First Financial Looks to China

By RON BROWNLOW AND STEVE PRICE | MORE ARTICLES BY AUTHOR

One of Taiwan's leading banks is setting itself up for liberalized trans-strait banking. Investors should get on board.

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WHEN YOU THINK OF TAIWAN, you think of its technology companies. But investors should take note of the island nation's financial sector, and in particular the state-controlled First Financial Holding Company (ticker: 2892.Taiwan).

Though not as well known as peers Fubon (2881.Taiwan) and Chinatrust (2881.Taiwan), First Bank, a subsidiary of the 32-percent state-owned First Financial Holding Company, ranks among Taiwan's top three in terms of loan-to-debt ratio and demand deposit as a percentage of total deposit—two factors that make it attractive to investors because the country is in the early stages of the credit cycle, and yield-curve spreads are expected to improve. Dexter Hsu, vice president of Asia Financial Research at J.P. Morgan Securities, has an Overweight rating on First Financial, with a potential upside of 30 percent. "When we see interest-rate hikes, they will benefit most," he says.

And that's not taking into account the China angle.

In November, Taipei signed a Memorandum of Understanding with Beijing on cross-strait banking. And in June, it inked the Economic Cooperation Framework Agreement, which was ratified by Taiwan's legislature on Tuesday. The agreements permit Taiwanese banks to set up branches in China, conduct business in renminbi and acquire Chinese banks—assuming Chinese agreement.

First Financial is part of the first tranche of banks—in addition to Taiwan Cooperative Bank (5854. Taiwan), Chang Hwa Bank (2801.Taiwan) and Land Bank of Taiwan (wholly state owned)—that have been cleared by Taiwan's Financial Supervisory Commission (FSC) to set up branches in China.

First Financial's shares—traded on Taiwan's benchmark Taiex —have surged 22% since May 25, the day after Taipei and Beijing ended the final round of negotiations on the ECFA, closing at NT$18.8 on Wednesday, Aug. 18. J.P. Morgan's price target is NT$24. First Financial's high valuation—at 18 times estimated 2010 earnings per share, compared with Changhwa at 11, Taishin (2887.Taiwan) at 13.3, Chinatrust (2891.Taiwan) at 13.9 and SinoPac (2890.Taiwan) at 22.3—reflects an expected EPS growth of 138.9% in 2010.

Still, KGI analyst Wenyen Fang likes First Financial because its client base—especially small and medium Taiwanese enterprises—is larger than its peers, its offshore-banking business has performed well, and it's more profitable than the other three state-controlled banks awaiting approval from Beijing.

To be sure, there are risks. Taiwan has been historically inclined to follow a pro-export monetary policy to drive growth, which artificially weakens the New Taiwan dollar and keeps interest rates low. And investors are awaiting the results of a government stress test of banks, to be completed on Sept. 15. Bad news would dent confidence in the suddenly buoyant financial sub-index.

According to local media reports, however, the FSC is expecting that the nation's 40 or so banks will only need to set aside an additional NT$30 billion to cover potential losses. And Taiwan's central bank has already announced a surprise interest rate hike in June to cool the overheating property market in northern Taiwan; analysts see the move as the first of a series of quarterly rises.

"We think First Financial Holding Company has the niche to perform better in China," Fang says. "When they are approved by China's government, that's the point to see a rise in the financial index."