Valuing Banks

December 9, 2006

American Appraisal
Structure
1. Introduction

The Value of a Bank
The Business of Banking

2. Analysis of a Bank

Industry Analysis
Company A...
The Value of a Bank
General
Financial Intermediary between
depositors and borrowers
Special Information hyposesis
Provisio...
The Value of a Bank
Why value banks?
M&A
Determination of conversion ratios
Minority stakes valuation

IPO’s
Restructuring...
The Business of Banking
Distinctive characteristics of banks
Financial Structure
Relatively few hard assets
The majority o...
The Business of Banking
Bank’s Balance Sheet
ASSETS

Cash and Due from CBRF
Securities
Loans and Advances to Banks
Loans a...
The Business of Banking
Bank’s Profit and Loss Account

Financials
Earned on loans issued
and fixed income
securities owne...
The Business of Banking
Criteria

Types of Banks

Types of banks

Target market

Retail
Corporate
Investment

Ownership

S...
Valuation Procedures
Preparatory Stage
Collection of Data
Management Interviews

Analysis Stage
Economy and Industry Analy...
Analysis of a Bank

Major Analytical Tools

Top down approach
Economy, Industry, Subject

Financial Statements analysis
Ra...
Industry

Analysis of a Bank
Historical Background
•General economic recovery

2006

•Growing competition - Entry of new p...
Industry

Analysis of a Bank

Russian Economy experiencing a steady GDP Growth
Banking Industry has been outpacing general...
Industry

Analysis of a Bank

Nevertheless, the penetration of banking services remains
low compared to other countries
Le...
Industry

Analysis of a Bank
Fragmented Industry
Large number of banks
– steadily decreasing
Majority are small banks

Con...
Industry

Analysis of a Bank

Role of the international players in the
Russian banking sector
180

14%

160
140

12%

120
...
Industry

Analysis of a Bank
Trends to watch in the banking industry
Historical and expected growth
Penetration
Economic a...
Company-specific
factors

Analysis of a Bank
Company-specific
factors

Economy and
Industry

Business profile (model)
Corp...
Valuation Approaches
Income Approach
Market
Approach

Market Value of
Shareholders’ Equity

Net Asset
Position

Minority /...
Income Approach
Major Questions
Where the Bank will be 3-5 years from now
What are the Company’s Prospects and its Strateg...
Projected Cash Flows
Consider expected operating and financial results of a bank
reflected in the Projected Financials
Bal...
Projected Cash Flows
Typical projection drivers

Balance
Sheet
Drivers

Profit &
Loss
Drivers

Balance Sheet
Structure

Gr...
Projected Cash Flows
Estimating Projection Drivers
Subject’s historical financials
Industry Analysis
Peer Analysis
Company...
Projection Drivers – Industry and Peer Analysis

05

03

Deposits Growth

03

115%

03

95%

05
06F
07F
08F
04

07F
08F

0...
Projection Drivers – Industry and Peer Analysis

Loans / Interest bearing liabilities
03
04
05

120%
110%

06F

06F
07F
08...
Projection Drivers – Industry and Peer Analysis
Equity / Total Assets

03

03

23%

04

21%

05

19%

05
06
06
05

04

06
...
Projected Cash Flows

Corporate Banks

Factors to watch for...
Income generation ability
Target vs. Existing Client Base
M...
Projected Cash Flows

Retail Banks

Factors to watch for...
Income generation ability
Business profile
Collateralized lend...
Projected Cash Flows

Retail Banks

Special Consideration: Fast Lending Growth
Increasing bad loans (especially for non-co...
Discount Rate Development

re = rf + β × MRP + CSR

CAPM

Risk free rate
Beta
Company specific risk

Size
Uncertainty of p...
Terminal Value
How to determine the terminal value
Gordon stable growth model
Sustainable long-term growth rate
Long-term ...
Market Approach
Two major variations
Guideline Companies Analysis
Guideline Transactions Analysis

Applicability varies wi...
Market Approach
Major Industry Valuation Metrics: PB and PE Multiples
PB (“Price to Book”)
Market Capitalization / Book Va...
Market Approach
PB vs. ROE

