CEE Banks: CEE 42 Euroland

1
CEE Banks CEE 42 Euroland

• Günter Hohberger
• Gernot Jany, CFA

1
ERSTE GROUP RESEARCH
2
Overview

• Negative banking sentiment p. 3
• Rising funding costs p. 5
• Funding quality and FX exposure p. 7
• Macro concerns p. 9
• Banking sector drivers p. 13
• Financials valuation p. 16
• Our team A in CEE OTP, Raiffeisen
  International p. 20
• Our team B in CEE BRD GSG, AIK Banka,
  
  Banca Transilvania, PKO BP, Komercni banka p.
  23
• Appendix p. 28

3
1. Negative banking sentiment

• US sub-prime crisis still dominates the sentiment
  of the global banking sector
• Sentiment shifted from direct effects (i.e. asset
  write-offs and capital needs) to indirect
  effects, i.e. slowing economic growth and
  increasing funding costs
• Unlike Western European peers, CEE banks are not
  involved in sub-prime related investments ? no
  asset write-offs, no emergency capital increases
• However, the share price performance of CEE banks
  (6M -19) is as bad as that of Western European
  banks (6M -21)

4
Overview

• Negative banking sentiment p. 3
• Rising funding costs p. 5
• Funding quality and FX exposure p. 7
• Macro concerns p. 9
• Banking sector drivers p. 13
• Financials valuation p. 16
• Our team A in CEE OTP, Raiffeisen
  Internatinal p. 20
• Our team B in CEE BRD GSG, AIK Banka,
  
  Banca Transilvania, PKO BP, Komercni banka p.
  23
• Appendix p. 28

5
2. Rising funding costs

• 3M Euribor increased by 125bp to 4.97, from
  3.725 at the beginning of 2007
• As a result, funding ability and funding quality
  have become an issue in the last couple of
  months, in order to secure asset growth at a
  reasonable price

Euribor yield curve, current vs. beginning of 2007
3M Euribor vs. ECB key rate
Source Bloomberg, ECB
Source Reuters
6
Overview

• Negative banking sentiment p. 3
• Rising funding costs p. 5
• Funding quality and FX exposure p. 7
• Macro concerns p. 9
• Banking sector drivers p. 13
• Financials valuation p. 16
• Our team A in CEE OTP, Raiffeisen
  International p. 20
• Our team B in CEE BRD GSG, AIK Banka,
  
  Banca Transilvania, PKO BP, Komercni banka p.
  23
• Appendix p. 28

7
3. Funding quality and FX exposure

• Stretched loan / deposit ratio in Russia (161),
  Ukraine (150), Slovenia (141), Hungary (132)
  and Romania (122)
• Medium loan / deposit ratio on the 100 level in
  most SEE countries
• Relaxed loan / deposit ratio in Czech Republic,
  Slovakia, Albania
• gt50 FX exposure in Hungary, Bulgaria, Romania,
  Ukraine
• Czech Republic, Croatia, Serbia provide safe
  haven FX exposure

Funding quality and FX exposure 2007
Source National Banks, Erste Group Research
8
Overview

• Negative banking sentiment p. 3
• Rising funding costs p. 5
• Funding quality and FX exposure p. 7
• Macro concerns p. 9
• Banking sector drivers p. 13
• Financials valuation p. 16
• Our team A in CEE OTP, Raiffeisen
  International p. 20
• Our team B in CEE BRD GSG, AIK Banka,
  
  Banca Transilvania, PKO BP, Komercni banka p.
  23
• Appendix p. 28

9
4. Macro concerns (1) Slowing GDP growth, rising
inflation

• CEE economies to slow down moderately in 2008 due
  to Euroland slowdown and decelerating consumer
  demand (limited employment growth, inflation,
  interest rate hikes)
• Competitive advantage of CEE countries to remain
  for many years (unit labor cost gap) and
  continues to attract foreign investments
• Inflation fueled by rising energy and food prices
  (higher weight in CEE)
• Pre-emptive interest rate hikes were justified
  and will prolong

GDP growth, y/y ()
Inflation, y/y ()
Source Bloomberg, Erste Bank Research
10
4. Macro concerns (2) Current account deficits
in spotlight

• CEE economies that have been driven by strong
  domestic demand (Balkan and Baltic states) faced
  growing external imbalances, some gt20 of GDP
  (Bulgaria, Latvia)
• Financing has become more challenging in
  liquidity squeeze and widened spreads environment
  ? rely on FDI inflows or growing external debt

