Wild Wild West

                                                                         on March 27, 2011

She's so mean but I don't care. I love her eyes and her wild wild hair.

Dance to the beat that we love best. Heading for the nineties.

Living in the wild wild west, The wild wild west.

             
                        Quoted from song lyrics – Wild wild West

                        Written and performed by Escape Club

To acquire or to be acquired is not the question. What is central to agenda for everything imaginable is to earn profit or lose in future.

Taiwan financial sector – Beehive of M&A activity in future

Hoopla over a future shakeup in financial sector arose lately. Banks in Taiwan will receive new abacuses as the government is reckoning a new round of consolidations in state-run and privately-owned financial holding corporations (FHC), or the FHC M&A with domestic financial institutes.

Expressing a stance towards more market-oriented mechanism in the so-called 3rd-phase financial reform, it strives to turbo-charge progress to shore up bank balance sheet and step up bank foray into mainland China . In 2002 during former DPP administration, Taiwan mapped out FHC laws to allow establishment of 14 FHCs, under which the gamut of operations comprises insurance, securities and commercial banking.

The 2nd-phase structure retooling was initiated in 2004 to slim down financial institute number within a limited timeframe and reshape the industry into a rise of FHCs. But the results were notoriously ropy due to a series of scandals involving corruption, political bribery and insider trade. The streamlining pitted banks against each other, extracting enormous money from bank coffers to grab a new ownership in others. A total of 56 financial institutes in 1997 consisting of regional S&L and insurances firms were scaled back to the current 37. But none of their market turfs has been large enough so far to achieve over 10%, and the aggregate branch cluster was amplified from 2,729 to more than 3,200.

A handful of market raiders pocketed windfall income by launching hostile takeover scheme, initially scooping up a targeted financial stock under QFII accounts and then unloading holdings to their subsidiaries at higher price. Together with increased voting rights, that outsized price discrepancies assisted them to rake in fat income booked in a gray area of income statement. Activism was especially boisterous in securities sector, forcing a bevy of small-sized securities houses to be marginalized or fall into extinction by cannibalized effect. That was a grim reality amid a market saturation coupled with cut-throat competition, by which board ousters found themselves not in a good position to bargain on prices and finally buckled under a proxy fight.

There were also unexpected mergers for state banks being snatched by a leveraged buyout powered by internal capital of listed firms at the expense of shareholders equity. After the pruning done, market activists galvanized their assets to be put on the block again without government meddling. There's one inadvertent area most ignored, - they fired workers left and right, helping cranking up the island's jobless rate. Truly to say, the market must be straightened out by a friendly M&A or tender offer, not by an ugly looting. Though convicted of price scalping or breach of trust, the raiders mostly remain at large with some still appealing their cases to the court and some enjoying teaching at colleges.

To some extent, Taiwan financial sector is like a hodgepodge of participants and those who bore down rivals got the goodies, but didn't reinvent the sphere. Through their power of eminent domain, a few of FHCs have taken advantage of regulation arbitrage by reallocating capital to land risky assets such as offshore high-yield derivates in 2008, artificially stimulate their own affiliate shares and fund those housing developers. While the government pitched regulatory overhauls often, it had opted to side with entrepreneurs juggernauts in a tendency that will repeat itself, no matter which political party is at the helms. A shrinking number is to no avail and has little if any impact on the creation of new economic activity or employment.   

Plan to lift bank capital by M&A

The government may be sitting on the right side of the world by exercising a renewed consolidation move, so ambitious as it may seem that it will face challenge, albeit not definitely doomed for a failure. The same holds true for current 37 banks which must raise their capital in future. The Basel III Accord stipulates that the minimum Tier 1 capital requirement for banks is to be raised to 6% from 4%, and the minimum common equity requirement be upped to 4.5% from 2%, both set to be effective Jan. 2015, with the former to rise to 8.5% and the latter to 7% if the contingency fund is set at 2.5%. Statistics shows that as of June 2010, 15 domestic banks saw their Tier 1 capital requirement stand below 8.5%, with 6 of the banks being linked by government. To meet the new Basel standard, the said 15 banks must enlarge capital by USD2.8-3.13 bn ahead of 2019.

The restored idea for financial industry reshuffling is announced to go forward on the principles of transparency, legality and selflessness. However, as was often the case in controversial policy matters in the past, there are varying characterization of decision makers' intent and even different interpretation of key terms and concepts that foster potential misunderstanding. Their mottos will be subject to change if condition warrant, since what they voiced is a bit ambivalent. Though government remaking attempt is still in an early or undecided stage, lack of detailed clarity for how it follows the principles will irk bankers, not to mention bank employee who might be agitated about losing a job. They must be well situated to take up the gauntlet, regardless of what it may come as a false alarm, or plunder and blunder.

Insider trading fueled by M&A 

To activate the future financial M&A in a fair and transparent fashion, the government is said to mull over plans to urge FHCs to gain approval for M&A in advance. Despite their struggling efforts, a whiff of M&A rumors might be leaked by insiders. When it comes down to valuation, things will get more complicated as to who will set the tone for the prices in the marriage among FHCs behemoths.

