7% 9,875 10,162 2.9%

Total expense (14,190) (17,338) 22.2% (5,924) (5,824) -1.7%

Income before tax 10,314 11,989 16.2% 3,951 4,338 9.8%

Net income 8,477 10,444 23.2% 3,504 3,745 6.9%

EPS (TWD) 1.16 1.32 13.8% 0.44 0.47 6.8%

E.SUN Bank


Fee income 7,327 8,991 22.7% 3,176 3,134 -1.3%

Investment income 4,220 5,286 25.2% 1,819 1,566 -13.9%

Other income 119 311 161.6% 69 116 69.4%


PPOP 10,856 13,985 28.8% 4,739 4,684 -1.2%

Net income 8,167 9,755 19.4% 3,276 3,388 3.4%

9M15(A) 2015E 2016E 2017E

Old New Old New

E.Sun Bank

NIM expansion (bps) 2 4 2 7 0 4

Loan growth (%) 10.1 10.0 10.0 10.0 7.5 8.2


NPL ratio (%) 0.18 0.20 0.20 0.20 0.25 0.27


Source: Company, Daiwa Source: Daiwa forecasts

E.Sun Bank: NIM E.Sun Bank: loan breakdown


E.Sun Bank: cost-income ratio E.Sun Bank: fee income breakdown


E.Sun FHC: one-year rolling PBR bands E.Sun FHC: EPS


1.28 1.28

1.29

1.271.28

1.29

1.31.3

1.3

1.32

1.24

1.25

1.26

1.27

1.28

1.29

1.30

1.31

1.32

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

(%)

SME24.9%

Large corporate loans24.8%

Mortgages22.0%

Secured personal loans

19.8%

UPL7.4%

Credit card loans1.0%

56.4

72.8

57.8

63.767.7

56.5

56.8

54.7

52.954

48.9

43

48

53

58

63

68

73

78

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

9M15

(%)

4.0

2.4

0.7 0.8 0.6

5.8

2.6

0.8 0.8 0.6

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Wealthmanagement

Credit card Corporatebanking

Consumerbanking

Securities &Others

9M14 9M15

(TWDbn)

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

(x)

Ave. +1SD

Ave. -1SD

Ave.

1.7

1.8

1.9

2.0

2.1

2.2

2.3

Jan-

15

Feb

-15

Mar

-15

Apr

-15

May

-15

Jun-

15

Jul-1

5

Aug

-15

Sep

-15

Oct

-15

Nov

-15

Dec

-15

Jan-

16

2016E EPS 2017E EPS

(TWD)


Taiwan Financials

What's new: We think it is too early to revisit CTBC FHC despite its recent

share-price correction. We reiterate our Underperform (4) rating and cut our

12-month target price to TWD14.3, now based on our 2016 forecasts.

What's the impact: Risks rising outside core banking business.

CTBC’s aggressive expansion plans have been a concern to us, as it

seems to be acquiring firms when the economy may well have peaked and

is now slowing. For example, Taiwan Life, for which CTBC FHC sealed the

deal in 2Q15, recorded a net loss of TWD0.7bn for 9M15 (vs. a gain of

TWD2bn for 9M14), with its unrealised loss increasing to TWD7.2bn as of

end-9M15 (TWD6.4bn for end-9M14).

To meet the capital needs of the M&A moves that it participates in (the

acquisition of Taiwan Life and China CITIC Bank international, the

establishment of a JV with Fujian Huatou investment Co, and the

acquisition of a 20% stake in ABC Life), CTBC announced a 2,397m share

issuance in tranches, which implies 12.8% dilution. According to the United

Daily News, the reference price for the first issuance (920m shares) was

set at TWD16.73 in 3Q15, below the share price of TWD19.5 at the time.

However, the share price has fallen to TWD16, posing a challenge for

CTBC to complete the capital increase. If it decides to postpone the plan,

settling the M&A deals to which it has committed may undermine its capital

position. If it insists on conducting the capital increase, it will likely have to

offer a lower reference price, adding pressure to the share price.

Banking business has held up well but won’t be spared from macro

shocks. NIM is likely to be under pressure on the back of potential rate

cuts by the CBC. We also see a rising default risk for its target redemption

forward (TRF) business on CNY weakness. A one-off profit of TWD7bn

from the sale of its headquarters should support 2015 earnings, however.

