initiation: favour insurance- taiwan financial centric...

See important disclosures, including any required research certifications, beginning on page 74.

■ Investment case We initiate coverage of the Taiwan Financial Sector with a Neutral rating. While we believe the key macro trends for 2015-16 will benefit the insurers greatly, drags could emerge from the banking side. Insurers: higher recurrent yield rates likely for 2015-16 driven by: 1) a steepening yield curve as a result of policy rate normalisation, 2) regulatory easing, which will allow insurers to chase higher yields overseas, and 3) a better hedging performance due to the USD rally (most unhedged positions are held in USD) and the build-up of FX reserves. The negative impact of a YoY decline in first year premium (FYP) income in 2015 would be small, in our view. A better product mix, ie, selling more regular-premium traditional life products with higher margins rather than deposit-like products, would help sustain the value of new business (VNB) and EV even if FYP declines in 2015 (see pages 7-8). Banks: NIMs should improve but downside risks also loom. 1) A wider lending spread for USD

loans amid the onset of a Fed tightening cycle, and 2) policy rate hikes from the central bank (the CBC) expected to take place in 3Q15 would help banks expand their margins going forward (we estimate a 12.5bp policy rate hike would lift NIMs by 1-3bps). However, lacklustre TWD loan and fee-income growth, lower CNY- related income on CNY weakness, and regulatory hurdles, including a higher business tax and lower maximum interest rate for the revolving balance of cash/credit cards, are some of the headwinds faced by banks. A liquidity pullback in the emerging markets (EM) would also add stress to asset quality. ■ Catalysts The main positive catalysts we see for the sector would be an interest-rate-hike cycle starting and/or regulations governing overseas investment being eased. The main negative catalysts: uninspiring GDP growth and a rise in provisions and/or tax rates that would hit the banks harder than the insurers. ■ Valuation Our top sector pick is Cathay FHC (2882 TT, TWD50.4), on which we initiate with a Buy (1) rating. Its life-insurance arm, Cathay Life, has been shortening its asset duration since 3Q13, which would allow a larger proportion of its assets to benefit from a rate-hike cycle. In addition, Cathay Life’s hedging performance has improved greatly over the past 3 years after the implementation of FX reserves.

We have an Outperform (2) on Fubon FHC (2881 TT, TWD56.1) as it should maintain a high recurrent yield for 2015-16. We also like its robust capital position (risk-weighted capital of 290% for 2014). We have Underperform (4) ratings on First Financial (2892 TT, TWD18.75) and CTBC Financial (2891 TT, TWD22.05), as we forecast both bank-centric FHCs to be hit by anaemic loan growth of 3.5% and 4.1% YoY for 2015, respectively, and post lower bancassurance income. Their valuations also look too rich to us, especially that for CTBC. We have a Hold (3) rating for Mega Financial (2886 TT, TWD26.0). Mega is a defensive pick amid the slowdown in TWD loan growth and fee income growth. We see its leading position in the USD lending market supporting its earnings. ■ Risks to our investment case The main downside risks: delays in the policy rate hike, a disorderly slowdown in the property market, and a financial meltdown in EM. The main upside risk: higher-than-expected TWD loan growth.

16 April 2015

Initiation: favour insurance-centric FHCs

• Key macro themes including the rate-hike cycle, USD rally, and the deregulation trend should benefit the insurers

• But while banks’ margins are likely to improve, risks also loom • Initiating with a Neutral sector view and expect the insurers to do

better than the banks; our top sector pick is Cathay FHC

Taiwan Financial Sector

Key stock calls

Source: Daiwa forecasts.

Financials / Taiwan

Positive

Neutral (initiation)

Negative

Christie Chien(852) 2848 [email protected]

New Prev.Cathay Financial Holdings (2882 TT)Rating BuyTarget 60.80Upside 20.6%

CTBC Financial (2891 TT)Rating UnderperformTarget 18.90Downside 14.3%

How do we justify our view?How do we justify our view?

Taiwan Financial Sector 16 April 2015

- 2 -

How do we justify our view?

Growth outlook

Valuation

Earnings revisions

Growth outlook Taiwan Financial Sector: ROE

ROEs for Taiwan’s financial holding companies (FHCs) is likely to fall in 2015 from the 2014 peak, as the one-offs (gains from bargain purchases, changes in accounting method for property investment, and the stock market rally) dissipate. Stripping out the one-offs, however, 2015 still looks like it will be a decent year. We forecast core income (net interest income plus net service fee income) to grow on average by 11.5% YoY for the insurance-centric FHCs and by 5.9% YoY for the bank-centric FHCs under our coverage for 2015.

Source: Bloomberg, Daiwa

Valuation Taiwan Financial Sector: 12-month rolling PBR

Taiwan’s FHCs are trading currently at 1.2x 12-month rolling PBR. The prevailing valuations are slightly lower than the past-10-year averages of 1.3x. Among the stocks under our coverage, First FHC has the lowest absolute 12-month rolling PBR of 1.1x. On the other hand, CTBC FHC has a relatively rich valuation, trading at a 1.4x 12-month rolling PBR, which is 17.4% higher than its past 10-year average. (Refer to the Valuation section of this report on pages 15-18 for more details.)


Earnings revisions Revisions to consensus 2015 net profit forecasts

The Bloomberg consensus 2015E earnings for the Taiwan FHCs have been revised up steadily since the beginning of 2014. In general, the 2015 net profit forecasts for Fubon and Cathay have been revised up the most over the past 15 months. The forecast for Mega, however, has remained quite stable. For the sector as a whole, consensus expectations favour insurance-centric FHCs over bank-centric FHCs. We expect another round of upward revisions for the insurance-centric FHCs as macro tailwinds help to drive earnings higher. For bank-centric FHCs, however, upward revisions to forecasts look limited to us.


Positive

Neutral (initiation)

Negative

0

2

4

6

8

10

12

2007

2008

2009

2010

2011

2012

2013

2014

2015

E

2016

E

(%)

0.6

0.9

1.2

1.5

1.8

2.1

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

90

100

110

120

130

140

150

Jan-

14

Feb-

14

Mar

-14

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr-1

5

Fubon Cathay Mega CTBC First

(2014/01/01=100)


- 3 -

Source: Daiwa forecasts

Sector stocks: key indicators

Share

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

Cathay Financial Holdings 2882 TT 50.40 Buy 60.80 3.584 3.964

CTBC Financial 2891 TT 22.05 Underperform 18.90 1.749 1.888

First Financial 2892 TT 18.75 Underperform 16.70 1.466 1.585

Fubon Financial Holding 2881 TT 56.10 Outperform 62.40 5.297 5.872

Mega Financial 2886 TT 26.00 Hold 26.90 2.488 2.663

Rating Target price (local curr.) FY1

EPS (local curr.)

FY2


- 4 -

Initiation: favour insurance-centric FHCs ................................................................................... 5 Investment summary ................................................................................................................ 5 Insurers: benefiting greatly from higher investment yields … ................................................. 5 … with a small bump in the road .............................................................................................. 7 Banks: margins to improve, but … ........................................................................................... 8 … challenges also loom ........................................................................................................... 11 Risks to our investment case .................................................................................................. 13

Valuations ................................................................................................................................... 15 Sector trading slightly below its 10-year average PBR ........................................................... 15 Cathay: valuation supported by ROE uptrend, repricing ...................................................... 15 Fubon: stable earnings growth should see share price rise ................................................... 16 Mega: looks fairly valued ........................................................................................................ 17 First: lacking growth drivers to support valuation ................................................................. 17 CTBC: valuation looks rich ..................................................................................................... 18

Company Section

Cathay Financial Holdings ...................................................................................................... 19 Fubon Financial Holding ....................................................................................................... 32 Mega Financial ....................................................................................................................... 44 First Financial .........................................................................................................................54 CTBC Financial ...................................................................................................................... 63

Contents


- 5 -

Initiation: favour insurance-centric FHCs

In our view, the insurance-centric FHCs stand to benefit more from the macro tailwinds than the bank-centric FHCs, while being less exposed to the downside risks

Investment summary

The key macro themes to play out in 2015-16, including policy rate normalisation by the Fed and the Central Bank of China (CBC), an extended period of USD strength, tight global USD liquidity, and the ongoing deregulation of overseas investments by the Financial Supervisory Commission (FSC), should continue to benefit the sector. However, the outlook is mixed at this stage, as we also see risks looming, especially for the bank-centric FHCs. Some stocks also look fairly valued already. As such, we initiate coverage of the Taiwan Financial Sector with a Neutral rating. We favour insurance-centric FHCs over bank-centric FHCs, as we see the former as being the major beneficiaries of the key macro themes while being less exposed to downside risks. Our stock picks are Cathay FHC and Fubon FHC, both of which are insurance-centric FHCs with what we regard as solid core earnings growth opportunities. Investment case: summary

Current share price (TWD) Target price (TWD) Upside (%) Rating Cathay 50.4 60.8 20.6 Buy Fubon 56.1 62.4 11.2 Outperform Mega 26.0 26.9 3.5 Hold First 18.8 16.7 -10.9 UnderperformCTBC 22.1 18.9 -14.3 Underperform

Source: Daiwa estimates

Our investment case assumes 3.2% YoY and 3.0% YoY GDP growth for Taiwan for 2015 and 2016, respectively. We also assume that the Fed and the CBC will start to deliver rate hikes in 3Q15. Any change to our macro forecasts, either domestically or internationally, would alter our investment case.

Insurers: benefiting greatly from higher investment yields …

Life insurers are set to embrace higher yield rates going forward as the yield curve steepens and more funds are made available for overseas investments thanks to regulatory changes. Steepening yield curve The Fed looks to be on track to begin raising interest rates in 3Q15. For Taiwan, we believe the CBC will start normalising its policy rate in 3Q15, more or less in tandem with the Fed’s first rate hike (based on our expectations). Our forecast calls for the policy rate to reach 2.125% at the end of 2015, from 1.875% at end-2014, implying 2 x 12.5bps rate hikes in 2015. Policy rate hikes usually come with a steeper yield curve, implying a higher long-term yield rate. This allows life insurers to earn better returns from reinvestments, even though any gains would be partially offset by a decrease in the value of their existing portfolios. Given the insurers’ long-term investment horizon, and that a loss is not realized unless the portfolio is sold, a steeper yield curve generally benefits insurers. Under a scenario of a steepening yield curve, having a shorter duration of assets is favourable, because it allows more assets to be reinvested in portfolios with higher yields. For 2014, asset duration was 8 years for Cathay Life and 12 years for Fubon Life. As such, 11-13% of Cathay Life’s assets will have to be reinvested in 2015, while the number for Fubon Life is a bit lower at 10%. Since another 13% of Cathay Life’s existing positions are mortgage & secured loans with floating rates, 24-26% of its total assets would benefit from a rate hike. For Fubon Life, the number is smaller at 13%. Investment portfolio as of end-2014

Fubon Life Cathay Life

TWD bn % TWD bn %Cash & cash equivalents 87.2 3.4 131.6 3.2Equity- domestic 269.0 10.4 350.9 8.4Equity- international 177.6 6.9 209.4 5.0Bond- domestic 602.8 23.3 459.2 11.0Bond- international 1176.5 45.5 1816.7 43.6Mortgage & secured loans 70.8 2.7 529.6 12.7Real estate 152.5 5.9 439.4 10.5Others 51.3 2.0 232.3 5.6Total 2587.7 100 4169.1 100

Source: Company, Daiwa


- 6 -

Investment yields Fubon Life Cathay Life

2013 2014 2013 2014Deposit & cash equivalent 0.8 0.7 0.9 0.8Equity- domestic 6.1 7.7 6.1 7.1Equity- international 5.6 8.1 6.1 6.4Bond- domestic 2.3 2.6 1.9 2.0Bond- international 5.9 6.2 5.4 5.0Mortgage loans 2.3 2.3 2.2 2.1Policy loans 5.2 5.1 6.1 5.9Real estate 11.0 4.8 3.3 6.8Total 4.4 4.5 4.1 4.3


Taking the percentage of assets for reinvestment into account, we estimate a 10bps increase in the long-term yield rate for both domestic and international bonds would add TWD259m to Fubon’s annual income and TWD500m to Cathay’s, if all the funds are invested back in bonds. A 10bps increase in mortgage & secured loan interest rates would add a further TWD71m for Fubon and TWD530m for Cathay, based on their portfolios at end-2014. In total, we estimate the gain would be roughly equivalent to 0.5% and 1.8% of the 2015E pre-provision operating profit (PPOP) for Fubon FHC and Cathay FHC, respectively. Regulation changes release more funds for overseas investments Insurers benefit from the FSC’s deregulatory measures, which have been delivered in tandem since mid-2014. The important pieces of deregulation are as follows: 1) relaxation of the regulations governing Formosa bonds/international bonds issued in Taiwan allowing them not to be included in life insurers’ 45% overseas investment cap, 2) lower the weighting of some risk assets when calculating the risk based capital (RBC); capital requirements for overseas real estate and financial institutions overseas cut by half; and 3) giving insurers more flexibility in terms of derivatives investment and hedging strategies. These changes can be seen as giving an immediate lift to insurers’ earnings. Most domestic corporate bonds and government bonds offer lower yield rates (1.5-3.0%) than overseas bonds. Take Fubon Life as an example. If Fubon shifted 1% of its investment assets from domestic bonds to international bonds, based on the investment yields at end-2014 (2.6% for domestic bonds, 6.2% for overseas bonds, 58bps hedging cost), its earnings would be lifted by TWD917m, or 1.5% of Fubon FHC’s 2015E PPOP.

Taiwan Government bond and US treasury yields (10 year)

Source: CEIC, Daiwa

Overseas investment accounted for 52.3% of the total investments for Fubon and 48.6% for Cathay as of end- 2014 (these numbers include the share invested in Formosa bond and foreign currency insurance policies, which is subject to a regulatory limit of 7.5% of the total assets). With more flexibility granted by the FSC, we expect their share of overseas investment to continue to rise and reach 53.5% for Fubon and 50.5% for Cathay by the end of 2015. Allowing more funds to be invested overseas also helps channel excess liquidity away from the domestic bond market. With less money flowing into the domestic bond market, bond prices should at least remain stable, if not decline. In other words, bond yields should stay stable or rise. With the domestic bond yield tending to rise simultaneously with the US treasury yield, based on historical experience, a rapid increase in the bond spread between US treasury and domestic bonds is unlikely, in our view. We see insurers benefiting from this trend as well. Not only will the insurers earn a higher yield from domestic bond investments, but a relatively stable bond spread between US treasury and Taiwanese government bonds also helps cap FX hedging costs. The pricing for cross-currency swaps (CCS), one of the major hedging tools used by insurers, is usually determined by the bond spread of the 2 countries. Better hedging performance on the USD rally The extended strengthening of the USD led by the Fed’s policy normalization is another major macro trend in 2015. Since much of the life insurers’ unhedged overseas assets are dominated in USD, a USD rally can translate directly into an immediate lift to the value of these assets, which are calculated in TWD on the balance sheet. Some 23.7% of the FX assets for Fubon are not fully hedged, while the figure for Cathay is higher at 42% as of end-2014.

0

1

2

3

4

5

6

Apr-0

3O

ct-0

3Ap

r-04

Oct

-04

Apr-0

5O

ct-0

5Ap

r-06

Oct

-06

Apr-0

7O

ct-0

7Ap

r-08

Oct

-08

Apr-0

9O

ct-0

9Ap

r-10

Oct

-10

Apr-1

1O

ct-1

1Ap

r-12

Oct

-12

Apr-1

3O

ct-1

3Ap

r-14

Oct

-14

Apr-1

5

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

(%)


- 7 -

In addition, since 2012 the FSC has allowed Taiwan life insurers to build up FX reserves under liabilities to absorb 50% of their FX losses rather than directly hitting the P&L. Over the past 3 years, Taiwan life insurers have gradually built up their FX reserves. These FX reserves also give the insurers more flexibility in managing FX risks and reducing their hedging costs. FX hedging costs will still likely increase in 2015 as the differential between the US/Taiwan bond yield enlarges on the back of the expected Fed tightening coming up, driving up the CCS cost. But the overall hedging environment still looks more benign than in the past (see below graph) given the reason stated in previous paragraphs. We look for hedging costs to come in at 70bps for Fubon and 50bps for Cathay in 2015. Hedging costs

Source: CEIC, Daiwa

Note: FX gain/loss & net provision of FX reserves are included.

… with a small bump in the road

FYP are likely to decline on a YoY basis in 2015 due to the base effect distortion resulting from regulatory changes. But the impact on the sector would be limited, in our view. In Taiwan, the line between bank deposits and insurance is a blurred one, with insurers selling a large amount of deposit-like products. The FSC’s ultimate goal is to clarify the line and promote the real function of insurance: offering protection from unforeseen losses or tragedy. As such, since the beginning of 2013, the FSC has tightened its scrutiny of insurance policies with deposit-like characteristics, such as single-premium and interest-sensitive policies. In particular, it announced in August 2014 that it had tightened the rules governing the sale of interest-credit annuity policies, such as setting higher terminating costs and

forbidding policies from paying cash interest in the first 10 years of the insurance period. The FSC’s action boosted the sale of deposit-like policies in the month after the announcement, as people rushed to buy policies governed by the old rules (when lower terminating costs applied). As a result, FYPE (first year premium equivalent) for Fubon Life and Cathay Life surged by 107% and 75% MoM for September 2014, respectively. Monthly FYPE for Cathay Life and Fubon Life

Source: Taiwan Insurance Institute, Daiwa

Given such a high base in 2014, the market generally estimates average FYP for the sector will drop by 15-25% YoY for 2015. While we agree with that view, we are not too concerned about the impact on the sector, however, due to the following:

1) Value of new business (VNB) looks as if it will remain on a growth trajectory despite a potential fall in FYP. Given stricter scrutiny on deposit-like products, insurers are now focusing more on selling regular-premium traditional life products. These kinds of products usually come with higher margins. Although FYP are much lower for regular-premium products than those for single-premium insurance policies, regular-premium products ensure sustainable income flows for the insurers, and support the VNB value, which represents the present value of the new business. We still look for VNB growth for the companies under our coverage to reach 1-3% YoY for 2015, implying that the growth trend of the embedded value (EV) will remain intact.

2) FYP is a relatively small number compared to the total amount of investment assets held by insurers. FYP collected in 2014 as a share of total investment assets was merely 7.4% for Fubon Life and 5.6% for Cathay Life. It is also worth noting that a decline in FYP in 2015 would not mean that the assets held by insurers were shrinking. Assets and EV would still be growing but at a slower pace.

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

Fubon Cathay

Implementation of FX reserves

(%)0

2

4

6

8

10

12

Jan-

14

Feb-

14

Mar

-14

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Cathay Life Fubon Life

(NTDbn)


- 8 -

3) A new “star product” could pop up again. The base effect distortions caused by the FSC’s regulatory changes have occurred a few times already over the past few years. In 2H12, the “star product” was single-premium short-duration life insurance policies, as a result of the FSC lowering the guarantee rate on those types of policies. In 2H14, the “star product” was clearly interest credit annuity policies. We would not be surprised if regulatory changes created another “star product” that gave FYP a strong boost in 2015. (On 17 March 2015, the FSC announced a loosening of the aforementioned rules set in 3Q14 of forbidding policies from paying cash interest in the first 10 years of the insurance period to first 6 years. Whether this policy change will lead to stronger FYP growth for the sector remains to be seen.)

In addition, the changing macro environment and innovations also help insurers attract customers. For example, since the beginning of 2015, USD-dominated insurance policies have been a hit in the market, thanks to the extended strengthening of the USD. Whether the increase in sales of these policies can offset the gap left by interest credit annuity policy remains unknown, but should help to mitigate the impact to some extent.

Banks: margins to improve, but …

In our view, banks’ margins will improve going forward as macro and industry trends play out. Lending spreads for both USD and TWD loans are likely to widen. The overseas contribution to income is likely to rise as banks expand their footsteps aggressively, especially in the ASEAN market. Wider spread for USD lending on the back of the Fed’s upcoming tightening Global USD liquidity should only get tighter in 2015 than in 2014 as the Fed’s upcoming tightening cycle approached. As such, LIBOR is likely to be driven up further. Taiwanese banks are important USD lenders in Asia, including to Mainland Chinese firms, as these banks are often flush with USD, which they get from exporting firms that need to swap their sales proceeds into TWD (current account surpluses is about 10% of GDP annually for Taiwan). Foreign currency loans (mostly in USD) account for a notable share of the total lending for Taiwanese banks, an important contributor to interest income. A higher LIBOR rate, which is the benchmark lending rate Taiwanese banks use for USD loans, lifts the banks’ margins.

Foreign currency loans as a percentage of total loans (as of end-2014)

Source: Companies, Daiwa

Note: Excluding TSB numbers for CTBC bank as the TSB lending is mostly dominated in Japanese Yen rather than USD.

Given tighter USD conditions in the global market, one could suppose that the USD funding cost should increase along with the rising lending rate, eroding the banks’ profit. However, the increase in funding costs is likely to be capped, in our view. The TaiFX rate, which is the interbank US dollar lending rate, describes USD liquidity conditions in Taiwan. Despite a recent rising LIBOR rate, TaiFX has remained at a low level since August 2014, reflecting liquid USD conditions in Taiwan. TaiFX and LIBOR

Source: Company, CEIC, Daiwa

We see the TaiFX rate stabilising at the current low level onwards as the USD demand and supply picture strikes a balance. Higher USD demand as a result of tighter global USD liquidity would be able to be filled by ample supply of USD deposits, which would likely be driven by:

1) Expectations for an extended USD rally and TWD depreciation.

2) Weaker expectations for CNY appreciation.

3) A lower CNY interbank rate offered by the BOC Taipei.

0

5

10

15

20

25

30

35

40

Mega Bank CTBC Bank First Bank Taipei FubonBank

Cathay UnitedBank

(%)

0.50

0.51

0.52

0.53

0.54

0.55

0.56

0.57

0.5

0.7

0.9

1.1

1.3

1.5

1.7

Dec

-12

Feb-

13

Apr-1

3

Jun-

13

Aug-

13

Oct

-13

Dec

-13

Feb-

14

Apr-1

4

Jun-

14

Aug-

14

Oct

-14

Dec

-14

Feb-

15

Apr-1

5

3M TaiFX (LHS) 3M LIBOR (RHS)

(%) (%)


- 9 -

The rally in the USD and weaker CNY has brought large inflows of USD deposits back to Taiwan. During our recent visits, banks told us that both individuals and firms have been keen to transfer some of their TWD or CNY deposits into USD accounts over the past few months. Banks’ willingness to hold CNY is further discouraged by the lower interbank rate offered by BOC Taipei (around 4% in 1Q14 which dropped to 3-3.3% for 4Q14), which is then partially replaced by USD. All these factors drive up banks’ reserves of USD, allowing banks to catch up with the increase in demand for USD. This should translate into a stable TaiFX rate for the next 1-2 years, in our view. On our estimates, a 10bps widening of the USD lending spread would add TWD210-750m to banks’ annual interest income (see table below). Expected gain if the LIBOR and TaiFX spread widens by 10bps

FC loans in 2014 (TWDbn)

Growth forecasts for FC loans (%)

Net gain if spread widens by 10bps (TWDm)

Taipei Fubon Bank 245 15% 270Cathay United Bank 185 15% 213Mega Bank 696 7.5% 748CTBC Bank 440 10% 484First Bank 335 15% 369

Source: Companies, Daiwa forecasts

Note: FC = foreign currency. For CTBC, we exclude from our calculation the loans made by Tokyo Star Bank (TSB), as the TSB’s loans are mainly in JPY rather than USD.

We would expect Mega Bank to benefit the most in absolute terms from an increase in the spread between LIBOR and TaiFX, due to its status as a USD clearing bank and as the largest USD lender in Taiwan. Cathay United Bank has the smallest pool of foreign currency lending but is expected to achieve a high USD lending growth for 2015, not only because of the low base of USD lending in 2014, but also due to its aggressive overseas expansion strategy over the past 2 years. For CTBC, we exclude from our calculation the loans made by Tokyo Star Bank (TSB), as the TSB’s loans are mainly in JPY rather than USD. Policy rate hike to lead to NIM expansion The rate hike by the CBC expected in 3Q15 would also help the banks to improve their NIMs. Generally speaking, a 12.5bp policy rate hike would lift NIMs for the Taiwanese banks by 1-3bps, as the lending spread would widen and the investment return becomes higher. Given an over-supplied banking environment, the domestic lending rate offered by each bank is unlikely to differ much. To what extent banks benefit from the rate hike would largely depend on their funding costs. As the demand deposit rate is the lowest among all other deposit rates, with a noticeable time lag for an

increase amid a rate-hike cycle, banks with higher demand deposit ratios are likely to benefit more. Policy rate, time deposit rate and demand deposit rate

Source: CEIC, Daiwa

However, money won’t just sit in demand deposit accounts forever if saving/time deposit rates start to become attractive. That is, banks with a higher ratio of demand deposits would need to bear the risk of a sharper increase in future funding costs, when money starts to flow from demand deposits to saving/time deposits. On our estimates, a 3% saving/time deposit rate could be a threshold for this transformation. Given that the 1-year time deposit rate for 5 leading domestic banks remained low at 1.36% for March 2015, we believe the risk of a run on money from demand deposits remains minimal in 2015. As such, banks with a higher share of demand deposits are likely to benefit more from the rate-hike cycle. Among the banks we cover, First Bank has the highest share of demand deposits. Demand deposits as a percentage of total deposits (as of end-2014)

Source: TEJ, Daiwa

0

1

2

3

4

5

6

7

8

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

Mar

-13

Mar

-14

Mar

-15

Policy rate 1 year Time deposit rate Demand deposit rate

(%)

64.0

60.0

54.9

50.0 49.2

40

45

50

55

60

65

First Bank Cathay UnitedBank

CTBC Bank Taipei FubonBank

Mega Bank

(%)


- 10 -

The FSC’s push for Asia regional banks Initially, the goal for the FSC was to help foster domestic consolidation through M&A, but the integration was soon found difficult given objections from major shareholders and labour unions. As such, banks turned their focus to overseas expansion, mainly in ASEAN countries and Mainland China. To help banks expand overseas, the FSC pushed for the Banking Act amendments. The major change is to raise the limits on M&A in the banking sector, from 40% of paid-in capital to 40% of net worth. This will release an additional TWD480bn in funds available for M&A abroad, according to the FSC’s note in June 2014. The amendment was proposed in November 2014 and passed by the Legislative Yuan in January 2015. The amendment has come in time, in our view. Liquidity in the emerging market will likely become tighter in 2015, as the Fed’s tightening triggers money outflows. This opens up a good chance for market entry, especially for Taiwanese banks with relatively low US dollar funding costs. Higher lending rates overseas will help Taiwanese banks to improve their margins. NIMs for ASEAN countries generally exceed 2.5% on average. NIMs in Indonesia can reach above 5%. China’s NIMs are about 2.5-3%. For Taiwan, NIMs are usually range-bound at above 1%. NIMs in selected Asian countries

Source: Companies, Daiwa

Although competition among the banks has become fierce in the ASEAN market, we believe Taiwanese banks still have advantages:

1) Taiwanese banks are known to be particularly good at managing SME loans, which is an area ASEAN and foreign banks are relatively weak at.

2) Taiwanese banks have a relative low USD funding cost, thanks to excessive domestic savings.

3) Taiwanese banks are used to a low NIM environment. For example, NIMs for Thailand average around 2.5% for 2014. This may be considered as low already to the local banks, but is still very juicy compared to Taiwan’s at 1.1-1.4% for 2014.

4) More and more Taiwanese manufacturers are setting up production bases in ASEAN countries on the back of rising Chinese labour costs. Trade ties between Taiwan and the ASEAN economies have become closer, which offer business opportunities to the Taiwanese banks.

Taiwan’s exports to ASEAN countries

Source: CEIC, Daiwa

Note: ASEAN-6 includes Singapore, Malaysia, Indonesia, Thailand, Vietnam, and the Philippines.

