Transcript Document 7836920

Equity Analysis of a Banking Company
March 2008
Presented by:
Asif Ali Qureshi, CFA
Head of Research
Invisor Securities (Private) Limited
Sequence
 Introduction
 Sector Analysis
 Trends in Pakistani Banking Sector
 Analyzing a Bank – Concepts & Application
 Building financial model of a bank
 Valuation
2
Introduction
3
Equity analysis is essentially a 5-part process
Macro/Sector
Analysis
Company Analysis
Financial Modeling
ANALYST
REPORT
Valuation
Recommendation
4
Single most important variable in valuation?
 Profitability!
– cash
flows, dividends, etc  driven from profitability
5
Profitability is essentially a function of…
 Volume
– Quantity
– Asset
sold for an industrial enterprise
size in case of a banking company
 Profit Margins
– Spreads
or Net Interest Margin in case of banking company
6
Allied Bank – Financial Statements
7
Bank’s P&L is closely tied with its Bal. Sheet
 Size (Volume) is related to:
– Earning Assets
– Interest
= Advance, Investments, FI Lending, etc.
Bearing Liabilities = Deposits, Borrowing, etc.
 Net Interest Margin (NIM) is a function of:
– Earning Asset
Mix, Deposit Mix, Interest Rates, etc.
 Other factors influencing profitability
– Non-Interest
Income (Fee income, Dividends, etc.)
– Non-Performing
– Operating
Loans (NPLs)
Efficiencies (i.e., Admin Cost)
8
Factors affecting a bank’s balance sheet/P&L
 Sector Related
– Need
for sector analysis!
– Extends
– Macro
beyond cross-sectional and time-series analysis
factors exert major influence
 Bank Specific
– Understanding
bank’s strategy and competitive strengths and
how they translate into profitability.
9
Sector Analysis
10
Sector Analysis
 Macro-Economy
 Regulatory Regime
 Capital Market
Development
 Develop sector outlook
 Identify key attributes of
relatively superior
banking strategy.
 Global and Regional
Trends
 Cross-sectional & Time
Series Comparisons
(Ratio Analysis)
11
Macro-Economic Factors
 Being an integral part of an economic system, the
banking sector is more sensitive (than most other
sector) to changes in macro-economic factors such as:
– Growth
& Inflation
– Monetary
– Fiscal
Policy
Policy
– External Account
 Understanding the mechanics of linkages between
macroeconomic factors and the banking sector is
therefore extremely important.
12
Banking Deposit Growth vs. M2 Growth
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
Banking Sector Deposit Growth
13
M2 Growth
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
0.0%
Beginning of an economy
14
Individual sells wheat to Govt. for Rs.1,000
GDP growth
Fiscal Deficit
wheat
Individual
Cash
T-bill
Central
Bank
Governmen
t
Cash
15
Individual deposits Rs.1,000 in a bank
16
Bank loans out Rs.800
 Borrower draws down Rs.500 and leaves the remaining
Rs.300 in bank account.
17
Impact of $1.0 million “private” FX inflow
Step-1: $1.0 million remittance received through Bank.
Step-2: Bank sells US$ to SBP, which credits Rs.60 million to the Bank’s
account with SBP  SBP’s NFA increases by $1.0 million.
Step-3: Bank in turn credits the account of recipient of remittance by
Rs.60 million.
18
Examples: Impact on Banking Sector
 ECONOMIC GROWTH
– Higher
GDP Growth  Higher M2 Growth  Faster expansion
in banks’ balance sheets
 EXTERNAL ACCOUNT
– Large
“private” FX inflows  More PKR Liquidity  Higher
deposit growth
 MONETARY POLICY
– Tightening
 Slower credit demand  Slower M2 growth 
Slower growth in banks’ balance sheets. ↑ SPREADS
 FISCAL DEFICIT
– Higher
monetization  More Liquidity  Higher deposit growth
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Regulatory Factors & Capital Market
 MAJOR REGULATORY CHANGES
– Min
Capital of PKR6.0 billion by Dec 2009  Consolidation
– Implementation
of Basel-II from 2008  investment in internal
control systems, credit rating culture, increased risk/exposure
consciousness, etc.
 CAPITAL MARKET DEVELOPMENT
– Banking
Sector and Capital Markets are, in many cases,
alternative channels of intermediation:  Mutual Funds and
Bond Market  slower intermediation through banking channel.
– NSS
reforms have so far helped banking sector more than
developing the capital market.
