sri lanka banking sector report - 02 01 2015.pdf

8/10/2019 Sri Lanka Banking Sector Report - 02 01 2015.pdf

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Sector ReportFC ResearchAnalyst: Reshan Wediwardana

SRI LANK

SRI LANKA COMMERCIAL BANKING SECTO

Figure 1: 2014 Price Change

igure 2: Banking Sector vs. ASPI

FC Research expects the banking sector to have a favorable phaseduring 2015-18E with improving credit growth in line with the GDP,margin improvements through enhancing CASA and growthstemming from the overseas operations. Hence we expect ourbanking sector universe to provide 18% average return for 2015E.

Growing GDP may assist banks to boost lending: We expect ab7% GDP growth to support lending mainly driven by growth in SME

and Construction segments alongside development in trade, value-added apparel and tourism sectors. We also expect lending growthflowing in through growth in consumer demand.

Private Sector Credit Growth to grow at a CAGR of 18%: We ecredit growth to pick up to 18-20% in 2015E while credit growth isexpected to continue at 18% through to 2018E. Credit Growth islikely to be ignited by the low interest rate regime in the country andan improvement in the credit to GDP ratio which is likely to reach35% by 2018E vs. current 29%.

Margins to Bottom-out: The struggling Banking sector margins alikely to have bottomed out in 2014E as we expect a recovery in themargins while margins in the medium is likely to be maintained at3.5%. Enhancement in CASA and re-pricing of FDs are likely adjustcost of funding downwards improving the margins.

Improving Asset Quality through diversified lending baseexpect sector non-performing loans to decline with improvingeconomic conditions and expected larger recoveries in selectedbanks. Further diversification in loan books may further assist banksto lower their exposure by expanding the risk appetite.

FC Research Coverage to provide 18% avg. return: We recomma BUYon NTB HNB X COMB X SEYB N and SEYB X counters

2014E 2015E 2014E 2015E

Commercial Bank - Voting HOLD 137,747 170.0 173.0 2% 12.6x 9.1x 2.1x 1.9x 10.1 6%

Commercial Bank - Non-Voting BUY 137,747 124.0 133.0 7% 9.2x 6.6x 1.6x 1.4x 10.1 8% 1

Hatton National Bank - Voting HOLD 62,504 194.1 198.0 2% 9.1x 7.8x 1.2x 1.1x 11.1 6%

Hatton National Bank - Non Voting BUY 62,504 150.0 161.0 7% 7.1x 6.1x 0.9x 0.8x 11.1 7% 1

ampath Bank HOLD 39,459 235.0 254.0 8% 8.5x 7.1x 1.1x 1.0x 13.3 6% 1

National Development Bank HOLD 40,299 245.0 248.0 1% 11.0x 8.3x 1.5x 1.3x 14.8 6%

Nations Trust Bank BUY 22,254 96.5 109.0 13% 8.1x 6.7x 1.6x 1.4x 3.7 4% 1

eylan Bank - Voting BUY 16,542 94.0 110.0 17% 9.2x 6.8x 1.3x 1.1x 3.4 4% 2

eylan Bank - Non-Voting BUY 16,542 57.5 66.0 15% 5.7x 4.2x 0.8x 0.7x 3.4 6% 2

ToRe

PER (x) PBV (x)Stock

Recommendation

PriceTargetPrice

Upside(%)

DPS2015E

DividendYield2015E

Mkt. Cap(LKR mn)

Struggle Ends Prosperity Begins 2 January 2015

(Source: CSE)


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FC ResearchStruggle Ends Prosperity egins

Banking Sector Report 2 1

Table of ontents

1.0 Introduction of Commercial banking sector .................................................................................... 3

1.1 State Banks retain a dominant presence with higher market share ............................ 31.2 Banking sector struggle in 2012-14 ........................................................................................... 3

1.3 Pawning Debacle in 2013 attributes to slow private sector credit growth ................................ 4

2.0 Growing GDP may assist banks to boost lending ............................................................................ 6

2.1 Continuous progress towards achieving future GDP growth ........................................ 6

2.2 SME and Construction sector drive lending growth .......................................................... 6

2.3 Growth in consumer demand to boost lending ................................................................... 8

3.0 Private Sector Credit Growth to grow at a CAGR of 18% ................................................................ 9

3.1 Low interest rate regime is likely to attract borrowers ................................................ 9

3.2 Private sector credit to reach 35% of GDP ........................................................................ 10

4.0 Margins to Bottom-out .................................................................................................................. 12

4.1 Lower cost of funding due to enhancement in CASA ................................................... 124.2 Margins to revert back to 3.5% ........................................................................................... 13

5.0 Selected Banks to thrive through cost management, improved asset quality and regionalpresence ............................................................................................................................................... 15

5.1 Effective cost-income management to thrive profitability .......................................... 15

5.2 Improving Asset Quality through diversified lending ................................................... 16

5.3 Banks with regional presence may benefit from growing economic conditions in the

region ........................................................................................................................... 18

6.0 FC Research Commercial Banking Sector Coverage to Provide 18% Return for 2015E .............. 19

6.1 Sri Lanka Banks are still cheaper compared to other banks in frontier markets .19

6.2 FC Research Top Banking Sector Buys: NTB, SEYB, SEYB.X, COMB.X, HNB.X .19

6.3 FC Research Banking Sector HOLD List: COMB.N, HNB.N, SAMP, NDB .22

7.0 Appendices ..................................................................................................................................... 24


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1.0 Introduction of Commercial banking sector

1.1 State Banks retain a dominant presence with highermarket share

Sri Lanka s Commercial Banking sector consists of 13 local banks and12 foreign banks which account for LKR 5.1bn (USD 40bn) asset base.From the overall banking sector, Private sector domestic commercialbanks hold 46% of the market share and two of the giant state bankshold 44%.