Banks have been aggressively seeking opportunities in the ASEAN market over the past 2 years. Cathay United Bank opened a branch in Laos in 4Q14 and agreed to an equity-sharing arrangement with a local bank in Indonesia and the Philippines (one each). Mega Bank was awarded by the Cambodian government a 2nd sub-branch in Cambodia, while the setting-up of its Yangon (Burma) representative office is currently in progress. CTBC Bank is awaiting Malaysia’s approval for a representative office, while Taipei Fubon Bank’s Singapore branch is set to be opened in 2015. First Bank is also seeking opportunities in ASEAN, including possible M&A deals in Thailand and the Philippines. First Bank also opened a branch in Laos on 31 March 2015. Besides ASEAN, China remains the most important market for Taiwanese banks to expand (see table below). Cathay United Bank, Mega Bank, CTBC Bank and First Bank are all planning to set up new branches in China. Fubon will continue to expand its business through the newly merged Shanghai-based First Sino Bank, which was re-named Fubon Bank (China) soon after the acquisition.

0

1

2

3

4

5

6

Indonesia Philippines Thailand China Ma laysia Singapore Taiwan

(% )

9

11

13

15

17

19

21

(5)

0

5

10

15

20

25

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Trade surplus earned from ASE AN-6 (LHS )Exports to ASEAN-6 as a % of total exports (RHS)

(US$bn) (% )


- 11 -

Taiwanese banks: footprint in China Branches

Open for business Approved by FSC Offices Taipei Fubon Bank

Fubon Bank (China) in Shanghai

- -

Cathay United Bank

Shanghai branch, including two sub-branches in Minxing and the free trade zone; Qingdao branch

A new subsidiary branch in Shanghai, Shenzhen branch, Jiading sub-branch

-

Mega Bank Suzhou branch and its sub-branch Wujiang

Ningbo branch -

CTBC Bank Shanghai branch Guangzhou branch and Shanghai free trade zone sub-branch

Beijing representative office

First Bank Shanghai branch, Chengdu branch, Shanghai free trade zone sub-branch

Xiamen branch and 12 rural banks in Henan province

-


We believe the banks will speed up their overseas expansion going forward, both organically and inorganically. Although integration and execution risks could emerge at the initial stage of the expansion, stepping out of Taiwan for higher yields should be fundamentally positive for the sector in the long term. It will also ease the over-liquid banking conditions and improve banks’ margins.

… challenges also loom

However, banks could face some challenges in 2015-16, in our view. While overseas businesses are set to boom, we see a lack of support on the domestic side. Lower income from CNY activities and an increased tax burden will likely undermine earnings ability. In addition, compared to insurers, banks are more exposed to the emerging markets. If the liquidity pullback resulting from the Fed’s tightening leads to stress in emerging market financial systems, banks would likely suffer more than insurers. Unexciting domestic earnings Most banks expect their TWD credit growth to be a mid-single digit for 2015, despite the Taiwanese Government’s optimistic GDP growth assumption of 3.8% YoY. We are more conservative, however, as we see a lack of export-growth drivers after the iPhone 6 boost, and believe domestic manufacturers are reluctant to invest at this stage. A cooling property market could be another drag. Daiwa’s economics team forecasts the country’s GDP growth to slow from 3.7% YoY for 2014 to 3.2% YoY for 2015. We only expect 0-3% YoY TWD credit growth for the banks under our coverage for 2015. Given a high base in 2014, we doubt that fee income can achieve double-digit growth again in 2015. Wealth management businesses do have the potential to grow (thanks to the FSC’s regulatory easing on investment

products that banks can offer), but stricter scrutiny over the treasury market unit (TMU) business could be a drag. We also see limited chance of the credit card business contributing much as both economic growth and household income growth are far from booming. Fee income growth for 2014


Note: Including Tokyo Star Bank’s number for CTBC

Fee income from bancassurance could also come in lower for 2015 than in 2014. The bank channel usually sells deposit-type insurance products, which the FSC now charges higher termination fees for and they have longer durations. Insurers are gradually depending more on their own tied-agents to sell the products than through the banks. (Note: tied agents are the sales agents paid for by a financial organisation to sell and give advice on its investment products, and not on those of its competitors.) An expected dropped in premiums in 2015 after the “rush sale” in 3Q14 is also not helping. We forecast average fee income growth for the banks under our coverage to slow from 16% YoY for 2014 to 1.6% YoY for 2015. Cathay Life: distribution channels

Source: CEIC, Daiwa

0

5

10

15

20

25

30

CTBC Bank CUB TFB Mega Bank First Bank

2013 2014

(TWD b)12.3%

28.3%29.9%

-7.2% 16.7%

77.8 83.2

15.615.1

6.5 1.6

0

20

40

60

80

100

2013 2014

Tied agents Bancassurance: Cathay United Bank Others

(%)


- 12 -

Fubon Life: distribution channel

Source: CEIC, Daiwa

Dragged down by China’s economic slowdown and CNY depreciation Money outflows in response to Fed tapering pressure have undermined China’s balance of payments and the PBOC’s balance sheet, thus contributing to a further deterioration in growth and credit. Daiwa’s economic team forecasts China’s GDP growth to slow from 7.4% YoY for 2014 to 6.9% YoY for 2015, and expects an interest-rate cut and 1 required-reserve-ratio (RRR) cut going forward, after 2 interest-rate cuts and one RRR cut since November 2014. The CNY could depreciate to 6.6 against the USD by the end of 2015, on our forecasts (see “Taking the punchbowl away”, 6 January, 2015). Taiwanese banks should feel the pinch from China’s slowdown and CNY depreciation. Asset quality could be at risk amid a slowing Chinese economy, and we expect bad-debt issues to occur sporadically going forward. Fortunately, since the share of CNY asset remains minimal in terms of bank assets (around 3-5%), and the banks’ counterparts in China are mostly state-owned banks and large SOEs, we believe the risk remains manageable at this stage. CNY depreciation could hit CNY deposit growth, and thus put a cap on banks’ ability to lend CNY. We also see the risk of Treasury Market Unit (TMU) business growth slowing in 2015. One of the major drivers for the TMU business over the past few years has been demand for speculating on one-way CNY appreciation. Given a weakening CNY in addition to stricter FSC scrutiny on structured products since mid-2014, we doubt that the TMU business can record meaningful growth in 2015-16. Business tax rise and lower rate for revolving credit The increase in the business tax (BT) from 2% to 5% will have an impact on the FHCs. The calculation of the business tax is levied on gross interest and fee income

of the banks’ domestic business, while it is applied on net premium income (excluding the provisions) for insurers, thus having a greater impact on the bank-centric FHCs. The table below summarises the impact of the BT rise. Impact of business tax rise from 2% to 5%

Fubon Cathay Mega CTBC Frist

Annual tax increase TWD800-900m TWD1.4bn

TWD700-800m

TWD1.3-1.4bn TWD1.0bn

% of 2015E PPOP for the FHC 1.4% 2.5% 2.0% 3.8% 4.9%


The Legislative Yuan passed an amendment on 14 January 2015 to lower the rate ceiling of cash/ credit card revolving loans from the current level of 20% to 15%, which may come into effective in mid-2015. Among our coverage, CTBC and Cathay United Bank have the highest outstanding credit card revolving balances. The impacts are summarised below: Impact of the decline in cash/credit card revolving interest rate TWD mn CTBC CUB TFB Mega First

Cash/credit card revolving loan balance as of Jan 2015 15,298 14,674 6,918 1,314 1,309Impact on interest income for 1pp revolving loan rate decline 153.0 146.7 69.2 13.1 13.1% of 2015E PPOP for the FHC 0.4 0.3 0.1 0.0 0.1

Source: Banking Bureau, Daiwa

Note: TFB = Taipei Fubon Ban; CUB = Cathay United Bank’ PPOP = Pre-provision operating profit

Liquidity pullback from the EM market adds stress to asset quality Tapering and the strengthening USD have led to a liquidity pullback from key markets, including gold and oil, over the past few months. Daiwa’s economics team notes that many Asian economies, especially those in emerging Asia, are in fact quite similar to the commodity markets in terms of capital flows during QE programmes. The appreciation of the US dollar will increase the burden of firms with USD-denominated debt, amplifying both default risk and pressure to deleverage if borrowers are hit by currency depreciation. Liquidity pullbacks at the country level would make financing even more difficult for these firms. These factors could combine to result in more widespread stress on corporate balance sheets, inflicting losses on banks and other financial institutions. We are concerned about the situation in China in particular. The latest balance of payment (BOP) data for China show that money outflows outside the current account (CA) were close to USD91bn in 4Q14, up from USD72bn for 3Q14. The current-account

23.8 30.1

44.341.1

19.5 17.1

12.4 11.7

0

20

40

60

80

100

2013 2014Tied agents Bancassurance: Taipei Fubon BankBancassurance: other banks Others

(%)

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/Regional_Economy-_150106.pdf#page=1


- 13 -

surplus declined from USD72bn in 3Q14 to USD61bn in 4Q14 – insufficient to cover the USD91bn outflow, and leaving an overall BOP deficit of USD30bn, the largest since data began in 1982. These outflows are drying up liquidity in China. Several rounds of PBOC liquidity injections were just about enough to compensate for the loss of liquidity from the system and gave a very limited boost to the economy. As it stands, the property market continues to weaken and profits in several industries are deteriorating. The slowdown has fed back into the banking system, as evidenced by a 13bps rise in China banks’ NPLs for 4Q14 – the fastest deterioration in China banks’ asset quality since the banks underwent restructuring back in 2004-06. China’s bank sector: NPL ratio

Source: Bank Bureau, Daiwa

The Taiwan banks’ exposure to China has risen significantly in recent years. Exposure to China (including lending activities and investments) stood at 68% of Taiwan bank’s total net worth in 4Q14, up from 50.7% for 3Q13. At 81.2% for 4Q14, the Taiwan banks under Daiwa’s coverage are even more exposed to China than is the sector as a whole. Taiwan banks: exposure to China

Source: Bank Bureau, Daiwa

Note: Figures represent the lending activities (including activities in the interbank market) and investments made in China. TFB= Taipei Fubon Bank, CUB= Cathay United Bank.

As Taiwan companies serve as important upstream providers for the downstream China manufacturers, we believe the real exposure of the banking sector to China could be larger than the number might suggest. Once financing become an issue for the downstream China firms, the suppliers will likely suffer as well if receivables fail to materialise. Such a scenario could be expected to hurt the Taiwan banks’ asset quality eventually. Our base case is for China is to muddle through the Fed’s tightening cycle. We do expect bad debt issues to arise sporadically, but we believe the situation remains manageable at this stage. However, investors will need to be mindful of the Taiwan banks’ predicament if China’s slowdown is less than orderly.

Risks to our investment case

Our investment case on the Taiwan Financial Sector is premised on assumptions of 3.2% YoY and 3.0% YoY GDP growth for Taiwan in 2015 and 2016, respectively. We also assume that the Fed and CBC start to deliver rate hikes in 3Q15. Changes to our macro forecasts, both domestically and internationally, would have implications for our investment case. Some of these risks are discussed below: Flatter-than-expected yield curve and delay in rate-hike schedule The major downside risk for the insurers, in our view, would be if the yield curve were to stay flat in 2015-16. The rate hikes that we expect the CBC to make in 3Q15 would steepen the yield curve, though the impact could be reduced by market expectations for low inflation, especially given low global oil prices and deflation fears in the Eurozone. The yield curve would flatten more if the Fed and CBC rate hikes were delayed to end-2015 or even 2016. The concern is not groundless. For 2014, the yield curve for both the US Treasury bond and Taiwan government bond flattened despite better GDP growth than was seen in 2013.

0.5

1.0

1.5

2.0

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

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

(% )

0

20

40

60

80

100

TFB Mega CTBC CUB First

4Q13 4Q14

(% to the bank's net worth)


- 14 -

US Treasury bond yield curve (end of the period)

Source: CEIC, Daiwa

Taiwan’s government bond yield curve

Source: CEIC, Daiwa

The US Treasury curve (specifically the spread between the 5Y yield and 30Y yield) has tumbled to its lowest level since February 2009. The apparent delays in Fed rate hikes matter (after all, at end-2013 the market was expecting a rate hike by mid-2014), but we believe lower inflation expectations, in addition to the perception of delayed rate hikes, have played an important role in narrowing the spread. US Treasury curve: the spread between the 5Y and 30Y yield

Source: CEIC, Daiwa

Although the spread between the 5Y and 30Y for Taiwan’s government bond has yet to see the narrowing trend, what has happened in the US bond market is still worth noting. Higher loan growth driven by “Big Data” CAPEX Daiwa’s Regional Head of Technology Research, Rick Hsu, predicts that the global IT demand is going through a major transformation, evolving from being primarily a market of smart phones and tablets to encompass Big Data, spurred by the fast-growing market for new Internet of Things (IoT) devices. He expects the market to take off in 2016 and grow quickly into a market size exceeding USD1tn in 2018 (see “Big Data: the next big thing”, published on 2 January 2015). Although Taiwan’s tech companies have been continuously investing in this big theme, upside risk still exists for the investment demand to surge before the take-off year of 2016, which will likely drive bank’s loan demand higher. Liquidity drain from the emerging markets leads to a global financial breakdown In previous section, we show our concern on liquidity pullback in the emerging markets (including China) as a result of Fed’s tightening to hit-hard on their economies. While our base case is for these markets to muddle through the Fed’s tightening cycle, the chance of a wide spread breakdown in the financial market can still not be ruled out. A shift to pessimistic stance on domestic property market Taiwan’s property market has started to cool down in 2014, but the slowdown by far remains an orderly one. If the government turns more hawkish on the domestic property market or the market sentiment suddenly turns towards extreme pessimism, mortgage loans for the Taiwanese banks could further be hit (see “Property after the boom” published on 17 March 2014).

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 20Y 30Y

(%)

Dec-13

Jun-14

13 Apr-15

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2Y 5Y 10Y 20Y 30Y

(%)

Dec-13

Jun-14

13 Apr-15

50

100

150

200

250

300

Apr-0

8Ju

l-08

Oct

-08

Jan-

09Ap

r-09

Jul-0

9O

ct-0

9Ja

n-10

Apr-1

0Ju

l-10

Oct

-10

Jan-

11Ap

r-11

Jul-1

1O

ct-1

1Ja

n-12

Apr-1

2Ju

l-12

Oct

-12

Jan-

13Ap

r-13

Jul-1

3O

ct-1

3Ja

n-14

Apr-1

4Ju

l-14

Oct

-14

Jan-

15Ap

r-15

(bps)

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/AsiaTechSector_150102.pdf#page=1

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/Taiwan_Economy-Property_140317.pdf#page=1


- 15 -

Valuations

Sector trading slightly below its 10-year average PBR

Overall, the Taiwan Financial Sector’s ROE reached 11.8% for 2014, up from 9.3% for 2013. Better economic growth (GDP growth rose from 2.2% YoY for 2013 to 3.7% YoY for 2014) and the ongoing deregulation theme have been positive for ROEs in the sector. Besides, the boost to ROEs has been driven partly by a surge in trading income and financial securities investments on the back of the stock-market rally (the TWSE index rose by 8.1% in 2014). One-offs, such as changes in the accounting method for property investments and gains from M&A deals (mainly the cut-price purchase of Tokyo Star Bank by the CTBC) conducted in 2014, should have provided another boost to ROEs. According to the Bloomberg consensus forecasts, the sector’s ROE will fall to 10.3% for 2015E from the 2014 peak. We agree with the consensus view that the sector’s ROE will decline this year, given one-offs should be stripped out when considering earnings for 2015. At the same time, the growth outlook for trading and financial securities investment income may be more volatile and less sustainable than it was last year. However, we believe the sector’s ROE for 2015 is likely to trend higher than its historical level (see the chart below). In our view, the fundamentals of Taiwan financial companies have gradually improved over the past decade, following years of consolidation, regulatory easing, and international expansion. We forecast the upcoming rate-hike cycle and ongoing deregulation trend to lead to core earnings (net interest income plus net service fee income) growing by an average of 9.5% YoY for the insurance-centric FHCs and 5.6% YoY for the bank-centric FHCs under our coverage in 2015.

Taiwan financial sector: ROE trend


We initiate coverage of the Taiwan Financial Sector with a Neutral view. We are upbeat on the share-price performance prospects of the insurance-centric FHCs but more cautious on the bank-centric FHCs. The 12-month rolling PBR for the sector is currently slightly below its 10-year average. Taiwan Financial Sector: 12-month rolling PBR


Among the stocks under our coverage, First FHC has the lowest absolute 12-month rolling PBR of 1.1x. On the other hand, CTBC FHC has relatively a rich valuation, in our view. It is trading at 1.4x 12-month rolling PBR, which is 17.4% higher than its past 10-year average.

Cathay: valuation supported by ROE uptrend, repricing

We initiate coverage of Cathay FHC with a Buy call and 12-month target price of TWD60.8, based on an SOTP valuation, implying a target of 1.7x 2015E PBR. The potential upside to our target price from current share price levels stands at 20.6%. Our positive view on the company is largely premised on our conviction that it is well placed to benefit from the

0

2

4

6

8

10

12

2007

2008

2009

2010

2011

2012

2013

2014

2015

E

2016

E

(%)

0.6

0.9

1.2

1.5

1.8

2.1

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.


- 16 -

major macro trends that we forecast for 2015-16. Cathay FHC is trading at a 12-month rolling PBR of 1.4x. Cathay FHC SOTP valuation

Implied 15E P/B Total Value Value/share % of total

Entity/Item Methodology (x) (TWDm) (TWD) (%)Cathay United Bank 1.1 x Book 1.1 167,503 13.3 22%Cathay Life Adj. 2015E EV 1.5 501,030 39.9 66%

Liability MTM 83,937 6.7 11%Cathay Century 0.8x Book 0.8 5,794 0.5 1%Cathay Securities 0.8x Book 0.8 4,962 0.4 1% Cathay FHC SOTP 1.7 763,226 60.8 100%Implied Upside (%) 20.6%Price as of 15 April 50.4


Cathay FHC has enjoyed a higher PBR than the sector over the past decade, trading at a past-10-year average PBR (12-month rolling based) of 1.9x versus 1.2x for the sector. In our view, this reflects the fact that Cathay FHC holds a large amount of greatly undervalued properties in its books under the cost-accounting method. In January 2014, the FSC allowed FHCs to choose between the cost method or fair-value method when valuing their investment properties (applied to the 2013 numbers and beyond). Cathay changed to the fair-value method. As such, Cathay FHC’s BVPS surged from TWD22.8 for 2012 to TWD31.7 for 2013, and to TWD34.9 for 2014, bringing the PBR down as the denominator became larger. Cathay FHC: 12-month rolling PBR


With the change in accounting method, the book values of Cathay FHC’s property assets are now closer to their market values. Therefore, we see Cathay FHC trading at a lower PBR in the future. However, our target PBR of 1.7x is still higher than the sector average of 1.3x. Besides earnings improvements, we see 2 other factors supporting the valuation:

1) A gap is still likely to exist between the real value and book value of Cathay FHC’s property assets. In general, after the appraisal of a property, the company would apply a certain discount before recording it in its books (companies tend to be more conservative when recording a book value to prevent any overvaluation of the property). We expect the discount to be around 20-30%. 2) The market will likely appreciate Cathay Life’s substantial investment assets (TWD4.1tn as of end-2014, almost double those of Fubon Life) more as interest rates start to rise. The assets that Cathay Life accumulated during the high interest rate era will now be seen as valuable assets, rather than a burden, along with a rise in interest rates.

Fubon: stable earnings growth should see share price rise

We initiate coverage of Fubon FHC with an Outperform (2) rating and SOTP-derived 12-month target price of TWD62.4, implying a 2015E target PBR of 1.4x and 11.2% upside to our target price from current share price levels. The stock is trading at a 12-month rolling PBR of 1.4x, higher than its past-10-year average of 1.2x. We expect the company’s solid core earnings growth to lift its book value steadily over our forecast period, allowing the share price to rise while its PBR is being maintained at 1.4x. Fubon FHC: SOTP valuation Implied 15E PBR Total Value Value/share % of totalEntity/Item Methodology (x) (TWDm) (TWD) (%)

Taipei Fubon Bank 1.0 x Book 1.0 175,829 17.2 28%Fubon Life Adj. 2015E EV 1.1 255,840 25.0 40%

Liability MTM 157,899 15.4 25%Fubon Insurance 0.8x Book 0.8 23,352 2.3 4%Fubon Securities 0.8x Book 0.8 25,441 2.5 4%Fubon FHC SOTP 1.4 632,394 62.4 100%Implied Upside 11.2%Price as of 15 April 56.1


0.5

1.0

1.5

2.0

2.5

3.0

3.5

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.


- 17 -

Fubon FHC: 12-month rolling PBR


Fubon FHC: PBR premium/discount to sector PBR


Mega: looks fairly valued

We initiate coverage of Mega FHC with a Hold (3) rating and 12-month target price of TWD26.9, based on an SOTP valuation, implying a target of 1.2x 2015E PBR. The potential upside to our target price from current share price levels stands at a modest 3.5%. The stock is trading at a 12-month rolling PBR of 1.2x, on our forecasts, in line with its past-1o-year average and the multiple used to derive our target price. Hence, we view it as fairly valued at current levels. Mega FHC: SOTP valuation

Implied 15E PBR Total Value Value/share % of totalEntity/Item (x) (TWDm) (TWD) (%)Mega Bank 1.2 281,910 22.6 84%Mega Bills 1.0 36,166 2.9 11%Chung Kuo Insurance 0.9 4,942 0.4 1%Mega Securities 0.8 12,251 1.0 4% Mega FHC -SOTP 1.2 335,269 26.9 100%Implied Upside 3.5%Price as of 15 April 26.0


Mega FHC: 12-month rolling PBR


Mega FHC: PBR premium/discount to sector PBR


First: lacking growth drivers to support valuation

We initiate coverage of First FHC with an Underperform (4) rating and 12-month target price of TWD16.7, based on an SOTP valuation, implying a target of 1.0x 2015E PBR. Potential downside from the current share price stands at 10.9%. The stock is trading currently at a 12-month rolling PBR of 1.1x, which may not be sustainable given our view that loan growth will slow as a result of the company’s high exposure to mortgage and SME loans. First FHC: SOTP valuation Implied 15E PBR Total Value Value/share % of totalEntity/Item (x) (TWDm) (TWD) (%)First Bank 1.0 148,617 16.1 96%First Securities 0.8 5,538 0.6 4%First Life 0.8 779 0.1 1% First FHC -SOTP 1.0 154,934 16.7 100%Implied Upside -10.9%Price as of 15 April 18.75


0.70.80.91.01.11.21.31.41.51.61.7

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

(40)

(30)

(20)

(10)

0

10

20

30

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(%)

Ave: -5.6%

0.40.50.60.70.80.91.01.11.21.31.41.51.6

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

(40)

(30)

(20)

(10)

0

10

20

30Ap

r-05

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(%)

Ave: -10.4%


- 18 -

First FHC: 12-month rolling PBR


First FHC: PBR premium/discount to sector PBR


CTBC: valuation looks rich

We initiate coverage of CTBC FHC with an Underperform (4) rating and 12-month target price of TWD18.9, based on an SOTP valuation, implying a target of 1.1x 2015E PBR (vs. a past-10-year average of 1.2x PBR). The potential downside to our target price from current share price levels stands at 14.3%. We find the stock is trading at a 12-month rolling PBR of 1.4x, or near its 1 standard deviation above its past-10-year average. The current valuation looks stretched, in our view, given our subdued outlook for the company’s bancassurance business and interest income from the credit-card business. Also, incorporating Tokyo Star Bank, which CTBC Bank acquired in 2014, will also be a challenge for management, in our opinion.

CTBC FHC SOTP valuation Implied 15E P/B Total Value Value/share % of total

Entity/Item (x) (TWD m) (TWD) (%)CTBC Bank 1.1 240,617 15.8 84%CTBC Life 1.0 37,273 2.4 13%CTBC Insurance 1.0 3,109 0.2 1%CTBC Securities 0.9 6,667 0.4 2% CTBC FHC -SOTP 1.1 287,666 18.9 100%Price as of 15 April 22.05Implied Upside -14.3%


CTBC FHC: 12-month rolling PBR


CTBC FHC: PBR premium/discount to sector PBR


0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

(50)

(40)

(30)

(20)

(10)

0

10

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(%)

Ave: -17.6%0.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

(60)(50)(40)(30)(20)(10)

010203040

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(%)

Ave: -10.9%

See important disclosures, including any required research certifications, beginning on page Error! Bookmark not defined.

■ Investment case We initiate coverage of Cathay Financial Holdings (Cathay FHC) with a Buy (1) rating and 12-month target price of TWD60.80. We expect subsidiary Cathay Life’s negative investment spread to narrow in 2015-16, as the interest-rate hike cycle should lift its investment yield. Cathay Life shortened its asset duration to 8 years at the end of 2014 (12 years for Fubon Life), which should allow more assets to benefit from this rate-hike cycle (from 3Q15). Given Daiwa’s macro assumptions of two 12.5bp policy-rate hikes by the CBC and a rise in the Fed funds rate to 0.625% by end-2015, we expect Cathay Life’s pre-hedging recurrent yield to reach 3.4% for 2015 and 3.8% for 2016, up from 3.2% for 2014. Cathay Life’s FX positions are less fully hedged than those of its peer Fubon Life, which in the past has led to higher earnings volatility for Cathay Life. Given the build-up of its

FX reserves and the ongoing USD rally trend (Cathay Life’s unhedged positions are mostly held in USD), we expect hedging costs to be kept low and more earnings stability for Cathay Life going forward. Meanwhile, Cathay United Bank’s earnings outlook for 2015-16 should remain favourable, as the drag from lower TWD loan growth should be largely offset by an improved NIM and resilient FX loan growth, as it reaches out aggressively to the ASEAN market. ■ Catalysts Monetary tightening by the CBC and the Fed would be the key share-price catalysts. We also expect the consensus to raise its 2015-16 earnings forecasts. Our 2015E EPS are 11% higher than consensus for 2015 and 14% higher for 2016, as we believe Cathay Life will benefit greatly from the rate-hike cycle. ■ Valuation The stock is trading at a 12-month rolling PBR of 1.4x, versus the sector average of 1.3x. Our target multiple is 1.7x. Decent core earnings growth for 2015-17, its still-undervalued investment properties and the likely rise in interest rates leading to investors reassessing Cathay Life’s assets would provide good valuation support for the stock, in our view.

■ Risks A prolonged low-interest rate environment, poor investment performance and USD weakness would be the key risks to our call.

Financials / Taiwan2882 TT

16 April 2015

Cathay Financial Holdings

Initiation: rise to the occasion

• Cathay Life stands to be a major beneficiary of an interest-rate rise and the rally in the USD

• We expect Cathay Life’s product mix and earnings stability to improve going forward

• Initiating with a Buy (1) rating and 12-month target price of TWD60.80

Source: FactSet, Daiwa forecasts

Financials / Taiwan

Cathay Financial Holdings2882 TT

Target (TWD): 60.80Upside: 20.6%15 Apr price (TWD): 50.40

Buy (initiation)

OutperformHoldUnderperformSell

1

2

3

4

5

95

101

108

114

120

40

44

48

51

55

Apr-14 Jul-14 Oct-14 Jan-15 Apr-15

Share price performance

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

(TWD) (%)

12-month range 40.28-52.40Market cap (USDbn) 20.263m avg daily turnover (USDm) 29.13Shares outstanding (m) 12,563Major shareholder Wan Pao Development Co. (17.8%)

Financial summary (TWD)Year to 31 Dec 15E 16E 17ETotal operating income (m) 124,610 134,185 145,946Pre-provision operating profit(m) 56,402 61,668 67,453Net profit (m) 46,286 49,798 54,662Core EPS (fully-diluted) 3.584 3.964 4.250EPS change (%) (9.0) 10.6 7.2Daiwa vs Cons. EPS (%) 11.0 14.1 12.4PER (x) 14.1 12.7 11.9Dividend yield (%) 3.9 3.9 4.2DPS 2.0 2.0 2.1PBR (x) 1.4 1.3 1.3ROE (%) 10.2 10.9 11.2



Financials / Taiwan 2882 TT

16 April 2015

- 20 -

Growth outlook Cathay FHC: EPS and ROE (2008-16E)

Cathay Life would benefit from a rise in interest ratesgiven its high share of assets (24-26%, versus 13% for Fubon Life) exposed to interest-rate risk. We see its negative investment spread narrowing and eventually closing once interest rates trend higher. The company is also shifting its focus to higher-margin products which should help sustain its embedded value. While 2015 headline earnings are likely to fall, as trading and other income (up 25% YoY for 2014) decline from the 2014 peak, we still forecast Cathay FHC’s core income (net interest income plus net service income) rising by 7.8% YoY for 2015 and 12.4% YoY for 2016.