Technical
explanation: Actual
Return exceeds
Required Return on
Equity

4,0
3,5
Finansbank

Pr...
Market Approach
Publicly Traded Guidelines
Lack of actively traded bank stocks in Russia
Average daily trading volume, 000...
Market Approach

Public Guidelines

1. Analysis of ratios indicated by guidelines
Price to Shareholders' Funds
Market Capi...
Market Approach

Public Guidelines

2. Weighing procedure
Price to Shareholders' Funds
4 Yr Avg
2004 to 2007
Sberbank
ING ...
Market Approach

Public Guidelines

3. Applying concluded multiples to the Subject
Period

4 Yr Average 2004 to 2007
2005
...
Market Approach

Public Guidelines

4. Reconciliation of the results
VALUATION SUMMARY

Approach

Detailed in
Table

Concl...
Market Approach
Investsberbank

Promstroibank

Date

07-2006

Buyer

OTP

Target

Stake purchased

96%

Transaction Value,...
Reconciliation
Banks’s size and
business profile

Income
Approach

Reliability of
information

Relevance of
information

G...
Спасибо за внимание!

American Appraisal
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Valuing a Bank

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Valuing a Bank

  1. 1. Valuing Banks December 9, 2006 American Appraisal
  2. 2. Structure 1. Introduction The Value of a Bank The Business of Banking 2. Analysis of a Bank Industry Analysis Company Analysis Income Approach 3. Valuation Approaches Market Approach 2 American Appraisal
  3. 3. The Value of a Bank General Financial Intermediary between depositors and borrowers Special Information hyposesis Provision of liquidity and payments Banking Frachise - Bank’s individual characteristics which make it a going concern Ability to generate a net profit from deposit-related services Ability to generate rents on the asset side as well Franchise Value Company specific Market vs. Investment Value Market share Intangible assets License – access to the market Customer relationships (Core deposit base) Brands Assembled workforce Other (software, scoring methodologies) Not a collection of assets Going concern vs. Liquidation value 3 American Appraisal
  4. 4. The Value of a Bank Why value banks? M&A Determination of conversion ratios Minority stakes valuation IPO’s Restructuring IFRS Corporate planning 4 American Appraisal
  5. 5. The Business of Banking Distinctive characteristics of banks Financial Structure Relatively few hard assets The majority of assets are financial The majority of liabilities are deposits No inventory, trade payables, no significant amount of receivables Cash and marketable securities – operating asset No clear distinctions between operating and financing activities Income statement Income is generated as an interest spread between interest received and interest paid (“Marginal business’) Revenue = Net interest income + Net commission income + Net trading gains Regulated Business Importance of Risk Management 5 American Appraisal
  6. 6. The Business of Banking Bank’s Balance Sheet ASSETS Cash and Due from CBRF Securities Loans and Advances to Banks Loans and Advances to Customers Fixed Assets Other Assets LIABILITIES Amounts Due to Banks Customer Accounts Securities Issued Other Liabilities Equity Financials Liquidity management + Obligatory reserves Interest Earning Assets Typically is an insignificant amount Interest Bearing Liabilities Source of business growth, minimum level subject to regulation 6 American Appraisal
  7. 7. The Business of Banking Bank’s Profit and Loss Account Financials Earned on loans issued and fixed income securities owned Interest Income Interest Expense Paid on deposits and securities issued Net Interest Income Provision for Losses Net Interest Income after provision for losses + Non-interest Income = Estimate of how well loans are repaid Net Commission Income + Net trading gains on securities and currencies REVENUE OF A BANK Administrative, Staff and Other Fixed Expenses Shows the efficiency of a bank’s operations Non-recurring Gains/Losses Pre-Tax Income Result of non-typical, oneoff transactions NET INCOME 7 American Appraisal
