Taiwan Financial Industry- Challenges and Opportunities December 2006 Sophia Cheng >> Research Analyst Merrill Lynch (Taiwan) No part of this report may be used or reproduced or quoted in any manner whatsoever in Taiwan by the press or other persons. Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on pages 32. Global Securities Research & Economics Group Global Fundamental Equity Research Department >> Employed by a non-US affiliate of MLPF&S and is not registered/qualified as a research analyst under the NYSE/NASD rules.

Refer to important disclosures on pages 32 2 Taiwanese banks: low valuation in the region Source: Merrill Lynch estimates 1.Still recovering from consumer debt problem 2.Gradual profit improvement in Need to find next areas of growth Follow your clients Management clients’ wealth How to improve?

Refer to important disclosures on pages 32 3 GDP growth: Taiwan lags other emerging Asian markets Source: Merrill Lynch estimates

Refer to important disclosures on pages 32 4 Credit Penetration: Total Loans as a Percentage of GDP (%) Source: Central Bank Data, Merrill Lynch estimates Note: Most data end-2005, some end 2004, some ML estimates

Refer to important disclosures on pages 32 5 Deposit Penetration: Total Deposits as a Percentage of GDP (%) Source: Central Bank Data, Merrill Lynch estimates Note: Most data end-2005, some end 2004, some ML estimates

Refer to important disclosures on pages 32 6 Too much surplus liquidity Source: CBC, TEJ

Refer to important disclosures on pages 32 7 Consumer credit outgrow corporate loans Source: Central Bank Data, Merrill Lynch estimates

Refer to important disclosures on pages 32 8 Margins remain thin Source: CBC, Merrill Lynch Benchmark rate gap between TW and US

Refer to important disclosures on pages 32 9 Three areas to grow Wealth management Treasury products Overseas operations Source: Company reports, Merrill Lynch

Refer to important disclosures on pages Non-loan business gaining importance

Refer to important disclosures on pages Taiwan households hold US$1.3tn assets Asset allocation in cash & deposit Taiwan: 41% USA: 30% Source: Central Bank, CEIC

Refer to important disclosures on pages Wealth Management & FX/Derivatives Sources: Company Data, Merrill Lynch estimates

Refer to important disclosures on pages FX – With Customers Sources: Company Data, Merrill Lynch estimates

Refer to important disclosures on pages OBU growing fast Sources: Company Data, Merrill Lynch estimates Note: OBU contribution in 2005 increased was mainly because of more provisioning in if taking out the extra provisioning, the contribution from OBU was < 20%

Refer to important disclosures on pages Taiwan corporate investing the most to China (HK + China already 41%) TW-China supervision MoU not signed

Refer to important disclosures on pages Taiwan is the biggest FDI in Vietnam 13% of Vietnam foreign direct investment comes from Taiwan in 2002-Aug06

Refer to important disclosures on pages Taiwan financial institutions landscape ____________________ Non-classified financial institutions (e.g. China Development, Waterland FHC) not included Figures in blue represent market cap in NT$ bn. Figures in green represent price-to- 1H06 book value ratios. Figures in grey represent FHC market cap in NT$ bn and FHC price-to-1H06 book ratio. Figures in red represent reported NPLs (%) Source: BOMA, Bloomberg, CBC, Taiwan Stock Exchange, SITCA. Assets and NPL ratios as of Sep 2003 and Dec 2003, respectively. Market cap data as of March 26, 2004 (1) As of January 2004 (2) Year 2005 Life Insurance Market Share of AUM Banks Securities Increasing consolidation expected; led by Yuanta and Fubon $75 1.2x $ x $22 1.1x $25 0.8x $44 1.1x $24 4.5x $16 1.0x $91 1.3x $ x $17 0.9x Asset Managers Foreign competition increasing Currently overpriced No single company big enough to deliver transforming transaction Mid-sized private banks likely to lead to consolidation Government-related BanksNew Private BanksFHCOld Private Banks Larger banks are largely government controlled $44 1.1x Reported NPLs (%) $ x 1.5x $26 1.6x $141 $96 1.2x $198 2x $ x $65 1.6x $ x $27 0.9x 1.0x $21 $24 1.2x $10 0.9x 5x $9 $91 1.3x 0.2x $3 0.6x $6 Life Insurance dominated by Cathay Group Remaining life insurers are small and some are capital constrained AIG-owned $ x $12 1.5x $62 2.2x $ x $24 1.6x $ x Remaining P&C insurers are small and some are capital constrained P&C Insurance 1.6x $4 3.4x $ x $6 1.6x $246 P&C Insurance dominated by Fubon (1) $ x $ x (2) $ x Cathay FHC Nan Shan Shin Kong FHC China Post Office ING Aetna Fubon FHC President Alliance Mercuries Life China Life Prudential 2005 Premium Income NT$ bn Fubon FHC Ming Tai Union Cathay FHC Central Taian Zurich Mega FHC Newa 2005 Direct Written Premium NT$bn x $ x x x x x x 1.2x $ x $17 0.8x $15 $14 0.7x $ x

Refer to important disclosures on pages Mortgage loan market share Sources: Company Data, Merrill Lynch estimates

Refer to important disclosures on pages Taiwan vs Korea: top 5 market share Source: Merrill Lynch estimates South Korea Taiwan

Refer to important disclosures on pages Private banks growing fast but still small Source: TEJ, Merrill Lynch Valuation more reasonable: from ~2x book to ~1.4x book Foreign interests in Taiwan MoF initial plan and rules 1) Reduce market share of government-controlled bank (in terms of assets) from 50% to 25%-30% 2) Open up to foreign financial groups

Refer to important disclosures on pages Government initiatives Product competitiveness: - how to compete with HK and Singapore Encourage industry consolidation - why not copy a DBS model in Taiwan - friendly takeover vs. hostile takeover - transparency requirement - who should have independent boards - how to make privatization process better Incentive for money and talents to stay - tax reform - incentive and compensation program - friendly environment Follow clients overseas - Vietnam: Taiwan banks expanding - China: indirect

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