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Taiwan's bank bazaar
The island is positively awash in banks, so Taipei intends to sell state institutions to promote long-overdue consolidation and modernization of its creaky financial system -- and benefit the whole economy. And this time it just may do it.
Chang Hwa Commercial Bank was to have been the test case of Taipei's commitment to financial reform. The government planned to sell its controlling stake to foreign investors so that the bank could act as a catalyst for bank consolidation. Market whispers suggested that Taiwan's sixth-largest bank, with $42 billion in assets and 166 branches, would be a bargain: Its shaky asset quality meant that it would sell at a steep discount, giving any purchaser a big potential upside.
Chang Hwa, however, turned out to be no prize. The price of nearly $600 million, or about 12 Taiwanese dollars (38 cents) per share, for the government's minority stake deterred would-be foreign buyers. Sources say a consortium of investors -- led by Japan's Shinsei Bank and including U.S. private equity fund Ripplewood Holdings -- were unwilling to shell out more than NT$5 a share. When the sale collapsed in May, an embarrassed Taipei withdrew Chang Hwa from the market indefinitely.
The bank's much-ballyhooed disposal was supposed to have been the centerpiece of President Chen Shui-bian's sweeping plan to drag Taiwan's antiquated state-owned financial sector -- which accounts for more than 60 percent of the country's bank assets -- kicking and screaming into the modern era. The failed sale threatened to set back, once again, Taipei's attempts at reform, but officials vow to redouble their efforts.
"We have to reach the goal to merge 12 banks into six by the end of this year," says Liu Teng-cheng, director general of the National Treasury Agency, the unit of the Finance Ministry that is directly responsible for state-owned banking assets (see box, page 56).
"Taiwan stands at a crossroads," says Christian Raubach, a partner at consulting firm McKinsey & Co. "Both industry and government could continue to pursue their incremental approach and hope the competitiveness of the financial sector does not further erode. Or they can take bold steps to change the rules of the game and put Taiwan back on the Asian banking map."
Taiwan is absurdly overbanked. Its 22 million people are served by 49 banks that together provide 3,324 branches. In Taipei alone there are 3.4 bank branches per 10,000 people, almost double Hong Kong's 1.9 and almost triple New York's 1.3. What's more, Taiwan's top five banks claim a market share of just 38 percent, compared with 81 percent for the top five U.K. banks and 56 percent for Hong Kong's Big Five.
The result of this bank glut is cutthroat price competition and wafer-thin margins. As of June 2004, Taiwanese domestic banks' return on equity averaged just 5.75 percent and return on assets only 0.35 percent -- way below international standards. McKinsey estimates that the country could shed more than 70 percent of its banks and scrap 40 percent of its bank branches. The optimal number of banks, the consulting firm contends, would be about five large-scale universal banks and eight niche banks; instead of 850 branches, Taipei would have 520.
A more efficient banking sector, of course, would enhance Taiwan's overall economic competitiveness. "A weak banking sector directs capital to poorly performing industries and companies," points out Raubach.
Indonesia, South Korea and Thailand all implemented banking reforms in the aftermath of the 1997'98 Asian financial crisis; Taiwan is now in danger of lagging those developing economies. "People say that if there's no change for a few more years, Taiwan's banking sector will be behind even Indonesia's," warns a regional banking analyst. "Its plan to reform its banks is a very late wake-up call."
Taipei appears to appreciate both the urgency of and the high stakes involved in this effort. "Previously, our financial industry was overregulated, and the banks were instruments to help manufacturers grow," explains Kong Jaw-sheng, chairman of the Financial Supervisory Commission. "Now the government has very different thinking. We want to develop the financial industry as a separate sector." Formed in July 2004, the FSC, an omnibus regulator-cum-promoter of the country's financial system, broadly oversees banks and ardently champions reforms.
The linchpin of the government's program is bank consolidation -- an oft-stated policy goal but one that has eluded every government to hold office in Taiwan for the past 15 years. Bank unions and their allies in the political opposition have repeatedly squelched real reforms. But Chen, who has made bank consolidation a central plank of his second four-year term, which ends in 2008, seems determined to disregard the political flak.