Source: TEJ, Daiwa estimates

Note: 2014 numbers include the one-off gain of TWD13.7bn

Valuation Cathay FHC: 12-month rolling PBR

We initiate coverage on Cathay FHC with a Buy (1) rating and 12-month target price of TWD60.80 based on a SOTP valuation, and implying a target 2015E PBR of 1.7x, below the stock’s past-10-year average of 1.9x. Cathay FHC’s change in accounting method for investment property (applied to 2013 and beyond) has brought the book values of its property assets nearer to their market values, and thus we see Cathay FHC trading at a lower PBR in the future. Our target PBR of 1.7x is higher than the sector average of 1.3x, as we believe the company’s property assets remain undervalued. We also see improvements in core earnings providing good valuation support for the stock in 2015-16.


Earnings revisions Cathay FHC: Bloomberg-consensus EPS forecasts

The Bloomberg consensus EPS forecasts for 2015-16remained relatively stable during 2014, before starting to rise significantly in early 2015, on the back of better earnings results for 4Q14. We believe the trend will continue as the overall macro environment turns in Cathay’s favour. Our EPS forecasts are 11% higher than consensus for 2015 and 14% higher for 2016.



Growth outlook

Valuation

Earnings revisions

0

2

4

6

8

10

12

14

0.00.51.01.52.02.53.03.54.04.5

2008

2009

2010

2011

2012

2013

2014

2015

E

2016

E

EPS (LHS) After tax ROE (RHS)

(TWD) (%)

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

2.4

2.6

2.8

3.0

3.2

3.4

3.6

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr-1

5

2015E EPS 2016E EPS

(TWD)

Buy (initiation)

OutperformHoldUnderperformSell

1

2

3

4

5


16 April 2015

- 21 -

Key assumptions

Profit and loss (TWDm)

Change (YoY %)


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 categorized 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 2017EFYP growth (%) – Life Insurance 26.2 (22.6) 4.6 (25.0) 16.5 (10.0) 10.0 10.0

Value of New Business – Life Insurance (local. Curr. bn)

43.0 44.0 50.0 51.4 53.5 54.0 54.6 55.1

Embedded Value – Life Insurance (local. Curr. Bn)

449.0 475.0 565.0 635.0 706.0 715.8 735.4 761.0

Recurrent Yield, pre-hedge (%) – Life Insurance

3.5 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 1.4 1.5 1.5Loan Growth (%) – Bank 7.3 11.8 0.2 4.5 8.6 4.3 4.5 5.0Tier-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 2017ENet-interest income 92,741 105,055 112,727 114,558 125,083 134,837 151,282 164,664Net fees & commission 185 920 2,207 791 369 406 759 1,154Trading and other income 18,663 10,005 35,285 63,480 79,465 75,932 75,267 78,096Net insurance income (65,281) (57,411) (79,559) (80,268) (88,342) (86,565) (93,124) (97,968)Total operating income 46,308 58,569 70,659 98,560 116,576 124,610 134,185 145,946Personnel expenses (28,140) (30,938) (32,724) (34,298) (35,106) (40,494) (42,226) (44,238)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) (68,208) (72,517) (78,493)Pre-provision operating profit 2,565 10,681 18,887 44,283 59,225 56,402 61,668 67,453Total provision 0 (1,063) (3,173) (1,484) (2,982) (4,094) (4,224) (4,360)Operating profit after prov. 2,565 9,618 15,715 42,799 56,243 52,308 57,444 63,093Non-operating income 1,283 956 1,025 1,237 1,573 1,253 1,260 1,269Profit before tax 3,848 10,574 16,740 44,036 57,815 53,561 58,704 64,362Tax 1,718 1,667 457 (4,779) (6,458) (7,275) (8,906) (9,700)Min. int./pref. div./other items 0 0 0 0 0 0 0 0Net profit 5,566 12,241 17,197 39,257 51,357 46,286 49,798 54,662Adjusted net profit 5,566 12,241 17,197 39,257 51,357 46,286 49,798 54,662EPS (TWD) 0.410 1.040 1.410 3.120 3.940 3.584 3.964 4.250EPS (adjusted) (TWD) 0.410 1.040 1.410 3.120 3.940 3.584 3.964 4.250EPS (adjusted fully-diluted) (TWD) 0.410 1.040 1.410 3.120 3.940 3.584 3.964 4.250DPS (TWD) 0.600 0.500 0.700 1.500 1.900 1.971 1.982 2.125

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest income 5.5 13.3 7.3 1.6 9.2 7.8 12.2 8.8Non-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 6.9 7.7 8.8Total expenses (19.2) 9.5 8.1 4.8 5.7 18.9 6.3 8.2Pre-provision operating profit (84.3) 316.4 76.8 134.5 33.7 (4.8) 9.3 9.4Total provisions n.a. n.a. 198.6 (53.2) 101.0 37.3 3.2 3.2Operating profit after provisions (84.3) 275.0 63.4 172.4 31.4 (7.0) 9.8 9.8Profit before tax (76.4) 174.8 58.3 163.1 31.3 (7.4) 9.6 9.6Net profit (adjusted) (48.6) 119.9 40.5 128.3 30.8 (9.9) 7.6 9.8EPS (adjusted, FD) (61.7) 153.7 35.6 121.3 26.3 (9.0) 10.6 7.2Gross loans 4.1 7.9 2.0 9.6 8.7 4.6 5.1 5.4Deposits 3.2 6.4 3.1 8.7 7.4 5.3 3.4 4.1Total assets 9.2 6.7 10.1 12.1 12.4 6.4 6.0 6.1Total liabilities 9.5 7.2 9.9 10.2 12.2 6.7 6.1 6.2Shareholders' equity 3.0 (2.2) 14.4 53.6 15.3 2.4 5.6 4.1Avg interest-earning assets 11.5 8.5 (6.9) (6.1) 10.1 10.5 9.7 8.0Avg risk-weighted assets 2.5 8.7 8.0 9.4 13.2 12.1 10.0 10.0

Financial summary


16 April 2015

- 22 -

Balance sheet (TWDm)

Key ratios (%)


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.

As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ECash & equivalent 742,594 814,156 422,667 483,611 586,296 652,473 661,811 681,060Investment securities 833,000 1,421,277 1,449,490 1,601,130 1,628,307 1,625,592 1,628,060 1,629,059Net loans and advances 1,383,122 1,492,075 1,521,712 1,667,392 1,812,774 1,895,557 1,991,756 2,099,038Fixed assets 37,941 38,606 114,634 103,394 92,878 50,377 50,726 51,206Goodwill 8,391 9,693 9,393 9,223 9,283 7,512 7,375 7,245Other assets 1,684,142 1,229,595 1,993,057 2,312,522 2,815,465 3,156,057 3,492,662 3,841,321Total assets 4,689,190 5,005,403 5,510,953 6,177,273 6,945,002 7,387,569 7,832,391 8,308,928Customers deposits 1,329,507 1,414,422 1,458,393 1,585,031 1,702,302 1,793,369 1,854,378 1,930,428Borrowing 87,462 101,612 89,524 148,174 230,710 238,104 245,266 253,409Debentures 65,105 84,744 95,371 102,467 134,404 137,757 121,644 116,472Other liabilities 2,984,609 3,186,913 3,619,516 3,962,090 4,439,264 4,773,674 5,142,060 5,520,699Total liabilities 4,466,683 4,787,691 5,262,804 5,797,762 6,506,681 6,942,904 7,363,349 7,821,009Share capital 101,544 103,575 108,654 119,650 125,632 125,632 125,632 125,632Reserves & others 117,032 110,086 135,744 255,680 307,049 317,460 342,151 361,268Shareholders' equity 218,576 213,661 244,398 375,330 432,681 443,092 467,783 486,900Minority interests 3,931 4,051 3,752 4,180 5,640 1,573 1,259 1,019Total equity & liabilities 4,689,190 5,005,403 5,510,953 6,177,273 6,945,002 7,387,569 7,832,391 8,308,928Avg interest-earning assets 3,826,116 4,150,101 3,862,132 3,627,032 3,992,807 4,411,221 4,841,041 5,226,616Avg risk-weighted assets 854,194 928,921 1,003,420 1,098,228 1,243,186 1,393,684 1,533,053 1,686,358BVPS (TWD) 21.912 21.020 22.839 31.718 34.889 35.394 37.335 38.837

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ELoan/deposit 66.4 67.0 64.9 63.8 64.4 65.2 65.9 66.4Tier-1 CAR 9.7 9.4 9.2 10.0 11.4 11.5 11.6 11.6Total CAR 11.4 12.0 12.6 13.5 16.2 16.3 16.4 16.4NPLs/gross loans 0.3 0.3 0.3 0.3 0.3 0.3 0.4 0.4Total loan-loss prov./NPLs 269.6 324.9 379.4 468.1 528.2 527.6 491.3 524.6ROAA 0.1 0.2 0.3 0.7 0.8 0.6 0.7 0.7ROAE 2.0 5.1 6.9 12.1 12.2 10.2 10.9 11.2Net-interest margin 2.4 2.5 2.9 3.2 3.1 3.1 3.1 3.2Gross yield 2.7 2.8 3.3 3.5 3.5 3.5 3.6 3.7Cost of funds 0.7 0.8 0.8 0.8 0.8 0.9 1.0 1.2Net-interest spread 2.0 2.0 2.4 2.7 2.7 2.6 2.6 2.5Total cost/total income 94.5 81.8 73.3 55.1 49.2 54.7 54.0 53.8Effective tax (67.0) (17.3) (2.9) 11.2 11.5 13.9 15.5 15.4Dividend-payout 146.3 48.1 49.6 48.1 48.2 55.0 50.0 50.0

Financial summary continued …


16 April 2015

- 23 -

Rise to the occasion

Cathay FHC enjoys the strongest macro tailwinds.

Investment summary: initiating with a Buy call

We initiate coverage of Cathay FHC with a Buy (1) rating and 12-month target price of TWD60.80, implying 20.6% upside from the current price of TWD50.40. Cathay FHC is the largest financial-holding company in Taiwan with total assets of TWD6,945bn at the end of 2014. Its primary subsidiaries are Cathay Life and Cathay United Bank. Cathay Life contributed 62.4% to the net income for 2014, while Cathay United Bank contributed 34.8%. Cathay FHC: net income of primary subsidiaries


Note: 9M13 figures were pro forma assuming the fair value method on investment property. Cathay United Bank’s and Cathay Life’s 9M14 net income included appraisal gain from investment property of TWD0.03bn and TWD13.7bn respectively.

Cathay Life: turning around

Both macro trends and the regulatory environment are turning in Cathay FHC’s favour, in our view. Potential policy rate hikes by the CBC (expected in 3Q15), as well as the FSC’s regulatory easing of regulations governing overseas investment, should allow Cathay Life to earn higher investment returns. Changes in its product mix should allow Cathay Life to chase a higher value of new business (VNB) margin over 2015-16.

Cathay Life is likely to lower its hedging costs on the back of the USD rally trend and the build-up of FX reserves, implying less earnings volatility going forward. Big beneficiary of interest-rate hikes With a higher share of assets exposed to interest-rate risk means Cathay Life would be a major beneficiary of any rise in interest rates later this year. Cathay Life has been reducing its cash position and increasing its international bond position since 2013, while at the same time shortening its asset duration to 8 years (12 years for Fubon Life) as at end-2014. It has also increased its holdings for mortgage & secured loans (12.7%), to which floating interest rates are applied. In sum, 24-26% of its assets would benefit from an interest-rate hike (versus 13% for Fubon Life).

Cathay Life: investment portfolio (pre-hedged)

% of total Investment yield

2013 2014 2013 2014

Deposit & cash equivalent 3.8 3.2 0.9 0.8Fixed income: domestic 15.0 11.0 1.9 2.0Fixed income: overseas 40.3 43.6 5.4 5.0Equity: domestic 9.2 8.4 6.1 7.1Equity: overseas 5.1 5.0 6.1 6.4Mortgage loans 12.6 12.7 2.2 2.1Policy loans 4.9 4.0 6.1 5.9Real estate 7.3 10.5 3.3 6.8Others 1.8 1.6 1.0 1.0Total portfolio 100 100 4.1 4.3


Its strategy of shortening its asset duration, however, led to Cathay Life seeing lower-than-expected investment returns in 2014. The after-hedge investment yield still reached 4.3% for 2014 (4.4% for 2013), thanks to the rebound of the Taiwan equity market and the gain from the accounting method change for property appreciation. The pre-hedging recurrent yield, however, fell to 3.2% (3.4% for 2013). Weaker-than-expected global economic growth leading to a delay in the interest-rate hikes by both the CBC and Fed was one of the main factors undermining Cathay Life’s recurrent yield rate in 2014. In early 2014, the consensus had expected the interest-rate hike cycle to start in 2H14.

27.6

14.8

0.3 0.3 0.2

31.9

17.8

0.7 0.3 0.40

5

10

15

20

25

30

35

Cathay Life Cathay UnitedBank

Cathay Century Cathay SITE Cathay Securities

FY13 FY14

(TWDbn)


16 April 2015

- 24 -

Cathay Life: pre-hedging recurrent yield


Cathay Life’s recurrent yield was 3.2% for 2014, which we believe was the trough – we think the bond yield will increase in 2H15 on the back of the Fed’s tapering and the CBC’s likely interest-rate hikes in 3Q15. We forecast the policy rate to reach 2.125% by the end of 2015, from 1.875% currently, and the Fed fund rate to reach 0.625% by end-2015 and 1.875% by end-2016, from 0.1% currently. This should allow Cathay Life to earn a higher recurrent yield going forward, especially when a relatively large proportion of its assets remain exposed to interest-rate risk. The FSC’s deregulatory measures on overseas investments (as explained in the main section of the report) should also help lift Cathay Life’s recurrent yield, given that bond yields are generally higher overseas (see page 5 of our sector report for details). Overseas investments accounted for 48.6% of Cathay Life’s total investments at the end of 2014 (including the share of its investments in foreign currency insurance policies). With more flexibility granted by the FSC, we expect the company’s share of overseas investments to continue to rise and reach 50.5% by the end of 2015, helping Cathay Life to earn a higher recurrent yield rate. We see Cathay’s pre-hedging recurrent yield reaching 3.4% for 2015, up from 3.2% for 2014. Better product mix likely to lead to higher margin First year premiums (FYP) rose strongly in 2014 by 16% YoY, but first-year premium equivalents (FYPE) declined by 3% YoY. This could be attributed to the fact that FYP growth was mainly driven by robust sales of investment-linked products (up 57% YoY for 2014), whose value is greatly discounted under FYPE calculations, as the premium payment period tends to be shorter. (Note: FYPE is a measure used for comparison of Taiwanese life insurance revenue. FYPE = FYP * coefficient, where the coefficient is respectively

equal t0 10%, 20%, 30%, 40%, 50% and 100% for 1, 2, 3, 4, 5 and above-6-year paid products.) Cathay Life: FYP breakdown


Note: Totals may not equal 100% due to rounding.

Cathay Life: FYPE breakdown


Note: Totals may not equal 100% due to rounding.

Cathay Life is shifting its focus to selling high-VNB-margin products from low-VNB-margin deposit-substitute products. A clear example is the shift from single-paid traditional life products to regular premium ones. The revenue contribution of 3-year and above regular-premium products increased significantly, from 34.4% for 2012 to 83% for 2014. Having comprehensive agent networks helped the transformation. Cathay Life had about 25,000 tied agents at the end of 2014 versus 16,681 for Fubon.

3.0

3.1

3.2

3.3

3.4

3.5

3.6

3.7

3.8

3.9

2010 2011 2012 2013 2014 2015E 2016E

(%)

45.8%61.2%

43.9%

34.4%4.9%

4.1%5.4%

0.4%

FY13 FY14Investment-linked Traditinoal lifeHealth, accident and others Interest crediting annuity

NTD200.4bnNTD233.4bn

16%

13.2% 22.5%

71.8% 64.0%

13.5% 13.3%

1.5% 0.1%

FY13 FY14

Investment-linked Traditional lifeHealth, accident and others Interest crediting annuity

NTD73.5bn NTD71.2bn


16 April 2015

- 25 -

Cathay Life: breakdown of traditional life FYP [


Compared to the bancassurance business, which has the advantage of selling deposit-like insurance products, agents are able to sell complicated and diversified insurance products to customers given their professional training. As 83% of the distribution channel for Cathay Life was through tied agents in 2014, we believe the company is now in a good position to improve its sales of regular-premium products. Cathay Life: distribution channel

Source: CEIC, Daiwa

We think the company is heading in the right direction in terms of its focus to lift the VNB margin, in our view. However, selling higher-VNB-margin products (that is, regular-premium products) means a slower decline in liability costs, as the cash from premiums collected does not all come in at once, which means the cost of funds is not diluted as much. Given the current low interest-rate environment, Cathay Life’s liability costs is still going to decrease in the future, but likely at a more modest pace vs. 2014, in our view. We look for a 4bps decrease in Cathay Life’s liability costs for 2015, versus a 9bps decrease for 2013 and an 11bps decrease in 2014.

Cathay Life: cost of liability


Low hedging cost, despite a modest pick-up Some TWD1.44tn, or 70%, of Cathay Life’s FX assets were exposed to FX risk in 2014. Of this, 58% was fully hedged by currency swaps (CS) and non-deliverable forwards (NDF), while 20% were partially hedged and 22% were unhedged.

Cathay Life: FX risk exposure (as of end-2014)


Note: AFS= available for sale

Although Cathay Life’s FX hedging costs could pick up later in 2015 (0.34% for 2014) given that the differential in the US/Taiwan bond yield is likely to enlarge as the Fed’s tightening cycle gets closer, the cost upside would be capped by the build-up of FX reserves at Cathay Life. The FX reserves system was implemented in 1Q12, and allows 50% of the FX losses to be absorbed through the FX reserves under the liabilities of the balance sheet, instead of hitting the P&L directly, thereby offering more flexibility for Cathay Life’s FX hedging strategy. We look for its hedging cost to rise to 50bps for 2015E and 70bps for 2016E, higher than 2014 but much lower than the level seen before the implementation of the FX reserves system (see chart below).

38.8% 34.4%51.1%

83.0%1.7% 5.0%

42.8%

13.4%

59.5% 60.6%

6.1% 3.6%

2011 2012 2013 20143 year and above regular premium 2 year regular premium Single premium

77.8 83.2

15.615.1

6.5 1.6

0

20

40

60

80

100

2013 2014

Tied agents Bancassurance: Cathay United Bank Others

(%)

5.4

5.07

4.83 4.784.63

4.544.43

4.0

4.2

4.4

4.6

4.8

5.0

5.2

5.4

5.6

2008 2009 2010 2011 2012 2013 2014

(%)

Currency Swap49%

Proxy & Open20%

AFS22%

NDF9%


16 April 2015

- 26 -

Cathay Life: hedging cost


Improved capital position

Cathay Life’s leverage ratio (assets/equities) has improved over the past few years, from a peak of 46.3x for 3Q11 to 14.4x for 4Q14. Cathay Life: leverage ratio (assets/equities)

Source: TEJ, Daiwa

The fair value accounting method on investment property and the new risk weighting for overseas investment drove up its risk-based capital (RBC) from 237% for 3Q14 to 287% for 4Q14, despite the drag from Cathay Life’s investment in the Philippines’ RCBC and Indonesia’s Bank Mayapada. In general, an RBC ratio of over 250% is seen as favourable by the regulator, while an RBC ratio of between 200% and 250% is seen as sufficient. Having an RBC ratio of above 250% would put Cathay Life in a better position to get FSC approval when applying for overseas investments and the sale of a new insurance product. Taking over Global Life and Singfor Life

On 23 March 2015, Cathay Life announced that it had won the bid held by the Taiwan Insurance Guaranty Fund (TIGF) to take over Global Life and Singfor Life with subsidies from TIGF of TWD30.3bn. The 2 companies currently have a negative net worth of

TWD54.6bn, which Cathay Life will have to bear (Cathay Life’s total investment assets amounted to TWD4,169bn at end-2014). However, we still see this acquisition as a positive move for Cathay Life, mainly because the FSC promised to provide certain regulatory support measures to the winner of the deal. These measures will likely include:

1) A certain percentage of the winner’s mortality and loading gain being able to be recognised as book value and included in the RBC calculation, rather than be held as liability reserves. This accounting change is likely to lift Cathay Life’s book value immediately and give it more ammunition for overseas expansion.

2) The winner’s 45% overseas investment cap lifted by 5% to 50%.

3) Favourable regulatory terms applied when examining new insurance products.

The actual regulatory support measures are confidential. The discussion above is based on our presumptions which could be subject to change. Expected YoY fall of FYP in 2015 unlikely to hurt much In the sector part of this report, we explain why the average FYP for the sector is likely to see a YoY fall of 15-25% in 2015 (see pages 7-8 of our sector report), but the impact could be limited. For Cathay Life, in particular, the drop could be less severe than for its domestic peers. Interest crediting annuity insurance policies, the main product for which the FSC has tightened its scrutiny, only accounted for 0.4% of the total FYP for Cathay Life for 2014. In addition, investment-linked policies (especially USD-dominated policies) have been selling well in recent months on the back of better equity market performances and the USD rally trend. As such, we see Cathay Life’s FYP drop by 10% YoY for 2015, a relatively mild decline versus the average sector decline of 15-25%. The impact of a 10% FYP fall for Cathay Life in 2015 should be limited, in our view, as: 1) FYP collected in 2014 as a share of total investment assets was only 5.6% for Cathay Life (7.4% for Fubon Life), 2) Cathay Life’s VNB looks as if it will remain on a growth trajectory given the better product mix, and 3) potential regulatory support measures should be made available to Cathay Life due to the takeover of Global Life and Singfor Life (see the section above). We believe Cathay Life’s core earnings growth should do better going forward compared to 2014.

0

50

100

150

200

250

300

350

400

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

E

2016

E

(bps)

Implementation of FX reserves

10

15

20

25

30

35

40

45

50

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

(times)


16 April 2015

- 27 -

Cathay United Bank: outlook remains stable

Cathay United Bank recorded a strong ROAE of 12.7% for 2014, driven by a NIM improvement (from 1.26% for 2013 to 1.33% for 2014), strong foreign currency loan growth (up 16.6% YoY for 2014) and robust fee income growth (up 31% YoY for 2014). For 2015, we forecast Cathay United Bank to maintain an ROAE of 12.4%. Our view on Cathay United Bank is summarised below: NIM: We expect a 4bps improvement in 2015 and 5bps for 2016 from the CBC’s likely rate hikes that are expected to start in 3Q15. Having a high share of demand deposits (60%) helps to cap the rise in the funding cost. Cathay United Bank: interest spread and NIM


Robust foreign currency loan growth: Cathay United Bank has been aggressively expanding its business in the ASEAN market over the past 2 years, and we believe the expansion will support its foreign currency lending growth in 2015. We look for its foreign currency loans to maintain a high growth rate of 15% YoY for 2015 (16.6% YoY for 2014). However, TWD loan growth could be sluggish given the cooling property market. Near 40% of Cathay United Bank’s loan book comprises mortgage loans. As such, downside from TWD mortgage loans could offset some of the gain from foreign currency loans in 2015. We forecast TWD mortgage loan growth to slow from 7.9% YoY for 2014 to 2.0% YoY for 2015, dragging down total loan growth from 8% YoY to 4.3% YoY.

Cathay United Bank: total loan growth


The NPL ratio could pick up moderately in 2015-16. Given Cathay United Bank’s aggressive move into the ASEAN market, it will be more exposed to the risk of an economic slowdown in ASEAN (Daiwa’s economics team assumes the ASEAN economy will slow in an orderly fashion from 2015-16). As such, we expect the bank’s NPL ratio to rise from 0.29% for 2014 to 0.33% for 2015 and 0.39% for 2016. This modest pick-up in NPL ratio should remain manageable, in our view. Cathay United Bank: asset quality


Fee income growth is likely to slow from its peak of 28.3% YoY for 2014, to 7% YoY growth for 2015 on our forecasts, which we see as decent compared to other banks we cover. Fee income from credit cards should remain on a growth trend, as the alliance with Costco should help Cathay United Bank gain some credit-card market share. The bank’s decentralisation strategy, implemented in 2014, of giving more power to its local branches is helping Cathay United Bank be more accommodating of the banking needs of the local population, and also helping it promote its wealth-management products more efficiently. However, lower fee income from its bancassurance business could be a drag on the bank’s earnings, as we forecast Cathay Life’s FYP to fall by

1.51

1.67 1.701.79 1.79 1.79 1.81 1.84

1.071.17

1.26 1.26

1.42 1.39 1.36 1.33

0.80.91.01.11.21.31.41.51.61.71.81.9

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

Interest spread NIM

(%)

0

2

4

6

8

10

12

2010 2011 2012 2013 2014 2015E 2016E

(% YoY)

0.15

0.20

0.25

0.30

0.35

0.40

200

300

400

500

600

700

800

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

Coverage ratio (LHS) NPL ratio (RHS)

(%) (%)


16 April 2015

- 28 -

10% YoY for 2015 (Cathay Life pays fees to Cathay United Bank for selling its insurance products). Cathay United Bank: fee income breakdown


Cathay United Bank: wealth management fee breakdown


The legal amendment to lower the interest-rate ceiling for cash/credit card revolving loans from the current level of 20% to 15%, expected to be in effect by mid-2015, will impact Cathay United Bank’s interest income. Given Cathay United Bank’s cash/credit card revolving loan balance of TWD14.7bn as of January 2015, the impact on interest income of a 1pp revolving loan rate decline would drag down Cathay United Bank’s earnings by TWD147m, on our estimates, equivalent to 0.6% of the bank’s 2015E PPOP (0.3% of Cathay FHC’s 2015E PPOP).