  8. 8. The Business of Banking Criteria Types of Banks Types of banks Target market Retail Corporate Investment Ownership State and Quasi-state Private Banks Independent Captive Foreign Geographic focus International National Regional Size Large Small 8 American Appraisal
  9. 9. Valuation Procedures Preparatory Stage Collection of Data Management Interviews Analysis Stage Economy and Industry Analysis Understanding the background of the transaction Calculations Stage Valuation Approaches Final Stages Preparation of the report Presentation to the client 9 American Appraisal
  10. 10. Analysis of a Bank Major Analytical Tools Top down approach Economy, Industry, Subject Financial Statements analysis Ratio analysis Growth Profitability Capitalization Liquidity Common-sized financials Peer comparison Non-operating assets (real estate, other) Non-recurring income or expenses Unusual material transactions Acquisitions and disposals Large write offs of loans Public companies and transaction analysis 10 American Appraisal
  11. 11. Industry Analysis of a Bank Historical Background •General economic recovery 2006 •Growing competition - Entry of new players, incl. International •Industry consolidation •Importance of retail Financial Crisis •Many banks experience losses: •Liabilities in USD – assets in Roubles •Losses on government bonds and derivaties 1998 • Borrowers default •Massive industry restructuring •Growing number of banks •Mainly corporate short-term lending, foreign exchange and securities trading •A lot of captive, non-market players 1991 1992 •First commercial banks are established on the basis of the branches of state banks 11 American Appraisal
  12. 12. Industry Analysis of a Bank Russian Economy experiencing a steady GDP Growth Banking Industry has been outpacing general economy Russian Banking Assets and Loans to GDP 50,0% 45,0% 40,0% 35,0% 30,0% 25,0% 20,0% 15,0% 10,0% 5,0% 0,0% 1999 12 2000 2001 2002 2003 Total Banking Assets / GDP 2004 2005 2006 Total Loans / GDP American Appraisal
  13. 13. Industry Analysis of a Bank Nevertheless, the penetration of banking services remains low compared to other countries Lending to GDP 140% 120% 100% Average Developed Europe 80% 60% 40% 20% Romania Russia Turkey Poland Ukraine Lithuania Slovak Republic Kazakhstan Bulgaria Hungary Slovenia Latvia Czech Republic 13 Estonia Croatia 0% American Appraisal
  14. 14. Industry Analysis of a Bank Fragmented Industry Large number of banks – steadily decreasing Majority are small banks Concentrated Industry Significant role of largest banks – steadily increasing Number of operating banks in Russia 1340 Role of the largest banks 75% 70% 65% 1300 60% 55% 1260 50% 45% 1.2005 1220 7.2005 1.2006 7.2006 Share of 30 largest banks in total capital 1180 01.2004 Share of 30 largest banks in total assets 01.2005 01.2006 Share of 30 largest banks in total loans 14 American Appraisal
  15. 15. Industry Analysis of a Bank Role of the international players in the Russian banking sector 180 14% 160 140 12% 120 1998 crisis 10% Russia upgraded to investment grade 8% 80 6% 60 4% 40 2% 0% 01.1996 20 0 01.1997 01.1998 01.1999 01.2000 01.2001 Share of non-residents in the total charter capital 15 100 Number of operating banks with foreign participation Share of non-residents in total charter capital. % 16% 01.2002 01.2003 01.2004 01.2005 01.2006 Number of operating banks with foreign participation Source: Central Bank of Russia American Appraisal