What we recommend: We continue to recommend that investors avoid

CTBC at this stage pending any developments on its capital increase plan

and progress on incorporating Taiwan Life. We cut 2016-17E EPS by 11%

and 13%, respectively, as we factor in higher credit costs. In turn, our

SOTP-based target price falls to TWD14.3 (from TWD18.2), based on our

2016 forecasts (previously mid-2015/16). We find the stock is trading at a

1.0x 12-month rolling PBR, lower than its past-10-year average of 1.1x. Our

2016 ROE forecast of 10.1% implies a target PBR of 1.0x, based on our

Gordon Growth model, but we use 0.9x given our concerns over CTBC’s

activities outside its core business. Higher loan growth and lower credit

cost are the main upside risks to our call.

How we differ: On 2016-17E core EPS, we are now 20.2% and 18.9%

below the Bloomberg consensus forecasts, respectively.

11 January 2016

CTBC Fi nanci al

Still not a good time to get on board

The timing of CTBC’s expansion plan seems inappropriate to us

Core earnings lacking growth momentum amid rising macro risks

Reiterate Underperform (4); TP cut to TWD14.3 on our 2016 forecasts



CTBC Financial (2891 TT)




[email protected]



PPOP change 3.6 3.8 1.7



95

104

113

121

130

15

17

19

21

23



CTBC Fin (LHS)Relative to TWSE Index (RHS)

(TWD) (%)

12-month range 15.90-22.80




Major shareholder Nan Shan Life Insurance (4.9%)

Financial summary (TWD)Year to 31 Dec 15E 16E 17E



Net profit (m) 36,032 27,183 30,600


EPS change (%) 8.9 (6.2) 12.6

Daiwa vs Cons. EPS (%) (12.9) (20.2) (18.9)

PER (x) 9.1 9.7 8.6


DPS 0.6 0.6 0.6

PBR (x) 1.0 1.0 0.9

ROE (%) 11.5 10.1 11.2

38

CTBC Financial (2891 TT): 11 January 2016

Financial summary

Key assumptions


Change (YoY %)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E


Loan growth (%) - bank 11.3 7.0 6.8 12.3 51.5 11.6 4.1 5.3





Tier-1 CAR (%) 11.6 11.4 11.9 9.7 10.6 10.6 10.8 10.8

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E




Net insurance income 0 (409) 1,334 869 1,590 3,803 4,330 5,176



Other expenses (15,232) (15,478) (15,452) (16,927) (21,730) (24,155) (24,518) (25,802)

Total expenses (33,358) (34,132) (35,549) (39,198) (48,557) (55,936) (56,777) (59,750)


Total provision (1,863) (559) (539) (6,416) (3,645) (2,445) (7,373) (8,218)


Non-operating income 0 0 0 0 14,814 7,049 0 0


Tax (3,188) (3,267) (3,417) (42) (5,718) (6,323) (6,928) (7,592)

Min. int./pref. div./other items 0 0 0 0 0 7,049 0 0

Net profit 14,142 18,297 21,298 21,510 39,445 36,032 27,183 30,600


EPS (TWD) 1.230 1.610 1.650 1.500 2.580 2.185 1.648 1.855

EPS (adjusted) (TWD) 1.230 1.610 1.650 1.500 1.614 2.185 1.648 1.855


DPS (TWD) 0.730 0.400 0.710 0.380 0.810 0.600 0.600 0.600

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E


Non-interest income 15.6 2.2 2.7 16.2 5.8 15.1 10.0 6.8


Total expenses 10.1 2.3 4.2 10.3 23.9 15.2 1.5 5.2


Total provisions (85.0) (70.0) (3.7) 1,091.3 (43.2) (32.9) 201.5 11.5

Operating profit after provisions 361.4 24.4 14.6 (12.8) 40.8 16.3 (3.4) 12.0

Profit before tax 361.4 24.4 14.6 (12.8) 109.5 (6.2) (19.5) 12.0


EPS (adjusted, FD) 778.6 30.9 2.5 (9.1) 7.6 8.9 (6.2) 12.6

Gross loans 8.6 7.8 7.0 13.3 43.1 11.6 4.1 5.3

Deposits 1.8 10.6 4.8 13.5 39.7 13.2 8.0 8.0

Total assets 3.1 11.3 4.6 14.7 50.7 10.7 6.3 7.1


Shareholders' equity 7.5 6.5 (1.5) 14.2 19.0 19.5 (3.4) 5.9


Avg risk-weighted assets (6.1) 3.9 4.8 14.7 31.8 21.3 10.0 10.0

39




Key ratios (%)


As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Cash & equivalent 123,113 159,428 155,552 240,287 407,940 478,701 549,292 603,355

Investment securities 507,643 588,978 587,327 591,604 912,326 1,138,538 1,233,195 1,344,210

Net loans and advances 983,755 1,060,090 1,133,807 1,284,855 1,838,176 2,050,921 2,135,862 2,248,945