How far the government can ward off insider trading is a head-scratcher. Those who allegedly involved have never been punished to what the society can generally accept. Market players have been active in seeking inside news to make hay. A pump-and-dump action took place long before M&A talks which were later proven much ado about nothing. Few will finger the mole in listed firms, let alone taking the stand for an insider-trading trial for violating the confidentiality.

Even worse, officials were not blamed much for the lapse. Publicly-traded firms were also seldom accused of making their financial showings flattering after stock prices rocketed. Regulators unconcerned with aberrant events such as proxy fight seemingly only pondered drafts that pandered to lobbyists and corporate largesse which sometime pounded out upbeat news favorable to price riggers. It did happen that an officially commissioned examination on those delisted found that in the lead-up to a collapse they used various accounting gimmicks.

It's tremendously sad to raise questions about the number of officials also joining into the hype. Unfortunately, there isn't any immediate magic pill or panacea to wipe out the wrongdoing, as the government seems to run out of ammo. What we're still experiencing is the conspicuous lack of market disciplines over corporate news release. To erase their gratification, trading of a specific stock can be suspended prior to any major event rollout, noticeably related to valuation of a scheduled M&A.

A third independent party, better a global well-known underwriter, will be fit to pick up the slack to deliver the metric of closely-watched value, and quell suspicion about divesting state assets at distressed levels. Further, it may help ensure a success to raise fund overseas to meet new Basel ratios. Banks should ramp up global publicity by undertaking offshore roadshows to offer ECB or GDR in int'l markets that include China. If to inflate banks capital size is govenremnt ultimate aim, M&A is not the sole resolution and overseas fund raising is another way to consider. However, that's a sure thing for local FHCs in future to net proceeds overseas at cheaper cost and gain easier access into global markets, once their capital sizes and financial ratings improved marvelusly.

Which will be on the watch list of M&A targets?

State-owned FHCs would handily get a go-ahead but private ones might confront an uphill fight against divided insiders. But uncertainty will certainly loom in investors mind regarding the candidates willing to jump out of the block in future integration, given the fact that domestic banks scored the highest-ever pretax income of NTD183 bn in 2010. A bullish vision of widening interest rate spread leading to another knock-out year in 2011 is also in the cards. Since profits rebounded resoundingly last year and dividend payout will be disbursed in a larger manner, most ot them will tend to take a muted response.  

Domestic banks started to weaken in 1998 and inked a sizable loss of NTD104 bn in 2002. A year later their results zoomed back into black, then in 2004 hitting a record high of NTD155 bn income, which however was halved in 2005 due to financial upheaval goosed by credit and cash card loan defaults. A global financial tsunami in 2H08 further knocked out big portion of profits.

What the government can do to accelerate the gear lies in a fruitful M&A in state-owned FHCs sector where sacrificial lambs are needed, thereby to be modeled by private FHCs and other financial institutes. The new round of M&A library reportedly will be mainly focused on state banks. Much is riding on hope that quasi-state Chang Hwa Bank and Waterland Financial Holdings, which will reelect board members in late 2011, will be the first batch to explore respective merger plans. The government has actively racked up its stake in Waterland apparently for purpose to redo its management.

Jih Sun, Ta Chong, Cosmos and Entie, the four private FHCs with nearly half of interest held by foreigners or private equity funds, are now being touted as potential acquisition baits. Cashing-out from their partners will be likely on the surface following their enticing profits last year, thus making them much more manageable targets. However, the speculation may be unjustified as their Taiwanese shareholders would be cloaked under the umbrella of "foreign investors" to polish corporate image years ago. 

Push to set sights in China market

Rosy prospects lie ahead for bank stocks, now deemed as lucrative China plays underpinned by ECFA effect. Amid fear of missing a bonanza, they have flocked to  China these past 2 years in lockstep with manufacturers' massive west-bound flights. A Taiwan legislator, visiting Shanghai in early Jan. opined that Taiwanese banks in Yangtze River Delta should organize a Taiwan financial zone in Shanghai as a base from which they can flourish in vast China market. Lately, Taipei and Beijing have agreed to create a platform supervising cross-strait banking as soon as possible, hopefully by June at the earliest.

Perhaps time had run out on Taiwanese bankers in forging inroad into China . It is a late-to-the-game mission by over 10 years for them, who pale in comparison with Chinese peers in global assets rankings. Taiwan Financial Holding is the largest and most profitable FHC in Taiwan with total asset close to NTD3.25 trillion, a threshold for being qualified to be categorized in global top 100 banks. The fact reflects that domestic banks are not big enough to challenge world supremacy in banking filed in China. To tie the knot with Chinese bank, albeit not a surely permanent bliss on shaky cross-strait political ground, appears as feasible lifeblood for Taiwanese bank there. Also, it's expected that banks can see bread-and-butter work pay off if awarded an investment trust license which entitles them to tap into fiduciary, securities, venture capital and consumer banking fields.

Is that what you've got?

Apart from coaxing Taiwan banks into joining a west-side party and resuming M&A, policy makers likely have no Excalibur to jumpstart a banking sector growth at present. That's a marathon, not a sprint, for banks to march toward the unknown Chinese territory - it is all about endurance and motivation. 