Last October the president announced four bold initiatives aimed at concentrating Taiwan's banking community: halve the number of government-controlled banks from 12 to six by the end of 2005; develop at least three so-called champion banks with potential market shares of more than 10 percent each, also by the end of this year; reduce the number of financial holding companies, which are allowed to provide asset management, insurance, investment banking and other financial services, from 14 to seven by the end of 2006; and have at least one financial company either controlled by a foreign institution or listed on an overseas stock exchange by the end of that year.
Taiwan should have plenty of allure for bank investors. The country has personal assets of $1.1 trillion, a savings rate of 25 percent and per capita GDP of $12,961, one of the highest in the region. The country is Asia's fourth-largest financial services market -- bigger than all of Southeast Asia combined.
In May, in a substantive but also highly symbolic move, the government put Chang Hwa on the block. The Ministry of Finance and other government entities only own one fifth or so of the bank outright, but they effectively control it. Taipei hoped that sophisticated foreign owners would take over the highly visible institution, ushering in a wave of vibrant competition and thereby triggering extensive bank mergers, which would rationalize the entire financial system.
For a while, it looked as if Taiwan's latest attempt to reform its banking system had met the same abysmal fate as so many others before it. Yet the Chang Hwa episode seems to have galvanized the government to try even harder. Chen has refused to budge from his goal of cutting the number of state-controlled banks in half.
"President Chen told me directly that this reform is very, very important for the country," says the FSC's Kong. "He has a very strong commitment. The country wants to upgrade and enhance its competitiveness." When his agency was set up last July, Kong seemed poised to play a central role in Chen's plans to force bank consolidation. But with the aborted Chang Hwa sale, the Finance Ministry took center stage in the consolidation push, leaving Kong in a supporting role.
The moment the Chang Hwa deal fell through, the National Treasury's Liu began considering ways to reduce the bank's nonperforming loans and improve its performance so that it could be put back on the market in better shape at a later -- but not too much later -- date. Chen, however, insisted that the bank be sold as is, and as soon as possible. Liu's office quickly became a hub of activity as he and Finance Minister Lin Chuan brainstormed ways to meet Chen's goal.
The pair hatched a plan that Liu is confident can deliver everything the president demands: Chang Hwa is to be sold to a domestic private bank in early fall; three more state institutions -- Farmers Bank of China, Taiwan Business Bank and the Central Trust of China's trust and insurance businesses -- will soon be offered for sale; and the government is considering putting another six on the market in the not-too-distant future.
"There are one or two [domestic] private banks that have great interest in Chang Hwa, and we expect that one is likely to buy Chang Hwa," says Liu. "We predict the deal will be completed by September." Word has it that the domestic banks are Fubon Financial Holding Co. and Cathay Financial Holding Co.
Liu adds that midsize Taiwan Business Bank and Farmers Bank also have great sales potential and that more details about Taipei's plans for them will be revealed before the end of this month. He also says that the insurance and trust assets of Central Trust of China, which is wholly owned by the government, "will be more attractive to foreign buyers" than Chang Hwa was.
The sale of six other state-controlled banks is under serious consideration, says Liu. Among them: Bank of Taiwan, First Financial Holding Co., Hua Nan Financial Holdings Co., Land Bank of Taiwan and Mega Financial Holding Co. "With four banks ready to sell and another eight under consideration, there is a high possibility of selling six banks before the end of this year," he concludes.
Like any bazaar, Taiwan's marketplace of big and small banks offers both bargains and boondoggles. The 12 state-controlled banks are Neanderthals weighed down by bloated staffs and high cost ratios. Their corporate cultures resist change, and their pugnacious unions put off investors. Says a senior Taiwanese executive who recently joined one of the biggest state-owned banks: "The executives here all came from Taiwan's top universities, and when they were hired, they thought they would be here until they were 65 as long as they didn't do anything seriously wrong. At a state-owned bank, an employee's main concern is avoiding mistakes, not performance."