Fixed assets 33,221 34,172 38,837 38,348 43,379 51,671 52,720 54,315

Goodwill 12,331 13,758 13,942 13,948 16,992 15,336 15,520 15,707

Other assets 154,531 163,460 184,051 255,678 435,867 309,955 315,356 340,972

Total assets 1,814,594 2,019,888 2,113,516 2,424,720 3,654,680 4,045,121 4,301,945 4,607,505


Borrowing 179,174 159,587 122,560 149,992 270,281 286,235 290,142 294,212

Debentures 60,372 55,182 66,122 70,470 117,573 96,834 98,705 101,567



Share capital 107,295 114,477 124,170 147,130 152,573 164,931 164,931 164,931

Reserves & others 53,641 56,872 44,661 45,640 76,780 109,162 99,879 115,522






BVPS (TWD) 15.260 15.316 13.597 13.102 15.032 16.619 16.056 17.004

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Loan/deposit 74.0 71.4 72.7 72.1 75.1 74.4 71.8 69.9

Tier-1 CAR 11.6 11.4 11.9 9.7 10.6 10.6 10.8 10.8

Total CAR 14.3 13.9 14.3 11.8 13.5 13.4 13.6 13.6

NPLs/gross loans 0.6 0.3 0.4 0.4 0.9 0.8 0.9 1.0


ROAA 0.8 1.0 1.0 0.9 0.8 0.8 0.7 0.7

ROAE 9.1 11.0 12.5 11.9 11.7 11.5 10.1 11.2


Gross yield 2.2 2.3 2.5 2.4 2.6 2.2 2.0 2.1

Cost of funds 0.7 0.7 0.8 0.8 0.9 0.8 0.7 0.7



Effective tax 18.4 15.2 13.8 0.2 12.7 17.9 20.3 19.9

Dividend-payout 59.3 24.8 43.0 25.3 31.4 27.5 36.4 32.3

Company profile

CTBC Financial Holding, formerly known as Chinatrust Financial Holding, was established in 2002.

It has a total of 9 subsidiaries covering banking, securities, life insurance, asset management and

etc. The company’s subsidiary, CTBC Bank, is the largest private bank in Taiwan in terms of assets.

CTBC Bank focuses on retail banking and is the biggest issuer of credit cards in Taiwan.

40


CTBC FHC: key quarterly data CTBC Bank: assumption changes


CTBC FHC

Total income 76,756 71,088 -7.4% 23,857 22,700 -4.8%

Total expense (35,342) (41,441) 17.3% (15,104) (13,292) -12.0%

Income before tax 41,414 29,647 -28.4% 8,753 9,408 7.5%

Net income 37,288 24,946 -33.1% 7,449 7,723 3.7%

EPS (TWD) 2.44 1.51 -38.1% 0.49 0.47 -4.1%

CTBC Bank


Fee income 21,289 23,633 11.0% 7,250 7,341 1.3%

Investment income 6,119 7,630 24.7% 2,950 2,175 -26.3%

Other income 13,215 (469) -103.5% (38) 382 -1105.3%

Operating expense (32,773) (38,327) 16.9% (14,242) (11,209) -21.3%

Pre-prevision profit 35,674 24,225 -32.1% 6,327 9,759 54.2%

Net income 32,315 19,619 -39.3% 5,632 6,891 22.4%

9M15(A) 2015E 2016E 2017E

Old New Old New


Loan growth (%) 10.4 4.0 10.1 4.2 4.2 5.4


NPL ratio (%) 0.78 0.92 0.78 0.90 0.90 0.95

Net credit cost (bps) 3.2 20 10 25 32 35


CTBC Bank: Interest rate spread and NIM CTBC Bank: coverage and NPL ratio


CTBC Bank: wealth management fee income breakdown Taiwan Life: key data

TWD mn 9M14 9M15 % YoY 2013 2014 % YoY

Net earned premium 53,471 40,654 -24.0% 51,859 63,726 22.9%

Net investment income 13,693 12,104 -11.6% 14,490 18,005 24.3%

Other income 5,359 3,488 -34.9% 9,789 7,197 -26.5%

Total cost and expense (70,271) (56,440) -19.7% (75,398) (86,745) 15.1%

Income before tax 2,252 (195) -108.6% 741 2,182 194.6%

Net income 1,979 (693) -135.0% 477 1,814 280.0%

Total asset 492,863 534,880 8.5% 449,732 508,322 13.0%

Total liability 478,711 522,294 9.1% 436,864 492,334 12.7%

Total equity 14,152 12,585 -11.1% 12,868 15,988 24.2%

BVPS 14.6 13.0 -11.1% 13.4 16.5 23.1%


CTBC FHC: 12-month rolling PBR CTBC FHC: Bloomberg-consensus EPS forecasts

Source: Bloomberg Source: Bloomberg

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

2.1

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

Interest spread NIM

(%)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

100

150

200

250

300

350

400

450

500

550

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15


(%) (%)