Valuation

We initiate coverage of Cathay FHC with a Buy (1) rating and a 12-month target price of TWD60.80, based on a SOTP valuation, implying a target 2015E PBR of 1.7x (versus the stock’s past-10-year average of 1.9x.) and representing 20.6% upside from the current share price of TWD50.40

Cathay FHC: SOTP valuation

Methodology Implied 15E P/B Total Value Value/share % of totalEntity/Item (x) (TWDm) (TWD) (%)Cathay United Bank 1.1 x Book 1.1 167,503 13.3 22%Cathay Life Adj. 2015E EV 1.5 501,030 39.9 66%

Liability MTM 83,937 6.7 11%Cathay Century 0.8x Book 0.8 5,794 0.5 1%Cathay Securities 0.8x Book 0.8 4,962 0.4 1% Cathay FHC Target Price 1.7 763,226 60.80 100%Implied Upside (%) 20.6%Price as of 15 April 50.40


Cathay FHC has enjoyed a higher PBR than the sector over the past decade, trading at a past-10-year average PBR (12-months rolling based) of 1.9x versus 1.3x for the sector. In our view, this reflects the fact that Cathay FHC holds a large amount of greatly undervalued property in its books under the cost model accounting system. In January 2014, the FSC allowed FHCs to choose between the cost model or fair value model when valuing their investment properties (applied to the 2013 numbers and beyond). Cathay changed to the fair value model. As such, Cathay FHC’s BVPS surged from TWD22.8 for 2012 to TWD31.7 for 2013, and to TWD34.9 for 2014, bringing the PBR down as the denominator became larger. Cathay FHC: 12-month rolling PBR


With the change in accounting method, the book values of Cathay FHC’s property assets are now closer to their market values. Therefore, we see Cathay FHC trading at a lower PBR in the future. However, our target PBR of 1.7x is still higher than the sector average of 1.3x. Besides earnings improvements, we see 2 other factors supporting the valuation: 1) A gap is still likely to exist between the real value and book value of Cathay FHC’s property assets. In general, after the appraisal of a property, the company would apply a certain discount before recording it in its books

40.7% 44.3% 47.3%48.2%

38.3% 36.4%31.8%

31.7%

3.7% 2.3% 2.7%

2.9%

16%15.9%

18.2%

17.3%

0

2

4

6

8

10

12

14

16

FY11 FY12 FY13 FY14

Wealth management Credit cards related FX Others

(TWDbn)

2532

2038

394175

3862

2386

33246

Insurance Mutual Funds Trust & Custody Structured products &Securities

2013 2014

(TWDm)

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.


16 April 2015

- 29 -

(companies tend to be more conservative when recording a book value to prevent any overvaluation of the property). We expect the discount to be around 20-30%. 2) The market will likely appreciate Cathay Life’s substantial investment assets (TWD4.1tn as of end-2014, almost double those of Fubon Life) more as interest rates start to rise. The assets that Cathay Life accumulated during the high interest rate era will now be seen as valuable assets, rather than a burden, along with a rise in interest rates. The following summarises the key assumptions we made in previous paragraphs when addressing the fundamentals of Cathay Life and Cathay United Bank. These are the assumptions we use for our earnings model. Key assumptions for Cathay Life

2014 2015E 2016EFYP growth (%) 16.5 -10 10Hedging cost (bps) 34 50 70After hedged investment yield (%) 4.30 4.35 4.41Pre-hedging recurrent yield (%) 3.20 3.37 3.75Cost of liability (%) 4.43 4.39 4.35

Source: Company, Daiwa’s estimates

Key assumptions for Cathay United Bank

2014 2015E 2016ENIM expansion (bps) 7 4 5Loan growth (%) 8.6 4.3 4.0Fee income growth (%) 28.3 7.0 7.0NPL ratio (%) 0.30 0.33 0.39

Source: Company, Daiwa’s estimates

Cathay Life. We look for Cathay Life’s FYP to drop by 10% YoY for 2015E after recording a gain of 16.5% YoY for 2014, due mainly to base effect distortion as a result of the FSC’s regulatory changes. We forecast its FX hedging cost to pick up later in 2015 to 50bps from 34bps for 2014, assuming the differential in the US/Taiwan bond yield widens as the Fed’s tightening cycle gets closer. The policy rate hikes from the CBC, expected in 2H15, would boost the investment yield for Cathay Life, and we look for the after-hedging investment yield and pre-hedging recurrent yield to reach 4.4% and 3.4% for 2015, respectively. Cathay Life’s liability cost should continue on a downward trajectory, as the absolute level of the current funding cost remains low. Cathay United Bank. We look for NIM expansion of 4bps for 2015 and 5bps for 2016. A 2H15 policy rate hike from the CBC would boost the bank’s NIM. We forecast its loan growth to slow to 4.3% YoY for 2015 and 4% YoY for 2016, due to sluggish TWD loan growth. Lower bancassurance income could drag down

total fee income growth, but Cathay United Bank’s strategy of expanding credit card issuance and its sale of wealth management products should lend some support. We see fee income growth remaining at a decent level of 7% YoY. The NPL ratio is likely to rise modestly to 0.33% for 2015 and 0.39% for 2016 as sporadic bad debt issues could occur, given the prevailing economic slowdown in the emerging markets, especially in ASEAN countries. We also stress that these assumptions are made based on our 2015 GDP forecasts of 3.2% YoY for Taiwan and 5.9% YoY for Asia-ex Japan. Two 12.5bps rate hikes from the CBC in 2H15 are factored in. We also assume a 3% risk-free rate and an 8% equity risk premium. Given the beta value of 1.04 for Cathay FHC, we calculate the cost of equity as 11.3%. Forecasts for GDP and CPI (% YoY) 2014 2015E 2016E

GDP CPI GDP CPI GDP CPITaiwan 3.3 1.2 3.2 0.8 3.0 1.1Asia-ex JP 6.0 3.0 5.9 2.4 5.6 1.9

Source: CEIC, Daiwa


In our view, Cathay FHC’s has less immunity to a flat/inverse yield curve than its domestic peers as a higher portion of its assets is exposed to interest-rate risk. As such, the key risk to our investment case is a lower interest-rate environment, resulting from delays in a policy rate hike (either from the CBC or the Fed) and lower inflation expectations. A lower interest-rate environment would also hit Cathay Life’s investment yield and thus alter our target price for Cathay FHC. USD weakness is a secondary risk factor to our investment case, as it undermines Cathay Life’s hedging performance and could bring more volatility to its earnings performance.


16 April 2015

- 30 -

Company profile

Cathay FHC was founded in 2001 with registered capital of TWD120bn. It has a full-functioning financial platform, including insurance, banking, security, and other diversified financial institutions. Cathay FHC is currently the largest listed financial holding company in Taiwan with total assets of TWD6,662bn as of September 2014. Aggressive overseas expansion The company has been aggressively extending its overseas business over the past decade. It was an early mover in developing the Mainland Chinese market, with its first Shanghai representative office for banking services set up in 2002. Cathay Life set up a 50:50 life insurance joint venture with China Eastern Airline Group in 2004. Banking subsidiary Cathay United Bank’s Shanghai Free-Trade Zone Sub-branch began operation in July 2014, while the Qingdao branch opened in October of the same year. Cathay United Bank plans to apply to open a Shenzhen branch and a Jiading Sub-branch, and upgrade its Shanghai branch into a subsidiary in 2015. Since 2013, Cathay FHC has been focusing on expanding its business in the ASEAN markets. After completing the acquisitions of RCBC Bank of the Philippines and Bank Mayapada of Indonesia in 2014, Cathay FHC has a presence in 9 out of the 10 ASEAN countries.

Cathay FHC: footprint in ASEAN countries Vietnam Cambodia Singapore Malaysia Laos Philippines Thailand Myanmar

Bank 36 16 1 1 1* 1 1 1 Life 6 P&C 2


Note: Not including RCBC and Bank Mayapada’s branches. As of 3Q14, RCBC had 450 branches in the Philippines while Bank Mayapada had 175 offices in Indonesia.

Subsidiaries Cathay Life was found in 1962 and became the first publicly listed insurance company in Taiwan. It has the highest branch coverage ratio and the biggest market share for policy-in-force in Taiwan. Cathay United Bank was formerly the United World Chinese Commercial Bank, founded in 1975. In 2003, the bank was merged with the former Cathay Commercial Bank and renamed Cathay United Bank. It is currently one of the largest commercial banks in Taiwan, being the second-largest credit card issuer in terms of purchase volume and cards in force. Cathay Century Insurance was founded in 1993 with registered capital of TWD2bn. The major business categories include fire insurance, marine insurance, motor insurance, air insurance, liability insurance, bond insurance, and reinsurance.


16 April 2015

- 31 -

Cathay FHC: parent/subsidiary structure


Cathay Financial (2882 TW)

Cathay Venture Inc.Cathay Securities

Investment Trust Co.,Ltd.

Cathay United Bank Co.,Ltd.Cathay Century Insurance

Co.,Ltd.Cathay Life Insurance

Co.,Ltd.

Lin Yuan (Shanghai) Real Estate Co.,Ltd.

Cathay Life Insurance (Vietnam) Co.,Ltd.

Cathay Conning Asset Management Co.,Ltd.

Seaward Card Co.,Ltd.Cathay Insurance (Vietnam)

Co.,Ltd.Cathay Securities Investment

Consulting Co.,Ltd.

Cathay United Bank (Cambodia)

Corporation Limited

Cathay Insurance (Bermuda) Co.,Ltd.

Indovina Bank LimitedCathay Insurance Co.,Ltd.

(China)Cathay Lujiazui Life

Insurance Company LimitedCathay Futures Co.,Ltd.

Cathay Securities Corporation

Cathay Investment Consulting (Shanghai)


■ Investment case We initiate coverage of Fubon Financial Holding (Fubon FHC) with an Outperform (2) rating and 12-month target price of TWD62.40. Although earnings are likely to fall in 2015, due to a high base in 2014, we expect its core earnings to remain on a growth trajectory. Compared to peer Cathay Life, Fubon FHC’s subsidiary Fubon Life is more conservative in terms of both investment and FX hedging strategies. It has kept its asset duration long at 12 years for 2014 (8 years for Cathay Life), which allows Fubon Life to maintain a high recurrent yield rate. Also, 76% of Fubon Life’s FX positions were fully hedged as at end-2014, which is higher than Cathay Life’s, at 58%. Fubon Life has been improving its product mix by selling more high-margin regular-premium traditional life policies. The company is also planning to add tied agents. A better

product mix would help to lift the long-term value of Fubon Life. It had large unrealised investment gains of TWD57.7bn as at end-2014, (TWD22.1bn for Cathay), which should serve as a buffer to absorb any earnings drag in 2015. It also has a strong capital position, with its risk-based capital (RBC) reaching 290% as at end-2014. With such solid fundamentals, we see the stock as a good alpha pick for investors. ■ Catalysts We see a higher recurrent yield as Fubon Life engages more in the Formosa bond market, cutting its low-yield domestic bond position. And it is able to relocate its assets overseas, driven by the FSC’s relaxation of regulations governing Formosa bonds. We forecast Fubon Life’s pre-hedging recurrent yield to reach 4% for 2015 and 4.1% for 2016, up from 3.84% for 2014. Meanwhile, Fubon Bank’s (China) earnings could take off in 2016, as initial operating expenses decline and more branches open. ■ Valuation The stock is trading at a 12-month rolling PBR of 1.4x, higher than its past-10-year average of 1.2x. We initiate coverage with an SOTP-based 12-month target price of

TWD62.40, implying a 2015E target PBR of 1.4x. Solid core earnings for 2015-16 would offer the stock good valuation support. ■ Risks A bad investment performance and a disorderly slowdown in China’s economy are the key risks.


16 April 2015

Fubon Financial Holding

Initiation: a good alpha pick

• High recurrent yield, large unrealised investment gains and strong capital position make the stock a good alpha pick

• Fubon Bank’s (China) earnings should take off in 2016-17, given lower initial operating costs and more business opportunities

• Initiating coverage with an Outperform (2) rating and 12-month target price of TWD62.40


Financials / Taiwan

Fubon Financial Holding2881 TT


BuyOutperform (initiation)

HoldUnderperformSell

1

2

3

4

5

90

101

113

124

135

35

41

48

54

60



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

(TWD) (%)

12-month range 39.00-58.80Market cap (USDbn) 18.373m avg daily turnover (USDm) 31.67Shares outstanding (m) 10,234Major shareholder City of Taipei, Taiwan (13.1%)

Financial summary (TWD)Year to 31 Dec 15E 16E 17ETotal operating income (m) 121,915 132,193 140,245Pre-provision operating profit(m) 64,395 71,485 75,900Net profit (m) 55,065 61,022 64,671Core EPS (fully-diluted) 5.297 5.872 6.219EPS change (%) (10.0) 10.9 5.9Daiwa vs Cons. EPS (%) (0.9) 6.9 12.4PER (x) 10.6 9.6 9.0Dividend yield (%) 4.2 4.7 5.0DPS 2.4 2.6 2.8PBR (x) 1.3 1.2 1.1ROE (%) 12.7 13.3 12.9




16 April 2015

- 33 -

Growth outlook Fubon FHC: EPS and ROE

Fubon FHC’s ROAE reached 16% for 2014, which is a record high. This was partially due to a surge in trading and other income, which was up 51.5% YoY for 2014. For 2015, we believe headline earnings are likely to come in lower than those for 2014, given that trading and other income is unlikely to be maintained at such a high level. Fortunately, core income (net-interest income plus net-service fees) is still likely to be on a growth trajectory, and we expect it to post another year of double-digit growth of 11.1% YoY for 2015 (19.9% YoY in 2014).

Source: Company, Daiwa forecasts

Note: 2014 numbers include the one-off gain of NTD1.8bn

Valuation Fubon FHC: 12-month rolling PBR

The stock is trading at a 12-month rolling PBR of 1.4x, higher than its past-10-year average of 1.2x. We initiate coverage on Fubon FHC with an Outperform (2) rating and an SOTP-based 12-month target price of TWD62.40, implying a 2015E target PBR of 1.4x. A high recurrent yield, large unrealised investment gains and strong capital position make the stock a good alpha pick for investors, in our view. We believe these solid fundamentals offer good valuation support to the stock.


Earnings revisions Fubon FHC: Bloomberg-consensus EPS forecasts

The Bloomberg consensus forecasts rose steadily over 2013-14. Our earnings forecasts are 1% lower than consensus for 2015, but 7% higher for 2016. We expect an improvement in Fubon Life’s product mix and higher earnings contribution (vs. 2014) from Fubon Bank (China) to be the key earnings drivers for Fubon FHC in 2016.

Source: Bloomberg, Daiwa forecasts


Growth outlook

Valuation

Earnings revisions

0

2

4

6

8

10

12

14

16

18

0

1

2

3

4

5

6

7

2008 2009 2010 2011 2012 2013 2014 2015E 2016E


(TWD) (%)

0.70.80.91.01.11.21.31.41.51.61.7

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

3.5

4.0

4.5

5.0

5.5

Sep-

13

Oct

-13

Nov

-13

Dec

-13

Jan-

14

Feb-

14

Mar

-14

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr-1

5

2015E EPS 2016E EPS

(TWD)

BuyOutperform (initiation)

HoldUnderperformSell

1

2

3

4

5


16 April 2015

- 34 -

Key assumptions


Change (YoY %)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017EFYP growth (%) – Life Insurance 50.8 (28.2) 12.1 (14.8) (10.3) (15.0) 10.0 10.0

Value of New Business (NTD bn) – Life Insurance

24.8 28.0 31.7 31.8 32.4 33.1 33.7 34.4

Embedded Value (NTD bn) – Life Insurance

155.5 176.0 217.8 295.7 304.6 319.8 335.8 352.6

Recurrent Yield, pre-hedge (%) – Life Insurance

3.5 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 1.3Loan Growth (%) – Bank 3.1 11.3 7.7 7.4 18.3 4.5 5.0 6.0Tier-1 BIS (%) – Bank 9.2 9.3 9.9 10.4 10.4 10.5 10.6 10.6

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest income 53,232 61,000 65,891 73,264 89,242 93,885 100,109 107,668Net fees & commission (744) (5,811) (6,875) (4,481) (6,770) (2,265) (1,817) (1,437)Trading and other income 18,000 25,962 28,696 45,152 68,425 59,465 59,892 61,113Net insurance income (6,980) (4,473) (11,599) (22,115) (26,661) (29,171) (25,990) (27,098)Total operating income 63,508 76,678 76,114 91,821 124,236 121,915 132,193 140,245Personnel expenses (20,584) (21,639) (22,670) (24,020) (26,434) (37,389) (39,186) (41,109)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)Pre-provision operating profit 24,246 36,712 32,985 48,282 74,937 64,395 71,485 75,900Total provision (1,099) (902) 512 (4,083) (2,989) (3,987) (4,236) (4,537)Operating profit after prov. 23,147 35,809 33,497 44,199 71,949 60,407 67,249 71,363Non-operating income 0 0 0 0 0 0 0 0Profit before tax 23,147 35,809 33,497 44,199 71,949 60,407 67,249 71,363Tax (2,428) (5,122) (4,348) (5,735) (11,466) (5,343) (6,227) (6,692)Min. int./pref. div./other items 0 0 0 0 0 0 0 0Net profit 20,719 30,687 29,149 38,464 60,483 55,065 61,022 64,671Adjusted net profit 20,719 30,687 29,149 38,464 60,483 55,065 61,022 64,671EPS (TWD) 2.330 3.390 3.070 3.310 5.887 5.297 5.872 6.219EPS (adjusted) (TWD) 2.330 3.390 3.070 3.310 5.887 5.297 5.872 6.219EPS (adjusted fully-diluted) (TWD) 2.330 3.390 3.070 3.310 5.887 5.297 5.872 6.219DPS (TWD) 1.000 1.000 1.000 1.500 2.050 2.384 2.642 2.799

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest income 17.1 14.6 8.0 11.2 21.8 5.2 6.6 7.6Non-interest income (42.0) 52.6 (34.8) 81.5 88.6 (19.9) 14.5 1.5Total operating income 0.5 20.7 (0.7) 20.6 35.3 (1.9) 8.4 6.1Total expenses 12.3 1.8 7.9 1.0 13.2 16.7 5.5 6.0Pre-provision operating profit (14.1) 51.4 (10.2) 46.4 55.2 (14.1) 11.0 6.2Total provisions (81.7) (17.9) n.a. n.a. (26.8) 33.4 6.2 7.1Operating profit after provisions 4.1 54.7 (6.5) 31.9 62.8 (16.0) 11.3 6.1Profit before tax 4.1 54.7 (6.5) 31.9 62.8 (16.0) 11.3 6.1Net profit (adjusted) 4.8 48.1 (5.0) 32.0 57.2 (9.0) 10.8 6.0EPS (adjusted, FD) (5.7) 45.5 (9.4) 7.8 77.9 (10.0) 10.9 5.9Gross loans 1.6 10.6 6.1 10.1 18.2 16.2 6.6 (4.5)Deposits 2.7 (0.1) 7.0 8.3 20.1 19.4 5.0 (8.4)Total assets 12.8 4.9 13.3 12.0 18.3 12.5 7.4 3.2Total liabilities 13.5 4.9 12.1 12.0 18.0 12.9 7.6 2.5Shareholders' equity 4.3 7.5 31.1 11.5 19.4 10.2 4.8 12.5Avg interest-earning assets 19.5 (4.1) (8.5) 5.1 12.5 28.3 20.5 3.3Avg risk-weighted assets 4.9 10.0 8.5 12.5 23.2 18.3 10.0 10.0

Financial summary


16 April 2015

- 35 -


Key ratios (%)


Company profile

Fubon Financial Holding (Fubon) is one of the largest financial holding companies in Taiwan. Its major subsidiaries include abank, 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

As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ECash & equivalent 268,447 297,263 244,372 298,729 335,037 355,516 366,593 378,284Investment securities 888,103 968,478 1,528,881 1,725,183 1,994,815 2,051,761 2,234,057 2,424,568Net loans and advances 1,047,250 1,158,340 1,229,034 1,352,884 1,599,199 1,857,566 1,980,502 1,891,295Fixed assets 27,211 32,517 33,821 34,452 43,580 34,653 37,400 40,394Goodwill 13,824 13,805 13,462 13,455 30,997 18,142 17,841 17,549Other assets 1,207,941 1,152,459 1,056,296 1,172,270 1,434,732 1,800,482 1,934,381 2,031,442Total assets 3,452,775 3,622,863 4,105,866 4,596,972 5,438,361 6,118,120 6,570,774 6,783,532Customers deposits 1,299,524 1,298,149 1,388,901 1,504,453 1,807,116 2,158,421 2,266,885 2,076,941Borrowing 147,395 136,662 137,961 184,815 321,663 286,973 310,576 350,542Debentures 97,107 102,576 106,287 118,728 151,842 152,190 140,409 114,929Other liabilities 1,686,476 1,851,794 2,166,287 2,447,077 2,741,592 3,070,898 3,381,607 3,710,917Total liabilities 3,230,502 3,389,180 3,799,437 4,255,072 5,022,214 5,668,481 6,099,477 6,253,329Share capital 85,584 90,137 95,269 102,336 102,336 102,336 102,336 102,336Reserves & others 131,806 143,545 211,160 239,342 305,707 347,302 368,961 427,867Shareholders' equity 217,390 233,683 306,429 341,678 408,043 449,638 471,297 530,203Minority interests 4,884 0 0 222 8,104 0 0 0Total equity & liabilities 3,452,775 3,622,863 4,105,866 4,596,972 5,438,361 6,118,120 6,570,774 6,783,532Avg interest-earning assets 2,009,527 1,927,933 1,764,350 1,854,215 2,086,707 2,677,805 3,227,843 3,333,287Avg risk-weighted assets 810,201 891,201 967,282 1,087,767 1,340,222 1,586,007 1,744,607 1,919,068BVPS (TWD) 25.401 25.925 32.165 33.388 39.873 43.937 46.054 51.810

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ELoan/deposit 73.9 80.5 82.3 81.6 81.2 81.6 82.8 84.4Tier-1 CAR 9.2 9.3 9.9 10.4 10.4 10.5 10.6 10.6Total CAR 13.0 13.5 13.9 13.5 13.1 13.3 13.4 13.4NPLs/gross loans 0.3 0.3 0.1 0.1 0.2 0.2 0.3 0.3Total loan-loss prov./NPLs 260.5 388.4 778.5 1,076.3 937.0 762.1 640.0 694.3ROAA 0.6 0.9 0.8 0.9 1.2 1.0 1.0 1.0ROAE 9.5 13.5 10.8 11.9 16.0 12.7 13.3 12.9Net-interest margin 2.6 3.2 3.7 4.0 4.3 3.5 3.1 3.2Gross yield 3.1 3.8 4.5 4.7 5.6 4.4 4.0 4.2Cost of funds 0.6 0.8 0.9 0.9 1.3 1.2 1.3 1.5Net-interest spread 2.5 3.0 3.6 3.9 4.2 3.2 2.7 2.7Total cost/total income 61.8 52.1 56.7 47.4 39.7 47.2 45.9 45.9Effective tax 10.5 14.3 13.0 13.0 15.9 8.8 9.3 9.4Dividend-payout 42.9 29.5 32.6 45.3 34.8 45.0 45.0 45.0



16 April 2015

- 36 -

A good alpha pick

High recurrent yield, large unrealised investment gains and a strong capital position make the stock a good alpha pick for investors

Investment summary: initiating with an Outperform (2) rating

We initiate coverage of Fubon FHC with an Outperform (2) rating and SOTP-derived 12-month target price of TWD62.40. Fubon FHC is the second-largest financial-holding company in Taiwan, with total assets of TWD5,438bn for 2014. Its primary subsidiaries include Fubon Life and Taipei Fubon Bank (TFB), which contributed 58.4% and 31%, respectively, to its 2014 net income. Fubon FHC: net income of primary subsidiaries


Fubon FHC’s 2014 ROAE reached 16%, a record high. This was partially due to a surge in trading and other income, which was up 51.5% YoY for 2014. But this could merely be temporary. We believe the fixed income and equity-markets rally could be a one-off and should not be taken for granted. As such, we expect Fubon FHC’s earnings to come in lower for 2015 vs. 2014 (10% decline in 2015E EPS vs. the 2014 number) as trading income is likely to fall from its peak in 2014. However, we believe core income (net-interest income plus net-service fees) is still likely to be on a growth trajectory, and forecast another year of double-digit growth of 11.1% YoY for 2015 (19.9% YoY for 2014).

Fubon Life: grasps the present

Unlike Cathay Life, which has taken an aggressive approach to the likely policy-rate hikes (in terms of shortening its asset duration to prepare for the hikes), Fubon Life has been more conservative. Its investment strategy is to ensure a higher recurrent yield for now, without placing too much attention on upcoming rate hikes. Maintaining a high recurrent yield Fubon Life has been reducing its cash and domestic fixed-income positions, and increasing its overseas fixed-income positions in order to chase a higher yield since 2013. It maintained an asset duration of 12 years (8 years for Cathay Life) as at the end of 2014, reflecting its view that the low-interest-rate environment will continue. Only about 13% of its assets are exposed to interest-rate risks (vs. 24-26% for Cathay). This investment strategy of having a longer asset duration helped Fubon Life earn a higher recurrent yield in 2014, at 3.84% vs. Cathay Life’s 3.2% for the same year (pre-hedged numbers, ie, returns before deducting FX hedging costs). The investment yield for its total portfolio reached 4.74% for 2014. In an analyst meeting held on 31 March, management said it expects limited change to its strategy, which is to chase the highest recurrent yield. Fubon Life: investment portfolio (pre-hedged)

% of total Investment yield

2013 2014 2013 2014

Deposit & cash equivalent 5.7 3.4 0.8 0.7Fixed income: domestic 28.4 23.3 2.3 2.6Fixed income: overseas 41.9 45.5 5.9 6.2Equity: domestic 10.6 10.4 6.1 7.7Equity: overseas 3.5 6.9 5.6 8.1Mortgage loans 2.4 2.7 2.3 2.3Policy loans 2.2 2.0 5.2 5.1Real estate 5.3 5.9 11.0 4.8Total portfolio 100 100 4.4 4.7


Given Fubon Life’s decision to maintain its current investment strategy, we believe its recurrent yield is likely to remain high for 2015-16. We even expect a modest pick-up in its recurrent-yield rate, as Fubon Life engages more in the Formosa bond market. The Financial Supervisory Commission’s (FSC) decision to relax the regulations governing Formosa bonds/international bonds issued in Taiwan in 2H14, allowing them to be excluded from the life insurers’ 45% overseas-investment cap, has granted insurers room to chase higher yields. This regulatory easing is especially important for Fubon Life, as it already holds an overseas-investment share close to the regulatory cap.

25.0

12.2

3.2 1.4

35.4

18.2

2.8 1.4

0

5

10

15

20

25

30

35

40

Fubon Life Taipei Fubon Bank Fubon P&C Fubon Securities

2013 2014

(TWDbn)


16 April 2015

- 37 -

Fubon Life had invested USD3bn, or 3.8% of its total investment assets, in Formosa bonds as at the end of 2014, and it expects to invest a further USD3bn by the end of 2015. We would consider Formosa bonds as a good replacement for domestic bonds/government bonds. Insurers are able to earn a yield of 4-5% on Formosa bonds, while that for domestic bonds/government bonds is usually low, at around 1.5-3%. As Fubon Life is likely to invest in more Formosa bonds over 2015-16 than previously, we forecast its pre-hedged recurrent yield to reach 4% for 2015 and 4.1% for 2016, up from 3.84% for 2014. Improving product mix First-year premiums (FYP) for 2014 declined by 10.3% YoY, while first-year premium equivalents (FYPE) rose by 7.5% YoY. We attribute this fall in the FYP to a decline in sales of interest-crediting annuity products (-85% YoY for Fubon Life) due to tighter FSC regulations. Fortunately, as Fubon Life has filled the shortfall with an increase in traditional life-product sales, especially regular-paid policies (up 45% YoY for 2014), Fubon FHC was able to maintain the growth trend for FYPE. (Note: FYPE is a measure used to compare Taiwan life-insurance revenue. FYPE = FYP * a coefficient, where the coefficient respectively is equal to 10%, 20%, 30%, 40%, 50% and 100% for 1, 2, 3, 4, 5 and 6+ year paid products.) Fubon Life: FYP breakdown


Note: Totals may not add up due to rounding

Fubon Life: FYPE breakdown


Note: Totals may not add up due to rounding

Fubon Life has been putting in a lot of effort to improve its product mixed by selling more regular-paid premium traditional life products rather than single-premium ones, as regular-premium products ensure a more stable capital inflow and have a higher VNB margin. Fubon Life aims to add around 3,000 tied agents in 2015 in order to achieve this goal. Fubon Life had 16,681 tied agents as at the end of 2014, versus 25,000 tied agents for Cathay Life. Given Fubon Life’s commitment to adding agents, we expect its product mix to continue to improve in 2015-16. However, it might take some time for Fubon Life to see any positive results from its move to sell more regular-premium products from single premiums. The most direct impact will be higher employee benefits and training costs as Fubon Life adds more agents. Putting more focus on regular-premium traditional life products will mean that the pace of decline for its liability costs will slow as it is receiving payments over a more spread-out period (single-premium policies accounted for 59% of its FYP for 2014). This means the cost of funds is not diluted as much as it was previously. Thus, shifting from single-premium traditional products to regular-premium ones will therefore imply that Fubon Life’s liability costs will start to decline at a slower pace than previously. We expect liability costs to decrease by 4bps YoY for 2015 and 3bps for 2016, versus a 10bps decrease for 2014.