1.2 Banking sector struggle in 2012-14

Challenging 2014 with lower loan growth and shrinking margins:2014 banking sector core profitability came down drastically due tonarrowing interest margins and subdued loan growth. However theprofitability improved due to one-off profits that arose from thetrading income with lowering interest rate in the economy and lower

impairment charges compared to 2013.Banking Sector 2005-13 Asset CAGR of 16% despite 2012-14 slowgrowth: The Banking sector has been experiencing a higher assetCAGR of 16% throughout the past 9 years with significant supportfrom higher interest margins that prevailed in the economy.However, the latter few years (2012-2014) saw some challengingconditions in the sector amidst heavy pawning related impairmentwrite-offs and subdued loan growth which hurt overall profitability.However, the sector emerged with applying different strategieswhich suites for all these issues. Further the current lower interest

rate regime has also caused banks to narrow their margins and thismay lead to short term difficulties.

Figure 4: Banking Asset Segmentation

State OwnedBanks 44%

ForeignCommercialBanks 11%

COMB 13%

HNB, 10%

SAMP8%

SEYB

NDB 4%

NTB 3

DFCVarda

a 2%PABC 1%

UBC 1%

Private SectorCommercialBanks 46%

1,573

5,112

2005 2013

Figure 3: Commercial Bank Assets (LKR Bn)

(Source: CBSL)

(Source: CBSL, Company annual & quarterly reports)


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Banking Sector

New Era of Growth: The current finance sector

consolidation process, innovative strategies of new entrants and apositive turnaround in the economy have led Sri Lanka Banking sectorenter into a new era of growth.

1.3 Pawning Debacle in 2013 attributes to slow Privatesector credit growth

Impact arising from declining pawning advances: Sri Lankan bankswith higher gold exposure, especially two of the largest government-owned commercial banks, recorded negative loan growth due to

declining pawning advances. Further, this has led banks to recordhigher impairment write-offs which again hurt their profitability.

Impact imminent from global gold price dip: Typically, gold is viewedas an inflation hedge and safe haven investment by global investors.Thus, gold prices are to a large extent influenced by a set of relatedfactors including the macroeconomic outlook for the U.S. and worldeconomies, the performance of alternative assets such as equitiesand the U.S. Dollar, the trajectory of interest rates and geopoliticaluncertainty.

100

150

200

250

300

350

400

5%

6%

7%

8%

9%

10%

11%

12%

13%

14%

15%

2009 2010 2011 2012 2013 Mar-14

P a w n i n g - L

K R b n

P a w n i n g a s a % o f G r o s s

l o a n s a n

d

a d v a n c e s

Figure 7: Pawning vs. Total Loan ExposureFigure 6: Gold Spot Price

Figure 5: Net Interest Margin Banking Sector

4.4%4.5%

4.7% 4.6%4.6%

4.2%4.1%

3.5%

2.90

2006 2007 2008 2009 2010 2011 2012 2013 2014E

Source: CBSL

1000

1100

1200

1300

1400

1500

1600

1700

1800

1900

2000

Dec-09 Feb-11 Apr-12 Jun-13 Aug-14

USD/toz.


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Figure 9: Loan growth as of 9M2014Figure 8: Private Sector Credit Growth - Monthly

0%

5%

10%

15%

20%

25%

30%

35%

40%

P r i v a t e s e c t o r C r e d i t G r o w t h - Y o Y - M o n t h l y

3%4%

15%

9%

20%

2%

17%

6%

11%

-2%

-5

-10%

-5%

0%

5%

10%

15%

20%

25%

SAMP HNB COMB NTB NDB SEYB PABC UBC DFCC V BOC

L o a n g r o w t h - . Y

T D

49%44%

33%27%

46%40%

47%

36%

18%

17%

17%19%

14% 30%

27%

24%

13%

1%15%

1%

19% 1%

4%

18%

1%

7%10%

1%

0%

6%

3%7%5%

6%

6%

27%

6%6%

11%9%

1%

2%

2%

3%

1% 3%

1%1%

1%

10% 2% 12%0% 2%

1%0%12% 13% 15%

10% 14% 13%7% 5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

COMB HNB SAMP NTB NDB SEYB PABC UBC

Term loans Overdrafts Trade Finance Pawning Lease rentals receivable Staff loans Credit Cards Others

Figure 10: Loan Book Diversification 9M2014

Source: Bankss Quarterl Statements

Source: Bankss Quarterl StatementsSource: CBSL


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2.0 Growing GDP may assist banks to boost lending

We expect above 7% GDP growth to support lending mainly drivenby the expansion of the Industrial and Service sectors. Expansion ofthe sectors is likely to lead to lending growth in the SME and

construction segments alongside development in trade, value-added apparel and tourism sectors. We also expect lending growthto flow in through growth in consumer demand.

2.1 Continuous progress towards achieving future GDP growth

Healthy GDP growth above 7% to continue: We expect the economyto grow above 7% with the main contribution coming from theIndustrial sector. The Manufacturing sector will continue to play a

pivotal role in the countrys economic expansion with further supportfrom improved value added production from the Agriculture andService sectors.

GDP enjoyed strong growth over the last 4 years: Sri Lankaeconomy has entered a tremendous growth phase after the end ofcivil war in 2009. Since then, the country has been able to maintainthe GDP growth rate above 6% supported by stable economic stance.The Governments expansionary economic policie s and growth in theIndustrial sector is expected to fuel future economic growth.