7.5

4.1

0.2 0.0

7.6

4.5

0.3 0.1

0

1

2

3

4

5

6

7

8

Bancassurance Mutual fund Custodian & trust Structured & Others

9M14 9M15

(TWDbn)

0.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

(x)

Ave. +1SD

Ave. -1SD

Ave.

1.6

1.7

1.8

1.9

2.0

2.1

2.2

2.3

2.4

2.5

Jan-

15

Feb

-15

Mar

-15

Apr

-15

May

-15

Jun-

15

Jul-1

5

Aug

-15

Sep

-15

Oct

-15

Nov

-15

Dec

-15

Jan-

16

FY16 EPS forecast FY17 EPS forecast

(TWD)


Taiwan Financials

What's new: A dim economic outlook for Taiwan and further rate cuts by

the Central Bank of China (CBC) is likely to hit First FHC in 2016-17.

Accordingly, we downgrade the stock to Sell (5) and cut our 12-month TP to

TWD11.7 as we see more challenges looming.

What's the impact: NIM contraction. We expect the CBC to deliver 2

more 12.5bp rate cuts in 2016, implying that First Bank’s NIM should come

under pressure. We were expecting its NIM to expand by 7bp for 2016E,

driven by an increasing share of FX lending, but now expect the NIM to

contract by 3bp instead.

Dealing with excess liquidity. We now expect outstanding loans to fall by

1.8% for 2016, vs. our previous forecast of 3.2% YoY growth. Deposit

growth, however, should hold up better. A lack of investment options, in

addition to operating risks, given the dim economic outlook could force

Taiwan companies to deposit less cash, leading to higher deposit growth.

We expect the bank’s loan-to-deposit ratio to fall from 77% for 2015E to

73% for 2016E.

A good way to absorb this excess liquidity would be via the sale of wealth

management products. As such, we expect First Bank’s fee income growth

to reach 10% YoY for 2016E, up from our previous forecast of 5% YoY.

Rising credit cost for 2016E. We raise our net income forecast by 27%

for 2015E, given a significant drop in the 9M15 provision expense (down

60.5% YoY) as asset quality improved. But for 2016E, we expect asset

quality to deteriorate amid the weak economic outlook. Lower loan recovery

in 2016E vs. 2015 would also push up the net credit cost for First Bank.

What we recommend: The share price has dropped by 13.4% since April

and rounds of EPS forecast cuts by the street have taken place. Given that

Daiwa’s economic view on Taiwan has turned more cautious, we believe

First Bank is likely to face stronger earnings headwinds going forward.

Accordingly, we cut our SOTP-based 12-month TP to TWD11.7 (from

TWD15.2). The stock is trading at 0.9x 12-month rolling PBR, lower than its

past-10-year average of 1.0x. Our target price implies an end-2016 PBR of

0.8x (1.0x in our previous forecast) as we expect a lower ROE for 2016E

(7.5% vs. 9.1% for our previous forecast). Higher-than-expected loan and

fee income growth, policy rate hikes and lower NPLs and credit costs would

be the key upside risks to our forecasts.

How we differ: Our 2016-17 core EPS forecasts are 17.8% and 14.7%

lower than consensus, respectively, on the back of rising macro risks.

11 January 2016

First Financial

Macro headwinds continue to blow

NIM likely to contract as the CBC is likely to cut rates further in 2016

Credit costs could rise on poor asset quality and lower recoveries

Downgrading to Sell (5); lowering TP to TWD11.7



First Financial (2892 TT)




[email protected]



PPOP change 4.4 (1.3) (1.9)



94

98

102

106

110

14.5

15.5

16.5

17.5

18.5



First Fin (LHS)Relative to TWSE Index (RHS)

(TWD) (%)

12-month range 14.85-18.10




Major shareholder Ministry of Finance (13.4%)





Net profit (m) 17,464 13,642 14,813


EPS change (%) (5.6) (17.1) 8.6

Daiwa vs Cons. EPS (%) 1.2 (17.8) (14.7)