51.1% 58.7%

16.3%26.3%

4.1%7.8%

2.4%2.8%26.1% 4.3%

2013 2014Traditional life – single paid Traditional life – regular paid Investment-linkedInterest crediting annuity Health, accident and others

TWD212.9bnTWD191.0bn

-10.3%

20.1% 19.3%

58.3%67.1%

1.8% 2.7%10.3%

1.4% 9.5% 9.5%

2013 2014Traditional life: Single-paid Traditional life: Regular-paid Investment-linked

Interest-sensitive annuity Health, accidents and others

7.5%

TWD54.2bnTWD58.2bn


16 April 2015

- 38 -

Fubon Life: liability costs


Although we expect higher employee-benefit expenses and a smaller decrease in liability costs over 2015-16, we still believe Fubon Life is moving in the right direction in its bid to improve its product mix. This should result in stronger fundamentals, which will likely add long-term value to the company. Large unrealised investment gains should offer a buffer against earnings drag The rush sale effect that we saw in response to the FSC’s regulation changes in 3Q14 (see pages 7-8 of our sector report for details) is likely to drag down the sector’s FYP collected in 2015 by 15-25% on average. For Fubon Life, we forecast a decline in the FYP of 15% for 2015, at the low end of the sector range, given that the increase in business from the greater number of new tied agents should buffer the decline. Also, a continued improvement in the product mix should help the FYPE maintain its growth trend for 2015. We forecast FYPE growth of 5% YoY for 2015 (7.5% YoY for 2014) for Fubon Life. Although the potential decline in the FYP for 2015 is likely to be due to the base effect, resulting from regulatory changes rather than a deterioration in the company’s fundamentals, the impact of this decline could still be drag on earnings for the year, especially on a YoY basis. Fortunately, as Fubon Life has unrealised investment gains of TWD57.7bn as at the end 2014, which is significant compared to its peer Cathay Life (TWD22.1bn), we believe this is sufficient to absorb the drag on the P&L as a result of likely declining FYP in 2015. Steady hedging performance Fubon Life has a good record of managing its FX risk. It uses currency swaps and cross-currency swaps to hedge its FX positions, which usually have lower costs than non-deliverable forward (NDF) contracts.

Fubon Life fully hedged 76% of its FX position in 2014, and a held a 7.9% USD cash position for the same period. Only 15.8% of its positions were unhedged. We believe Fubon’s hedging strategy is unlikely to change much in the near term. Fubon Life: FX positions (as at the end-2014)


Fubon Life’s FX hedging cost was 58bps for 2014 vs. 68bps for 2013. Given that we expect the differential between the US and Taiwan bond yields to widen as the Fed’s tapering continues, the costs of its currency-swap and cross-currency swap deals should rise accordingly. Thus, we forecast Fubon Life’s hedging costs to rise to 70bps for 2015 and 90bps for 2016. Strong capital position Fubon Life has maintained a strong capital position over the past few years. Fubon Life’s risk-based capital (RBC) has been maintained at a high level of 250-300% (regulatory level: 200%). Given the regulatory changes for the RBC calculation, Fubon Life’s RBC reached 290% as at the end of 2014. Given this strong capital position, and the regulatory easing on overseas investments, we believe Fubon Life is in a good position to expand overseas, either organically or inorganically, when opportunities arise.

Banking: taking off in China

Fubon FHC has been expanding aggressively into Mainland China. In January 2014, Fubon FHC acquired an 80% stake in First Sino Bank (29% held directly by Fubon FHC, and 51% by subsidiary Taipei Fubon Bank [TFB]), which was soon renamed Fubon Bank (China). This acquisition gives Fubon FHC extended access to the China market, as it has become the Taiwan FHC with the most extensive China branch network.

4.56

4.16

4.16

4.07 4.06 4.04 4.01 3.98 3.95 3.933.89 3.88

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

(%)

Fully hedged76.3%

USD7.9%

Othercurrencies

2.0%

Equitiesmutual funds

13.8%


16 April 2015

- 39 -

Although its operating expenses are likely to surge during the first few years following the acquisition (management expect 40% YoY growth in operating expenses for 2015), we see Fubon Bank (China) as an important earnings contributor for TFB going forward. Fubon Bank (China) is aggressively expanding its business, and targets to open 6 new branches (in cities such as Beijing, Nanjing, Chengdu and the free trade zones) in 2015. Its asset quality also improved, with its NPL ratio falling from 1.48% for 2Q14, to 0.89% for 4Q14, vs. the average NPL ratio for China’s commercial banks rising from 1.08% to 1.25% over the same period, and we believe this trend will continue. This was mainly done through tighter lending standards. Fubon Bank’s (China) outstanding loans grew by only 0.4% YoY for 2014 (vs. 7.7% for 2013), reflecting the focus on improving the asset quality. We expect Fubon Bank (China) to achieve net income growth of 10% YoY for 2015E, before reaching 18% YoY for 2016E and 25% for 2017E, as the increase in operating expenses should have started to decline by then. TFB: revenue composition


For TFB as a whole, we summarise our view as follows: NIM: we forecast a 5bp improvement in the NIM for 2015 and 6bps for 2016, driven by the 2 rate hikes that we expect the CBC to implement in 2H15, and a prospective decline in excess liquidity in the system as more overseas investment channels are made available by the FSC. Also, as it plans to restructure its loan book by lending less to the government (which usually comes with a lower lending rate), this should help to enhance the NIM.

TFB: interest spread and NIM


We forecast its fee income growth to slow from 30% YoY for 2014 to 3% for 2015. We see a lack of growth drivers for its credit card business in the near term (driven by our assumption of slower GDP growth for 2015). Fee income for its TMU business is likely to decline on stricter FSC scrutiny and diminishing expectations of a CNY:USD rally (see page 12 of our sector report for details). Meanwhile, the outlook for the bancassurance business looks clouded for 2015, as we expect the FYP decline by 15% for Fubon Life (similar to the deal between Cathay FHC and Cathay Life, Fubon Life pays fees to TFB to sell its insurance products). TFB: fee income breakdown


55% 50% 47% 46%

32% 28% 25%24%13%

22%28%

31%

12%

2011 2012 2013 2014Net inerest income Net fee income Treasury & others Fubon Bank (China)

1.31.34 1.33 1.33

1.27

0.940.99 1.01

1.051.10

0.8

0.9

1.0

1.1

1.2

1.3

1.4

2010 2011 2012 2013 2014

Interest spread NIM

(%)

0

2

4

6

8

10

12

Total fee income Wealth management Credit card Sydication loan2013 2014

(TWDbn)

24.0% YoY

31.5% YoY

7.2% YoY30.4% YoY


16 April 2015

- 40 -

TFB: wealth-management-product fee breakdown


Loan growth: TFB’s loan-to-deposit ratio (LDR) for its foreign currency loans was low, at 63.6% as of the end of 2014, implying that there is still ample room for its foreign currency loans to grow further. We forecast these loans to expand by 15% YoY for 2015 (versus 19.5% YoY for 2014). However, TWD loan growth is looking sluggish given the cooling property market – 33% of TFB’s current loan book is made up of mortgages. Any slowdown in TWD loan growth would offset some of the gains that we expect for its FX loans. We forecast TWD loan growth to slow from 6.8% YoY for 2014 to 2% for 2015, dragging down total loan growth from 9.2% to 4.5% (excluding government loan) for the same period respectively. NPLs: Sporadic bad debts could occur given China’s slowing economy (Daiwa’s economics team forecasts China’s GDP growth to slow from 7.4% YoY for 2014 to 6.9% YoY for 2015, and 6.5% YoY for 2016). Given TFB’s high exposure to China, we expect its NPLs to rise from 0.17% for 2014, to 0.23% for 2015E and 0.3% for 2016E. TFB: asset quality


Note: Loans to Taiwan Polysilicon Corp (TPC) worth NTD1.1bn have been classified as NPLs,and were recognised in 3Q14.

Valuation

We initiate coverage of Fubon FHC with an Outperform (2) rating and SOTP-derived 12-month target price of TWD62.40, implying a target 2015E PBR of 1.4x and a 11.2% upside to our target price from current share price levels. Fubon FHC: SOTP valuation

Implied 2015E PBR Total Value Value/share % of totalEntity/Item Methodology (x) (TWDm) (TWD) (%)Taipei Fubon Bank 1.0 x Book 1.0 175,829 17.2 28%Fubon Life Adj. 2015E EV 1.1 255,840 25.0 40%

Liability MTM 157,899 15.4 25%Fubon Insurance 0.9x Book 0.8 23,352 2.3 4%Fubon Securities 0.8x Book 0.8 25,441 2.5 4%Fubon FHC Target Price 1.4 638,361 62.40 100%Implied Upside 11.2%Price as of 15 April 56.1


The stock is trading at a 12-month rolling PBR of 1.4x, higher than its past-10-year average of 1.2x. We expect the company’s solid core earnings growth to lift its book value steadily over our forecast period, allowing the share price to rise while maintaining the PBR at the current level of 1.4x. Fubon FHC: 12-month rolling PBR


Fubon FHC: PBR premium/discount to sector PBR


806 831514 616 797 807 875 714

708 663774

9841007 986

1290

762

197 204 423228

268 393

373

320

87 80 7985

90 71

65

92

0

300

600

900

1,200

1,500

1,800

2,100

2,400

2,700

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

Mutual funds Insurance commission Structured products Custodian and trust

(TWDm)

0

200

400

600

800

1,000

1,200

1,400

0.05

0.10

0.15

0.20

0.25

0.30

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

NPL ratio (LHS) Coverage ratio (RHS)

(%) (%)

0.70.80.91.01.11.21.31.41.51.61.7

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

(40)

(30)

(20)

(10)

0

10

20

30

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(%)

Ave: -5.6%


16 April 2015

- 41 -

The following table shows the key assumptions in our earnings model for Fubon FHC for the 2015-16 period. Our target price is based on a 4.4% investment yield and 3.8% liability cost for 2015. Key assumptions for Fubon Life

2014 2015E 2016EFYP growth (%) -10.3 -15 10Hedging cost (bps) 58 70 90After hedged investment yield (%) 4.74 4.35 4.52Pre hedging recurrent yield (%) 3.84 4.02 4.10Cost of liability (%) 3.88 3.84 3.81


Key assumptions for Taipei Fubon Bank

2014 2015E 2016E

NIM expansion (bps) 5 5 6Loan growth (%) 18.3 4.5 5.0Fee income growth (%) 29.9 3.0 10.0NPL ratio (%) 0.17 0.23 0.30


We look for Fubon Life’s FYP to drop by 15% for 2015, due mainly to the high base effect as a result of FSC regulatory changes. Also, Fubon Life’s decision to focus more on selling regular-premium traditional life-insurance products rather than on single-premium products should also cause a decline in FYP. Meanwhile, Fubon Life’s FX hedging cost could pick up later in 2015E to 70bps, from 58bps for 2014, given that we expect the differential between the US and Taiwan bond yields to get wider, as both the Fed’s tapering and the rate-hike cycle get closer. The FSC’s deregulatory measures on overseas investment are likely to push up Fubon Life’s pre-hedging recurrent yield to reach 4.02% and 4.1% for 2015E and 2016E, respectively. Its liability cost should continue to decline, but the change in product mix could lead to the pace of decline falling over 2015-16. We forecast its liability cost to fall by 4bps for 2015 and 3bps or 2016. We look for TFB’s NIM to expand by 5bps for 2015 and 6bps for 2016, bolstered by the CBC’s likely policy rate hikes in 2H15 and as a result of TFB reducing its government loans. We forecast TFB’s loan growth to slow from 18.3% YoY for 2014, to 4.5% YoY for 2015 and 5% YoY for 2016, dragged down by sluggish mortgage loans. Likely declines in its bancassurance and TMU businesses’ income could drag down TFB’s fee income growth – we see its fee income growth slowing from 29.9% YoY for 2014, to 3% YoY for 2015. TFB’s NPL ratio is likely to rise to 0.23% for 2015 and 0.3% for 2016, on the back of sporadic bad debts appearing driven by China’s economic slowdown.

We also stress that these assumptions are made based on our 2015 GDP forecasts of 3.2% YoY for Taiwan and 5.9% YoY for Asia-ex Japan. We also factor in 2 CBC rate hikes of 12.5bps each in 2H15. We also assume a risk-free rate of 3% and an 8% equity risk premium. Given the beta value of 1.15x for the stock, we calculate a cost of equity of 12.2%. Daiwa’s GDP and CPI forecasts

2014 2015E 2016E

(% YoY) GDP CPI GDP CPI GDP CPI

Taiwan 3.3 1.2 3.2 0.8 3.0 1.1Asia-ex JP 6.0 3.0 5.9 2.4 5.6 1.9

Source: CEIC, Daiwa forecasts


Relative to the other Taiwan FHCs, Fubon has wider coverage or exposure to the Mainland market, especially after the group acquired First Sino Bank in 2014. As such, the impact of a disorderly slowdown in China’s economy would hit Fubon harder than the other FHCs. While Daiwa’s economics team expects an orderly slowdown in China’s economy (GDP growth slowed from 7.4% YoY for 2014 to 6.9% YoY for 2015E and 6.5% YoY for 2016E), which we see as manageable for Fubon, a slowdown in growth could be sharper than we expect it to be, especially as the Fed’s tightening in 2H15 is likely to add intense pressure on capital outflows from the country. Meanwhile, a secondary risk to our positive call would be a poorer-than-expected investment performance for 2015-16.

Company profile

Fubon FHC owns a strong financial-services platform, including Taipei Fubon Bank, Fubon Bank (China), Fubon Bank (Hong Kong), Fubon Life, Fubon Insurance and Fubon Securities. Fubon FHC is the second-largest listed financial-holding company in Taiwan, with total assets of TWD5,438bn as at the end of 2014. It has also been the most profitable financial-holding company in the country for the past 6 years, setting record highs for both its net income and EPS in 2014. Overseas expansion: China focus Fubon FHC has been expanding aggressively into Mainland China. It was the first FHC in Taiwan to buy a 20% stake in a China bank, Xiamen City Bank,


16 April 2015

- 42 -

through its Hong Kong subsidiary in 2008. In January 2014, Fubon FHC acquired an 80% stake in First Sino Bank, which was soon renamed into Fubon Bank (China). Fubon Bank (China) now has 4 branches and 10 sub-branches in China, which are mostly located in Shanghai. For 2015, Fubon Bank (China) aims to open 5-7 new branches across the country. Fubon Bank (China): key statistics (CNYm) 2013 2014Loans 31,031 31,163Deposits 44,070 42,063NIM 2.31% 1.85%LDR 71.07% 70.13%NPL ratio 0.86% 0.89%Cost-income ratio -28.99% -35.08%Net income 277 422ROAE 9.39% 11.09%ROAA 0.59% 0.76%


Fubon FHC currently has less coverage in the ASEAN market than it does in China. Fubon Life and Fubon P&C each have a subsidiary in Vietnam – Fubon Life (Vietnam) and Fubon P&C (Vietnam). Taipei Fubon Bank’s Singapore branch has been granted to open by the SFC and should open in 2015. But beyond these, Fubon has no exposure to other ASEAN countries. Main subsidiaries Fubon Life Insurance was founded in 1993, and it consolidated ING Life into its operations in 2009. Fubon Life has become the second leading company in the sector (in terms of total premium revenue).

Taipei Fubon Bank: On 1 January 2005, Taipei Bank and Fubon Bank were officially merged into Taipei Fubon Bank, the first merger between a government-owned and private bank in Taiwan. Taipei Fubon Bank offers an extensive product line covering corporate and consumer banking, wealth management, credit cards, financing, trust, and public treasury, enabling it to offer a one-stop shop for financial services. Fubon Bank (Hong Kong): The acquisition by Fubon FHC of International Bank of Asia occurred in 2004, and the bank was renamed Fubon Bank (Hong Kong) in 2005. At the end of 2008, Fubon Bank (Hong Kong) acquired a 19.99% stake in Xiamen City Commercial Bank (since named Xiamen Bank). Fubon Bank (China) was First Sino Bank before the acquisition in 2014. Founded in 1997, First Sino Bank was one of the first Sino-foreign joint venture commercial banks approved by the China government. In January 2014, Fubon FHC and Taipei Fubon Bank acquired a controlling 80% stake in the bank, and changed its name to Fubon Bank (China) in April 2014. Fubon Insurance: Established in 1961, Fubon Insurance was Taiwan's first private property insurer, and the first member of the Fubon Group. The company has led the sector (in terms of insurance policy sold) since 1982, and currently has a more than 20% share of the sold-insurance-policy market. Fubon Securities: Founded in 1988, Fubon Securities holds the third-largest share of the spot brokerage market and leads the market for investment-banking business.


16 April 2015

- 43 -

Fubon FHC: parent/subsidiary structure


Fubon Bank (Hong Kong)

Fubon Direct Marketing Consulting

Fubon Life Insurance (Vietnam)

Fubon Property & Casualty Insurance

(Co.,Ltd.)

Fubon Insurance (Vietnam Co.,Ltd.)

Taipei Fubon Bank

Fubon Life Insurance Fubon Insurance

Fubon Bank (China) Co.,Ltd.

Taipei Fubon Bank Life Insurance Agency

Co.,Ltd.

Taiwan Sport Lottery Corp.

Fubon AMC

Fubon Credit (Hong Kong) Limited

FB securities (Hong Kong) Limited

Fubon Insurance Brokers Limited

FB Investment Management Limited

Fubon Nominees (Hong Kong) Limited

Fubon Financial Holding Venture Capital

Corp.

Fu-Sheng Life Insurance Agency

Fu-Sheng General Insurance Agency

Fubon Securities

Fubon Insurance Broker (Philippines)

Corp.

Fubon Financial (2881 TW)

Fubon Asset Management

Fubon Investment Service

Fubon Futures

Fubon Securities (BVI) Ltd.

Fubon Securities (Hong Kong) Limited


■ Investment case We initiate coverage of Mega Financial Holdings (Mega FHC) with a Hold (3) rating and 12-month SOTP-based target price of TWD26.90. Mega FHC is a defensive pick amid the sector-wide risks of declines both in mortgage lending and bancassurance income. The overseas earnings contribution for subsidiary Mega Bank was high at 64% for 2014 (vs. below 40% for most banks), making the bank a natural hedge against domestic uncertainties. Mega Bank’s exposure to mortgages was low at 17% for 2014, vs. its peers at 25-35%. Additionally, fee income only accounted for 17% of its earnings in 2014, also lower than peers’ at 20-25%. Tighter global USD liquidity due to the Fed’s tightening expected in 3Q15 would likely boost global USD demand. Since the USD supply in Taiwan is likely to remain ample, as

the current account surplus continues to grow, domestic USD funding costs will likely be kept low. Given its leading position in the FX exchange market in Taiwan, Mega Bank would benefit from this trend, as tighter global USD liquidity would bolster its loan growth and offer a better lending spread. As such, we forecast its net interest income to grow by a decent 7.3% YoY for 2015 and 7.8% YoY for 2016. However, lower fee income from FX settlements could be a drag on Mega Bank’s earnings. Falling oil prices since 4Q14 have hit Taiwan’s trade value of crude oil and petroleum-related products hard (down 16% YoY for 4Q14), lowered the value of FX settlements, and reduced the fee income collected by banks. The drag on Mega Bank would be 2.3% of 2015E pre-provision operating profit (PPOP), on our estimates. ■ Catalysts We believe Mega FHC’s ability to benefit from tighter USD liquidity globally and its high dividend yield (5.4% for 2015E) are good reasons to hold the stock. ■ Valuation Mega FHC is trading at a 1.2x 12-month rolling PBR, in line with its past 10-year average. We believe it is fairly valued at this stage.

■ Risks A delay in the Fed’s tightening schedule is the key risk to our forecasts. In addition, if oil prices fail to stabilise, fee income from FX settlements could see a further decline.


16 April 2015

Mega Financial

Initiation: a defensive name

• A beneficiary of tighter global USD liquidity, largely immune to the risk of falling mortgage lending and bancassurance income

• Lower fee income from FX settlement could be a drag, however • Initiating with a Hold (3) rating and 12-month target price of

TWD26.90


Financials / Taiwan

Mega Financial2886 TT


BuyOutperformHold (initiation)

UnderperformSell

1

2

3

4

5

94

98

102

106

110

23.0

24.0

25.0

26.0

27.0



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

(TWD) (%)

12-month range 23.10-26.80Market cap (USDbn) 10.363m avg daily turnover (USDm) 13.56Shares outstanding (m) 12,450Major shareholder Ministry of Finance (9.2%)

Financial summary (TWD)Year to 31 Dec 15E 16E 17ETotal operating income (m) 62,923 66,863 71,736Pre-provision operating profit(m) 39,094 42,243 46,294Net profit (m) 30,981 33,151 36,327Core EPS (fully-diluted) 2.488 2.663 2.918EPS change (%) 2.4 7.0 9.6Daiwa vs Cons. EPS (%) 2.1 3.9 2.6PER (x) 10.4 9.8 8.9Dividend yield (%) 5.4 6.1 6.7DPS 1.4 1.6 1.8PBR (x) 1.2 1.1 1.1ROE (%) 11.5 11.6 12.3




16 April 2015

- 45 -

Growth outlook Mega FHC: EPS and after tax ROE

We believe tighter global USD liquidity due to the expected Fed tightening will be the driver for Mega Bank’s USD lending activities and bolster its interest income. Although lower fee income from FX settlements and recognising the losses from Taiwan High Speed Rail Corp (THSRC) (in which Mega FHC owns TWD4bn worth of preferred stock) could be a drag on earnings, we still look for core earnings (net interest income plus net fee income) to grow by a decent 4.6% YoY for 2015 and 6.9% YoY 2016 albeit down from 14.8% YoY growth for 2014). Source: TEJ, Daiwa forecasts

Valuation Mega FHC: 12-month rolling PBR

Mega FHC is trading currently at a 1.2x 12-month rolling PBR, in line with its past-10-year average. We initiate coverage on the stock with a Hold (3) rating and 12-month target price of TWD26.90 based on a SOTP valuation, implying a target PBR of 1.2x on our 2015E BVPS. Our target price takes into account 2 possible 12.5bp rate hikes from the CBC in 3Q15, while expecting the Fed’s fund rate to reach 0.625% by end-2015 and 1.875% by end-2016. The stock looks fairly valued at this stage, in our view.


Earnings revisions Mega FHC: Bloomberg-consensus EPS forecasts

The Bloomberg consensus 2015-16 EPS forecasts have been rising since mid-2014. Our adjusted EPS forecasts are slightly higher than the consensus forecasts for 2015-16, by 2.1% for 2015 and 3.9% for 2016. If we factor in the potential losses from THSRC’s preferred share investment, our EPS forecast for 2015 would then be 4.4% lower than the Bloomberg consensus.



Growth outlook

Valuation

Earnings revisions

0

2

4

6

8

10

12

14

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2007

2008

2009

2010

2011

2012

2013

2014

2015

E

2016

E

2017

E


(TWD) (%)

0.40.50.60.70.80.91.01.11.21.31.41.51.6

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

2.1

2.2

2.3

2.4

2.5

2.6

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr-1

5

FY15 EPS forecast FY16 EPS forecast

(TWD)

BuyOutperformHold (initiation)

UnderperformSell

1

2

3

4

5


16 April 2015

- 46 -

Key assumptions


Change (YoY %)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest margin (%) - bank 1.1 1.2 1.2 1.2 1.3 1.3 1.4 1.4Loan growth (%) - bank 4.3 9.4 4.1 10.1 4.8 4.5 4.5 5.0Loan to deposit ratio (%) - bank 85.3 91.5 87.4 85.4 85.1 85.9 86.8 87.6Provision coverage (%) 310.1 462.0 700.2 772.9 802.7 661.3 552.1 508.3Fee to income ratio (%) 22.8 20.1 17.7 18.8 18.3 16.4 16.1 15.6Expense to income ratio (%) 50.1 45.8 42.8 41.5 39.2 37.9 36.8 35.5Tier-1 CAR (%) 9.5 9.3 9.6 9.4 9.8 9.8 9.9 9.9

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest income 25,064 28,279 29,572 31,276 36,674 39,692 42,744 46,568Net fees & commission 9,544 9,204 9,147 10,367 11,121 10,312 10,733 11,173Trading and other income 6,232 6,941 11,831 11,885 11,180 10,499 10,798 11,228Net insurance income 1,027 1,380 1,216 1,664 1,737 2,421 2,588 2,767Total operating income 41,867 45,803 51,766 55,192 60,712 62,923 66,863 71,736Personnel expenses (14,468) (13,899) (15,179) (15,689) (15,751) (16,315) (16,857) (17,419)Other expenses (6,525) (7,075) (6,971) (7,226) (8,044) (7,515) (7,764) (8,023)Total expenses (20,993) (20,973) (22,150) (22,916) (23,795) (23,830) (24,621) (25,442)Pre-provision operating profit 20,873 24,830 29,616 32,277 36,917 39,094 42,243 46,294Total provision (2,234) (3,714) (4,342) (5,276) (1,588) (2,811) (3,092) (3,433)Operating profit after prov. 18,640 21,116 25,274 27,000 35,329 36,282 39,150 42,861Non-operating income 0 0 0 0 0 (2,000) 0 0Profit before tax 18,640 21,116 25,274 27,000 35,329 34,282 39,150 42,861Tax (3,490) (3,430) (4,479) (4,506) (5,089) (5,301) (5,999) (6,534)Min. int./pref. div./other items 0 0 0 0 0 0 0 0Net profit 15,150 17,686 20,795 22,495 30,240 28,981 33,151 36,327Adjusted net profit 15,150 17,686 20,795 22,495 30,240 30,981 33,151 36,327EPS (TWD) 1.340 1.540 1.820 1.960 2.430 2.328 2.663 2.918EPS (adjusted) (TWD) 1.340 1.540 1.820 1.960 2.430 2.488 2.663 2.918EPS (adjusted fully-diluted) (TWD) 1.340 1.540 1.820 1.960 2.430 2.488 2.663 2.918DPS (TWD) 0.900 0.850 1.100 1.110 1.458 1.397 1.598 1.751

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest income (5.3) 12.8 4.6 5.8 17.3 8.2 7.7 8.9Non-interest income (15.7) 4.3 26.6 7.8 0.5 (3.4) 3.8 4.3Total operating income (9.8) 9.4 13.0 6.6 10.0 3.6 6.3 7.3Total expenses 4.7 (0.1) 5.6 3.5 3.8 0.1 3.3 3.3Pre-provision operating profit (20.8) 19.0 19.3 9.0 14.4 5.9 8.1 9.6Total provisions (69.4) 66.3 16.9 21.5 (69.9) 77.0 10.0 11.0Operating profit after provisions (2.2) 13.3 19.7 6.8 30.8 2.7 7.9 9.5Profit before tax (2.2) 13.3 19.7 6.8 30.8 (3.0) 14.2 9.5Net profit (adjusted) 5.6 16.7 17.6 8.2 34.4 2.5 7.0 9.6EPS (adjusted, FD) 3.1 14.9 18.2 7.7 24.0 2.4 7.0 9.6Gross loans 4.3 9.4 2.8 10.1 4.8 4.5 4.5 5.0Deposits 5.0 1.9 8.1 12.6 5.3 3.6 3.5 4.0Total assets 0.5 4.3 4.1 14.2 5.0 4.6 4.2 4.5Total liabilities 0.3 4.6 4.2 14.1 4.8 4.4 4.2 4.6Shareholders' equity 2.7 1.0 3.6 14.8 8.1 7.0 4.2 3.3Avg interest-earning assets 1.7 3.0 4.8 8.3 8.8 2.6 2.4 4.7Avg risk-weighted assets 3.2 6.6 7.6 11.3 9.5 4.7 4.5 4.8

Financial summary


16 April 2015

- 47 -


Key ratios (%)


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).