2.2 SME and Construction sector drive lending growth

Expansionary policies result in more lending: We expect prevailingeconomic expansionary polices to continue in the next couple ofyears by providing a platform to expand existing major economicactivities (Consumption, Government Expenditure and Investments).Hence, we expect small and medium entrepreneurship sectors toplay a vital role by expanding their businesses in order to cater higherdemand soar from both locally and internationally. Further,

construction related activities may also drive growth consistent withthe developing tourism industry and enhancing governmenti f t t j t

GDP Growth Forecast 2013 2014E 2015ECBSL 7.3% 7.8% 8.2%World Bank 7.2% 6.9%

MF 7.0% 6.5%Standard Charted 7.5% 7.8%

Average 7.3% 7.4% 7.4%

6.8%6.0%

3.5%

8.0% 8.2%

6.3%7.3% 7.4% 7.0%

0.0%

2.0%

4.0%6.0%

8.0%

10.0%

2007 2008 2009 2010 2011 2012 2013 2014E 2015E

Figure 12: Annual GDP growth (Real)Figure 11: Quarterly GDP growth (Real)

4.8%

6.3% 6.1%6.8%

7.9% 8.2% 7.6% 7.8%

0.0%

2.0%

4.0%6.0%

8.0%

0.0%

3Q2012 4Q2012 1Q2013 2Q2013 3Q2013 4Q2013 1Q2014 2Q2014

(Source: Department of Statistics and Consensus) (Source: Department of Statistics and Consensus)


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Relationship between GDP and the private sector credit growth:Private sector investment play a key role in an expansionary economyproviding greater support by enhancing the domestic production.Over the past few decades, Sri Lanka has sighted how Private sectorborrowing helped to achieve intended economic growth by providingnecessary funding.

Improving Industrial sector driven growth and related borrowings:Since 2006 economic growth has been mainly driven by theconstruction-led Industrial sector. The Manufacturing and Apparelsectors too have played a vital role in economic growth during therecent period.

0

0

0

0

0

0

0

2006 2007 2008 2009 2010 2011 2012

Agriculture Industry Services

Figure 13: Annual GDP growth Index

Industrial Sector growth CAGR of8.1% compared to diminishinggrowth in Agriculture and Service

Sectors.

Figure 15: Private sector credit growth vs. GDP

Figure 14: GDP growth vs. Construction Sector Growth

0%

5%

10%

15%

20%

25%

Construction Sector GDP

-4%

-2%

0%

2%

4%

6%

8%

10%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

P S C G r o w t h - Y o Y

Private Sector Credit Growth GDP Growth

Source: De artment o Statistics and Consensus and CBSL

(Source: Department of Statistics and Consensus)

(Source: Department of Statistics and Consensus)


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2.3 Growth in consumer demand to boost lending

Growing consumer demand to support growth : We expectconsumer demand to boost in 2015 by main driver stemming fromthe borrowings against leasing consistent with the tariff cut granted

from the budget 2015. Further with the increasing per capita income,credit card related borrowings may also expect to enhance withchanging life style of the consumers buying patterns.

-

50

100

150

200

250

300

2009 2010 2011 2012 2013 2014E

N o : o f V e h i c l e s - ' 0 0 0

Private Cars Motor Cycles Three Wheelers0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

2009 2010 2011 2012 2013 2014E

V e h i c l e i m p o r t a s a % o f T o t a

l I m p o r t s

Figure 18: Vehicle import as a % of Total ImportsFigure 17: New Motor Vehicle Registration

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

200,000

300,000

400,000

500,000

600,000

700,000

C r e d i t C a r d R e

l a t e

d L o a n s - L K R m n

Per capita GDP at market prices (Rs.) Credit Cards Loans (LKR mn)

There is a 95% correlation betweenPercapita Income and credit cardrelated loans in Sri Lanka with 2004-

2013 CAGR of 20%. Hence alongwith our growth targets in GDP, weexpect 2013 to 2016 CAGR of 16% incredit card related loan segment.

Figure 16: Relationship between CC Related Loans and Percapita

(Source: CBSL and FC Research Estimates)

(Source: Department of Motor Traffic and FC Research

Estimates)



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3.0 Private Sector Credit Growth to grow at a CAGRof 18%

We expect credit growth to pick up to 18-20% in FY15E while creditgrowth is expected to continue at 18% through to 2018E. Creditgrowth is likely to be ignited by the low interest regime in thecountry and an improvement in the credit to GDP ratio which islikely to reach 35% by 2018E vs. current 29%.

3.1 Low interest rate regime is likely to attract borrowers

Declining inflation to steer low interest rate: In 2015E, we expectinflation to remain at current levels with possible decline in prices ofglobal energy commodities. In 2014 inflation came below 5% due to

the substantial decline in fuel and energy commodity prices. Henceoccasional policy rate cuts in line with lower inflation to fostereconomic growth has resulted a lower interest rate regime.

Figure 19: CCPI (2006/07 =100)

0%

2%

4%

6%

8%

10%

12%

Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14

YoY Annual Average

44

54

64

74

84

94

104114

W T I C r u d e O i l - U

S D / B a r r e

l

WTI Crude Oil

Figure 20: LPG Prices Figure 21: WTI Crude Oil Prices

0.70.80.9

11.11.21.31.41.51.61.7

P r o p a n e - U

S d / G a l

l o n

LPG Prices

(Source: Department Census and Statistics)


10/26



Excess liquidity in the market may further support lower interestrate: Prevailing higher market liquidity and limited investmentalternatives may further support banks to retain lower interest rateregime for a greater span of time.