PER (x) 10.3 12.5 11.5


DPS 0.8 0.8 0.8

PBR (x) 0.9 1.0 1.0

ROE (%) 9.7 7.5 8.4

42

First Financial (2892 TT): 11 January 2016

Financial summary

Key assumptions


Change (YoY %)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E


Loan growth (%) - bank 13.9 7.9 6.7 (0.4) 4.6 (1.2) (1.8) 3.1





Tier-1 CAR (%) - bank 7.1 8.3 8.5 8.4 9.1 11.1 11.0 11.0

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E




Net insurance income 4 (35) 67 291 568 350 500 800



Other expenses (5,667) (6,135) (5,923) (6,103) (7,013) (6,620) (6,754) (7,037)

Total expenses (16,588) (17,971) (18,922) (18,973) (20,789) (20,579) (20,996) (21,876)


Total provision (5,491) (5,347) (3,551) (4,047) (4,015) (2,197) (5,592) (6,021)




Tax (2,025) (1,735) (1,978) (2,172) (2,405) (2,749) (2,886) (3,060)


Net profit 7,032 7,602 10,226 10,889 14,085 16,464 13,642 14,813


EPS (TWD) 1.090 1.010 1.180 1.260 1.521 1.437 1.190 1.292

EPS (adjusted) (TWD) 1.090 1.010 1.180 1.260 1.521 1.437 1.190 1.292


DPS (TWD) 0.300 0.400 0.450 0.500 0.700 0.750 0.750 0.750

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Net-interest income 15.3 13.1 13.5 3.5 9.0 1.6 (0.4) 4.4

Non-interest income (8.9) (9.5) (8.5) 6.1 28.3 1.8 9.4 9.7


Total expenses 3.8 8.3 5.3 0.3 9.6 (1.0) 2.0 4.2


Total provisions (48.3) (2.6) (33.6) 13.9 (0.8) (45.3) 154.5 7.7

Operating profit after provisions 199.1 2.4 32.0 7.4 26.3 16.5 (14.0) 8.1

Profit before tax 199.1 2.4 32.0 7.4 26.3 16.5 (14.0) 8.1


EPS (adjusted, FD) 153.5 (7.3) 16.8 6.8 20.7 (5.6) (17.1) 8.6

Gross loans 14.8 7.9 5.8 (0.4) 4.6 (1.2) (1.3) 3.1

Deposits 4.5 1.7 0.7 6.8 5.3 5.5 4.0 4.0

Total assets 4.5 1.6 2.1 6.5 4.1 5.6 3.4 4.0


Shareholders' equity 4.9 19.5 4.3 6.5 9.4 20.9 (5.7) 1.2



43




Key ratios (%)


As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Cash & equivalent 142,273 176,557 175,309 219,270 243,459 336,001 389,080 422,934



Fixed assets 23,694 26,370 28,299 28,465 28,299 27,822 28,100 28,381

Goodwill 255 166 304 346 430 402 422 443

Other assets 104,356 95,803 102,078 136,293 137,854 159,165 172,645 182,403

Total assets 2,048,868 2,080,970 2,124,279 2,263,385 2,355,709 2,486,743 2,571,302 2,673,452


Borrowing 201,460 193,139 183,759 173,400 165,816 158,545 164,944 171,699

Debentures 36,944 37,029 53,503 55,492 52,593 41,880 43,136 44,862



Share capital 64,768 76,654 81,254 86,535 92,593 114,611 114,611 114,611

Reserves & others 41,229 50,063 50,890 54,194 61,352 71,437 60,886 62,967






BVPS (TWD) 16.366 16.531 16.263 16.263 16.626 16.233 15.312 15.494

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Loan/deposit 78.9 84.0 88.5 82.5 82.0 76.9 73.0 72.3

Tier-1 CAR 7.1 8.3 8.5 8.4 9.1 11.1 11.0 11.0

Total CAR 10.5 11.1 11.6 11.1 11.8 14.2 14.3 14.3

NPLs/gross loans 0.8 0.5 0.4 0.5 0.2 0.2 0.4 0.4


ROAA 0.4 0.4 0.5 0.5 0.6 0.7 0.5 0.6

ROAE 6.7 6.5 7.9 7.9 10.0 9.7 7.5 8.4


Gross yield 1.5 1.8 1.9 1.9 2.0 1.9 1.9 2.0

Cost of funds 0.5 0.7 0.6 0.6 0.7 0.7 0.7 0.8



Effective tax 22.5 18.8 16.3 16.6 14.6 14.3 17.5 17.1

Dividend-payout 27.5 39.6 38.1 39.7 46.0 52.2 63.0 58.0

Company profile

First FHC is a government-affiliated FHC, in which the government holds a 28.5% stake (including

direct and indirect holdings). First Bank, a flagship subsidiary of First FHC, is one of the top-5

commercial banks in Taiwan in terms of total assets, and the leader in SME loans domestically.

