The other shoe dropping
While 2008 ushered in a financial-sector meltdown, 2009 will witness the
fallout in the real economy. That means loan losses at the banks, and only
some Taiwanese banks have the capital to weather the storm. Valuations
have rebounded from trough levels but it is too early for a sustained
recovery, particularly as the first wave of bad debts has yet to hit. Focus
on the best franchises and stocks with balance sheets that provide
resilience to losses. Chinatrust is our only remaining BUY.
Positioned for a tough cycle
􀂉 We forecast 4.4% new nonperforming loans (NPLs) as a percentage of total loans
over the next two years versus 3.5-4.0% in the wake of the dot-com bust in 2001.
􀂉 The economy is weaker but Taiwan is now better positioned to avoid credit losses.
􀂉 Low system-wide loan growth, reduced corporate leverage, better management and
a stronger property market all bode well for the economy.
􀂉 Moreover, the government may intervene to prevent the largest defaults.
Sensitivity to rising loan losses
􀂉 While bank balance sheets are stronger than a decade ago, weaker pre-provision
profits mean there is less of a cushion against loan losses.
􀂉 We stress test the banks’ pre-provision profit and capital-adequacy levels.
􀂉 Most banks can take 4-5% loan losses over the next two years without having to
recapitalise, but some may then need new capital to expand.
􀂉 Chinatrust, SinoPac, Yuanta, Fubon and First Financial unlikely to need new equity.
Balance sheets at risk
􀂉 Aggressive loan growth at the banks is a red flag for risk.
􀂉 We also look at who is lending more to companies with weak Altman-Z scores.
􀂉 US lending and corporate bonds are another area of concern.
􀂉 First Financial and Chang Hwa have among the least risky profiles, while SinoPac
and Chinatrust get flagged only for US lending.
Too early for a sustained rally
􀂉 Our forecasts assume big losses in 2009 and depressed earnings through 2010.
􀂉 Low valuations reflect a grim outlook, but it is far too early to buy the sector.
􀂉 We need the other shoe to drop on NPLs before thinking about a sustained shareprice
recovery.
􀂉 With the right combination of pre-provision operating profit (PPOP) and capital
adequacy, Chinatrust is the most resilient to loan losses and is our only sector BUY.

Contents
Executive summary ............................................................................ 3
Positioned for a tough cycle ............................................................... 5
Sensitivity to rising loan losses ........................................................ 25
Balance sheets at risk ...................................................................... 37
Too early for a sustained rally .......................................................... 58
Appendices
1: Company financials...........................................................................84
2: Altman-Z data ...............................................................................109