As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ECash & equivalent 398,186 503,392 458,490 551,247 634,546 741,899 792,151 845,857Investment securities 566,058 481,593 569,241 653,156 625,778 593,142 598,728 604,444Net loans and advances 1,336,835 1,462,054 1,502,701 1,654,577 1,733,994 1,812,533 1,894,097 1,988,801Fixed assets 21,139 21,417 22,331 22,150 22,126 19,426 19,870 20,328Goodwill 237 297 304 318 308 66 67 68Other assets 187,393 149,649 173,902 232,177 253,825 253,255 259,277 265,485Total assets 2,509,848 2,618,402 2,726,969 3,113,626 3,270,577 3,420,321 3,564,190 3,724,984Customers deposits 1,558,573 1,588,561 1,717,989 1,933,723 2,036,404 2,109,216 2,183,038 2,270,360Borrowing 584,277 665,745 622,337 763,283 785,849 853,608 910,546 972,477Debentures 61,912 63,150 64,330 60,292 71,563 72,733 72,733 73,260Other liabilities 103,844 97,766 111,832 114,738 115,581 105,244 106,566 108,109Total liabilities 2,308,607 2,415,223 2,516,489 2,872,036 3,009,397 3,140,801 3,272,883 3,424,206Share capital 110,594 112,806 114,498 124,498 124,498 124,498 124,498 124,498Reserves & others 90,277 90,075 95,701 116,907 136,523 154,821 166,609 176,080Shareholders' equity 200,871 202,881 210,200 241,406 261,021 279,320 291,107 300,578Minority interests 370 297 281 187 162 200 200 200Total equity & liabilities 2,509,848 2,618,402 2,726,969 3,113,628 3,270,580 3,420,321 3,564,190 3,724,984Avg interest-earning assets 2,307,034 2,375,681 2,490,607 2,697,140 2,933,879 3,009,031 3,080,669 3,226,632Avg risk-weighted assets 1,488,189 1,585,718 1,707,021 1,900,590 2,081,052 2,178,044 2,276,056 2,384,294BVPS (TWD) 18.163 17.985 18.358 19.390 20.966 22.436 23.382 24.143

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ELoan/deposit 85.3 91.5 87.4 85.4 85.1 85.9 86.8 87.6Tier-1 CAR 9.5 9.3 9.6 9.4 9.8 9.8 9.9 9.9Total CAR 11.5 11.7 12.0 11.3 11.8 11.9 12.0 12.0NPLs/gross loans 0.4 0.3 0.2 0.2 0.2 0.2 0.3 0.3Total loan-loss prov./NPLs 310.1 462.0 700.2 772.9 802.7 661.3 552.1 508.3ROAA 0.6 0.7 0.8 0.8 1.0 0.9 0.9 1.0ROAE 7.6 8.7 10.1 10.0 12.5 11.5 11.6 12.3Net-interest margin 1.1 1.2 1.2 1.2 1.3 1.3 1.4 1.4Gross yield 1.6 1.7 1.7 1.7 1.9 1.9 2.0 2.2Cost of funds 0.5 0.6 0.6 0.6 0.7 0.6 0.7 0.7Net-interest spread 1.1 1.2 1.2 1.1 1.2 1.3 1.4 1.4Total cost/total income 50.1 45.8 42.8 41.5 39.2 37.9 36.8 35.5Effective tax 18.7 16.2 17.7 16.7 14.4 15.5 15.3 15.2Dividend-payout 67.2 55.2 60.4 56.6 60.0 60.0 60.0 60.0



16 April 2015

- 48 -

A defensive name

High overseas earnings contributions make the stock a natural hedge for uncertainties arising domestically. Mega Bank also should benefit from tighter global USD liquidity, although lower fee income from FX settlements could be a drag

Initiating with a Hold rating

We initiate coverage of Mega FHC with a Hold (3) rating and 12-month SOTP-based target price of TWD26.90. Mega FHC is a government-affiliated FHC with total assets of TWD3,275bn as at end-2014. Its primary subsidiaries include Mega International Commercial Bank (Mega Bank) and Mega Bills Finance, which contributed 86.4% and 7.1% of net income for 9M14, respectively. Mega FHC: net income of primary subsidiaries


A defensive pick

In the sector part of this report (see pages 11-13 of our sector report), we highlight some earnings downsides for bank-centric FHCs, including sluggish TWD loan growth, a slowdown in fee income growth, and regulatory hurdles such as a lower maximum interest rate for revolving balances of cash/credit cards.

Banking subsidiary Mega Bank, which accounts for around 85% of Mega FHC’s earnings, is relatively isolated from these risks, in our view. The fact that Mega Bank has a high overseas earnings contribution (64% for 2014, versus below 40% for most other banks) makes it a natural hedge for any uncertainties that may arise domestically. Its loan book structure and low contribution of fee income to its P&L also look favourable to us, as detailed below. Sector-wide TWD loan growth could be sluggish for 2015-16 as we see a risk of mortgage lending encountering a double-digit decline amid a cooling property market. Fortunately, Mega Bank’s exposure to mortgages is relatively small, at 17% for 2014 versus peers’ average of 25-35%. As such, we see Mega Bank’s TWD loan growth slowing at a relatively modest pace, from 3.7% YoY for 2014 to 2.5% YoY for 2015. Mega Bank: loan breakdown (as of December 2014)


Mega Bank’s asset quality remained benign in 2014, with its NPL ratio coming in low at 0.18% for 2014 (down from 0.43% for 2013). For 2015-16, we expect Mega Bank’s asset quality to remain strong. However, we look for its NPL ratio to rise from 0.18% for 2014 to 0.23% for 2015 and 0.29% for 2016 given a potential decline in bad debt recovery.

Mega Bank: asset quality


18.8

2.60.5 0.6

25.9

3.00.8 0.5

0

5

10

15

20

25

30

Mega Bank Mega Bill Mega Securities Mega AssetManagement

2013 2014

(NTDbn)

Large corp.41.0%

SME32.0%

Other corp.2.0%

Gov-linked2.0%

Mortage17.0%

Other consumer6.0%

0.0

0.1

0.2

0.3

0.4

0.5

100

600

1,100

1,600

2,100

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14


(%) (%)


16 April 2015

- 49 -

Mega Bank is also more immune to the risk of a sector-wide slowdown in bancassurance fee income, as we see it. Fee income from bancassurance was just TWD732m for 2014, or just 2.3% of Mega Bank’s 2014 PPOP (versus 33.9% for Cathay Bank (CTBC FHC; 2891 TT, TWD22.05, Underperform [4]). This implies that the impact of a potential decline in bancassurance income (due to lower premium growth and a shift of sales channel from bancassurance to tied agents (see page 11 of our sector report for more details) should have a limited impact on Mega Bank compared with other banks. Regulatory hurdles like the lowering of the maximum interest rate for revolving balances of cash/credit cards will likely have a limited impact on Mega Bank. It is the smallest credit card issuer among the banks we cover, with a cash/credit card revolving loan balance of just TWD1.3bn as of November 2014, versus TWD15.3bn for CTBC Bank and TWD15bn for Cathay United Bank (Cathay FHC; 2882 TT, TWD50.40, Buy [1]). Taiwan: impact of decline in cash/credit card revolving interest rate (TWD m) CTBC CUB TFB Mega First Cash/credit card revolving loan balance as of Jan 2015 15,298 14,674 6,918 1,314 1,309Impact on interest income for 1pp revolving loan rate decline 153.0 146.7 69.2 13.1 13.1% of 2015E PPOP for the FHC 0.5 0.3 0.1 0.0 0.1


Note: TFB= Taipei Fubon Ban; CUB= Cathay United Bank’ PPOP= Pre-provision operating profit

Benefits from tight USD liquidity

We believe Mega Bank stock will prove defensive against the Fed’s policy normalisation trend expected to start in 3Q15. As more US Dollars flow back to the Fed, global liquidity, especially in Asia, is likely to become tighter. This will likely be the case despite monetary easing from the ECB and the BOJ. Asia remains a Dollar-centric world and a large portion of Asian banks’ leverage is conducted through USD, if not in the currency of each country. One example is the wide use of USD in trade finance. According to the Bank for International Settlements (BIS), around 80% of letters of credit (LC) are denominated in USD in Asia. This is a status the EUR and JPY cannot compete with. Tighter USD liquidity boosts the demand for USD loans and allows LIBOR to rise, implying a better USD lending rate for the banks. USD funding costs for Taiwan banks are also likely to rise in tandem, but the increase in funding costs would likely be capped. Taiwan runs a large current account surplus every year,

at around 10% of its GDP, which is mostly earned in USD terms. The USD rally and TWD depreciation trend, in addition to weaker CNY expectation, have prevented these fresh USD liquidities from being exchanged into other currencies. This has brought large inflows of USD deposits back to Taiwan and driven up banks’ reserves of USD, which should translate into stable USD funding costs for the next 1-2 years for Taiwanese banks (see pages 8-9 of our sector report for more details). As the leader in USD lending activities and the sole USD clearing bank in Taiwan (which allows Mega’s USD funding cost to be 10-20bps lower than peers), Mega Bank will benefit from this tight global USD liquidity trend. Mega Bank’s average USD assets (including cash, loans and inter-banking items) rose strongly by 14.7% YoY for 2014, while its USD liability (including deposit and inter-banking items) kept up the pace, recording a 18.9% YoY gain. We believe Mega Bank will benefit from this balance sheet expansion going forward. Mega Bank: USD assets


However, NIMs could be under pressure despite the widening USD lending spread. Mega Bank’s foreign currency (FC) NIM fell from 1.41% for 3Q14 to 1.22% for 4Q14 despite an improvement in its FC loan yield from 2.21% to 2.23% over the same period. This is because a large portion of the balance sheet expansion for USD items is involved in inter-banking activities, which recorded more than 130% YoY growth for 3Q14 (versus 7% YoY for USD loan growth). Mega Bank’s lending spread earned from USD inter-banking activities averaged 0.3% for 4Q14 versus 1.6% from USD loans, dragging down the headline NIM from 1.27% for 3Q14 to 1.18% for 4Q14.

600

700

800

900

1,000

1,100

1,200

1,300

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

(TWD b)


16 April 2015

- 50 -

Mega Bank: loan spread and NIM (total)


We are not too concerned about this NIM contraction, however, as it was due to Mega Bank’s additional involvement in inter-banking activities rather than margin erosion of its core lending spread. Since operating costs for inter-banking activities are low, and given that the USD deposits from banks have been able to match the growth rate of USD lending to banks (see below graph), becoming more involved in inter-banking activities will not cause much of a cost burden to Mega Bank, in our view. We think its total interest income will still increase despite the NIM contraction. We forecast Mega Bank’s net interest income (NII) to maintain a growth rate of 7.3% YoY for 2015 and 7.8% YoY for 2016, after surging by 16.8% YoY for 2014. Mega Bank: USD inter-banking activities


Lower fee income from FX settlement

With Mega Bank being the leading bank in Taiwan for FX settlements, we see lower fee income for 2015-16 as a key downside for the bank. Mega Bank’s fee income fell by 28% YoY for 4Q14 (-7.2% YoY for 2014), largely due to lower FX settlements as a result of lower oil prices. The Brent crude oil price plunged by 42% in 4Q14, a 30% YoY drop on average. This hit Taiwan’s

trade value of crude oil and petroleum-related products (down by 16% YoY in total for 4Q14), lowered the value of FX settlements, and hit the fee income collected. The fee income collected from FX settlements accounted for 18% of Mega Bank’s total fee income in 2014, making it an important part of its fee income. Brent crude oil price


Mega Bank: fee income breakdown (for 2014)


The US Energy Information Administration (EIA) expects the Brent crude oil price to average USD59/barrel in 2015, 40% lower than the level seen in 2014, which would make it tough for Mega Bank’s fee income to rebound. We see Mega Bank’s total fee income dropping further by 10% YoY for 2015 before recording a 5% YoY gain in 2016. Fortunately, since fee income contributes less to Mega Bank’s net income (17% for 2014 versus 20-25% for most banks), we estimate the drag will have no more than a 2.3% 2015 PPOP impact.

Potential bankruptcy of THSRC

Taiwan High Speed Rail Corp (THSRC) could end up in bankruptcy in 1H15 as the reform proposal from the Ministry of Transportation and Commutation was rejected by the Legislative Yuan in January 2015.

1.431.46

1.421.46

1.44

1.391.42

1.441.41

1.221.20 1.19

1.251.27 1.28

1.32

1.27

1.181.10

1.15

1.20

1.25

1.30

1.35

1.40

1.45

1.50

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

Interest rate spread NIM

(%)

0

100

200

300

400

500

600

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

USD loan to banks USD deposit from banks

(TWDbn)

40

50

60

70

80

90

100

110

120

Jun-

14

Jun-

14

Jun-

14

Jul-1

4

Jul-1

4

Aug-

14

Aug-

14

Sep-

14

Sep-

14

Oct

-14

Oct

-14

Nov

-14

Nov

-14

Nov

-14

Dec

-14

Dec

-14

Jan-

15

Jan-

15

Feb-

15

Feb-

15

Mar

-15

(USD/Barrel)

-42% QoQ for 4Q14

Wealth Management

22%

FX18%

Corp. loan31%

Custodian3%

Credit Card3%

Securities15%

Bills8%


16 April 2015

- 51 -

Although the loan to THSRC is likely to be fully guaranteed by the government, Mega FHC will suffer losses from its preferred stock investment. Mega currently owns TWD4bn worth of THSRC’s preferred stocks, or 10.2% of its 2015E PPOP, which is the largest amount among the banks we cover. Although the government and THSRC shareholders could compromise eventually and come up with a deal to prevent the bankruptcy, the risk of Mega FHC having to bear all the losses remains. How much of the loss Mega FHC will eventually have to bear will also depend on the court’s decision. We expect Mega FHC to take the initiative to recognise 50% of the loss in 2015.

Valuation

We initiate coverage of Mega FHC with a Hold (3) rating and 12-month SOTP-based target price of TWD26.90, implying a target PBR of 1.2x based on our 2015 BVPS forecast (1.2x past 10-year average) and offering 3.5% upside from the current share price of TWD26.00. Mega FHC: SOTP valuation

Implied 15E P/B Total Value Value/share % of totalEntity/Item (x) (TWD mn) (TWD) (%)Mega Bank 1.2 281,910 22.6 84%Mega Bills 1.0 36,166 2.9 11%Chung Kuo Insurance 0.9 4,942 0.4 1%Mega Securities 0.8 12,251 1.0 4% Mega FHC SOTP valuation 1.2 335,269 26.9 100%Implied Upside 3.5%Price as of 15 April 26.0


Mega FHC is now trading at a 1.2x 2015E PBR, which we see as a fair valuation. We believe Mega FHC’s ability to benefit from tighter global USD liquidity and the high dividend yield (5.4% for 2015E) will provide valuation support for the stock. Over the past 10 years, the stock’s average 12-month rolling PBR has been 1.2x. The shares are trading at a discount of 0.3% to the sector’s PBR level (10-year average: -10.4%).

Mega FHC: 12-month rolling PBR


Mega FHC: PBR premium/discount to sector PBR


Following are the key assumptions for our earnings forecasts for Mega FHC for 2015-16. We also assume that 50% of the loss from the THSRC preferred share investment will be recognised in 2015. Key assumptions for Mega Bank

2014 2015E 2016ENIM expansion (bps) 3.0 2.0 4.0Loan growth (%) 4.8 4.5 4.5Fee income growth -7.2 -10.0 5.0NPL ratio (%) 0.18 0.23 0.29

Source: Company, Daiwa estimates

We forecast modest NIM expansion of 2bps for 2015. The policy rate hikes from the CBC expected in 3Q15 and the rise of LIBOR would help banking subsidiary Mega Bank’s NIM to improve. However, higher engagement in USD inter-banking activities would be a drag on headline NIM. For 2016, we look for its NIM to expand by 4bps, as LIBOR rises further along with a higher Fed fund rate (the Fed’s median forecast for the its fund rate is 0.625% for end-2015 and 1.875% for end-2016). We forecast Mega Bank’s loan growth to remain at 4.5% YoY for both 2015 and 2016, just slightly lower than 4.8% YoY for 2014, supported by USD loans. Lower fee income from FX settlements due to low oil

0.40.50.60.70.80.91.01.11.21.31.41.51.6

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

(40)

(30)

(20)

(10)

0

10

20

30Ap

r-05

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(%)

Ave: -10.4%


16 April 2015

- 52 -

prices could lead to a further decline of 10% YoY in fee income for 2015. Asset quality should remain benign, despite a moderate pick-up in 2015-16 due to lower bad debt recovery given that the absolute NPL is already at a low level. We also stress that these assumptions are based on our 2015 GDP forecasts of 3.2% YoY for Taiwan and 5.9% YoY for Asia-ex Japan. Two 12.5bps rate hikes from the CBC in 2H15 are factored in. We also assume a 3% risk free rate and an 8% equity risk premium . Given the historically average beta value of 0.84 for the stock, we calculated the cost of equity to be 9.7%. Forecasts for GDP and CPI (% YoY) 2014 2015E 2016E

GDP CPI GDP CPI GDP CPITaiwan 3.3 1.2 3.2 0.8 3.0 1.1Asia-ex JP 6.0 3.0 5.9 2.4 5.6 1.9

Source: CEIC, Daiwa


A delay in the Fed’s tightening schedule is the key risk to our forecasts. Fee income from FX settlements could see a further decline if oil prices fail to stabilise. Since we assume 50% of the loss from the THSRC preferred share investment will materialise and be recognised in 2015, any changes on this front could also alter our forecasts.

Company profile

Mega FHC (formerly known as CTB Financial Holdings) was listed on the Taiwan Stock Exchange in 2002. It has a total of 8 subsidiaries covering banking, securities, property and casualty insurance, bill financing, securities investment trusts, asset management and venture capital. The company’s market capitalisation ranked 4th among the domestic listed financial holding companies as of 31 December 2014.

Major subsidiaries Mega International Commercial Bank (Mega Bank) was the result of a merger between International Commercial Bank of China and Chiao Tung Bank in 2006. Mega Bank is the sole domestic USD settlement bank in Taiwan. It was also chosen to be the settlement bank for the EUR in October 2014, whose activities are due to commence in mid-2015. It dominates around 15% of the FX market in Taiwan. Mega Bills Finance, formerly called ChungHsing Bills Finance, was found in 1976. It became part of Mega FHC in 2002. Mega Bills now holds the largest market share in Taiwan for bill financing. Mega Securities was founded in 2003 through an integration of Chung Hsing Bills Finance Corporation, Barits Securities, and Chung Hsing Securities. Mega Securities has 46 branches and about a 3% market share in Taiwan. Chung Kuo Insurance was established in 1931. In 2002, the company joined Mega FHC as a wholly owned subsidiary. Today, Chung Kuo Insurance operates a network of 26 outlets, 10 branch offices and 16 corresponding offices in Taiwan. Overseas expansion Mega Bank currently has 37 overseas franchises in 19 different countries. Such diversity of allocation has helped it sustain its leadership in foreign currency lending and corporate loans. Besides the China and ASEAN markets, which are the markets on which most Taiwanese banks focus, Mega Bank has also extended its footprint to the Middle East. It currently has representative offices in Abu Dhabi and Bahrain. Mega Bank plans to upgrade its representative office in Abu Dhabi to a branch in 2015. For the US market, Mega currently has 4 branches located in New York, Chicago, Los Angeles and Silicon Valley. It also has 4 branches in Canada and 2 in Central America.


16 April 2015

- 53 -

Mega FHC: parent/subsidiary structure


Ramlett Finance Holdings Inc.

Win Card Co., Ltd.

Yung-Shing Industries Co.ICBC Assets Management &

Consulting Co., Ltd.

China Products Trading Co.

Mega International Commercial Bank (Canada)

Mega Futures Co., Ltd.

Cathay Investment & Development Corp.

Mega International Investment Services Co., Ltd.

Mega Management & Consulting Corporation

Mega Securities Holdings Co., Ltd.

Mega I Venture Capital Co., Ltd.

Mega Capital (Asia) Co., Ltd.

Cathay Investment & Warehousing Co, S.A

Mega Securities (Hong Kong) Co., Ltd.

Mega International Commercial Bank Public Co.,

Mega International Commercial Bank

Chung Kuo Insurance Co., Ltd.

Mega Securities Co., Ltd.Mega Life Insurance Agency

Co., Ltd.

Mega Financial (2886 TW)

Mega International Investment Trust Co., Ltd.

Mega Asset Management Co., Ltd.

Mega Bills Finance Co., Ltd.Mega Venture Capital Co.,

Ltd.


■ Investment case We initiate coverage of First Financial Holdings (First FHC) with an Underperform (4) rating and 12-month target price of TWD16.70. With TWD loans accounting for 78% of its loan book for 2014 (peers’ average: 60-70%), First Bank should be a big beneficiary of the domestic rate-hike theme. It also has a high proportion of demand deposits (64% of its total deposits). As the cost of funding for demand deposits is the lowest of all deposits, with a noticeable time lag to increase if there is a rate-hike cycle, we expect 2 policy rate hikes of 12.5bp each in 3Q15 to drive up First Bank’s NIM by 5bps for 2015E and 7bps for 2016E. However, we see sluggish TWD loan growth for 2015, as a result of falling mortgage lending and lacklustre SME loan growth, dragging down total loan growth, from 4.6% YoY for 2014 to 3.5% YoY for 2015. We also forecast fee-income growth to slow

from 16.7% YoY for 2014 to 5% YoY for 2015, as its bancassurance income and TMU business could lose growth momentum on the back of a sector-wide decline in FYP, ongoing CNY weakness and stricter FSC scrutiny on structured products. The strong growth of trading and other income achieved in 2014 (54% YoY) might not be sustainable in 2015, as it would depend largely on macro and market conditions. We expect this income to fall back to the average level seen in 2011-13, translating into a 33% YoY decline for 2015 (8.1% of 2015E PPOP). Finally, we expect First FHC to recognise 50% of the loss it has made on its Taiwan High Speed Railway Corp (THSRC) preferred stock investment, which is equivalent to 5% of its 2015E PPOP. ■ Catalysts Likely disappointing earnings could push down the share price, in our view. Accordingly, our adjusted 2015-16 core EPS forecasts are 9.3% and 8.1% lower than the Bloomberg consensus, respectively. ■ Valuation The stock is trading at a 12-month rolling PBR of 1.1x, in line with its past-10-year average. We initiate with an SOTP-derived 12-month

target price of TWD16.70, implying a 2015E target PBR of 1.0x. ■ Risks to our investment case A faster-than-expected increase in the policy rate would be the main upside risk to our call. A secondary risk to our call would be higher-than-expected TWD loan growth.


16 April 2015

First Financial

Initiation: earnings likely to disappoint

• Any gains from NIM enhancement in 2015 could be offset by sluggish TWD loan and fee-income growth

• With earnings likely to disappoint going forward, the stock may not be able to sustain a PBR multiple of 1.1x

• Initiating coverage with an Underperform (4) rating and 12-month target price of TWD16.70


Financials / Taiwan

First Financial2892 TT

Target (TWD): 16.70Downside: 10.9%15 Apr price (TWD): 18.75

BuyOutperformHoldUnderperform (initiation)

Sell

1

2

3

4

5

98

102

107

111

115

16.5

17.3

18.0

18.8

19.5



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

(TWD) (%)

12-month range 16.54-19.43Market cap (USDbn) 5.563m avg daily turnover (USDm) 5.82Shares outstanding (m) 9,259Major shareholder Ministry of Finance (13.4%)

Financial summary (TWD)Year to 31 Dec 15E 16E 17ETotal operating income (m) 40,678 43,126 45,594Pre-provision operating profit(m) 20,360 21,847 23,304Net profit (m) 13,570 14,676 15,660Core EPS (fully-diluted) 1.466 1.585 1.691EPS change (%) (3.7) 8.2 6.7Daiwa vs Cons. EPS (%) (9.3) (8.1) (6.0)PER (x) 12.8 11.8 11.1Dividend yield (%) 2.5 3.0 3.2DPS 0.5 0.6 0.6PBR (x) 1.1 1.1 1.0ROE (%) 8.7 9.1 9.4




16 April 2015

- 55 -

Growth outlook First FHC: adjusted EPS and after-tax ROE

We see a lack of earnings-growth drivers for 2015-16 even though we expect First Bank’s NIM to rise by 5bps for 2015E and 7bps for 2016E, amid the upcoming rate-hike cycle. The outlooks for its credit volume, fee income and earnings from CNY-denominated activities look lacklustre to us. We forecast First FHC’s core earnings (net interest income plus net service fee income) to be flat for 2015 and 6.5% YoY growth for 2016, and for the ROE to fall from 10% for 2014 to 8.7% for 2015 (7.9% for 2013). If we assume that First FHC will recognise 50% of the loss it made on its Taiwan High Speed Railway Corp preferred stock investment in 2003, then the ROE should fall to 8.1% for 2015E, on our estimates.

Source: TEF, Daiwa forecasts

Valuation First FHC: 12-month rolling PBR

The stock is trading currently at 2015E PBR of 1.1x in line with its past-10-year trading average. The stock is trading at a discount of 8.2% to the sector PBR (10-year average: -17.5% on the Bloomberg consensus forecasts). We initiate coverage of First FHC with an Underperform (4) rating and SOTP-derived 12-month target price of TWD16.70, implying a 2015E target PBR of 1.0x. We have factored into our target price 2 possible rate hikes of 12.5bp each by the CBC in 2015, and for the Fed’s fund rate to reach 0.625% at the end of 2015.


Earnings revisions First FHC: Bloomberg-consensus EPS forecasts

The Bloomberg consensus has continued to raise its 2015-16 EPS forecasts since September 2014. However, we believe the consensus has yet to factor in the risk of First FHC facing slower domestic credit volume and fee income growth. Our adjusted core 2015-16 EPS forecasts are 9.3% and 8.1% lower than consensus, respectively. If we are correct in assuming that First FHC will recognise 50% of the loss it has made on its THSRC preferred stock investment (TWD1bn, or 5% of 2015E PPOP) in 2015, its reported core EPS for 2015E would be NTD1.35, which is 7.4% lower than our adjusted core EPS forecast. Source: Bloomberg, Daiwa


Growth outlook

Valuation

Earnings revisions

0

2

4

6

8

10

12

14

0.0

0.5

1.0

1.5

2.0

2.5

2007

2008

2009

2010

2011

2012

2013

2014

2015

E

2016

E

2017

E


(TWD) (%)

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

1.2

1.3

1.4

1.5

1.6

1.7

1.8

Nov

-13

Dec

-13

Jan-

14

Feb-

14

Mar

-14

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr-1

5

2015 EPS forecast 2016 EPS forecast

(TWD)


Sell

1

2

3

4

5


16 April 2015

- 56 -

Key assumptions


Change (YoY %)

Source: FactSet, Daiwa forecasts Note: Non-interest income includes fee income, trading income, FX gain/loss and other operating income.