44


First FHC: key quarterly table First Bank: forecast changes


First FHC

Total income 31,417 30,780 -2.03% 9,864 10,753 9.01%

Total expense (17,922) (16,391) -8.54% (5,165) (6,005) 16.26%

Income before tax 13,495 14,389 6.62% 4,699 4,748 1.04%

Net income 11,705 12,018 2.67% 3,999 3,910 -2.23%

EPS (TWD) 1.19 1.21 1.68% 0.38 0.39 2.63%

First Bank


Fee income 4,636 5,238 12.99% 1,842 1,806 -1.95%

Investment income 3,309 2,375 -28.23% 214 1,396 552.34%

Other income 60 273 355.00% 168 21 -87.50%


Pre-prevision profit 15,424 14,526 -5.82% 4,351 5,378 23.60%

Net income 10,936 12,013 9.85% 3,796 4,117 8.46%

9M15(A) 2015E 2016E 2017E

Old New Old New

NIM expansion (bps) -1 5 -1 7 -3 2

Loan growth (%) -1.6 3.5 -1.2 3.2 -1.8 3.1


NPL ratio (%) 0.18 0.30 0.20 0.36 0.36 0.38

Net credit cost (bps) 1.3 20 15 25 35 40

Source: Company, Daiwa Source: Daiwa forecasts

First Bank: NIM First Bank: coverage and NPL ratio


First Bank: loan breakdown First Bank: fee income breakdown


First FHC: 12-month rolling PBR First FHC: Bloomberg-consensus EPS forecasts

Source: Bloomberg Source: Bloomberg, Daiwa

1.201.21

1.26 1.26 1.26 1.26

1.28 1.28 1.28 1.281.29

1.28

1.25

1.15

1.20

1.25

1.30

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

(%)

0.1

0.2

0.3

0.4

0.5

0.6

0.7

100

200

300

400

500

600

700

800

900

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15


(%) (%)

SMEs 39.6%

Mortgage 26.7%

FX loan 23.0%

Large corporates 7.4%

Others 3.4%

0

500

1,000

1,500

2,000

2,500

3,000

Wealthmanagement

Loan-related FX related Credit card Others

9M14 9M15

(TWD m)

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

(x)

Ave. +1SD

Ave. -1SD

Ave.

1.4

1.5

1.6

1.7

1.8

Jan-

15

Jan-

15

Fe

b-15

Mar

-15

Mar

-15

Apr

-15

May

-15

May

-15

Jun-

15

Jul-1

5

Jul-1

5

Aug

-15

Sep

-15

Oct

-15

Oct

-15

Nov

-15

Dec

-15

Dec

-15

Jan-

16

2016 EPS forecast FY17 EPS forecast

(TWD)

45


Daiwa’s Asia Pacific Research Directory

HONG KONG

Takashi FUJIKURA (852) 2848 4051 [email protected]

Regional Research Head

Kosuke MIZUNO (852) 2848 4949 / (852) 2773 8273

[email protected]

Regional Research Co-head

John HETHERINGTON (852) 2773 8787 [email protected]

Regional Deputy Head of Asia Pacific Research

Rohan DALZIELL (852) 2848 4938 [email protected]

Regional Head of Product Management

Kevin LAI (852) 2848 4926 [email protected]

Chief Economist for Asia ex-Japan; Macro Economics (Regional)

Junjie TANG (852) 2773 8736 [email protected]

Macro Economics (China)

Jonas KAN (852) 2848 4439 [email protected]

Head of Hong Kong and China Property

Cynthia CHAN (852) 2773 8243 [email protected]

Property (China)

Leon QI (852) 2532 4381 [email protected]

Banking (Hong Kong/China); Broker (China); Insurance (China)

Anson CHAN (852) 2532 4350 [email protected]

Consumer (Hong Kong/China)

Jamie SOO (852) 2773 8529 [email protected]

Gaming and Leisure (Hong Kong/China)

Dennis IP (852) 2848 4068 [email protected]

Power; Utilities; Renewables and Environment (Hong Kong/China)

John CHOI (852) 2773 8730 [email protected]

Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap

Kelvin LAU (852) 2848 4467 [email protected]

Head of Automobiles; Transportation and Industrial (Hong Kong/China)

Brian LAM (852) 2532 4341 [email protected]

Transportation – Railway; Construction and Engineering (China)

Jibo MA (852) 2848 4489 [email protected]

Head of Custom Products Group

Thomas HO (852) 2773 8716 [email protected]