The top five state banks, in order of size -- Bank of Taiwan, Taiwan Cooperative Bank, Land Bank, First Financial and Hua Nan -- account for nearly 40 percent of all banking assets. Together state-owned and state-controlled banks -- those in which the government has a stake of 10 percent or more -- hold more than 60 percent of all banking assets in Taiwan.
Private sector banks present a refreshing contrast that might have come straight out of an economics textbook extolling the virtues of free enterprise. In 1991, Taipei tried to shake up the sleepy banking sector by introducing 16 private sector players. Founded mainly by established Taiwanese businessmen, several of these upstart institutions are today among Asia's best small banks. Bank SinoPac, Cathay United Bank, Chinatrust Commercial Bank, E.Sun Commercial Bank, Fubon Bank and Taishin International Bank are sales- and service-driven institutions that are able to compete in their home market with the best international banks, which have been allowed branches for years.
Yet none has built significant market share in the face of the overweening state banks. Chinatrust leads the field with about 5 percent, Fubon and Cathay are next with 4 percent each, and Taishin, SinoPac and E.Sun follow with 1 to 2 percent each. Taiwan's 35 foreign banks together account for just 6 percent of domestic bank assets; only Citibank has a significant presence, and the U.S. bank has just 11 branches on the island.
The National Treasury Agency's Liu is the first to acknowledge that his urgent mission of revamping Taiwan's financial system, starting with the calcified state banks, represents a gargantuan challenge. He predicts massive resistance from bank employees and senior bank executives, who as civil servants are accustomed to lifetime jobs, as well as from politicians. The Legislative Yuan, or Parliament, "always gives many directions and opinions," notes Liu.
History is not so encouraging on this score. Taipei has been talking about promoting financial consolidation for more than a decade and supposedly became dead earnest about it in 2001 -- officially dubbed the "Year of Bank Reform." In the ensuing four years, however, the number of state banks has been reduced by just four.
"The government has been talking about using state-owned banks as a catalyst for consolidation for years," observes Norman Yin, an opposition legislator with the People First Party and the head of the Legislative Yuan's Finance Committee. "But after the unions make a noise on the street, it always goes nowhere. Nobody wants to offend the unions because they're afraid of losing votes."
For their part, the unions fear, not without reason, that workers will suffer significant job losses from the merging of the inefficient state banks. Huang Shui-chuan, president of the National Federation of Bank Employees Unions, tells Institutional Investor that his organization will oppose any bank layoffs that are made without "reasonable cause." He is also strictly against new managements' tampering with the way state banks determine seniority and thus set pay: It now is based solely on length of service, not on job performance.
Last November, NFBEU general secretary Hang Shr-Shian led more than 100 union members on a protest march to bank regulator FSC's headquarters at Banciao City, on the outskirts of Taipei. They demanded to speak to chairman Kong and accused the commission of drafting a reform plan that favored foreign banks over domestic ones. The protesters clamorously called for the FSC to allow four state banks -- Bank of Taiwan, Central Trust of China, Land Bank and Taiwan Cooperative Bank -- to merge to prevent foreign domination of the banking sector. The FSC's exasperated vice chairman, Lu Tung-ying, angrily told them that his agency wasn't against state banks but simply wanted to upgrade the whole Taiwanese banking sector with the help of foreign expertise.
A bit more momentum ebbed from the reform bandwagon with the results of December's legislative elections. Chen's Democratic Progressive Party and its coalition partner, the Taiwan Solidarity Union, were expected to gain control of the Legislative Yuan; instead, the opposition Kuomintang party and its coalition partner, Yin's People First Party, retained a thin majority in the 225-seat body. Chen's government must negotiate the sale of state-owned banks with an opposition-controlled legislature that, although not averse to bank consolidation in principle, is loath to hand the government a notable policy success.
Nor are all of Taiwan's troubled politics local. Heightened tensions with Beijing have diverted the government's attention from domestic matters. In late April, Taiwanese opposition leader Lien Chan, head of the Kuomintang, paid a historic visit to China to meet with President Hu Jintao. Beijing extended the invitation in an attempt to isolate and undermine Chen, who has been a staunch defender of Taiwan's independence from China. Earlier this year Beijing, which regards Taiwan as a rogue province, alarmed Taipei by passing an antisecession law that codifies its long-standing threat to use military force against the island if it continues to insist upon independence.
