First Financial Holdings shortlists five

Bake-offs take place today (Wednesday) for a roughly $600 million GDR mandate.

The first in a number of Taiwanese banks seeking to bolster tier 1 capital through the international equity markets has moved forward with plans for a deal. Having invited five banks to submit initial pitches, First Financial has invited five back to Taipei today, numbering Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, Salomon Smith Barney and UBS Warburg.

The all new share deal will mark a welcome diversion from Taiwan's heavy, constant stream of tech issuance and is regarded as an interesting but extremely challenging transaction to execute. As country experts continually reiterate, the main problem with the domestic banking sector is a lack of clarity over the true level of NPLs and shape of the industry post shake-out.

On a stand-alone basis, First Financial also has some of the weakest ratios of any of the major listed banks and particularly the newer and more aggressive private sector banks, which have monopolised foreign investor interest to date. Compounding this is a current price to book valuation ahead of the sector average, which could potentially complicate pricing of a deal within a reasonable discount.

At a share price of NT$22, for example, First Financial trades on a price to book ratio of 1.74 times forecast 2003 earnings, compared to a sector average valuation of 1.66 times. With a market capitalization of roughly $2.4 billion, the partially government-owned banks sits between Hua Nan and Taishin.

In terms of 2003 ROE, analysts estimate it stands at 13.6% compared to a 14.1% industry average, with an ROA of 0.6% compared to an industry average of 1.2% and an NPL coverage ratio of 38% compared to a 43% industry average. At the end of 2002, analysts say the bank had an NPL ratio of about 5.8% compared to an industry average of 6.12%

A sizeable government share overhang could also be a problem. The Taiwanese government is said to have total direct and indirect holdings of just under 50%, of which 12.3% is held through the Bank of Taiwan and 23.7% through the Ministry of Finance. The government has previously said that First Financial sits at the top of its bank privatization agenda and hopes to sell Bank of Taiwan's stake through the GDR market at some point this year and find a strategic investor for its own stake.

On the positive side, if the bank does finally manage to free itself of government ownership, it will be one of the best-placed larger banks to take advantage of sector consolidation. First Commercial Bank, the main entity of First Financial is one of the oldest and still one of the largest domestic commercial banks, with 6% of system wide assets, more than 180 branches and an SME focus. The government first started to sell down its ownership in 1998.

And as Taiwan Ratings commented in a credit report published last year, "A more pro-active and profit aware culture has manifested since privatization and the bank has become more aggressive in restructuring its operations."

Indeed, it has been one of the biggest sellers of NPLs and is credited with pioneering the whole auction process after establishing standardized procedures last spring. In 2001, for example, the bank liquidated NT$14.7 billion ($422 million) NPLs and sold off a total of NT$75 billion ($21.5 billion) NPLs in 2002. This year it estimates it will sell a further NT$10 billion to NT$20 billion.

To maintain its Capital Adequacy Ratio (CAR), the bank has previously made use of the domestic subordinated debt markets, raising NT$10 billion in 2001 and over NT$18 billion in 2002. However, the bank's CAR is now falling dangerously close to the BIS minimum and First Financial's dynamic new president Ray Dawn recently said it hopes to use a GDR to raise it back from 8.2% to 10%.

In order to sell a deal to risk-averse institutional investors, experts believe the bank will have to re-address its dividend policy. It currently pays no dividend and said last year it would cap prospective dividend pay-outs at NT$0.6 per share at times when its CAR fell below 10%. And even with a CAR greater than 10%, it added that the pay-out ratio would be a maximum of 50% of net profits.

But experts believe that a pay-out ratio of up to 70% of 2003 profits will be necessary. The bank estimates that 2003 net profits will total about $160 million.

First Financial's efforts to underpin its balance sheet were given a further spur this week by new government initiatives to speed reform of Taiwan's 52 banks and 300 credit co-operatives. Under a previous government initiative known as Target "258" banks have until the end of 2004 to reduce NPLs to 5% and improve capital ratios to 8%. However, the Finance Ministry now says that banks able to get their NPL ratios below 2.5% will gain a number of privileges, including automatic approval of offshore branches including China and faster regulatory approval of new products.