First Financial launches GDR

Pre-marketing officially begins today for a re-capitalization exercise that will provide a telling indicator of investors'' belief in Taiwan''s financial sector reform.

Joint bookrunners Citigroup and Deutsche Bank are starting to begin pre-marketing of a 1 billion share offering for First Financial Holdings that could theoretically raise up to $608 million at the bank's current share price of NT$21.08.

Because the transaction is a re-capitalization exercise, the deal is an all new share issue representing about 20.7% of First Financial's share capital post offering. This will reduce the government's holding in the group from 36% to 25.2%, although it has not yet been decided whether the greenshoe will be composed of primary or secondary shares. The government currently holds 23.7% through the Ministry of Finance and 12.3% through the Bank of Taiwan, but has created a share overhang, since it intends to divest both to either strategic or institutional investors.

Formal roadshows are scheduled to begin on Wednesday July 9, with pricing expected on Tuesday July 22. Alongside the leads, Daiwa and ING are co-leads, with ABN Amro and First Taisec as co-managers.

The deal marks a landmark transaction for Taiwan as it is the first straight equity deal to come to the international markets from the predominantly state-owned banking sector. Over the past year, there has been hectic issuance activity, but it has been confined to the equity-linked market and the more aggressive private-sector banks.

As such First Financial's transaction will be a clear gauge of how successful investors believe the government has been in cleaning up the financial sector and how far they sense it has yet to go.

At its current share price, analysts say First Financial is trading at roughly 1.5 times reported 2002 book taking into account the integration of non-bank subsidiaries Mingtai, NITC and Taisec, due to be completed at the end of July. Taking the mid-point of an Ernst & Young audit, it is trading at roughly 2.3 times 2002 adjusted book on the same basis. Analysts assign a book value of roughly NT$60 billion in 2002 increasing by a further NT$40 billion in 2003.

First Financial's current stock price stands at a premium to virtually all of Taiwan's major listed banks. Partially government-owned Hua Nan, for example, is trading around 2 times adjusted book and the country's largest privately-owned bank, Chinatrust, at roughly 1.6 times.

Many expect the stock to naturally drift down during the course of marketing, resulting in a lower base issue price. But the success of the transaction will depend on how steep a discount investors demand on top of this. Syndicate research obtained by investors suggests that NT$18 is a sensitive level for the company, because any issue price below this may mean further cash calls to allow the bank to fully clean up its balance sheet.

An additional factor comes from the fact that this is a debut GDR and will not be fungible for three months. The last three companies that fell into this category during 2002 - Realtek, Powerchip and Promos - all needed a relatively wide discount for investors to feel comfortable and priced at respective discounts to spot of 12.2%, 11.7% and 20%.

Currently, First Financial is one of the least well known of the listed Taiwanese banks with few houses offering research and a QFI ownership level of only 3.7% compared to over 30% for SinoPac.

The bank is chiefly known for its aggressive NPL sales and was the pioneer of the auction process in Taiwan. During 2002, First Financial sold off NT$74 billion ($2.1 billion) NPL's and has said it intends to sell off a further NT$55 billion ($1.6 billion) over the coming 12 months.

It's pro-active approach to balance sheet management compared to the foot dragging exhibited by most of the overnment-owned banks is likely to be one of the GDR's chief selling points. In preparation for the deal, for example, First Financial commissioned Ernst & Young (E&Y) to complete an independent audit of its loan and NPL portfolios to make sure investors receive a completely realistic picture. It also hired consultants Mercer Oliver Wyman to transform the bank's credit risk management systems.

Using IAS 39 standards, E&Y concluded that real NPL's stood at NT$57 billion at the end of 2002 compared to reported NPL's of NT$50 billion. It also advocated the bank to increase its loan loss reserves from NT$7.2 billion to NT$38 billion, since it has an extremely weak coverage ratio of only 14%. In all instances, E&Y used the three month past due international standard, which has not yet been implemented in Taiwan.

Pending a successful re-capitalization, analysts estimate the bank will be able to improve its CAR from 8.99% at the end of 2002 to just over 10% at the end of 2003, with its coverage ratio hitting 68% and gross NPL's standing at just under 6%.

Key to maintaining these ratios will be to prevent new NPL's forming. The bank has already had some success in this respect and new NPL's are expected to drop from 3.2% in 2002 to about 1.4% in 2003. As a result of its consultant's advice, the bank is already planning to implement five rather four classifications to its loan book.

It is also hoping to make better use of its retail franchise by moving into higher margin products and expanding its private banking operations. Its current loan portfolio is split 67% corporate lending and 33% consumer lending, with most of the latter in mortgages.

First Financial is Taiwan's largest non-wholly owned government bank and has a roughly 6% market share across assets, deposits and loans. Mingtai, meanwhile is Taiwan's second largest P&C insurer, while NITC is the country's only listed fund management company.

However, as analysts point out, a number of other FHC's have already moved aggressively into wealth management, leaving First Financial with significant implementation risk, but at least a solid base from which to try.

Yet for investors, the main problem with Taiwan remains the lack of much visibility. While the government has made steady progress forcing consolidation on its fragmented banking industry, it is still impossible to tell what the sector will look like even a few years down the road, nor say with much certainty which banks will thrive.