Coincidentally, late April saw another setback for bank reform. Steve Hsieh, the highly regarded chairman of state-owned First Commercial Bank, resigned after an uproar over his use of an expletive at a routine question-and-answer session before the Legislative Yuan's Finance Committee. Finance Minister Lin had installed Hsieh, who had turned Taishin into one of Taiwan's best private sector banks, at First Bank in 2003 to try to transform it into a flagship of banking reform and a catalyst for consolidation. Taipei saw First Bank, which has $42 billion in assets and 92 branches, as a potential national and regional banking champion.
The FSC's Kong defines such a creature as having, inter alia, more than 10 percent of Taiwan's banking assets, a return on equity of 15 to 20 percent, a return on assets of more than 1 percent, a capital-adequacy ratio of at least 10 percent, nonperforming loans of less than 2.5 percent and a cost ratio of less than 40 percent.
Hsieh had made substantial progress, writing off bad loans worth $1.3 billion and positioning the bank for a merger. Before his resignation he told II that First Bank is "more an acquirer than an acquiree" but that he would not rule out selling a stake to a foreign buyer. "A couple of foreign institutions have asked us for a joint venture," he said. "The advantage of this would be that then we would have deeper pockets to be able to buy bigger banks in Taiwan."
Taiwanese Premier Frank Chang-ting Hsieh (no relation to Steve Hsieh) has named Chao Yuan-chi, a former president of First Bank's parent, First Financial Holding Co., as the bank's acting chairman. "He is moving ahead under the same concept" as his predecessor, says Liu. "The operation has some adjustments to make, but it is still moving ahead." Nonetheless, the loss of an aggressive bank reformer like Steve Hsieh is a blow to First Bank's aspirations to be a national banking champion -- and thus to the bank consolidation campaign.
Perhaps the greatest threat at this point, though, is the mundane but politically charged issue of pricing: How does Liu ultimately settle on prices for state banks that are acceptable to both skeptical buyers and no-less-skeptical legislators?
Consider Chang Hwa. Foreign investors were plainly put off by the price tag affixed by the government. But might a domestic private bank be willing to pay enough to assuage legislators hostile to Chen and able to derail even the best-laid plans? Investment bankers calculate that the local synergies to be gained from a merger between Chang Hwa and some domestic private bank could add NT$3 a share to the state bank's purchase price.
If that's insufficient to placate bellicose opposition legislators, however, Liu's strategy for the bank could unravel. He expresses confidence that the pricing gap can be bridged and emphasizes that the government's overwhelming desire is to sell Chang Hwa to a private Taiwanese bank. The theory is that combining Chang Hwa with a private sector enterprise would do far more to infuse it with a competitive ethos, and to further bank consolidation, than pairing it with another, equally bureaucratic state bank.
But what if that gambit fails? Liu has a contingency plan: sell Chang Hwa to a partially privatized state-controlled bank such as First Financial, Hua Nan or Mega Financial. "At least these banks can reach the goal of modernizing the banks in our country," he says.
Yet for those outside the corridors of power, such a plan B would represent an utter failure to meet the spirit of Chen's stated goals. "If Chang Hwa were simply transferred into the hands of other state banks, we would see that as not really a true privatization," says Krista Yue, a Taipei-based banking analyst with J.P. Morgan Securities. "We do not see that the other state banks are in particularly good positions themselves to initiate a much more meaningful restructuring within Chang Hwa, either to return profitability or to improve asset-quality issues that it has faced in the past."
As important as Chang Hwa is to bank reform, its prominence as a symbol tends to exaggerate its role in the larger scheme of things. Taipei in fact has several options to promote consolidation. For instance, Liu might realistically use government-controlled but partially privatized state banks such as First Financial, Hua Nan and Mega Financial to try to launch a bank merger wave. First Financial in particular is in much better shape than Chang Hwa and would have far greater appeal to both foreign and domestic suitors.