• Romanias flexible exchange rate regime faced
  periods of strong sell-offs
• Fears about economic vulnerability and the impact
  of a weaker currency on the economy, particularly
  on banks (FX exposure)
• Romanias C/A deficit to GDP to remain flat this
  year
• C/A deficit partly financed by FDI inflows
  (estimated at 6 of GDP) and further growth of
  external borrowing (mainly private sector)

Current account deficit / GDP (2007, )
Source Erste Bank Research, Consensus Forecasts
11
4. Macro concerns (3) RO FX risk and interest
rate risk

• C/A deficit not as bad as it looks backed by FDI
  and remittances, consumption on declining trend
• RON depreciation causes concerns on growing loan
  default
• Timing of loan drawing limits FX related risk
• In base scenario only 14/39 months bear risk of
  5-10 increase of instalment

Combined EUR/RON interest rate stop lights
Source NBR, Reuters, Erste Group Research
12
Overview

• Negative banking sentiment p. 3
• Rising funding costs p. 5
• Funding quality and FX exposure p. 7
• Macro concerns p. 9
• Banking sector drivers p. 13
• Financials valuation p. 16
• Our team A in CEE OTP, Raiffeisen
  International p. 20
• Our team B in CEE BRD GSG, AIK Banka,
  
  Banca Transilvania, PKO BP, Komercni banka p.
  23
• Appendix p. 28

13
5. Banking sector drivers (1) Strong loan
growth, high FX exposure
Annual growth of loans and deposits in 2007

• gt50 loan growth in Bulgaria, Romania, Ukraine
  and Russia driven by retail loans
• 80 FX loan growth in Bulgaria, Romania, Ukraine
  resulted in FX exposure gt50
• Fastest deposit growth in Ukraine, Serbia and
  Russia

Source National Banks, Erste Group Research
14
5. Banking sector drivers (2) Still lots of
catch-up potential

• Deposits/GDP are closer to Euro levels as the
  growth on the deposit side started earlier
• Loans/GDP for most CEE countries provide gt100
  catch-up potential to Euroland levels
• Banking markets will grow at higher pace than GDP
  for years

Penetration rates 2007
Source National Banks, Erste Group Research
15
Overview

• Negative banking sentiment p. 3
• Rising funding costs p. 5
• Funding quality and FX exposure p. 7
• Macro concerns p. 9
• Banking sector drivers p. 13
• Financials valuation p. 16
• Our team A in CEE OTP, Raiffeisen
  International p. 20
• Our team B in CEE BRD GSG, AIK Banka,
  
  Banca Transilvania, PKO BP, Komercni banka p.
  23
• Appendix p. 28

16
6. Financials valuation (1)
Regression P/BV vs. ROE 2008e

• Valuation premiums of gt20 in PL and RO have
  disappeared
• P/BV returned to levels below 4x
• High R2 most premiums and discounts are
  justified by corresponding ROE
• Value play OTP Large discount not justified,
  due to high profitability
• Growth play RI Deserves higher premium, due to
  strong growth and regional diversification

Prices as of June 17, 2008
Source JCF, Erste Group Research
Note Regression adjusted for outliner (OTP and
Komercijalna)
17
6. Financials valuation (2)
Prices as of June 17, 2008
Source JCF, Erste Group Research
18
6. Financials valuation (3)
Funding quality of CEE banks (2007)

• BRD, BRE, OTP, Raiffeisen in the range of 100
  loan/deposit ratio
• Aik Bankas LTD ratio quite stretched
• FHB almost zero deposits
• Komercijalna banka, Komercni, Pekao,
  Transilvania, BZ WBK, PKO BP, with relaxed LTD
  ratio

Source Erste Group Research
19
Overview

• Negative banking sentiment p. 3
• Rising funding costs p. 5
• Funding quality and FX exposure p. 7
• Macro concerns p. 9
• Banking sector drivers p. 13
• Financials valuation p. 16
• Our team A in CEE OTP, Raiffeisen
  International p. 20
• Our team B in CEE BRD GSG, AIK Banka,
  
  Banca Transilvania, PKO BP, Komercni banka p.
  23
• Appendix p. 28

20
7. Our team A in CEE (1) OTP (Buy, HUF 8,500)

• Value play trading at heavy discounts
• clear regional expansion strategy (9 countries)
• strong position in Hungary, Bulgaria and
  Montenegro
• presence in fast growing markets in SEE and CIS
• still high margins and profitability
• highly attractive valuation
• Risks
• re-pricing of subsidized mortgage loans in HU
• negative effects from austerity package and
  growth dent in HU
• potential increase in credit risk, due to rising
  FX exposure in HU and RO
• integration of foreign subsidiaries