3.2 Private sector credit to reach 35% of GDP

Private sector credit to reach 35% of GDP: We expect Sri LankaPrivate sector credit growth to revive aggressively reaching 35% ofGDP by 2018E. Currently, Credit to private sector stands at 29% in SriLanka lagging behind its peers in lower middle income categorycompared to lower middle income average of 35%. Mainly attributing

to subdued loan growth which prevailed in the economy in lastcouple of years.

2,534

5,380

2013 2018E

CAGR 18%2.1X

Figure 22: CBSL Holdings of Government Securities

0

50

100

150

200

250

300

J a n - 0 7

A p r - 0 7

A u g - 0 7

N o v - 0

7

M a r - 0

8

J u n - 0 8

O c t - 0

8

J a n - 0 9

M a y - 0

9

S e p - 0 9

D e c - 0

9

A p r - 1 0

J u l - 1 0

N o v - 1

0

M a r - 1

1

J u n - 1 1

O c t - 1

1

J a n - 1 2

M a y - 1

2

A u g - 1 2

D e c - 1

2

M a r - 1

3

J u l - 1 3

O c t - 1

3

F e b - 1 4

M a y -

4

L K R

b n

Figure 23: Private sector credit as a % of GDP

(Source: CBSL)

(Source: FC Research Estimates and CBSL)


11/26



Pawning crisis led to the credit growth decline: Private sector creditdeclined to the level of 29% of GDP in 2013 in a volatile manner due

to pawning crisis. In 2006, this boosted up to 34% and dipped downto 25% in 2009 due to political uncertainty that prevailed in thecountry. We believe that the current growth momentum has apossibility for Private sector credit to reach back to previous levelswith favorable macro conditions.

29% 28%28%

29%

31%

33%

34%

33%

29%

25%

27%

31%

31%

29

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

Figure 25: Private sector credit as a % of GDP

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

0%

V i e t n a m

U k r a i n e

M o r o c c o

V a n u a t u

M o n g o

l i a

C a b o V e r d e

H o n

d u r a s

I n d i a

B o l i v i a

S a m o a

A r m e n i a

P a r a g u a y

B h u t a n

G u y a n a

E l S a

l v a d o r

M o l

d o v a

G e o r g i a

I n d o n e s i a

P h i l i p p i n e s

K o s o v o

P a p u a N e w G u i n e a

S o l o m o n I s

l a n d s

G u a t e m a l a

S e n e g a

l

S a o T o m e a n

d P r i n c i p e

D j i b o u t i

S r i L a n

k a

N i c a r a g u a

E g y p t , A r a

b R e p .

S w a z i l a n d

L e s o t h o

M i c r o n e s i a , F e

d . S t s .

C o t e

d ' I v o i r e

G h a n a

P a k i s t a n

C a m e r o o n

Z a m

b i a

C o n g o , R e p .

T i m o r - L

e s t e

S u d a n

Figure 24: Private Sector Credit as a % of GDP

(Source: World Bank)

(Source: C


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4.0 Margins to Bottom-out

The struggling Banking sector margins are likely to have bottomedout in 2014E as FC Research expects a recovery in the margins whilemargins in the medium is likely to be maintained at 3.5%.

Enhancement in CASA and re-pricing of FDs are likely adjust cost of funding downwards improving the margins. Improving macro-economic conditions resulting in the ability to maintain low interestrate regime is likely prevent margins from reaching high levels of anaverage of 4.5% mark.

4.1 Lower cost of funding due to enhancement in CASA

CASA improvement through minor switching effect: We expect costof funding to descend from 2015E with improving CASA by makingfixed deposits slighter attractive for depositors due to lower spreadbetween savings deposits and FDs. Because drastic reduction in fixeddeposit rates may demotivate clients to shift from saving deposits tofixed deposits which provide higher returns.

Reverting CASA ratio amidst Financial Sector Consolidation : Wexpect CASA ratio to reverse back to the positive levels due to lowercompetition stemming from the Non-banking and finance sector inthe face of the consolidation process being implemented by the

Central Bank. It will further enable banks to reduce their cost offunding significantly and CASA ratio has already shown signs ofimprovement during 1H2014.

Figure 26: Commercial Bank CASA vs. CB Market Share

79%

80%

81%

82%

83%

84%

85%

86%

35%

40%

45%

50%

55%

60%

1998 2000 2002 2004 2006 2008 2010 2012* Q1,2014*

C A S A

CASA Market Share - CB (Source: CBSL)

41% 42%

46%

29%27%

37%

29%

20%

26%

39% 41%

25%

30%

35%

40%

45%

50%

C A S A 2013 9M2014

Figure 28: CASA Improvement

8.8%

5.3%

11.8%

8.6%

16.1%

4.4%

16.4%

4.5%

-1.5%

6.2%

4.1%

Figure 27: Deposit growth


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4.2 Margins to revert back to 3.5%

Margins to recover with re-pricing of FDs and higher CASA: With thsteep drop in deposit rates during the last 6 months, fixed depositswhich are a major component of overall bank deposit base are likelyto re-price at lower rates during 2015E resulting in a recovery ofmargins. Further, the expected growth in CASA ratio may alsosupport margins.