In any event, consolidation continues, albeit on too small a scale to have the desired impact. In April, Shinkong Financial Holding Co., the seventh-largest financial holding company by assets, announced that it would acquire Macoto Bank, a small consumer bank, through a share swap worth $638 million. Meanwhile, the eighth-largest bank, Taishin, and midsize International Bank of Taipei have each submitted merger offers to SinoPac Holdings Co., a small but sought-after private bank. SinoPac's chairman, Richard Hong, reportedly favors an acquisition by Taishin, while its chief executive, Paul Lo, prefers a merger with IBT. The matter was left up in the air at the May 10 shareholders' meeting when Lo failed to get the two-thirds majority he needed to force a merger with IBT.
In June 2004, E.Sun gained control of Kaohsiung Business Bank, a small private bank with assets of $1.4 billion and 45 branches, from the government's Central Deposit Insurance Corp. in return for assuming $112 million of the bank's liabilities. So E.Sun is not in the market right now for Chang Hwa. "We need more time," says E.Sun's chief strategy officer, Joseph Huang. "It would take three to five years to digest a major state-owned bank."
Meanwhile, Fubon has its hands full integrating its operations with those of TaipeiBank, which it bought from the government in a $2.36 billion share swap in August 2002. The experience of absorbing a state-owned bank has been a sobering one for Fubon. Such mergers are "energy-sapping," says chairman Daniel Tsai. "I don't know how many deals of this kind an institution like ours can afford."
Despite his reservations, Tsai says that Fubon's best course now might be to seek a "milestone deal" with a big state bank that would vault the No. 9 Taiwanese bank to national champion status in one step. "After that we can just concentrate on consolidation and not think about doing other deals for maybe three or four years," he says. Still, he admits that he would much prefer to buy one or two small but well-managed private banks, though they are seldom for sale.
Understandably, foreign banks have shown little appetite for trying to turn around the state-owned behemoths. As Willard McLane, Morgan Stanley's Hong Kongbased head of investment banking for Taiwan, observes: "Their labor unions can be difficult, and sometimes these banks have policy roles. Citibank is the only foreign bank with any scale in Taiwan, so where would other foreign banks get the local management if they took over a state-owned bank?"
Don't despair, however, for the state banks, because they do have a few potential suitors -- Taiwanese private banks and foreign private equity firms. Carlyle Group (which had been nosing around Chang Hwa), Lone Star Funds and Newbridge Capital are all known to be eyeing the banks, though none will comment.
Some observers believe that the foreign private equity firms might well emerge as agents of change. "The opportunities in Korea to restructure and turn around troubled banks -- such as Newbridge did with Korea First Bank and Carlyle did with KorAm Bank -- are now very limited," says Morgan Stanley's McLane. "No question, private equity houses are sometimes frustrated in Taiwan, but this is one place in Asia where there's some real opportunity."
Newbridge recently sold Korea First Bank to Standard Chartered, while Carlyle had a 100 percent gain on the sale of its stake in KorAm Bank to Citigroup.
What's more, Taiwan's top private banks are "among the best in Asia in terms of profitability growth over the past five years," according to McKinsey's Raubach. He projects that consumer lending profits will almost triple by 2010. And because the weak state banks control most of the market, there is ample potential for foreign banks to grab market share, just as private sector banks are doing.
Investment bankers confide that Citigroup, HSBC Holdings, Standard Chartered and three or four other banks are looking around for opportunities. But most of the attractive private banks aren't for sale, because their founders want to keep them in the family or at least maintain control in a merger. Liu reasons that a champion bank or two would turn up the competitive heat on the private banks and make them less picky.
Raubach laments that many foreign banks are so focused on mainland China that they have overlooked Taiwan, which he says offers an ideal training ground for honing a China strategy, by enhancing a bank's Chinese-speaking management capacity. The consultant contends that for a foreign bank, buying a small Taiwan bank with 50 to 80 branches is a "no-brainer."
The money "needed to buy control of a decent bank with assets of some $650 million isn't an investment that is going to blow you up," says Raubach. "If you turn it around, you have enormous upside potential and a management platform for China expansion. Taiwan is a great training ground. That is its true asset."