  16. 16. Industry Analysis of a Bank Trends to watch in the banking industry Historical and expected growth Penetration Economic and disposable income growth Diversification and new services 16 Competitive Environment Porter Analysis Industry Consolidation Share of foreign banks The role of the State and Staterelated banks Drive for cost-efficiency Increase of the role of brands Regulatory environment Licensing Minimum capital and reserves requirements Deposit insurance scheme Risk supervision – concentration, capital adequacy Financial reporting requirements American Appraisal
  17. 17. Company-specific factors Analysis of a Bank Company-specific factors Economy and Industry Business profile (model) Corporate, retail, investment Clients and Markets Strategy Risk Concentration Liquidity Valuation Assumptions (Income and Market Approaches) Capital adequacy / Overcapitalization Size Transparency 17 American Appraisal
  18. 18. Valuation Approaches Income Approach Market Approach Market Value of Shareholders’ Equity Net Asset Position Minority / Marketability discounts (if applicable) Allocation for Equity Stakes 18 American Appraisal
  19. 19. Income Approach Major Questions Where the Bank will be 3-5 years from now What are the Company’s Prospects and its Strategy What is the Company’s current and target market position Who are the Potential Investors Financial Future Major Projection Drivers Reporting standards used Level of uncertainty Uncertainty of the results Company-specific risk factors 19 American Appraisal
  20. 20. Projected Cash Flows Consider expected operating and financial results of a bank reflected in the Projected Financials Balance Sheet Income Statement Represents “potential dividends” available to shareholders NOT Extrapolation Depreciation CAPEX Increase in reserves with CBRF Additional Capital Requirements Net Income Free Cash Flow 20 American Appraisal
  21. 21. Projected Cash Flows Typical projection drivers Balance Sheet Drivers Profit & Loss Drivers Balance Sheet Structure Growth Drivers Return Drivers Growth Drivers Total Loans / Customer and Bank Accounts and Securities Issued Loan Loss Provision / Gross Loans and Advances Deposits (Retail, Corporate) growth rate % Interest income on loans (securities) Non-interest income growth rate Due to banks / Customer Accounts and Securities Issued Trading securities growth rate % Interest expense on deposits (securities) Equity / Total Assets Other assets (liabilities) growth rate Effective tax rate Operating Expenses growth rate 21 American Appraisal
  22. 22. Projected Cash Flows Estimating Projection Drivers Subject’s historical financials Industry Analysis Peer Analysis Company’s strategy and competitive position Special Considerations Financial reporting standards Fair Value vs. Book Value of Assets and Liabilities Non-recurring operations 22 American Appraisal
  23. 23. Projection Drivers – Industry and Peer Analysis 05 03 Deposits Growth 03 115% 03 95% 05 06F 07F 08F 04 07F 08F 03 04 05 06F 07F 08F 04 08F 05 06F 07F 04 05 06F 07F 08F 03 04 04 05 06F 35% 03 04 05 06F 07F 08F 55% 06F 75% 15% Russian Banking Industry Largest 30 Banks Sberbank VTB Rosbank Bank of Moscow Vozrozhdenie Source: Company Reports, analyst estimates 23 American Appraisal
  24. 24. Projection Drivers – Industry and Peer Analysis Loans / Interest bearing liabilities 03 04 05 120% 110% 06F 06F 07F 08F 04 05 03 03 07F 08F 05 06F 07F 08F 03 60% 03 04 05 06F 03 70% 04 05 06F 07F 08F 04 04 05 06F 04 05 06F 03 80% 03 90% 05 06F 07F 08F 100% 04 50% 40% Russian Banking Industry Largest 30 Banks Sberbank VTB Rosbank Bank of Moscow Vozrozhdenie Russian Standard Source: Company Reports, analyst estimates 24 American Appraisal
  25. 25. Projection Drivers – Industry and Peer Analysis Equity / Total Assets 03 03 23% 04 21% 05 19% 05 06 06 05 04 06 05 06 03 05 06 03 05 03 04 03 04 06 11% 9% 04 04 05 06 03 04 06 13% 03 15% 04 05 17% 7% 5% Russian Banking Industry Largest 30 Banks Sberbank VTB Rosbank Bank of Vozrozhdenie Russian Moscow Standard Source: Company Reports, analyst estimates 25 American Appraisal