Margins to recover and maintain at 3.5% in the medium term:Following the re-pricing adjustment and the recovery in creditgrowth, we believe Sri Lanka banking sector margins to reach back to3.5% and r emain at that level in the medium term. Sri Lankas growthtrajectory which creates demand for lending and the current financialsector consolidation will also help to maintain NIMs around the 3.5%

Figure 29: Banking Sector - NIMs

4.4%4.5%

4.7%4.6%

4.6%

4.2%4.1%

3.5%

2.9%3.1%

3.4%

3.5%3


Figure 30: Quarterly NIMs

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

Q u a r t a r

l y N I m s

COMB HNB SEYB SAMP

(Source: Banks s Quarterly Reports)


14/26



Temporary Distress due to Asset-Liability mismatch: The overalBanking sector has been experiencing a tough time due to heavydecline in pawning related loans along with stagnant overall creditgrowth which has been a primary reason for the declining margins.

6%

8%

10%

12%

14%

16%

18%

J a n - 0 1

J a n - 0 2

J a n - 0 3

J a n - 0 4

J a n - 0 5

J a n - 0 6

J a n - 0 7

J a n - 0 8

J a n - 0 9

J a n - 1 0

J a n - 1 1

J a n - 1 2

J a n - 1 3

J a n - 1 4

A W F D R - M

o n t h

l y

Figure 32: AWFDR - Monthly

Figure 31: AWPR vs. AWDR (1996 to Present)

(5.00)

-

5.00

10.00

15.00

20.00

25.00

AWPR AWDR Spread

(Source: CB

(Source: CBS


15/26



5.0 Selected Banks to thrive through costmanagement, improved asset quality andregional presence

5.1 Effective cost-income management to thrive profitability

We expect selected banking counters to perform exceptionally wellthrough improved cost management strategies and continuous

progress towards achieving greater core income through developedmarketing abilities and diversity in income generation.

Diversity in Income generation: Banks with diversified incomesources where income generation is done through different sourceshave greater ability of maintaining stable profitability. Despite thelowering margins these counters have been able to improveprofitability through other income sources.

Figure 33: Cost to Income ratio

45%

55%

65%

75%

85%

95%

105%

SAMP HNB COMB NTB NDB SEYB PABC UBC DFCCV

BOC PB

C o s t - t

o - I n c o m e

9M2013 9M2014

Figure 34: Fee Based Income as a % of Total Income

5%

10%

15%

20%

25%

30%

SAMP HNB COMB NTB NDB SEYB PABC UBC DFCC

V

BOC F e e B a s e

d I n c o m e a s a % o f T o t a l

I n c o m e

9M2013 9M2014

(Source: Quarterly reports)


16/26



Effective cost management Selected banking counters havemanaged to enhance their profitability by enhancing the efficiency ofoperations by reducing the cost. Further, implementation of leanmanagement philosophy has also enabled them to lower costthrough enhancing automation of activities and efficiency of theroutine work.

5.2 Improving Asset Quality through diversified lending base

We expect Banking sector non-performing loans to decline withimproving economic conditions and expected larger recoveries inselected banks. Further diversification in loan books may furtherassist banks to lower their exposure by expanding the risk appetite.

-

10

20

30

40

50

60


BOC PB

C o s t p e r B r a n c

h - L

K R M n

Cost per branch -9M2013 Cost per branch -9M2014

Figure 36: Cost per branch

Figure 35: Revenue Per Employee

1.0

1.5

2.0

2.5

3.0

3.54.0

4.5

5.0

5.5


BOC PB R e v e n u e P e r E m p l o y e e - L

K R M n

Revenue per employee ( Core Income) -9M2013

Revenue per employee ( Core Income) -9M2014




17/26



Economic growth related asset quality: Non-performing advances ofCommercial banking sector has been declining in the past few yearsdue to favorable macro-economic environment. Therefore, weexpect NPL to increase marginally in 2014 and 2015 due to deprivedgrowth momentum and reach the lower middle income country

average of 5.7% in 2018E.

Figure 37: Gross NPLs vs. GDP Growth

-4%

-2%

0%

2%

4%

6%

8%

10%

6%

7%

8%

9%

10%11%

12%

13%

14%

15%

16%

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

w

G r o s s N P L s a s a % o f L l o a n s

Gross Non-performing Advances Ratio GDP Growth

2.7%3.6% 3.9% 3.5%

2.5%

10.6%

8.0% 8.2%

5.1%4.3%

4.9%

0%

2%

4%

6%

8%

10%

12%

14%

G r o s s N P L s

9M2014 2013

Figure 38: Gross NPLs as at 30 September 2014

(Source: CBSL)



18/26



5.3 Banks with regional presence may benefit from growingeconomic conditions in the region

We expect local banks to expand their presence into other growingregional destinations in order to utilize their potential. Currently

few banks have been able to cater into these markets enjoying withhigher profitability.

Superior Returns with Risk Management : Sri Lankas locacommercial banks have expanded their presence in other countriesin the region which has led to enjoy better economic conditions inthose countries. Hence this has enabled banks to generate superiorreturns amidst providing effective geographical risk managementprocess.

COMB Presence in Bangladesh: Currently COMB holds a

considerable market share in Bangladesh s Banking sector andrecorded a 2003-13 loan growth CAGR of 19%. Currently theBangladesh operations provide 13% PAT to the group profitability.We expect substantial growth to be immense from Bangladesh withgrowing Apparel sector (With GSP+) and export oriented Agriculturalsector.