20
Trends in Pakistani Banking Sector
21
Aggregate Post-tax Profits
100
PKR Billion
90
80
70
60
50
40
30
20
10
-20
22
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
-10
1997
0
Return on Equity (ROE)
30%
20%
10%
-10%
-20%
-30%
-40%
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2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
0%
Return on Assets (ROA)
2.5%
2.0%
1.5%
1.0%
0.5%
-1.0%
-1.5%
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2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
-0.5%
1997
0.0%
Banking Deposit Growth
28.0%
24.0%
CAGR: 13.2% pa
20.0%
16.0%
12.0%
8.0%
4.0%
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2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
0.0%
Advances (Loans) Growth
45.0%
40.0%
35.0%
CAGR: 14.0% pa
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
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2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
0.0%
Higher interest rates  higher spreads
10.0%
18.0%
16.0%
9.0%
14.0%
8.0%
12.0%
10.0%
7.0%
8.0%
6.0%
6.0%
4.0%
5.0%
2.0%
Lending-Deposit Rate Spread
27
T-bill Yield
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
0.0%
1997
4.0%
Net NPLs as % of Net Loans
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
28
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
0.0%
Analyzing a Bank –
Concepts & Application
29
Quantitative Analysis
 FINANCIAL SOUNDNESS
– Profitability
– Solvency
 GROWTH and FUNDING MIX
– Deposits
– Borrowings
– Loans
– Investments
 RISK ASSESSMENT
– Credit
Risk
– Market
Risk
– Liquidity
Risk
30
Risk Assessment
 CREDIT RISK
– Concentration
– How
in fewer sectors.
much of banks’ lending is to pro-cyclical sectors.
 LIQUIDITY RISK
– GAP
Analysis: Difference between a bank’s liabilities and assets
as both mature over time.
 MARKET RISK
– Exposure
to equities, derivatives and bonds.
31
Non-Quantitative Factors
 Ownership
 Market Positioning & Strategy
 Product Mix & Delivery Channels
 Human Resource Quality
 Internal Control Systems
 IT Platform (Core Banking Solution, ATM Network, Online networks, Internet banking, etc. )
 Investor Relations
32
Profit & Loss Statement
33
Balance Sheet
34
Net Profit
5.0
PKR Billion
4.4
4.1
4.0
3.0
3.0
2.0
1.0
0.4
0.2
-1.0
-2.0
-1.5
35
2007
2006
2005
2004
2003
2002
0.0
Return on Assets (ROA)
2.5%
2.0%
2.0%
1.8%
1.4%
1.5%
1.0%
0.3%
0.5%
0.1%
-1.0%
-1.5%
-1.4%
-2.0%
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2007
2006
2005
2004
2003
-0.5%
2002
0.0%
Return on Equity (ROE)
30%
28.6%
26.0%
25%
21.7%
20%
15%
10%
6.1%
5%
-10%
-10.3%
-15%
-20%
37
2007
2006
2005
2004
2003
-5%
2002
0%
Revenue Analysis
38
Net Interest Margin (NIM)
39
Non-Interest Income
40
Balance Sheet Growth - Liabilities
41
Balance Sheet Growth - Assets
42
Loan Book
43
Efficiency Ratio
44
Building financial model of a bank
45
Key Assumptions – Macro/Sector
 Translate economic/sector analysis in forecasts for:
– M2
growth
– Interest
rates
– Deposit
growth
– Advances
growth
 Sources of economic forecasts
– Multilaterals:
– State
IMF/WB/ADB
Bank of Pakistan
– Consensus
forecasts maintained by data services such as
Reuters, Bloomberg, etc.
46
Key Assumptions – Bank Specific
 Balance Sheet – Develop forecasts for:
– Deposit
Growth
– Deposit
Mix
– Borrowing
– Advances
Growth
– Non-Performing
– Investment
– Cash/FI
Loans (NPLs)
Portfolio Mix
lending
 Net Interest Margin (NIM) – Forecast based on:
– Interest
– Cost
Yield = f (interest rates, portfolio mix)
of Funds = f (interest rates, deposit/borrowing mix)
47
Key Assumptions – Bank Specific
 Non-Interest Income
– Fee
– FX
income = f (trade, guarantees, advisory, etc)
income = f (exchange rate, trade, remittances)
– Dividend/Capital
Gains = f (equity portfolio)
 NPL provisioning
– NPL
charge = f (credit risk)
 Administrative Cost
 Taxation Rate (35%)
48
Allied Bank – Key Assumptions
49
Allied Bank – P&L Statement
50
Allied Bank – Balance Sheet
51
Allied Bank – Output Ratio
52
Valuation
53
Key approaches to bank’s valuation
 Distributable Dividend Model
 Price/Book Valuation
– Time
series and/or cross-sectional comparisons.
– Justified
P/BV multiple: [ROE – Growth] / [Re – Growth]
 Price/Earnings Multiple
– Time
series and/or cross-sectional comparisons.
 Market Cap/Deposits
– Adjusted
for NIM, it is a measure of Franchise Value.
54
Justified Price/Book Value
P0
=
Re – G
BV0,1
G
ROE – G
=
P0
: Price at t = 0
BV0,1
: Avg. BV for t = 0 &1
ROE
: Sustainable ROE
G
: Sustainable growth
Re
: Equity Disc. Rate
b
: dividend payout ratio
ROE x (1 – b)
55
Allied Bank – Valuation based on justified P/B
56
THANK YOU.
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