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest margin (%) - bank 1.0 1.1 1.3 1.3 1.3 1.3 1.4 1.4Loan growth (%) - bank 13.9 7.9 6.7 (0.4) 4.6 3.5 3.2 3.5Loan to deposit ratio (%) - bank 78.9 84.0 88.5 82.5 82.0 82.2 82.9 83.6Provision coverage (%) 130.4 232.6 263.3 268.3 685.8 505.9 462.4 451.2Fee to income ratio (%) 20.4 18.9 17.7 18.4 18.0 18.5 18.3 18.1Expense to income ratio (%) 53.4 55.3 54.7 52.6 50.4 49.9 49.3 48.9Tier-1 CAR (%) - bank 7.1 8.3 8.5 8.4 9.1 9.0 9.2 9.3

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest income 19,530 22,083 25,067 25,932 28,278 29,181 31,224 33,248Net fees & commission 6,328 6,151 6,135 6,632 7,428 7,539 7,886 8,250Trading and other income 5,204 4,324 3,352 3,214 5,014 3,358 3,416 3,496Net insurance income 4 (35) 67 291 568 600 600 600Total operating income 31,066 32,523 34,621 36,069 41,287 40,678 43,126 45,594Personnel expenses (10,921) (11,835) (13,000) (12,870) (13,776) (13,782) (14,434) (15,120)Other expenses (5,667) (6,135) (5,923) (6,103) (7,013) (6,536) (6,845) (7,170)Total expenses (16,588) (17,971) (18,922) (18,973) (20,789) (20,318) (21,279) (22,290)Pre-provision operating profit 14,479 14,553 15,699 17,096 20,498 20,360 21,847 23,304Total provision (5,491) (5,347) (3,551) (4,047) (4,015) (4,051) (4,295) (4,595)Operating profit after prov. 8,987 9,206 12,147 13,049 16,483 16,309 17,553 18,709Non-operating income 0 0 0 0 0 (1,000) 0 0Profit before tax 8,987 9,206 12,147 13,049 16,483 15,309 17,553 18,709Tax (2,025) (1,735) (1,978) (2,172) (2,405) (2,749) (2,886) (3,060)Min. int./pref. div./other items 70 131 57 12 7 10 10 10Net profit 7,032 7,602 10,226 10,889 14,085 12,570 14,676 15,660Adjusted net profit 7,032 7,602 10,226 10,889 14,085 13,570 14,676 15,660EPS (TWD) 1.090 1.010 1.180 1.260 1.521 1.358 1.585 1.691EPS (adjusted) (TWD) 1.090 1.010 1.180 1.260 1.521 1.466 1.585 1.691EPS (adjusted fully-diluted) (TWD) 1.090 1.010 1.180 1.260 1.521 1.466 1.585 1.691DPS (TWD) 0.300 0.400 0.450 0.500 0.532 0.475 0.555 0.592

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest income 15.3 13.1 13.5 3.5 9.0 3.2 7.0 6.5Non-interest income (8.9) (9.5) (8.5) 6.1 28.3 (11.6) 3.5 3.7Total operating income 4.9 4.7 6.5 4.2 14.5 (1.5) 6.0 5.7Total expenses 3.8 8.3 5.3 0.3 9.6 (2.3) 4.7 4.8Pre-provision operating profit 6.3 0.5 7.9 8.9 19.9 (0.7) 7.3 6.7Total provisions (48.3) (2.6) (33.6) 13.9 (0.8) 0.9 6.0 7.0Operating profit after provisions 199.1 2.4 32.0 7.4 26.3 (1.1) 7.6 6.6Profit before tax 199.1 2.4 32.0 7.4 26.3 (7.1) 14.7 6.6Net profit (adjusted) 153.0 8.1 34.5 6.5 29.4 (3.7) 8.2 6.7EPS (adjusted, FD) 153.5 (7.3) 16.8 6.8 20.7 (3.7) 8.2 6.7Gross loans 14.8 7.9 5.8 (0.4) 4.6 3.5 3.2 3.5Deposits 4.5 1.7 0.7 6.8 5.3 3.4 2.3 2.7Total assets 4.5 1.6 2.1 6.5 4.1 2.5 2.9 3.0Total liabilities 4.5 0.6 1.9 6.6 3.7 2.5 2.7 3.1Shareholders' equity 4.9 19.5 4.3 6.5 9.4 2.2 5.0 1.0Avg interest-earning assets 6.3 2.8 1.9 3.5 4.7 3.2 2.5 3.0Avg risk-weighted assets 3.8 5.9 9.3 7.6 6.2 5.1 5.0 5.0

Financial summary


16 April 2015

- 57 -


Key ratios (%)


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.

As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ECash & equivalent 142,273 176,557 175,309 219,270 243,459 241,849 243,063 244,301Investment securities 519,887 424,710 381,820 447,937 448,406 447,338 461,842 473,537Net loans and advances 1,258,404 1,357,363 1,436,469 1,431,075 1,497,261 1,549,402 1,598,983 1,654,947Fixed assets 23,694 26,370 28,299 28,465 28,299 27,822 28,100 28,381Goodwill 255 166 304 346 430 402 422 443Other assets 104,356 95,803 102,078 136,293 137,854 147,109 150,773 155,183Total assets 2,048,868 2,080,970 2,124,279 2,263,385 2,355,709 2,413,922 2,483,184 2,556,792Customers deposits 1,584,636 1,611,407 1,621,999 1,731,890 1,823,298 1,884,843 1,928,194 1,980,256Borrowing 201,460 193,139 183,759 173,400 165,816 158,545 164,944 171,699Debentures 36,944 37,029 53,503 55,492 52,593 35,947 37,025 38,506Other liabilities 119,078 112,034 132,295 161,398 159,625 176,841 187,378 198,971Total liabilities 1,942,119 1,953,609 1,991,555 2,122,179 2,201,332 2,256,176 2,317,542 2,389,432Share capital 64,768 76,654 81,254 86,535 92,593 92,593 92,593 92,593Reserves & others 41,229 50,063 50,890 54,194 61,352 64,677 72,572 74,290Shareholders' equity 105,997 126,717 132,143 140,729 153,945 157,269 165,165 166,883Minority interests 752 644 581 477 432 477 477 477Total equity & liabilities 2,048,868 2,080,970 2,124,279 2,263,385 2,355,709 2,413,922 2,483,184 2,556,792Avg interest-earning assets 1,890,826 1,943,972 1,980,391 2,049,568 2,146,380 2,214,799 2,271,239 2,338,337Avg risk-weighted assets 1,087,328 1,152,012 1,259,457 1,355,358 1,439,018 1,512,240 1,587,852 1,667,245BVPS (TWD) 16.366 16.531 16.263 16.263 16.626 16.985 17.838 18.023




16 April 2015

- 58 -

Initiation: earnings likely to disappoint

The 2015-16 growth outlook for First FHC’s TWD credit volume and fee income look lacklustre to us.

Investment summary: initiating with an Underperform (4) call

We initiate coverage of First FHC with an Underperform (4) rating and 12-month target price of TWD16.70. The stock is currently trading at a 1.1x 12-month rolling PBR, which may not be sustainable as we see a lack of earnings-growth drivers over 2015-16. First FHC is a government-affiliated FHC, with the government holding a 28.5% stake (including direct and indirect holdings). Its primary subsidiary is First Bank, which accounted for 95.1% of its total net income for 2014. First FHC: net income of its primary subsidiaries


Note: First-Aviva life insurance business made a net loss of TWD24m for2013 and TWD15m for 2014, which are not included in the graph

NIM to improve…

First Bank’s TWD loans accounted for around 78% of its loan book for 2014, which is higher than most of its Taiwan peers, at 60-70%. Demand deposits account for 64% of First Bank’s total deposits (vs. the average of its peers’, at around 52%), which helps to keep its cost of funding low, at 26bps for 2014. We see First FHC as a

beneficiary of the domestic rate hike theme for 2015-16 and expect its NIM to expand by 5bps for 2015E and 7bps for 2016E, on the back of the 2 rate hikes that we expect the CBC to announce in 2H15. First Bank: interest spread and NIM


First Bank: demand deposits as a % of total deposits (as of September 2014)

Source: TEJ, Company, Daiwa

Note: December 2014 number for First Bank

… but challenges loom

The benefits gained from an improved margin in 2015-16 could be offset by sluggish domestic lending volume growth, however. As one of the government’s affiliated banks, First Bank is an important channel for the delivery of government policy, such as supporting SMEs and taking into account the government’s housing policies by lending more to relevant groups. The SME loans and mortgage segments accounted for 38.9% and 26% of the loan book for 2014, respectively.

10.6

0.2 0.1 0.1

13.4

0.3 0.1 0.10

2

4

6

8

10

12

14

16

First Bank First AMC First Securities FSITC

2013 2014

(TWDbn)

1.48 1.491.52 1.53 1.54 1.55 1.55 1.55 1.55 1.55

1.20 1.211.26 1.26 1.26 1.26 1.28 1.28 1.28 1.28

1.1

1.2

1.3

1.4

1.5

1.6

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

Interest spread NIM

(%)

64.061.6 61.0

55.9 54.2 52.849.9 49.3

43.5

36.2

35

40

45

50

55

60

65

70

FirstBank

Hun Nanbank

CathayUnitedBank

ChangHwaBank

E. SUNBank

CTBCBank

MegaBank

TaipeiFubonBank

TaishinBank

Bank ofTaiwan

(%)


16 April 2015

- 59 -

First Bank: loan breakdown (2014)


We forecast First Bank’s mortgages to record a double-digit percentage decline YoY for 2015, given the cooling property market and tighter CBC regulations (see “Property after the boom”, published on 17 March 2014). The 2015 outlook for SME loans is also likely to be clouded by the country’s lower GDP growth for 2015 (Daiwa’s forecast: 3.2% YoY for 2015, versus 3.7% YoY for 2014). We expect sluggish TWD loan growth of 0.2% YoY for 2015E, down from 2.5% YoY for 2014. First Bank: monthly new mortgage lending


The bank is likely to maintain strong foreign currency loan growth momentum in 2015, as it is currently setting up more overseas branches, which should lead to more business opportunities. Foreign currency loans grew by 14.3% YoY for 2014, and we forecast 15% YoY growth for 2015. However, as its foreign currency loans accounted for only 22% of its total loan book for 2014, its foreign-currency loan contribution as a percentage of its total loan growth is unlikely to be exciting for 2015-16. We expect overall loan growth of 3.5% YoY for 2015 and 3.2% YoY for 2016 (vs. the company’s guidance of 4-5% YoY for 2015). It is also worth noting that although falling mortgage lending and sluggish SME loan growth are the main

downside risks that we see for the sector, First Bank is likely to be more hard hit in these areas given its high exposure to these sectors (combined 65% of its loan book). First Bank: total loans & LDR


Meanwhile, fee income grew by 16.7% YoY for 2014. Its wealth management products and TMU businesses, which respectively accounted for 50% and 7.3% of total fee income for 2014, were the major drivers of the fee-income growth. For 2015, however, we look for the fee income growth to slow. Bancassurance income, which accounted for 55% of First Bank’s fee income earned from wealth management product, is likely to struggle, as we expect FYP to see a sector-wide decline of 15-25% YoY (see pages 7-8 of our sector report for more details). We are more cautious than management on the outlook for the TMU business for 2015-16. Management believes the demand for the bank’s TMU business is likely to rise strongly in 2015-16 as exchange rate volatility (especially the CNY) looks set to increase globally. Although we agree with management’s view that hedging demand should increase along with the rise in exchange-rate uncertainty, we believe one of the major earnings-growth drivers for the TMU business is speculative demand on CNY long positions. Given the weakening CNY (Daiwa’s economics team expects the CNY to hit 6.6 against the USD by the end of 2015 and 6.83 by the end of 2016), in addition to stricter FSC regulations since mid-2014, we doubt that the bank’s TMU business will be able to record meaningful fee-income growth in 2015-16. Overall, we expect total fee-income growth to ease from 16.7% YoY for 2014 to 5% YoY for both 2015 and 2016.

SMEs38.9%

Mortgage26.0%

FX loan22.3%

Large corporates

8.8%

Others4.0%

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Sep-

13

Oct

-13

Nov

-13

Dec

-13

Jan-

14

Feb-

14

Mar

-14

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

(TWDm)

-27% YoY for 4Q14

78

80

82

84

86

88

90

1,360

1,380

1,400

1,420

1,440

1,460

1,480

1,500

1,520

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

Total loan (LHS) LDR (RHS)

(TWDbn) (%)

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/Taiwan_Economy-Property_140317.pdf#page=1


16 April 2015

- 60 -

First Bank: fee-income breakdown


First FHC’s PPOP rose by 19.9% YoY for 2014, partially due to a larger earnings contribution from the trading and other income. Trading and other income surged by 14.5% YoY and accounted for 24.5% of First FHC’s PPOP for 2014 (up from 18.8% for 2013). First FHC’s core income (net interest income plus net fee income) grew by 9.6% YoY for 2014, which we see as a decent growth rate but lower than the headline suggested. First FHC’s performance of trading and other income depends largely on whether the macro and market environments become more volatile. We expect trading and other income to fall back to the average level for 2011-13, translating into a 33% YoY decline for 2015E from the 2014 peak level of TWD5bn.

Potential bankruptcy of THSRC

Taiwan High Speed Rail Corp (THSRC) could end up filing for bankruptcy in 1H15 as the Ministry of Transportation and Commutation’s reform proposal was rejected by the Legislative Yuan in January 2015. Although loans to THSRC are likely to be fully guaranteed by the government, First FHC will make a loss on its preferred stock investment. First FHC currently owns TWD2bn worth of THSRC’s preferred stocks, or 10% of its 2015E PPOP. How much of the loss on the preferred stock investment First FHC will have to bear depends on the court’s decision. We expect First FHC to take the initiative and recognise 50% of the loss in 2015.

Valuation

We initiate coverage of First FHC with an Underperform (4) rating and an SOTP-based 12-month target price of TWD16.70, implying a 2015E target PBR of 1.0x (past-10-year average one-year rolling PBR of

1.1x). Our target price offers 11% downside to the current share price level of TWD18.75. First FHC: SOTP valuation

Implied 15E PBR Total Value Value/share % of totalEntity/Item (x) (TWDm) (TWD) (%)First Bank 1.0 148.617 16.1 95.9First Securities 0.8 5,538 0.6 3.6First Life 0.8 779 0.1 0.5 First FHC 1.0 154,934 16.7 100Implied upside -10.9%Current price (15 April 2015) 18.75


First FHC is currently trading at one-year rolling PBR of 1.1x. The stock is trading at an 8.2% discount versus the current sector PBR, based on the Bloomberg consensus (10-year average: -17.6%). First FHC: 12-month rolling PBR


First FHC: PBR premium/discount to sector PBR


According to management, First FHC could raise capital in 2015 to strengthen its capital position and to fund its overseas expansion. We expect the equity raising to involve around 1bn shares, or 11% dilution, based on our market research, although the details have not yet been finalised. Note that we have yet to factor into our model any potential increase in capital in 2H15.

2,499

893 926

353726

3,083

927 940

386

854

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Wealthmanagement

Loan-related FX related Credit card Others

2013 2014

(TWDm)

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

(50)

(40)

(30)

(20)

(10)

0

10

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(%)

Ave: -17.6%


16 April 2015

- 61 -

The following table shows the key assumptions in our earnings model for First FHC over the 2015-16 periods: First Bank: key assumptions

2014 2015E 2016ENIM expansion (bps) 2 5 7Loan growth (%) 4.6 3.5 3.2Fee income growth 16.7 5.0 5.0NPL ratio (%) 0.20 0.30 0.36

Source: Company, Daiwa’s forecasts

We forecast NIM expansion of 5bps for 2015 and 7bps for 2016, likely to be driven by the rate hike cycle that we expect to see. We expect loan growth to slow to 3.5% YoY for 2015E and 3.2% YoY for 2016E, dragged down by lower TWD loan growth. Fee income growth could witness a sharper slowdown for 2015-16 (vs. 2014) as fee-income growth momentum for the bancassurance and TMU businesses look set to lose steam over this period. We look for a moderate pick-up in the NPL ratio, from 0.2% for 2014 to 0.3% for 2015, due to lower bad loan recoveries. We also expect to see sporadic bad debt over 2015-16 as China’s ongoing economic slowdown is likely to have an impact on the profitability of Taiwan firms, given the closer cross-strait ties. We also stress that our assumptions are made based on Daiwa’s 2015 GDP forecast of 3.2% YoY for Taiwan and 6.1% YoY for Asia-ex Japan. We have factored in two 12.5bps rate hikes by the CBC in 2H15. We also assume a 3% risk free rate and an 8% equity risk premium. Given the 0.86 beta for the stock, according to Bloomberg, we calculate a cost of equity of 9.9%, which we use in our model. Daiwa’s Forecasts for GDP and CPI

2014 2015E 2016E

(% YoY) GDP CPI GDP CPI GDP CPITaiwan 3.7 1.2 3.2 0.8 3.0 1.1Asia-ex JP 6.4 2.3 6.1 2.0 5.8 1.6

Source: Company, CEIC, Daiwa

Risk to our call

As we see First Bank as a beneficiary of the domestic rate hike theme, the main upside risk to our call would be an earlier- or larger-than-expected increase in the policy rate. A secondary risk to our call would be a greater-than-expected increase in loan growth if the next wave of “Big Data” (see page 14 of our sector report for more details) drives up demand for investment loans in 2015. Also, while we assume that 50% of the loss made on the THSRC preferred share investment will materialise and be recognized in 2015, a lower level of loss recognition, which will largely depend on the court’s ruling, could alter our earnings forecasts.

Company profile

First Financial Holding Co., Ltd. was incorporated in 2003, with First Bank as its flagship entity. The government is the major shareholder, holding a 28.5% stake (including both direct and indirect holdings). As such, First Bank is an important channel for the government’s policy delivery, such as supporting SMEs with cheap loans. First Bank has the largest share of the SME lending market in Taiwan. First FHC is also involved in the securities business, life insurance business and investment-trust businesses through its subsidiaries. Overseas expansion First FHC currently has 2 bank branches in Shanghai, and leasing businesses in Suzhou and Chengdu. The banking branch in Chengdu and the sub-branch in the Shanghai Free Trade Zone were opened in 3Q14. A branch in Xiamen is expected to open in 1H15. Meanwhile, the FSC has approved applications for the bank to set up branches in Henan Province. For ASEAN, First Bank set up two new sub-branches in Phnom Penh in 2Q14. The Vientiane branch was opened on 31 March 2015. Taking these new offices into account, Frist FHC will have 11 offices in ASEAN including Singapore, Thailand, Myanmar, Laos, Cambodia and Vietnam by 1H15.


16 April 2015

- 62 -

First FHC: parent/subsidiary structure (as at end 2014)


First Financial (2892 TW)

First Bank First Securities First AMC First Securities

Investment Trust CoFirst-Aviva Life Insurance


■ Investment case We initiate coverage of CTBC Financial Holding (CTBC FHC) with an Underperform (4) rating and 12-month SOTP-based target price of TWD18.9. Potential decline in fee income. In our view, CTBC’s fee income is at risk as its bancassurance income is likely to decline in 2015-16. This decline is not only because of a potential sector-wide drop in premiums in 2015, but also due to insurers’ shifting their focus from deposit-like insurance products to high-margin traditional life products, implying that the insurers may rely more heavily on tied agent channels rather than bancassurance going forward. As CTBC’s banking subsidiary, CTBC Bank, focuses more than its peers on retail banking, with its fee income making up 38% of its operating revenue in 2014 (vs. peers’ 20-30%), the drag from slower fee income growth would hit CTBC Bank harder.

Adversely affected by lower ceiling for revolving loan rates. We expect the FSC’s lower ceiling for revolving loan rates (from 20% to 15%) to take effect in mid-2015. As the largest credit-card issuer in Taiwan, CTBC will be impacted the most. We estimate that a 1pp revolving loan rate decline would lower its 2015E pre-provision operating profit (PPOP) by 0.4%. Absorbing TSB could prove difficult. CTBC’s plan for Tokyo Star Bank (TSB), which it acquired in June 2014, is to expand cross-border business between Japan and Greater China. We see potential for this business, but challenges could loom for TSB, given its high NPL ratio, the limited upside we see for loan growth, and the persistently weak Yen. ■ Catalysts The share price rose by 20% from 2Q-3Q14 largely due to the bargain purchase of TSB. However, any earnings disappointments going forward would exert downward pressure on the share price. ■ Valuation The stock is now trading at a 1.4x 12-month rolling PBR, close to 1SD above its past-10-year average of 1.2x. We think this is unsustainable, given that we expect the consensus to cut earnings forecasts for 2015-16.

■ Risks Higher loan growth, higher fee income growth, and a stronger Yen are the key risks to our forecasts.


16 April 2015

CTBC Financial

Initiation: overvalued

• Falling bancassurance income and revolving loan rates could drag earnings growth; incorporating TSB also a challenging task

• The stock is trading at a 1.4x 12-month rolling PBR, close to 1SD above its past 10-year average of 1.2x, which we see as unsustainable

• Initiating with an Underperform (4) rating and 12-month target price of TWD18.9


Note: CTBC Bank started to incorporate TSB numbers since 2Q14, and thus the numbers for 2015 could be distorted by some base effect.

Financials / Taiwan

CTBC Financial2891 TT

Target (TWD): 18.90Downside: 14.3%15 Apr price (TWD): 22.05


Sell

1

2

3

4

5

90

98

105

113

120

17

18

20

21

23



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

(TWD) (%)

12-month range 17.30-22.05Market cap (USDbn) 10.763m avg daily turnover (USDm) 19.75Shares outstanding (m) 15,257Major shareholder Nan Shan Life Insurance (4.9%)

Financial summary (TWD)Year to 31 Dec 15E 16E 17ETotal operating income (m) 89,017 94,731 103,235Pre-provision operating profit(m) 35,339 38,248 43,794Net profit (m) 26,687 28,808 33,488Core EPS (fully-diluted) 1.749 1.888 2.195EPS change (%) 8.4 7.9 16.2Daiwa vs Cons. EPS (%) (14.8) (11.8) (15.6)PER (x) 12.6 11.7 10.0Dividend yield (%) 3.2 3.4 4.0DPS 0.7 0.8 0.9PBR (x) 1.3 1.2 1.2ROE (%) 10.9 10.9 12.2




16 April 2015

- 64 -

Growth outlook CTBC FHC: reported EPS and after tax ROE

We see CTBC’s growth outlook clouded by a potential fall in bancassurance income and decline in revolving loan rates. Near-term challenges also loom for CTBC in assimilating TSB, given TSB’s high NPL ratio, limited earnings upside and the Yen weakness. We expect core income (net interest income plus net service fee income) growth for CTBC Bank, including a contribution from TSB, to come in at 6.4% YoY for 2015E and 6.2% YoY for 2016E, from 24.6% YoY for 2014.

Source: TEJ, Daiwa

Valuation CTBC FHC: 12-month rolling PBR

CTBC is trading currently at a 1.4x 12-month rollingPBR versus its average of 1.2x for the past 10 years. We initiate coverage of the stock with an Underperform (4) rating and 12-month target price of TWD18.9 based on a SOTP valuation, implying a target 2015E PBR of 1.1x. We take 2 possible 12.5bp rate hikes from the CBC in 2H15 into account, and expect the Fed funds rate to reach 0.625% by the end of 2015. We believe the stock is too expensive right now, as it is trading close to 1SD above its past 10-year average of 1.2x.


Earnings revisions CTBC FHC: Bloomberg-consensus EPS forecasts

The Bloomberg consensus EPS forecasts for 2015-16 have remained relatively stable since December 2014. We see little room for upward revisions as CTBC looks set to face some earnings headwinds this year and next. Our 2015-16 EPS forecasts are 14.8% and 11.8% lower than the consensus, respectively, as we are more cautious on the progress of incorporating TSB given the earnings downside we see looming.



Growth outlook

Valuation

Earnings revisions

0

5

10

15

20

0.0

0.5

1.0

1.5

2.0

2.5

2008 2009 2010 2011 2012 2013 2014 2015E 2016E 2017E


(TWD) (% )

0.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.

1.6

1.7

1.8

1.9

2.0

2.1

2.2

2.3

2.4

Dec

-13

Jan-

14

Feb-

14

Mar

-14

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr-1

5

FY15 EPS forecast FY16 EPS forecast

(TWD)


Sell

1

2

3

4

5


16 April 2015

- 65 -

Key assumptions


Change (YoY %)

Source: FactSet, Daiwa forecasts Note: Non-interest income includes fee income, trading income, FX gain/loss and other operating income.

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest margin (%) - bank 1.5 1.6 1.7 1.7 1.8 1.5 1.6 1.6Loan growth (%) - bank 11.3 7.0 6.8 12.3 51.5 4.0 4.2 4.2Loan to deposit ratio (%) - bank 74.0 71.4 72.7 72.1 75.1 75.9 76.8 77.7Provision coverage (%) 254.9 482.6 305.6 409.1 167.5 190.7 209.7 232.9Fee to income ratio (%) 48.6 42.5 36.0 33.1 26.8 27.6 26.1 25.5Expense to income ratio (%) 63.5 60.7 58.5 58.4 58.8 60.3 59.6 57.6Tier-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 2017ENet-interest income 24,677 27,760 31,540 33,160 46,561 50,717 54,614 59,527Net fees & commission 25,563 23,926 21,913 22,250 22,161 24,544 24,737 26,274Trading and other income 2,311 4,979 6,015 10,886 12,238 9,953 11,051 12,258Net insurance income 0 (409) 1,334 869 1,590 3,803 4,330 5,176Total operating income 52,551 56,256 60,803 67,165 82,550 89,017 94,731 103,235Personnel expenses (18,126) (18,655) (20,097) (22,271) (26,827) (30,498) (32,093) (33,773)Other expenses (15,232) (15,478) (15,452) (16,927) (21,730) (23,180) (24,391) (25,669)Total expenses (33,358) (34,132) (35,549) (39,198) (48,557) (53,678) (56,484) (59,442)Pre-provision operating profit 19,193 22,124 25,254 27,968 33,993 35,339 38,248 43,794Total provision (1,863) (559) (539) (6,416) (3,645) (4,146) (4,510) (4,911)Operating profit after prov. 17,330 21,564 24,715 21,552 30,348 31,194 33,737 38,882Non-operating income 0 0 0 0 14,814 0 0 0Profit before tax 17,330 21,564 24,715 21,552 45,162 31,194 33,737 38,882Tax (3,188) (3,267) (3,417) (42) (5,718) (4,507) (4,930) (5,394)Min. int./pref. div./other items 0 0 0 0 0 0 0 0Net profit 14,142 18,297 21,298 21,510 39,445 26,687 28,808 33,488Adjusted net profit 14,142 18,297 21,298 21,510 24,630 26,687 28,808 33,488EPS (TWD) 1.230 1.610 1.650 1.500 2.580 1.749 1.888 2.195EPS (adjusted) (TWD) 1.230 1.610 1.650 1.500 1.614 1.749 1.888 2.195EPS (adjusted fully-diluted) (TWD) 1.230 1.610 1.650 1.500 1.614 1.749 1.888 2.195DPS (TWD) 0.730 0.400 0.710 0.380 0.645 0.700 0.755 0.878

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ENet-interest income 10.4 12.5 13.6 5.1 40.4 8.9 7.7 9.0Non-interest income 15.6 2.2 2.7 16.2 5.8 6.4 4.7 8.9Total operating income 13.1 7.1 8.1 10.5 22.9 7.8 6.4 9.0Total expenses 10.1 2.3 4.2 10.3 23.9 10.5 5.2 5.2Pre-provision operating profit 18.6 15.3 14.1 10.7 21.5 4.0 8.2 14.5Total provisions (85.0) (70.0) (3.7) 1,091.3 (43.2) 13.7 8.8 8.9Operating profit after provisions 361.4 24.4 14.6 (12.8) 40.8 2.8 8.2 15.3Profit before tax 361.4 24.4 14.6 (12.8) 109.5 (30.9) 8.2 15.3Net profit (adjusted) 479.7 29.4 16.4 1.0 14.5 8.3 7.9 16.2EPS (adjusted, FD) 778.6 30.9 2.5 (9.1) 7.6 8.4 7.9 16.2Gross loans 8.6 7.8 7.0 13.3 43.1 4.1 4.2 4.2Deposits 1.8 10.6 4.8 13.5 39.7 3.5 2.9 3.0Total assets 3.1 11.3 4.6 14.7 50.7 4.2 3.5 3.5Total liabilities 2.6 11.8 5.2 14.8 53.5 3.7 3.4 3.5Shareholders' equity 7.5 6.5 (1.5) 14.2 19.0 12.9 4.5 3.5Avg interest-earning assets 2.8 7.3 7.7 8.6 32.1 24.5 5.8 3.7Avg risk-weighted assets 0.7 (3.1) 4.8 14.7 31.8 21.3 10.0 10.0

Financial summary


16 April 2015

- 66 -


Key ratios (%)


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.