Factors BangaladeshPopulation (Mn) 158.2

( )

Factors Sri LankaPopulation (Mn) 21.0

Figure 39: Growth potential in Bangladesh


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6.0 FC Research Commercial Banking SectorCoverage to Provide 18% Return for 2015E

6.1 Sri Lanka Banks are still cheaper compared to otherbanks in frontier markets

MSCI Frontier Market Index: Sri Lankas banks are still be hind mosof the peers in MSCI Frontier Market Index reflecting a potential forfurther price upside. This may attract foreign investors providinggreater returns compared to other banks in frontier markets.

6.3 FC Research Top Banking Sector Buys:NTB, SEYB.N, SEYB.X, COMB.X, HNB.X

Figure 40: PER Comparison with Banks in MSCI FrontierMarkets Index

.7x 16.5x 16.1x14.0x

13.0x11.5x 10.8x

7.2x 7.1x5.4x

3.4x 2.7x

N a t i o n a l B a n k o f K u w a i t

A t t i j a r i w a f aB

a n k

B u r g a nB a n

k S A K

M C B B

a n k L t d

A l - S a l a m B a n k

E q u i t y

B a n k L t d

S r i L a n k a nB

a n k s

G u a r a n t y T r u s t B

a n k P L C

B a n k M u s c a t S A O G

Z e n i t h

B a n k P L C

H a l y k S a v i n g s B

a n k o f

K az a k h s t a n J S C

U n i t e d B a n

k f o r A f r i c a P L C

Figure 41: PBV Comparison with Banks in MSCI FrontierMarkets Index

3.1x2.6x

1.9x 1.8x1.6x

1.4x1.2x

1.0x 1.0x0.8x 0.7x

0.5

E q u i t y B

a n k L t d

M C B B

a n k L t d

A t t i j a r i w a f aB

a n k

G u a r a n t y T r u s t B

a n k P L C

N a t i o n a l B a n k o f K u w a i t

S A K P

S r i L a n k a nB

a n k s

B u r g a nB a n

k S A K

B a n k M

u s c a t S A O G

Z e n i t h B

a n k P L C

H a l y k S a v i n g s B

a n k o f

K az a k h s t a n J S C

A l - S a l a m B

a n k

U n i t e d

B a n k f o r A f r i c a P L C(Source: Bloomberg and MSCI)(Source: Bloomberg and MSCI)

2014E 2015E 2014E 2015E

Commercial Bank - Voting HOLD 137,747 170.0 173.0 2% 12.6x 9.1x 2.1x 1.9x 10.1 6%

Commercial Bank - Non-Voting BUY 137,747 124.0 133.0 7% 9.2x 6.6x 1.6x 1.4x 10.1 8%

Hatton National Bank - Voting HOLD 62,504 194.1 198.0 2% 9.1x 7.8x 1.2x 1.1x 11.1 6%

Hatton National Bank - Non Voting BUY 62,504 150.0 161.0 7% 7.1x 6.1x 0.9x 0.8x 11.1 7%

Sampath Bank HOLD 39,459 235.0 254.0 8% 8.5x 7.1x 1.1x 1.0x 13.3 6%

National Development Bank HOLD 40,299 245.0 248.0 1% 11.0x 8.3x 1.5x 1.3x 14.8 6%

Nations Trust Bank BUY 22,254 96.5 109.0 13% 8.1x 6.7x 1.6x 1.4x 3.7 4%

Seylan Bank - Voting BUY 16,542 94.0 110.0 17% 9.2x 6.8x 1.3x 1.1x 3.4 4%

Seylan Bank - Non-Voting BUY 16,542 57.5 66.0 15% 5.7x 4.2x 0.8x 0.7x 3.4 6%

R

PER (x) PBV (x)Stock

Recommendation

PriceTargetPrice

Upside(%)

DPS2015E

DividendYield2015E

Mkt. Cap(LKR mn)


20/26



Nations Trust Bank (Target Price: 109, Total Return: +17%): NTBhigh yielding market leadership in credit card business and leasingportfolio is expected to maintain its NIM above its peers despiteoperating in a lower interest rate regime. Further, higher fee basedincome may also expect to assist bank to thrive its topline. [RefeFigure 10 & 34 for detailed analysis]

1.9x

1.4x

1.1x

0.8x1.0x

1.3x1.4x

1.1x

0.7x

9.1x

6.6x

7.8x

6.1x

7.1x

8.3x

6.7x 6.8x

4.2x

Figure 42: Forward PER of FC Research Coverage Figure 43: Forward PBV of FC Research Coverage

P/E 31 Dec 2011 2012 2013 2014E 2015E 2015E

Net Interest Income (LKR mn) 4,404 5,755 7,675 9,013 10,144 12,32

Net Profit (LKR mn) 1,607 1,935 2,136 2,750 3,300 4,36

EPS (LKR) 7.0 8.4 9.3 11.9 14.3 18

YoY % Growth 20% 10% 29% 20%Valuations

PER (x) 13.8x 11.5x 10.4x 8.1x 6.7x 5

PBV (x) 3.3x 2.6x 2.2x 1.9x 1.6x 1

Dividend Yield (%) 2.1% 2.2% 2.2% 3.2% 3.9% 5

NAVPS 37.4 43.8 50.9 59.7 70.3 84

Adjusted DPS (LKR) 2.0 2.1 2.1 3.1 3.7 4

Dividend Payout 29% 25% 23% 26% 26% 2

Expected NTB price for 2015E

PER based target price 107.3 Justified PBV based target price 110.3

Average Target Price 108.8

Figure 44: Dividend Yield 2015E

5.9%

8.1%

5.7%

7.4%

5.7% 6.0%

3.8% 3.6%

5.9%

Source: FC Research Estimates Source: FC Research Estimates

(Source: FC Research Estimates)


21/26



Commercial Bank Non-Voting (Target Price: 133, Total Return:+15%): We expect COMB to register a higher profitability byexpanding its loan books in both its Sri Lanka and Bangladeshoperations. Higher CASA base may also assist the bank to maintain itscost of funding at a lower level compared to other banking counters.