If there's a state bank merger adding to layer of jobless pressure, then that is orchestrated to ease government burden in pension fund or retirement benefits. If that is the case it wishes for, then the government should be downsized first, alongside state-owned enterprises. Ask yourselves a question: why does China Petroleum Corp. always lose grounds in rivaling Formosa Plastic? It deserves a notice that the government should play a role as a profit generator for banks, as well as lay out what is needed to turn rhetoric into reality.

Financial innovation and Chinese buying on "T" shares

For years, we have been sick of repeated rhetoric to drive the island into a regional financial hub. In actuality, odds favored Taiwan to attain that end in the past, with a strong backdrop that it is a high-tech island chock full of manufacturers and listed firms. They require financial tools to cover hedging and trading in FX market and global investment. Innovation and promotion of financial products by local financial cohorts can be credentials as measures to update their hedging, or at least their knowledge to escape the pitfalls framed by overseas bankers' selling baskets including a ponzi scam.

Financial derivative is not a tormenter itself, but a cure to avoid risk. Rather, what could be the culprits to mess up global financial system derives from ailing quality of underlying assets and associated market liquidity condition. The reasons Taiwan hit a wall before can be partly traced to a still tight FX control and a non-globalized currency, NTD. As is a widely-perceived wisdom, a cap in personal outward remittance is not meaningful in a sense that those who demanding that will use nominee accounts. It's time to pull the plug on that control.

The government should embrace a laxer, or laissez faire attitude to be on par with HK and Singapore. The latter could become offshore RMB center after China's largest bank, Ind. & Commercial Bank of China, opened a RMB processing center there this month. In its move to internationalize RMB, Beijing has created an offshore version of the currency, called the CNH. Singapore is one of 8 countries with a swap line agreement with China, set at 150 bn RMB (USD22.8 bn). Meanwhile, Singapore bourse has continued its USD8 bn takeover bid of the Sydney bourse.

Taiwan should not meander by a wait and see mode in face of the dynamic forces driving development among global exchanges M&A. It can play a catch-up game along with China to form a new stock exchange that trades both-sides stocks, or more encouragingly, allowing Chinese to directly buy Taiwan shares classified as "T" shares denominated in RMB. Taiwan banks can act as clearing house and custodian bank, a step to beef up their profits. An already-strengthened political tie will cause the plans to be plausible, bringing cool back to Taiwan stock market which, after all, hasn't yet fully reflected Chinese investors' craving for the island. Meanwhile, Taiwan banks may also glow under China shadow to keep pace with Singapore as one of offshore RMB centers.  

That will be a long way for Taiwan banks to build a solid footing in commercial banking area in China, but private banking looks promising. Because some state-run banks represent major brand names in Taiwan, and because their stocks had shown much more vigor to defy gravity recently, the government makeover intention in the industry, if put into practice again, will have investors place bullish bets on the counter in future.

Taiwan stock market - On the ropes

Despite bouts of negative news related to Japan nuclear crisis and western military action against Libya, bulls rope-a-doped bears this past week, reiterating a pledge to keep faith in Taiwan stock market which ended at 8,610, up 216 points WoW. Volume was anemic as shown by a cautious tone among mom-and-pop investors. The market outstanding margin loan, an indicator of retail investors' risk/reward appetite, barely bulged to nearly flatline at NTD301.6 bn, up slightly by NTD452 mn WoW. In the aftermath of Japan quake on Mar. 11, the loan languished from NTD315.8 bn, meaning that worry about a pull-back was percolating among them.

Last-ditch buying from foreigners who posted a net buy of NTD12 bn Friday prodded the market to record a winning streak of 5 consecutive sessions. But a plethora of domestic bearish economic reports would signal potential market capitulation. Taiwan's export orders edged 5.33% higher YoY in Feb, the first disappointing, single-digit growth in 16 months; West-bound investment in China totaled USD1.82 bn in the first 2 months of 2011, rising 33.29% YoY, while China invested USD6.9 mn in Taiwan, down 77.8% YoY in the period; Jobless rate in Feb. surged to 4.69%, up by 0.05 pct from Jan., ending a 6-month string of declines yet skidding by 1.07 pct from a year ago.

The worst might be yet to shine on the export segment on the heel of Japan quake, as Taiwan imported 20.7% of goods from Japan which is the mainstay of tech material supplier to Taiwan. The quake and tsunami could cost Japan as much as USD308 bn, more than doubling the level in 1995 Kobe quake. The lingering crisis of nuclear plant will cast additional doubts about Japan's economic momentum, with its snowballing effect over Taiwan remaining as the spotlight for market's every twist-and-turn in future.

Rough ride might be in stores for Taiwan market which is due for a technical breakdown next week. A shortfall of volume, failing to confirm a bullish implication for last week corrective rebound, is suggesting market hesitance to climb the wall of worry. Against the weaker fundamental and technical circumstances, the market will be vulnerable to any depressing event. Chance for it to retrace last week gains is not ruled out, while significant overhead will still rest at the area over 8,550.

Good Luck !