  26. 26. Projected Cash Flows Corporate Banks Factors to watch for... Income generation ability Target vs. Existing Client Base Market position and competitive advantages Large non-recurring transactions Non-interest income generation Cost-efficiency Risks Concentration of clients (industry, individual clients) Operations with related parties (critical factor for captive banks) Non-performing loans (history and expectations) 26 American Appraisal
  27. 27. Projected Cash Flows Retail Banks Factors to watch for... Income generation ability Business profile Collateralized lending (autoloans and mortgages) Uncollateralized lending (consumer finance) Penetration of services rendered on the target market Market share: retail network Brand power: sales and promotion channels Quality of execution – “commodity” business Risks Determined by business profile and quality of risk management Growing competition Deteriorating quality of loan portfolio 27 Lack of funding for growth American Appraisal
  28. 28. Projected Cash Flows Retail Banks Special Consideration: Fast Lending Growth Increasing bad loans (especially for non-collateralized lending) – makes risk management extremely important Lack of cheap and long term funding Fast growth requires significant equity injections from shareholders Increasing competition with foreign market players 9 000 3,0% 8 000 Share of overdue loans to individuals grows to 2.7% 2,5% 7 000 RUR bln 6 000 2,0% 5 000 1,5% 4 000 3 000 Share of Loans to Individuals 7% 1,0% 2 000 0,5% 1 000 - 0,0% 01.2003 28 Share of Loans to Individuals 22% 01.2004 Total Loans 01.2005 Total Loans to Individuals 01.2006 Share of Overdue Loans to Individuals Source: CBRF American Appraisal
  29. 29. Discount Rate Development re = rf + β × MRP + CSR CAPM Risk free rate Beta Company specific risk Size Uncertainty of projections Historical Adjusted Betas for Guideline Companies 1,2 1 Average beta for Guidelines = 0.975 0,8 0,6 0,4 0,2 0 29 Sberbank ING Bank Slaski BRE Bank Komercni banka OTP Bank Garanti Bank Finansbank AKBank Unibanco Banco Bradesco American Appraisal
  30. 30. Terminal Value How to determine the terminal value Gordon stable growth model Sustainable long-term growth rate Long-term profitability and capital structure Applying market-derived ratios Checking the terminal value for consistency Stabilization of cash flows Consistent return on equity and total assets Sustainable capitalization levels Potential sale considerations 30 American Appraisal
  31. 31. Market Approach Two major variations Guideline Companies Analysis Guideline Transactions Analysis Applicability varies with Availability of guidelines Size Business profile Risk profile Availability of data 31 American Appraisal
  32. 32. Market Approach Major Industry Valuation Metrics: PB and PE Multiples PB (“Price to Book”) Market Capitalization / Book Value of Shareholders’ Equity Usually Exceeds 1.0 Growth of PB multiples with time - Recent Trend in the Emerging Markets Sberbank's share price 600% Price to Book 06F 500% 4.3 Price to Book 04 400% 1.75 300% 200% 100% 0% 01.2005 32 07.2005 01.2006 07.2006 Source: RTS American Appraisal
  33. 33. Market Approach PB vs. ROE Technical explanation: Actual Return exceeds Required Return on Equity 4,0 3,5 Finansbank Price to Book 2006 Why PB multiples for banks are usually above 1.0? Sberbank 3,0 Banco Bradesco 2,5 BRE Bank Komercni Bank 2,0 OTP Bank AKBank ING Bank Slaski Garanti Bank Unibanco 1,5 1,0 10% 12% 14% 16% Other factors: 18% 20% 22% 24% 26% 28% ROE (2005-2007F) High Expected Growth (Industry and Company) Fair Values vs. Book Values Intangible Assets not registered on the balance sheet Price to Book alone not sufficient – other value indicators (ratios) and approaches should also be used: 33 PE, Price to Total Assets, Price to Gross Operating Profit, Price to Cash Flow American Appraisal 30%