As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ECash & equivalent 123,113 159,428 155,552 240,287 407,940 451,168 465,178 480,860Investment securities 507,643 588,978 587,327 591,604 912,326 1,057,600 1,088,320 1,121,013Net loans and advances 983,755 1,060,090 1,133,807 1,284,855 1,838,176 1,912,782 1,993,277 2,077,161Fixed assets 33,221 34,172 38,837 38,348 43,379 43,108 43,985 45,318Goodwill 12,331 13,758 13,942 13,948 16,992 15,336 15,520 15,707Other assets 154,531 163,460 184,051 255,678 435,867 329,266 334,860 340,672Total assets 1,814,594 2,019,888 2,113,516 2,424,720 3,654,680 3,809,261 3,941,140 4,080,731Customers deposits 1,311,145 1,450,712 1,520,139 1,725,349 2,410,680 2,495,306 2,567,670 2,644,700Borrowing 179,174 159,587 122,560 149,992 270,281 294,391 298,379 302,532Debentures 60,372 55,182 66,122 70,470 117,573 102,742 104,731 107,774Other liabilities 102,874 182,955 235,778 286,063 626,707 657,914 699,762 745,615Total liabilities 1,653,565 1,848,436 1,944,599 2,231,874 3,425,241 3,550,353 3,670,542 3,800,621Share capital 107,295 114,477 124,170 147,130 152,573 152,573 152,573 152,573Reserves & others 53,641 56,872 44,661 45,640 76,780 106,258 117,948 127,460Shareholders' equity 160,936 171,349 168,831 192,770 229,353 258,830 270,521 280,033Minority interests 93 103 86 77 87 77 77 77Total equity & liabilities 1,814,594 2,019,888 2,113,516 2,424,720 3,654,680 3,809,261 3,941,140 4,080,731Avg interest-earning assets 1,594,757 1,711,504 1,843,277 2,001,820 2,643,930 3,291,914 3,484,163 3,612,904Avg risk-weighted assets 1,111,113 1,076,415 1,128,299 1,294,473 1,706,347 2,070,028 2,277,031 2,504,734BVPS (TWD) 15.260 15.316 13.597 13.102 15.032 16.964 17.731 18.354




16 April 2015

- 67 -

Overvalued

A 12-month rolling PBR of 1.4x looks too high to us, especially when earnings downside looms. Besides, incorporating TSB could be a near-term challenge for CTBC.

Challenges ahead

We initiate coverage of CTBC with an Underperform rating and 12-month TP of TWD18.9. The stock is now trading at a 1.4x 12-month rolling PBR, which we consider too expensive, given that over the past 10 years, the average 12-month rolling PBR is 1.2x. CTBC’s primary subsidiary is CTBC Bank, which contributed 86.9% of net income for 2014. In June 2014, CTBC Bank acquired 100% of TSB, completing the first takeover of a Japanese bank by a foreign lender. CTBC Bank recognised a total gain of TWD14.8bn (recorded as “non-operating income” on CTBC’s P&L) from the bargain purchase of TSB and started to incorporate TSB’s numbers in 2Q14. CTBC FHC: net income of primary subsidiaries


Note: 1) Including TSB numbers for 9M14. 2) Other subsidiaries include Chinatrust Venture Capital, Asset Management, Taiwan Lottery, Securities, Investment Trust and adjustment items for compiling consolidated statement.

Earnings headwinds

In addition to the downside risks that are widely seen for the sector, such as a potential drop in mortgage loans amid a cooling property market (20% of CTBC’s

loan book comprised mortgages in 2014), we believe CTBC could face some other earnings challenges in 2015-16. CTBC Bank: loan breakdown


Fee income contributed 37.8% of CTBC Bank’s operating revenue for 2014, which was higher than its peers at around 20-30%. In particular, bancassurance was an important source of fee income, amounting to TWD9.9bn for 2014, equivalent to 32.4% of the company’s total fee income, or 33.8% of the PPOP for the period. CTBC Bank: net income breakdown


Note: 2014 numbers exclude the gain from the bargain purchase of TSB

However, in our view, income growth from bancassurance is at risk for the following reasons:

1) Market observers estimate first year premiums (FYP) sector-wide will drop by 15-25% for 2015, given the FSC’s stricter scrutiny of interest-sensitive policies and a high base in 2014.

2) An increasing number of insurers are relying more on their own tied agent channels to sell their products rather than on bancassurance, as they try to sell more regular-premium, traditional life insurance products (which usually have a higher margin) rather than deposit-like products in order to enhance their margins.

23.7

0.2 2.7

0.3

(0.4)

34.3

1.6 2.6 0.3 0.7

(5)

0

5

10

15

20

25

30

35

40

Bank Life Insurance Broker Securities Others

2013 2014

(TWDbn)

28.747.9

34.7

25.9

27.919.7

7.4 5.51.2 0.9

0%

20%

40%

60%

80%

100%

2013 2014 (inculde TSB)Foreign currency loans Corporate NTD loans Mortages

Retail unsecured loans Others

46.6 52.3

40.4 37.8

(2) (2)

11.3 5.93.8 6.0

(20%)

0%

20%

40%

60%

80%

100%

2013 2014 (inculde TSB)

Net interest income Fee income Others Derivatives & FX Trading income


16 April 2015

- 68 -

We forecast CTBC’s bancassurance income to decline by 3% YoY for 2015 (versus 22% YoY growth for 2014), dragging down overall fee income growth to 3% YoY for 2015, from 12.3% YoY for 2014. CTBC Bank: fee income breakdown


CTBC Bank: wealth management fee breakdown


As the bank that issues the most credit cards in Taiwan, CTBC will be most affected by the law amendment to lower the rate ceiling of cash/credit card revolving loans from the current level of 20% to 15% expected to be in effect in mid-2015. Given CTBC’s cash/credit card revolving loan balance of TWD15.3bn, we estimate that a 1pp average revolving loan rate decline would drag CTBC Bank’s earnings down by TWD153m, equivalent to a 0.4% decline in the 2015E PPOP. CTBC Bank vs. peers: impact of a decline in cash/credit card revolving interest rates TWD mn CTBC CUB TFB Mega First

Cash/credit card revolving loan balance as of Jan 2015 15,298 14,674 6,918 1,314 1,309Impact on interest income for 1pp revolving loan rate decline 153.0 146.7 69.2 13.1 13.1% of 2015E PPOP for the FHC 0.4 0.3 0.1 0.0 0.1


Note: TFB= Taipei Fubon Bank; CUB= Cathay United Bank; PPOP= Pre-provision operating profit

As such, earnings upside now depends on foreign currency loan growth, which we expect to reach another double-digit percentage after accelerating strongly, by 32% YoY, for 2014 (excluding TSB’s financials). However, foreign currency loans only account for 28% of the loan book, and thus may not be enough to drive overall loan growth higher, especially when mortgage lending looks set to decline amid a cooling property market. If we take TSB’s numbers into account, foreign currency loans would rise to 48% of CTBC’s loan book. However, since CTBC aims to improve TSB’s loan quality by adopting stricter scrutiny of its loan activities, the loan growth contribution from TSB is likely to be limited in 2015-16. Overall, we look for CTBC Bank’s total loan growth to slow from 51.5% YoY for 2014 to 4% YoY for 2015. Excluding TSB’s numbers, we forecast total loan growth of 5.2% YoY for 2015, down from 16.8% YoY for 2014.

Incorporating Tokyo Star Bank

In June 2014, CTBC Bank acquired 100% of TSB, completing the first takeover of a Japanese bank by a foreign lender. CTBC’s plan for TSB is to focus on cross-border business between Japan and Greater China, for which we see considerable potential in the mid-long term. However, incorporating TSB will take time and involve some execution risks in the near term, in our view. First, asset quality is likely to be an issue. TSB has a higher NPL ratio at 3.2% for 4Q14 (under Japan’s NPL definition). This pushed up CTBC Bank’s NPL ratio (under Taiwan’s NPL definition) to 0.94% for 4Q14, much higher than the level before the acquisition of 0.26% for 1Q14. CTBC has plans to increase TSB’s provision coverage, which could be a drag on its 2015-16 consolidated profitability.

13.4

4.6 4.53.7

1.7

15.6

5.0 4.63.6

1.8

02468

1012141618

Wealthmanagement

Lottery Credit card Corporatebusiness

Retail business

2013 2014

(TWDbn)

8.1

5.0

0.3 0.0

9.9

5.4

0.3 0.00

2

4

6

8

10

12

Bancassurance Mutual fund Custodian & trust Structured & Others

2013 2014

(TWDbn)


16 April 2015

- 69 -

CTBC Bank: asset quality

Source: TEJ, Daiwa

Note: TSB numbers included since 2Q14

Second, we see limited earnings potential in the near term for TSB. Japan is already a mature market with fierce competition among the banks, which we think limits the upside for TSB’s loan growth. CTBC Bank: total loans and LDR ratio

Source: TEJ, Daiwa

Note: TSB’s numbers included since 2Q14

Risk also looms for TSB’s margin (its NIM was 1.2% for 4Q14) which we think may be squeezed in 2H15, if the BOJ conducts another round of easing to lift inflation (Daiwa’s economics team expects this to happen in 2H15). CTBC Bank: interest spread and NIM


Note: TSB numbers included since 2Q14

Finally, given the potential further easing from the BOJ in 2H15, the Yen may well weaken further which would inevitably hit TSB’s contribution to CTBC Bank’s consolidated earnings. Daiwa’s economics team forecasts the Yen to drop to JPY126:USD1 by end-2015 and to JPY135:USD1 by end-2016, while forecasting the TWD at TWD32.5:USD1 and TWD32:USd1, respectively. In other words, the Taiwan Dollar is likely to appreciate by 5% against the Yen by the end of 2015 and by a further 8% by the end of 2016, meaning that the earnings contributions from TSB for 2015 and 2016 will have to be discounted by 5% and 8%, respectively.

Valuation

We initiate coverage of CTBC with an Underperform (4) rating and 12-month target price of TWD18.9, based on a SOTP valuation, and implying a target 2015E PBR of 1.1x, and calling for 14.3% downside for the current share price of TWD22.05. CTBC FHC SOTP valuation

Entity/Item Implied

15E P/B (x)Total Value

(TWDm) Value/share

(TWD) % of total (%)CTBC Bank 1.1 240,617 15.8 84%CTBC Life 1.0 37,273 2.4 13%CTBC Insurance 1.0 3,109 0.2 1%CTBC Securities 0.9 6,667 0.4 2% CTBC FHC 1.1 287,666 18.9 100%Price as of 15 April ‘15 22.05Implied Upside -14.3%


Note: CTBC Life acquired Manulife in 2013 and started to incorporate the numbers in 2014.

CTBC is now trading at a 1.4x 2015E PBR, which we consider expensive, considering the past-10-year average 12-month rolling PBR of 1.2x. The stock is trading at a PBR premium of 11.2% to the sector (10-year average: discount of 10.9%). CTBC: 12-month rolling PBR


0.1

0.3

0.5

0.7

0.9

1.1

1.3

100

150

200

250

300

350

400

450

500

550

4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14


(%) (%)

69

70

71

72

73

74

75

76

800

1,000

1,200

1,400

1,600

1,800

2,000

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

Total loans (LHS) LDR ratio (RHS)

(TWDbn) (%)

2.082.03

1.97 1.941.90 1.90

1.82 1.80

1.93

1.79

1.57 1.56 1.55 1.52 1.51 1.541.59

1.541.50 1.47

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

Interest spread NIM

(%)

0.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(x)

Ave. +1SD

Ave. -1SD

Ave.


16 April 2015

- 70 -

CTBC: PBR premium/discount to sector PBR


The followings are the key assumptions for our earnings model for CTBC in 2015-16. CTBC Bank: key assumptions

2014 2015E 2016ENIM expansion (bps) -4 2 2Loan growth (%) 51.5 4.0 4.2Fee income growth 12.3 3.0 4.0NPL ratio (%) 0.94 0.92 0.90

Source: Daiwa’s forecasts

We look for modest NIM expansion of 2bps for both 2015 and 2016. The policy rate hikes from the CBC expected in 2H15 would boost CTBC’s NIM, but a lower NIM for TSB would somewhat offset the rise, especially if the BOJ looks to conduct another round of easing in 2H15, as Daiwa expects. For 4Q14, CTBC’s NIM came in at 1.47%, excluding the TSB numbers, versus 1.39% after the consolidation. We forecast CTBC Bank’s loan growth to slow to 4% YoY for 2015 and 4.2% YoY for 2016, given a lack of growth drivers. Lower bancassurance income could drag down total fee income growth, which we look to slow from 12.3% YoY for 2014 to 3% YoY for 2015. The NPL ratio is likely to decline also as CTBC concentrates on improving TSB’s loan quality. We would stress that these assumptions are made based on Daiwa’s 2015 GDP forecasts of 3.2% YoY for Taiwan and 6.1% YoY for Asia-ex Japan, and assume 2 12.5bps rate hikes from the CBC in 2H15. We also assume a 3% risk free rate and 8% equity risk premium. Given the historical average beta value of 0.92 for the stock, we calculate the cost of equity to be 10.3%. Forecasts for GDP and CPI

2014 2015E 2016E

(% YoY) GDP CPI GDP CPI GDP CPI

Taiwan 3.7 1.2 3.2 0.8 3.0 1.1Asia-ex JP 6.4 2.3 6.1 2.0 5.8 1.6

Source: CEIC, Daiwa


Higher loan growth, driven by stronger growth of private consumption and investment demand, is an upside risk to our investment case. Policy decisions, such as a faster increase in the policy rate from the CBC and the abandonment of further easing from the BOJ, would help CTBC’s NIM improve to a greater extent and alter our forecasts. A stronger Yen would also provide upside for our forecasts as it would boost the earnings contribution from TSB. During the analyst meeting held on 11 March, management expressed great interest to expand the company’s life insurance business through acquisition. A potential candidate is Taiwan Life Insurance (2833 TT, not rated), which CTBC tried to acquire in 2014 but failed due to opposition from Taiwan Life’s major shareholders. However, the shareholders seem to have changed their minds now and the door for negotiation looks to be open again. Whether CTBC decides to proceed with the deal or not will likely become clear in late 2Q15. In addition, we also see risk of CTBC conducting a capital increase in 2015 as the company aims to expand more aggressively in the next few years. CTBC also needs to fund its investment in ABC Life Insurance. The board of CTBC approved a plan in August 2014 to take a 19.99% stake in ABC Life Insurance, which is 51% owned by Agricultural Bank of China. CTBC will pay CNY4.2 per share or CNY1.7bn in total, to buy the shares from Agricultural Bank of China. The deal is still pending regulatory approval from Taiwanese and Chinese regulatory authorities.

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. Major subsidiaries CTBC Bank, formerly known as China Securities Investment, was founded in 1966 and has been affiliated with CTBC since 2002. CTBC Bank had a total of 147 branches in Taiwan and 100 overseas offices at the end of 2014. It is the largest private bank in Taiwan. Tokyo Star Bank (TSB) was established in June 2011 out of the reorganisation of the bankrupt Tokyo Sowa Bank. CTBC Bank acquired a 100% stake in TSB

(60)(50)(40)(30)(20)(10)

010203040

Apr-0

5

Oct

-05

Apr-0

6

Oct

-06

Apr-0

7

Oct

-07

Apr-0

8

Oct

-08

Apr-0

9

Oct

-09

Apr-1

0

Oct

-10

Apr-1

1

Oct

-11

Apr-1

2

Oct

-12

Apr-1

3

Oct

-13

Apr-1

4

Oct

-14

Apr-1

5

(%)

Ave: -10.9%


16 April 2015

- 71 -

in June 2014, completing the first takeover of a Japanese bank by a foreign lender. TSB currently has an ROE of 10% and an ROA of 0.6%. CTBC’s goal is to improve these figures to 13% and 0.99% after 3 years. After acquiring TSB, CTBC Bank’s overseas income share would rise from 30% to 45%, based on our forecasts. CTBC Life: In 2011, CTBC acquired MetLife Taiwan Insurance and renamed it CTBC Life Insurance in 2012. In July 2013, CTBC Life announced a merger with Manulife Taiwan. The merger closed on 1 January 2014. CTBC Life also aims to enter the China market by taking a 19.99% stake in ABC Life Insurance, which is 51% owned by Agricultural Bank of China. The deal is pending regulatory approval from Taiwanese and Chinese regulatory authorities. CTBC Securities, formerly known as Pou Chen Securities, was founded in 1989. In 2003, it was renamed CTBC Securities. CTBC Insurance Brokers became a CTBC subsidiary in 1996 and merged with CTBC Holdings in 2002. The CTBC Insurance Brokers’ sales network comprises telemarketing and sales personnel and its products are divided into property and casualty and life insurance. CTBC Asset Management was founded in May 2003, mainly for the purpose of taking advantage of the large quantities of non-performing assets arising from Taiwan’s domestic financial reform. CTBC AMC manages debt trading for financial institutions and for the leasing investment industry. In the meantime, a leasing investment company was established in Hong

Kong with the primary purpose of investing in the leasing industry in China. Taiwan Lottery was officially registered in 2006 as a CTBC Holding subsidiary. From 2007 to 2013, it was primarily entrusted with the distribution, sales, marketing, operations and management of the lottery and with handling the prize money. CTBC Bank has now obtained the lottery distribution rights for the fourth time, the duration of which will be from 2014 to 2023. Overseas expansion CTBC Bank has the greatest number of overseas operational bases among the Taiwanese banks. It has branches in Hong Kong, Singapore, New Delhi, Shanghai, New York, Ho Chi Minh City and Tokyo. Its subsidiaries can be found in Japan, the US, Canada, Indonesia and the Philippines. It also has representative offices in Bangkok, Hanoi, Los Angeles and Beijing.

CTBC: parent/subsidiary structure


CTBC Financial (2891 TW)

CTBC Life CTBC Securities

Tokyo Star Bank CTBC Taiwan Lottery

CTBC Insurance Brokers

CTBC Bank CTBC AMC CTBC Investments CTBC Security

CTBC Capital


16 April 2015

- 72 -

Daiwa’s Asia Pacific Research Directory

HONG KONG

Hiroaki KATO (852) 2532 4121 [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)

Christie CHIEN (852) 2848 4482 [email protected] 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

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)

Lynn CHENG (852) 2773 8822 [email protected] IT/Electronics (Semiconductor) (Greater 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

Becky HAN (852) 2848 4464 [email protected] Small/Mid Cap (Regional)

Joey CHEN (852) 2848 4483 [email protected] Steel (China)

Kelvin LAU (852) 2848 4467 [email protected] Head of Transportation (Hong Kong/China); Transportation (Regional)

Brian LAM (852) 2532 4341 [email protected] Transportation – Aviation (Hong Kong/China); 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] Capital Goods (Construction and Machinery)

Iris PARK (82) 2 787 9165 [email protected] Consumer/Retail

Jun Yong BANG (82) 2 787 9168 [email protected] Oil; Chemicals; Tyres

Thomas Y KWON (82) 2 787 9181 [email protected] Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game

TAIWAN

Rick HSU (886) 2 8758 6261 [email protected] Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design (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

Evon TAN (65) 6499 6546 [email protected] Property and REITs

Jame OSMAN (65) 6321 3092 [email protected] Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)

Becky HAN (852) 2848 4464 [email protected] Small/Mid Cap (Regional)


16 April 2015

- 73 -

Daiwa’s Offices

Office / Branch / Affiliate Address Tel Fax

DAIWA SECURITIES GROUP INC

HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 (81) 3 5555 0661

Daiwa Securities Trust Company One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. (1) 201 333 7300 (1) 201 333 7726

Daiwa Securities Trust and Banking (Europe) PLC (Head Office) 5 King William Street, London EC4N 7JB, United Kingdom (44) 207 320 8000 (44) 207 410 0129

Daiwa Europe Trustees (Ireland) Ltd Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469

Daiwa Capital Markets America Inc Financial Square, 32 Old Slip, New York, NY10005, U.S.A. (1) 212 612 7000 (1) 212 612 7100

Daiwa Capital Markets America Inc. San Francisco Branch 555 California Street, Suite 3360, San Francisco, CA 94104, U.S.A. (1) 415 955 8100 (1) 415 956 1935

Daiwa Capital Markets Europe Limited 5 King William Street, London EC4N 7AX, United Kingdom (44) 20 7597 8000 (44) 20 7597 8600

Daiwa Capital Markets Europe Limited, Frankfurt Branch Trianon Building, Mainzer Landstrasse 16, 60325 Frankfurt am Main, Federal Republic of Germany

(49) 69 717 080 (49) 69 723 340

Daiwa Capital Markets Europe Limited, Paris Representative Office 36, rue de Naples, 75008 Paris, France (33) 1 56 262 200 (33) 1 47 550 808

Daiwa Capital Markets Europe Limited, London, Geneva Branch 50 rue du Rhône, P.O.Box 3198, 1211 Geneva 3, Switzerland (41) 22 818 7400 (41) 22 818 7441

Daiwa Capital Markets Europe Limited, Moscow Representative Office

Midland Plaza 7th Floor, 10 Arbat Street, Moscow 119002, Russian Federation

(7) 495 641 3416 (7) 495 775 6238

Daiwa Capital Markets Europe Limited, Bahrain Branch 7th Floor, The Tower, Bahrain Commercial Complex, P.O. Box 30069, Manama, Bahrain

(973) 17 534 452 (973) 17 535 113

Daiwa Capital Markets Hong Kong Limited Level 28, One Pacific Place, 88 Queensway, Hong Kong (852) 2525 0121 (852) 2845 1621

Daiwa Capital Markets Singapore Limited 6 Shenton Way #26-08, DBS Building Tower Two, Singapore 068809, Republic of Singapore

(65) 6220 3666 (65) 6223 6198

Daiwa Capital Markets Australia Limited Level 34, Rialto North Tower, 525 Collins Street, Melbourne, Victoria 3000, Australia

(61) 3 9916 1300 (61) 3 9916 1330

DBP-Daiwa Capital Markets Philippines, Inc 18th Floor, Citibank Tower, 8741 Paseo de Roxas, Salcedo Village, Makati City, Republic of the Philippines

(632) 813 7344 (632) 848 0105

Daiwa-Cathay Capital Markets Co Ltd 14/F, 200, Keelung Road, Sec 1, Taipei, Taiwan, R.O.C. (886) 2 2723 9698 (886) 2 2345 3638

Daiwa Securities Capital Markets Korea Co., Ltd. One IFC, 10 Gukjegeumyung-Ro, Yeouido-dong, Yeongdeungpo-gu, Seoul, 150-876, Korea

(82) 2 787 9100 (82) 2 787 9191

Daiwa Securities Capital Markets Co Ltd, Beijing Representative Office

Room 3503/3504, SK Tower, No.6 Jia Jianguomen Wai Avenue, Chaoyang District, Beijing 100022, People’s Republic of China

(86) 10 6500 6688 (86) 10 6500 3594

Daiwa SSC Securities Co Ltd 45/F, Hang Seng Tower, 1000 Lujiazui Ring Road, Pudong, Shanghai 200120, People’s Republic of China

(86) 21 3858 2000 (86) 21 3858 2111

Daiwa Securities Capital Markets 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 Capital Markets 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


16 April 2015

- 74 -

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 Capital Markets Co. Ltd., 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 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. 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); Rexlot Holdings Ltd (555 HK); Neo Solar Power Corp (3576 TT); Accordia Golf Trust (AGT SP); Hua Hong Semiconductor Ltd (1347 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. 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. 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. DHK market making DHK may from time to time make a market in the securities covered by this research. 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 Stockbroking 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. Ownership of Securities

For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. India

This research is distributed by Daiwa Capital Markets India Private Limited (DAIWA) which is an intermediary registered with Securities & Exchange Board of India. This report is not to be considered as an offer or solicitation for any dealings in securities. While the information in this report has been compiled by DAIWA in good faith from sources believed to be reliable, no representation or warranty, express of implied, is made or given as to its accuracy, completeness or correctness. DAIWA its officers, employees, representatives and agents accept no liability whatsoever for any loss or damage whether direct, indirect, consequential or otherwise howsoever arising (whether in negligence or otherwise) out of or in connection with or from any use of or reliance on the contents of and/or omissions from this document. Consequently DAIWA expressly disclaims any and all liability for, or based on or relating to any such information contained in or errors in or omissions in this report. Accordingly, you are recommended to seek your own legal, tax or other advice and should rely solely on your own judgment, review and analysis, in evaluating the information in this document. The data contained in this document is subject to change without any prior notice DAIWA reserves its right to modify this report as maybe required from time to time. DAIWA is committed to providing independent recommendations to its Clients and would be happy to provide any information in response to any query from its Clients. This report is strictly confidential and is being furnished to you solely for your information. The information contained in this document should not be reproduced (in whole or in part) or redistributed in any form to any other person. We and our group companies, affiliates, officers, directors and employees may from time to time, have long or short positions, in and buy sell the securities thereof, of company(ies) mentioned herein or be engaged in any other transactions involving such securities and earn brokerage or other compensation or act as advisor or have the potential conflict of interest with respect to any recommendation and related information or opinion. DAIWA prohibits its analyst and their family members from maintaining a financial interest in the securities or derivatives of any companies that the analyst cover. This report is not intended or directed for distribution to ,or use by any person, citizen or entity which is resident or located in any state or country or jurisdiction where such publication, distribution or use would be contrary to any statutory legislation, or regulation which would require DAIWA and its affiliates/ group companies to any registration or licensing requirements. The views expressed in the report accurately reflect the analyst’s personal views about the securities and issuers that are subject of the Report, and that no part of the analyst’s compensation was, is or will be directly or indirectly, related to the recommendations or views expressed in the Report. This report does not recommend to US recipients the use of Daiwa Capital Markets India Private Limited or any of its non – US affiliates to effect trades in any securities and is not supplied with any understanding that US recipients will direct commission business to Daiwa Capital Markets India Private Limited. 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 Philippines 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 Link 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”).


16 April 2015

- 75 -

This report is prepared by analysts who are employed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates. While the information is from sources believed to be reliable, neither the information nor the forecasts shall be taken as a representation or warranty for which 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 incur any responsibility. 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 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 Capital Markets Europe Limited 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, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and/or its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and/or its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.

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. Regulatory disclosures of investment banking relationships are available at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Germany 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 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 This material is provided as a reference for making investment decisions and is not intended to be a solicitation for investment. Investment decisions should be made at your own discretion and risk. Accordingly, no representation or warranty, express or implied, is made as to and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this document, Content herein is based on information available at the time the research material was prepared and may be amended or otherwise changed in the future without notice. All information is intended for the private use of the person to whom it is provided without any liability whatsoever on the part of Daiwa Capital Markets Europe Limited, Bahrain Branch, any associated company or the employees thereof. If you are in doubt about the suitability of the product or the research material itself, please consult your own financial adviser. Daiwa Capital Markets Europe Limited, Bahrain Branch retains all rights related to the content of this material, which may not be redistributed or otherwise transmitted without prior consent. 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 (telephone 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.


16 April 2015

- 76 -

Disclosure of investment ratings

Rating Percentage of total

Buy* 61.0% Hold** 26.1% Sell*** 12.9%

Source: Daiwa

Notes: data is for Daiwa’s coverage universe in Asia (ex Japan) and correct as of 31 March 2015. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings and stocks not formally rated by Daiwa *** 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 to 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

initiation: favour insurance- taiwan financial centric...

Documents