Custom Products Group

PHILIPPINES

Bianca SOLEMA (63) 2 737 3023 [email protected]

Utilities and Energy

SOUTH KOREA

Sung Yop CHUNG (82) 2 787 9157 [email protected]

Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Shipbuilding; Steel

Mike OH (82) 2 787 9179 [email protected]

Banking; Capital Goods (Construction and Machinery)

Iris PARK (82) 2 787 9165 [email protected]

Consumer/Retail

SK KIM (82) 2 787 9173 [email protected]

IT/Electronics – Semiconductor/Display and Tech Hardware

Thomas Y KWON (82) 2 787 9181 [email protected]

Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game

Kevin JIN (82) 2 787 9168 [email protected]

Small/Mid Cap

TAIWAN

Rick HSU (886) 2 8758 6261 [email protected]

Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design (Regional)

Christie CHIEN (886) 2 8758 6257 [email protected]

Banking; Insurance (Taiwan); Macro Economics (Regional)

Steven TSENG (886) 2 8758 6252 [email protected]

IT/Technology Hardware (PC Hardware)

Christine WANG (886) 2 8758 6249 [email protected]

IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer

Kylie HUANG (886) 2 8758 6248 [email protected]

IT/Technology Hardware (Handsets and Components)

Helen CHIEN (886) 2 8758 6254 [email protected]

Small/Mid Cap

INDIA

Punit SRIVASTAVA (91) 22 6622 1013 [email protected]

Head of India Research; Strategy; Banking/Finance

Saurabh MEHTA (91) 22 6622 1009 [email protected]

Capital Goods; Utilities

SINGAPORE

Ramakrishna MARUVADA (65) 6499 6543 [email protected]

Head of Singapore Research; Telecommunications (China/ASEAN/India)

Royston TAN (65) 6321 3086 [email protected]

Oil and Gas; Capital Goods

David LUM (65) 6329 2102 [email protected]

Property and REITs

Shane GOH (65) 64996546 [email protected]

Small/Mid Cap (Singapore)

Jame OSMAN (65) 6321 3092 [email protected]

Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)

46


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Daiwa Securities Co. Ltd., Bangkok Representative Office 18th Floor, M Thai Tower, All Seasons Place, 87 Wireless Road,

Lumpini, Pathumwan, Bangkok 10330, Thailand (66) 2 252 5650 (66) 2 252 5665

Daiwa Capital Markets India Private Ltd 10th Floor, 3 North Avenue, Maker Maxity, Bandra Kurla Complex, Bandra East, Mumbai – 400051, India

(91) 22 6622 1000 (91) 22 6622 1019

Daiwa Securities Co. Ltd., Hanoi Representative Office Suite 405, Pacific Palace Building, 83B, Ly Thuong Kiet Street, Hoan Kiem Dist. Hanoi, Vietnam

(84) 4 3946 0460 (84) 4 3946 0461

DAIWA INSTITUTE OF RESEARCH LTD

HEAD OFFICE 15-6, Fuyuki, Koto-ku, Tokyo, 135-8460, Japan (81) 3 5620 5100 (81) 3 5620 5603

MARUNOUCHI OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6756 (81) 3 5555 7011 (81) 3 5202 2021

New York Research Center 11th Floor, Financial Square, 32 Old Slip, NY, NY 10005-3504, U.S.A. (1) 212 612 6100 (1) 212 612 8417

London Research Centre 3/F, 5 King William Street, London, EC4N 7AX, United Kingdom (44) 207 597 8000 (44) 207 597 8550

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Important Disclosures and Disclaimer

This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Group Inc., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person. Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including market making activities, derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures. Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationship For “Investment Banking Relationship”, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Japan

Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship Within the preceding 12 months, the subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: Modern Land (China) Co. Ltd (1107 HK); econtext Asia Ltd (1390 HK); Accordia Golf Trust (AGT SP); GF Securities Co Ltd (1776 HK); Mirae Asset Life Insurance Co Ltd (085620 KS); China Reinsurance Group Corporation (1508 HK).

*Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa

Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd.

Hong Kong

This research is distributed in Hong Kong by Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司) (“DHK”) which is regulated by the Hong Kong Securities and Futures

Commission. Recipients of this research in Hong Kong may contact DHK in respect of any matter arising from or in connection with this research. Relevant Relationship (DHK) DHK may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage.