  34. 34. Market Approach Publicly Traded Guidelines Lack of actively traded bank stocks in Russia Average daily trading volume, 000 USD 2005 Sberbank 2006 16,900 75,100 675 486 - 218 Bank of Moscow 70 118 Vozrozhdenie 29 45 Promstroibank Rosbank Guidelines from other markets may be used 34 American Appraisal
  35. 35. Market Approach Public Guidelines 1. Analysis of ratios indicated by guidelines Price to Shareholders' Funds Market Capitalisation : Price to Shareholders' Funds Guideline Companies Country 4 Yr Avg 2004 to 2007 Previous Year 2005 Sberbank ING Bank Slaski BRE Bank Komercni banka, a.s. OTP Bank Garanti Bank Finansbank AKBank Unibanco (Uniao de Bancos Banco Bradesco S.A. Russia Poland Poland Czech Hungary Turkey Turkey Turkey Brazil Brazil 3,5 2,2 2,3 2,4 2,6 1,9 3,6 2,1 2,0 3,2 4,2 2,3 2,7 2,7 2,9 2,1 3,9 2,2 2,1 3,7 2,6 0,6 0,2 2,9 0,8 0,3 Average Std Deviation Std Deviation / Average Current Year 2006 Forecast Year 2007 Concluded Weights 3,1 2,1 2,2 2,2 2,5 1,8 3,5 2,3 1,8 2,8 2,4 2,0 2,0 2,0 2,2 1,6 2,6 1,8 1,6 2,3 15% 11% 7% 11% 7% 8% 10% 8% 15% 10% 2,4 0,6 0,2 2,0 0,3 0,2 100,0% 35 American Appraisal
  36. 36. Market Approach Public Guidelines 2. Weighing procedure Price to Shareholders' Funds 4 Yr Avg 2004 to 2007 Sberbank ING Bank Slaski BRE Bank Komercni banka, a.s. OTP Bank Garanti Bank Finansbank AKBank Unibanco (Uniao de Bancos Brasileiros SA) Banco Bradesco S.A. Sum of Weighted Multiples Percent of Weight Used "Comparably" Weighted Multiple Multiples times Weights Previous Year Current Year 2005 2006 Forecast Year 2007 0,5 0,2 0,2 0,2 0,2 0,1 0,4 0,2 0,3 0,3 0,6 0,0 0,2 0,3 0,2 0,2 0,4 0,2 0,3 0,4 0,5 0,2 0,2 0,2 0,2 0,1 0,4 0,2 0,3 0,3 0,4 0,2 0,1 0,2 0,2 0,1 0,3 0,1 0,2 0,2 2,6 100,0% 2,7 89,5% 2,4 100,0% 2,0 100,0% 2,6 3,0 2,4 2,0 36 American Appraisal
  37. 37. Market Approach Public Guidelines 3. Applying concluded multiples to the Subject Period 4 Yr Average 2004 to 2007 2005 2006 2007 Concluded Multiples 2,6 3,0 2,4 2,0 Subject Company US$ 000,000 1 000 1 600 2 000 2 200 Indicated Value US$ 000,000 2 624 4 816 4 890 4 508 Concluded Weights 20% 20% 50% 10% Weighted Conclusions US$ 000,000 525 963 2 445 451 Sum of Weighted Streams Percent of total Weight Used 4 384 100% Indicated Market Capitalisation 4 384 37 American Appraisal
  38. 38. Market Approach Public Guidelines 4. Reconciliation of the results VALUATION SUMMARY Approach Detailed in Table Concluded Equity Value Selected Value Weights (g) US$ 000,000 Price to Shareholders' Funds Price to Net Income Price to Total Assets Total Rounded to 1 2 3 4 384 4 039 3 126 Weighted Conclusions US$ 000,000 70% 20% 10% 3 069 808 313 0,0% 4 189 4 200 38 American Appraisal
  39. 39. Market Approach Investsberbank Promstroibank Date 07-2006 Buyer OTP Target Stake purchased 96% Transaction Value, USD m 477 Guideline Transactions Vozrozhdenie Impexbank Rosbank 12-2005 07-2006 07-2006 07-2006 VTB Raiffeisen SocGen Texaka-bank, Kazakhstan Inst. Investors 50% 480 100% 550 10% Aval, Ukraine Mriya, Ukraine 07-2006 10-2005 01-2006 Sberbank Raiffeisen VTB 10% 54 317 80% 50 94% 98% 1 036 70 Aval Mriya PB'05 Ratios 6,0 5,0 4,0 3,0 2,0 1,0 Investsberbank Promstroibank Impexbank Rosbank Vozrozhdenie Special Considerations in analyzing transactions Texakabank Source: Companies’ press-releases, financial statements Intent of the purchaser / Potential synergies Market Entry “Overheated” market Inter-group transactions (portfolio optimization) 39 American Appraisal
  40. 40. Reconciliation Banks’s size and business profile Income Approach Reliability of information Relevance of information Guideline Companies Reconciled Value Continuous Process... 40 American Appraisal
  41. 41. Спасибо за внимание! American Appraisal

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