Total income breakdown (2007)
21
7. Our team A in CEE (2) Raiffeisen
International (Buy, EUR 114)

• Growth play with country diversification
• network banks in 16 CEE countries
• first mover advantage in many countries
• strong market position in SEE and CIS regions
• excellent acquisition track record
• experienced management
• strong asset and profit growth
• Risks
• low market shares CZ, PL HU
• branch network expansion puts pressure on costs
• political and legal insecurity in some of RIs
  markets
• still low retail exposure
• increasing loan/deposit ratio (2007 119)

Total income breakdown (2007)
22
Overview

• Negative banking sentiment p. 3
• Rising funding costs p. 5
• Funding quality and FX exposure p. 7
• Macro concerns p. 9
• Banking sector drivers p. 13
• Financials valuation p. 16
• Our team A in CEE OTP, Raiffeisen
  International p. 20
• Our team B in CEE BRD GSG, AIK Banka,
  
  Banca Transilvania, PKO BP, Komercni banka p.
  23
• Appendix p. 28

23
8. Our team B in CEE (1) BRD GSG (Accumulate,
RON 25.60)

• One of the most profitable banks in CEE
• No. 2 in RO, with an even stronger foothold in
  high growth high margin retail and SME segment
• Highly efficient and profitable, despite fast
  network expansion (currently around 800 branches)
• Strong geographic coverage
• Support from parent company (funding, know how)
• Risks
• Highest valuation in CEE banking sector
• Increasing competition puts pressure on margins
• Vulnerable to RON depreciation, due to high FX
  exposure

Total income breakdown (2007)
24
8. Our team B in CEE (2)AIK Banka (Accumulate,
RSD 9,660)

• Highly efficient corporate bank
• Quickly improving market position (No. 6)
• Strong position in high growth margin SME
  business
• Outstanding profitability, based on high margins
  and cost efficiency
• Possible takeover target (Greek ATE Bank holds
  20)
• Risks
• Higher business risk, due to focus on corporate
  and SME segment
• Weak deposit base (high loan/deposit ratio), but
  improving fast

Total income breakdown (2007)
25
8. Our team B in CEE (3) Banca Transilvania
(Accumulate, RON 0.51)

• Strong growth and improving profitability
• No. 2 position in high growth high margin SME
  segment
• Pole position in asset management
• Strong position in the fast growing region around
  Cluj
• Strong branch network of around 430 units
• Higher focus on efficiency can boost
  profitability
• Potential takeover target, lacking strategic
  investor
• Risks
• Higher business risk, due to focus on SME segment
• Regional bias of branch network coverage
• Profitability currently depressed, due to fast
  network expansion
• Vulnerable to RON depreciation, due to high FX
  exposure

Total income breakdown (2007)
26
8. Our team B in CEE (4) PKO BP (Accumulate, PLN
55)

• Strong profitability and huge deposit base
• strong position in retail banking
• among most recognized banks in PL
• above average loan quality in PL
• strong growth of consumer loans, mortgage loans
  and the credit card business
• CIR improved to 53 (59)
• good funding quality (loan/deposit ratio 88)
• Risks
• high staff level
• increasing personnel costs
• management board replacements
• CIR still above Polish peers

Total income breakdown (2007)
27
8. Our team B in CEE (5) Komercni banka.
(Accumulate, CZK 4,700)

• Highly efficient value play with relaxed balance
  sheet
• strengthening position in fast growing retail
  market
• strong foothold in mortgage business
• strong franchise among Czech customers
• slightly improving NIM
• further improving CIR despite low level (45.7)
• improved asset quality
• Risks
• still low interest environment with thin spreads
• competition for big-ticket lending squeezes
  margins
• flat FC income dynamics suffer from decreasing
  asset management fees and flat loan fees
• increasing cost of risk, due to higher risk
  profile

Total income breakdown (2007)
28
Appendix

• Peer group comparison
• Valuation methodologies
• Disclosures

29
Peer group comparison
Prices as of June 17, 2008
Source JCF, Erste Group Research
30
Valuation methodologies

• Recommendation based on Dividend Discount Model
• 3-stage DDM, due to growth pattern of banks
  operating in emerging markets
• Stage I explicitly forecast EPS until 2012
• Stage II gradually declining growth rates,
  profitability and cost of equity to more
  sustainable levels (10 years)
• Stage III determination of terminal value by
  multiplying BVPS 2022 with P/BV derived by Gordon
  Growth Model
• Peer group valuation to check plausibility
• Regression of P/BV 08e vs. ROE 08e (highest R2)
• Average of P/E ratios for the years 2008-2009

31
Disclosures