With COMBs strong m arket position in Bangladesh highercontribution from the growing Bangladesh market is an addedadvantage for the Group. COMB now looks at Myanmar as its nextlocation of regional expansion. [Refer Figure 9 & 35 for detailedanalysis]

Hatton National Bank Non-Voting (Target Price: 151, Total Return:

+16%): HNBs higher CASA base and improving core profitability mayassist bank to improve its profitability while maintaining higherdividend payout ratio. [Refer Figure 26 & 28 for detailed analysis]

Expected COMB.X price for 2015E

PER based target price - Voting 187 Justi fi ed PBV based targe t price - Voting 157 Average Target Price 172.2 Voting non-voting Spread 23%

Average Target Price 133

Expected HNB.X price for 2015E

PER based target price - Voting 197 Justified PBV based target price - Voting 198 Average Target Price 197.6 Voting non-voting Spread 20%Average Target Price 159

P/E 31 Dec 2011 2012 2013 2014E 2015E 2016E

Net In terest Income (LKR mn) 18,678 22,852 25,322 25,742 31,740 39,1

Net Profit (LKR mn) 7,932 10,080 10,563 11,703 16,220 19,3

EPS (LKR) 9.2 11.6 12.2 13.5 18.7 2


Non-Voting - PER (x) 13.8x 10.8x 10.3x 9.3x 6.7x

Non-Voting - PBV (x) 2.5x 2.1x 1.8x 1.6x 1.4x

Non-Voting - Dividend Yield ( 4.5% 5.0% 5.0% 5.8% 8.0%

NAVPS 51.0 61.2 71.0 79.2 90.6 10

Adjusted DPS (LKR) 5.7 6.3 6.3 7.3 10.1 1

Dividend Payout 62% 54% 51% 54% 54%

P/E 31 Dec 2011 2012 2013 2014E 2015E 2016E

Net Interest Income (LKR mn) 16,920 22,424 25,050 25,078 27,713 32

Net Profit (LKR mn) 6,819 8,111 7,650 8,530 9,933 13

EPS (LKR) 17.0 20.2 19.0 21.2 24.7

YoY % Growth 19% -6% 11% 16%Valuations


Non-Voting - PBV (x) 1.5x 1.2x 1.1x 1.0x 0.9xNon-Voting - Dividend Yield (%) 4.7% 5.4% 5.4% 6.1% 7.1%

NAVPS 103.5 129.6 143.3 159.4 177.4 2

Adjusted DPS (LKR) 7.3 8.4 8.4 9.6 11.1



22/26



Seylan Bank Voting (Target Price: 110, Total Return: +21%) and Non-Voting (Target Price: 66, Total Return: +21%): SEYBs improving cost-to-income ratio and possible recovery in selected large default loanbase and aggressive lending stance may assist the bank to register ahigher return in 2015E. [Refer Figure 9, 33 & 35 for detailed analysis]

6.2 FC Research Banking Sector HOLD List:COMB.N, HNB.N, SAMP, NDB

Commercial Bank - Voting (Target Price: 173, Total Return: +8%)

Hatton National Bank - Voting (Target Price: 198, Total Return: +8%)

P/E 31 Dec 2011 2012 2013 2014E 2015E 2016E

Net Interest Income (LKR mn) 8,605 9,034 9,861 10,818 12,775 16,

Net Profit (LKR mn) 676 2,075 2,326 3,472 4,714 6,2

EPS (LKR) 1.9 6.1 6.8 10.2 13.8 1


Voting - PER (x) 48.7x 15.5x 13.8x 9.2x 6.8x

Voting - PBV (x) 1.8x 1.7x 1.4x 1.3x 1.1x

Voting - Dividend Yield (%) 0.8% 1.0% 2.1% 2.7% 3.6%


Non-Voting - PBV (x) 1.1x 1.0x 0.9x 0.8x 0.7x

Non-Voting - Dividend Yield (%) 1.3% 1.7% 3.4% 4.4% 6.0%

NAVPS 51.7 56.2 65.7 73.2 83.5 9 Adjusted DPS (LKR) 0.7 1.0 2.0 2.5 3.4


P/E 31 Dec 2011 2012 2013 2014E 2015E 2016E

Net In terest Income (LKR mn) 18 ,678 22,852 25,322 25,742 31,740 39

Net Profit (LKR mn) 7,932 10,080 10,563 11,703 16,220 19 EPS (LKR) 9.2 11.6 12.2 13.5 18.7





NAVPS 51.0 61.2 71.0 79.2 90.6 1

Adjusted DPS (LKR) 5.7 6.3 6.3 7.3 10.1


Expected SEYB price for 2015E

PER based target price 124 Justified PBV based target price 95 Average Target Price 109

Voting non-voting Spread 40%Average Target Price 66

Expected COMB.N price for 2015E

PER based target price - Voting 187.3

ustified PBV based target price - Voting 157.0 Average Target Price 172.2

P/E 31 Dec 2011 2012 2013 2014E 2015E 2016E

Net Interest Income (LKR mn) 16,920 22,424 25,050 25,078 27,713 32

Net Profit (LKR mn) 6,819 8,111 7,650 8,530 9,933 13

EPS (LKR) 17.0 20.2 19.0 21.2 24.7





NAVPS 103.5 129.6 143.3 159.4 177.4 2

Adjusted DPS (LKR) 7.3 8.4 8.4 9.6 11.1


xpected HNB price for 2015E

ER based target price - Voting 197 ustified PBV based target price - Voting 198

Average Target Price 198


23/26



Sampath Bank (Target Price: 254, Total Return: +14%)