Singapore This research is distributed in Singapore by Daiwa Capital Markets Singapore Limited and it may only be distributed in Singapore to accredited investors, expert investors and institutional investors as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time. By virtue of distribution to these category of investors, Daiwa Capital Markets Singapore Limited and its representatives are not required to comply with Section 36 of the Financial Advisers Act (Chapter 110) (Section 36 relates to disclosure of Daiwa Capital Markets Singapore Limited’s interest and/or its representative’s interest in securities). Recipients of this research in Singapore may contact Daiwa Capital Markets Singapore Limited in respect of any matter arising from or in connection with the research.

Australia

This research is distributed in Australia by Daiwa Capital Markets Australia Limited and it may only be distributed in Australia to wholesale investors within the meaning of the Corporations Act. Recipients of this research in Australia may contact Daiwa Capital Markets Stockbroking Limited in respect of any matter arising from or in connection with the research.

India This research is distributed in India to Institutional Clients only by Daiwa Capital Markets India Private Limited (Daiwa India) which is an intermediary registered with Securities & Exchange Board of India as a Stock Broker, Merchant Bank and Research Analyst. Daiwa India, its Research Analyst and their family members and its associates do not have any financial interest save as disclosed or other undisclosed material conflict of interest in the securities or derivatives of any companies under coverage. Daiwa India and its associates may have received compensation for any products other than Investment Banking (as disclosed) or brokerage services from the subject company in this report during the past 12 months. Unless otherwise stated in BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action, Daiwa India and its associates do not hold more than 1% of any companies covered in this research report. There is no material disciplinary action against Daiwa India by any regulatory authority impacting equity research analysis activities as of the date of this report.

Taiwan This research is distributed in Taiwan by Daiwa-Cathay Capital Markets Co., Ltd and it may only be distributed in Taiwan to institutional investors or specific investors who have signed recommendation contracts with Daiwa-Cathay Capital Markets Co., Ltd in accordance with the Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. Recipients of this research in Taiwan may contact Daiwa-Cathay Capital Markets Co., Ltd in respect of any matter arising from or in connection with the research.

Philippines This research is distributed in the Philippines by DBP-Daiwa Capital Markets Philippines, Inc. which is regulated by the Philippines Securities and Exchange Commission and the Phil ippines Stock Exchange, Inc. Recipients of this research in the Philippines may contact DBP-Daiwa Capital Markets Philippines, Inc. in respect of any matter arising from or in connection with the research. DBP-Daiwa Capital Markets Philippines, Inc. recommends that investors independently assess, with a professional advisor, the specific financial risks as well as the legal, regulatory, tax, accounting, and other consequences of a proposed transaction. DBP-Daiwa Capital Markets Philippines, Inc. may have positions or may be materially interested in the securities in any of the markets mentioned in the publication or may have performed other services for the issuers of such securities. For relevant securities and trading rules please visit SEC and PSE links at http://www.sec.gov.ph/irr/AmendedIRRfinalversion.pdf and http://www.pse.com.ph/ respectively.

Thailand

This research is distributed to only institutional investors in Thailand primarily by Thanachart Securities Public Company Limited (“TNS”).

This report is prepared by analysts who are employed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates. This report is provided to you for informational purposes only and it is not, and is not to be construed as, an offer or an invitation to make an offer to sell or buy any securities. Neither Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees accept any liability whatsoever for any direct or consequential loss arising from any use of this research or its contents.

The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable. However, Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees make no representation or warranty, express or implied, as to their accuracy or completeness. Expressions of opinion herein are subject to change without notice. The use of any information, forecasts and opinions contained in this report shall be at the sole discretion and risk of the user.

Daiwa Securities Group Inc. and/or its non-U.S. affiliates perform and seek to perform business with companies covered in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates, their respective directors, officers, servants and employees may have positions and financial interest in securities mentioned in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this research. Therefore, investors should be aware of conflict of interest that may affect the objectivity of this research.

United Kingdom This research report is produced by Daiwa Securities Co. Ltd. and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange and Eurex. This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available. Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory.

Germany

https://daiwa3.bluematrix.com/sellside/Disclosures.action


http://www.sec.gov.ph/irr/AmendedIRRfinalversion.pdf%20and%20http:/www.pse.com.ph/

http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory

48


This document is distributed in Germany by Daiwa Capital Markets Europe Limited, Niederlassung Frankfurt which is regulated by BaFin (Bundesanstalt fuer Finanzdienstleistungsaufsicht) for the conduct of business in Germany.

Bahrain This research material is distributed in Bahrain by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113

United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (Tel no. 212-612-7000).

Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months. Disclosure of investment ratings

Rating Percentage of total

Buy* 63.9%

Hold** 21.3%

Sell*** 14.8%

Source: Daiwa

Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 December 2015. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings. Additional information may be available upon request.

Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items.

In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction.

In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.

For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.

There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.

There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us.

Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association






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