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					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
                                     Company Analysis
        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   sold for an industrial enterprise
   – Asset   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 = Advance, Investments, FI Lending, etc.
    – Interest   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     Loans (NPLs)
    – Operating    Efficiencies (i.e., Admin Cost)


                                      8
Factors affecting a bank’s balance sheet/P&L

 Sector Related
   – Need   for sector analysis!
   – Extends   beyond cross-sectional and time-series analysis
   – Macro   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                 Develop sector outlook
  Development                    Identify key attributes of
                                  relatively superior
 Global and Regional             banking strategy.
  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    Policy
   – Fiscal   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%


0.0%
        1997

               1998

                      1999

                             2000

                                    2001

                                                2002

                                                       2003

                                                              2004

                                                                     2005

                                                                            2006

                                                                                   2007
               Banking Sector Deposit Growth                          M2 Growth

                                           13
Beginning of an economy




                    14
Individual sells wheat to Govt. for Rs.1,000
               GDP growth                   Fiscal Deficit
              wheat                T-bill
                       Governmen                  Central
 Individual
                           t                       Bank
              Cash                 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
                                 19
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
 0
       1997


              1998


                     1999


                            2000


                                   2001


                                               2002


                                                      2003


                                                             2004


                                                                    2005


                                                                           2006


                                                                                  2007
-10
-20

                                          22
Return on Equity (ROE)

30%


20%


10%


 0%
       1997


              1998


                     1999


                            2000


                                   2001


                                               2002


                                                      2003


                                                             2004


                                                                    2005


                                                                           2006


                                                                                  2007
-10%


-20%


-30%


-40%

                                          23
  Return on Assets (ROA)

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%
        1997


               1998


                      1999


                             2000


                                    2001


                                                2002


                                                       2003


                                                              2004


                                                                     2005


                                                                            2006


                                                                                   2007
-0.5%

-1.0%

-1.5%

                                           24
Banking Deposit Growth

28.0%

24.0%
                        CAGR: 13.2% pa
20.0%

16.0%

12.0%

8.0%

4.0%

0.0%
        1997

               1998

                      1999

                             2000

                                    2001

                                                2002

                                                       2003

                                                              2004

                                                                     2005

                                                                            2006

                                                                                   2007
                                           25
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%

0.0%
        1997


               1998


                      1999


                             2000


                                    2001


                                                2002


                                                       2003


                                                              2004


                                                                     2005


                                                                            2006


                                                                                   2007
                                           26
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%

4.0%                                                                                     0.0%
        1997

                1998

                       1999

                              2000

                                     2001

                                            2002

                                                   2003

                                                          2004

                                                                 2005

                                                                        2006

                                                                                  2007
               Lending-Deposit Rate Spread                         T-bill Yield

                                            27
Net NPLs as % of Net Loans

12.0%


10.0%


8.0%


6.0%


4.0%


2.0%


0.0%
        1997


               1998


                      1999


                             2000


                                    2001


                                                2002


                                                       2003


                                                              2004


                                                                     2005


                                                                            2006


                                                                                   2007
                                           28
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   in fewer sectors.
   – How   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, On-
  line 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
0.0
          2002




                     2003




                            2004




                                        2005




                                               2006




                                                      2007
-1.0

         -1.5
-2.0


                                   35
Return on Assets (ROA)

2.5%
                                             2.0%
2.0%                                 1.8%
                                                     1.4%
1.5%

1.0%

0.5%            0.3%
                        0.1%
0.0%
         2002




                 2003




                         2004




                                      2005




                                              2006




                                                      2007
-0.5%

-1.0%

-1.5%
        -1.4%

-2.0%

                                36
Return on Equity (ROE)

30%                                         28.6%
                                    26.0%
25%
                                                    21.7%
20%

15%

10%
                       6.1%
 5%

 0%
       2002




                2003




                        2004




                                     2005




                                             2006




                                                     2007
-5%

-10%
              -10.3%
-15%

-20%

                               37
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:     IMF/WB/ADB
   – State   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       Loans (NPLs)
   – Investment    Portfolio Mix
   – Cash/FI    lending

 Net Interest Margin (NIM) – Forecast based on:
   – Interest   Yield = f (interest rates, portfolio mix)
   – Cost   of Funds = f (interest rates, deposit/borrowing mix)
                                      47
Key Assumptions – Bank Specific

 Non-Interest Income
   – Fee   income = f (trade, guarantees, advisory, etc)
   – FX   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      : Price at t = 0
  P0           ROE – G
        =
                                 BV0,1   : Avg. BV for t = 0 &1
BV0,1           Re – G
                                 ROE     : Sustainable ROE

                                 G       : Sustainable growth
 G      =   ROE x (1 – b)
                                 Re      : Equity Disc. Rate

                                 b       : dividend payout ratio




                            55
Allied Bank – Valuation based on justified P/B




                       56
THANK YOU.




             57

				
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