National Development Bank (Target Price: 248, Total Return: +7%)

Expected SAMP price for 2015E

PER based target price - Voting 266.2 ustified PBV based target price - Voting 240.8


P/E 31 Dec 2012 2013 2014E 2015E 2016E

Net Interest Income (LKR mn) 12,039 15,095 15,591 16,657 19,911 Net Profit (LKR mn) 5,437 3,635 4,755 5,907 7,418

EPS (LKR) 33.4 21.7 27.6 33.3 40.3 YoY % Growth -33% 31% 24% 2Valuations

PER (x) 7.2x 11.0x 8.7x 7.2x 5.9PBV (x) 1.4x 1.2x 1.1x 1.0x 0.Dividend Yield (%) 5.0% 4.9% 4.6% 5.6% 6.NAVPS 172.9 197.3 215.8 238.7 267.6

Adjusted DPS (LKR) 12.0 11.6 11.1 13.3 16.1 Dividend Payout 36% 54% 40% 40% 40

P/E 31 Dec 2011 2012 2013 2014E 2015E 2015E

Net Interest Income (LKR mn) 4,909 5,819 7,012 6,906 8,735 10,98

Net Profit (LKR mn) 2,527 8,854 2,642 3,652 4,873 5,72 EPS (LKR) 15.4 53.9 16.1 22.2 29.7 34


PER (x) 16.5x 4.7x 15.8x 11.4x 8.6x 7

PBV (x) 2.5x 1.7x 1.7x 1.5x 1.3x 1

Dividend Yield (%) 3.0% 5.9% 3.9% 4.4% 5.8% 6NAVPS 103.1 151.5 149.3 167.3 193.3 218

Adjusted DPS (LKR) 7.5 15.0 10.0 11.1 14.8 17

Dividend Payout 49% 28% 62% 50% 50% 5

Expected NDB price for 2015E

PER based target price - Voting 198.9 ustified PBV based target price - Voting 296.8



24/26



Appendices

Appendix: 1

Capital adequacy ratios are well above the minimumrequirements by CBSL

Appendix: 3

Net interest margins for foreign banks in Bangladesh arestill higher than domestic banks

0%

10%

20%

30%

40%

50%

60%

Tier 1 Tier 2

Figure 45: Tier 1 and Tier 2 as at 30 September 2014 Figure 46: Number of Branches

216250 256

86 82155

78 61137

571


BOC

(Source: Financial Stability Report Bangladesh)

Figure 47: NIMs in Bangladesh


Appendix: 2

Higher branch network may assist banks to improve their profitability by maintaining higher deposit base


Appendix: 4

Sector-wide reduction in pawning exposure

Figure 48: Pawning exposure as a % of total loans

20%

13%

2%3% 3%

11%

7%

11%

7%

18%

2

11%

7%

1% 2%4%

6%

3%

7%

4%

11%

Dec-13 Sep-14



25/26



Glossary

DFCC DFCC Bank DFCC V DFCC Vardhana Bank PLC SEYB Seylan Bank PLC PABC Pan Asia Banking Corporation PLC NDB National Development Bank PLC NTB Nations Trust Bank PLC SAMP Sampath Bank PLC UBC Union Bank of Colombo COMB Commercial Bank of Ceylon PLC CB Commercial Banks HNB Hatton National Bank PLC BOC Bank of Ceylon CB Commercial Banks PB Peoples Bank ASPI All Share Price Index BFI Banking and Finance Industry CBSL Central Bank of Sri Lanka CAGR Compound Annual Growth Rate SME Small and Medium Enterprises GDP Gross Domestic Product CASA Current and Savings Deposits as a Percentage of Total Deposits AWPR Average Weighted Prime Lending Rate AWDR Average Weighted Deposit Rate AWFDR Average Weighted Fixed Deposit Rate NIM Net Interest Margin NPL Non-Performing Loans PAT Profit After Tax PER Price-Earnings Ratio PBV Price-Book Value


26/26

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Disclaimer:

This Review is prepared and issued by First Capital Equities (Pvt) Ltd. based on information in the public domain, internally developed and other sources, believed to becorrect. Al though al l reasonable care has been taken to ensure the contents of the Review are accurate, Firs t Capital Equit ies (Pvt) Ltd and/or i ts Directors,employees, are not responsible for the correctness, usefulness, reliability of same. First Capital Equities (Pvt) Ltd may act as a Broker in the investments which are thesubject of this document or related investments and may have acted on or used the information contained in this document, or the research or analysis on which it isbased,before its publication. First Capital Equities (Pvt) Ltd and/or its principal, their respective Directors, or Employees may also have a position or be otherwise interestedin the investments referred to in this document. This is not an offer to sell or buy the investments referred to in this document. This Review may contain data which areinaccurate andunreliable. You hereby waive irrevocably any rights or remedies in law or equity you have or may have against First Capital Equities (Pvt) Ltd with respect tothe Review and agree to indemnify and hold First Capital Equities (Pvt) Ltd and/or its principal, their respective directors and employees harmless to the fullest extentallowed by law regarding all matters related to your use of this Review. No part of this document may be reproduced, distributed or published in whole or in part by anymeans to any other person for any purpose without prior permission.

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