BRAC Bank Ltd DSE: BRACBANK Bloomberg: BRAC:BD

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1 Price, BDT Turnover, BDT MM Analysts: Sajid Huq Farjad Siddiqui DSE: BRACBANK Bloomberg: BRAC:BD Company Summary Ticker BRACBANK Sector Bank Date of Operation Inception 4-Jul-01 Date of Listing 28-Jan-07 Financial Year End December Number of Shares (mn) Current Market Capitalization (BDT bn) DSE Market Capitalization (BDT bn) 2, % of DSE Market Capitalization 0.55% 52 Week High (BDT) Week Low (BDT) 30.2 YTD Return (%) Week Average Volume Traded (BDT mn) 28.5 Trailing EPS (BDT) 6.28 Trailing P/E ratio (x) 6.71 Revenue BDT MM E 2012E Net Interest Income 5, , ,582.6 Investment Income 2, , ,369.5 Commissions Income 2, , ,760.6 Other income Total revenue 10, , ,058.9 Margin and efficiency (%) E 2012E Operating efficiency 46.93% Loan/Deposit 98.21% 85.73% 83.67% ROE 21.39% 22.99% 29.38% ROA 1.91% % Other Key Indicators (%) E 2012E Int. Rate Spread % 6.94% 5.75% 6.75% NIM % % Cost-to-Income 46.93% NPL 5.85% 5.6 Price performance of BBL in last 12 months Sources: Dhaka Stock Exchange Turnover Price Rating: Outperform Dec-2012 Fair Value Estimate: BDT 52 per share February 14, 2012 Moderate Profit Growth Expected amid Banking Sector Downturn We forecast BRAC Bank Limited (BBL) Loan & Advance (L&A) will grow 18% YoY and deposits will grow 21% YoY in We further expect 2011-LDR of 8, lower than 2010-level of 98%. LDR is expected to fall owing to 2011E multi-year high deposits growth rate (GR) driven by a slowing stock market as well as significant M2 GR contraction. We anticipate 2011 net interest margin (NIM) of 4.8 and interest rate spread (IRS) of 5.07%. BBL has the largest SME operation in the industry and thus basic business model is SME oriented. BBL is continually searching for diversifying its business to protect profitability in future competition bkash and ELDORADO are such initiatives. As a non-pd, BBL is not expected to be substantially affected by 2011 government borrowing. However, increased Statutory Liquidity Reserve (SLR) requirements since December 2010 are expected to raise BBL s treasury investments by 2. BBL s aggregate yield from treasuries (including capital gains) is 18%. We expect investment income from treasury securities GR of 56.47% YoY in 2011 on booking of trading profit from held-for-trade (HFT) and available-for-sale treasury bonds. BBL secured 4 th position in total inward remittance market share among all the domestic private commercial banks (PCBs) and 7 th position among all the domestic banks in We estimate 2011 commission & fees income GR of 15% YoY, decline from 2010 GR of 2 YoY considering significant fall in income from merchant bank-brokerage subsidiaries. On set of high inflation and decline in IRS income whereas a 44% market correction eroded portfolio gains from 2010 DGEN appreciation of nearly 83%. We estimate 2011 EPS to be BDT 6.95, against BDT 6.28 in 2010, 10.7% higher YoY, but lower than 4-Year average GR of 58.61%. Last but not least, worth noting that BBL has lower P/E ratio and higher ROE than most leading banks in other frontier markets (e.g., Sri Lanka, and Oman). Comparative price multiples and trading liquidity are illustrated in enclosed report for select frontier market banks via scatter plot. Rating: We estimate EPS of BDT 8.70 and BVPS of BDT for the year ending December 2012, and set a target price of BDT per share with an OUTPERFORM rating. This implies a 35.5 price return on current share price of BDT (as on 14 h February 2012).

2 L&A (BDT MM) GR (YoY) Growth in Loans and Advances (L&A) We estimate (BBL) 2011 L&A growth rate (GR) of 18% YoY, lower than 2010 L&A GR of 35% YoY, and 4-year L&A CAGR of 4, on 2H11 M2 GR of -5. (21.3% to 19. June-Nov11) driven by inflationary pressures and FX depreciation. Bangladesh Bank (BB) raised repo rates multiple times, restricted loan-deposit ratio (LDR) to 9 and allowed large loans very selectively. Mandate by BB to domestic private banks is to enable large loans to agriculture, SME, and export-oriented sectors, but restrict them in case of capital markets, real estate, and retail sectors. Figure 1: BBL L&A Growth 120, , , ,000 40, % 18% , L&A (BDT MM) GR (YoY) M2 GR fell in March-Sep11 nearing BB s FY12 year-end target of 18%. We anticipate an M2 GR lower than BB-target, as BB tries to mitigate the inflationary effect of a BoP deficit and FX depreciation. Government borrowing is likely to drop in 1H12 with its impact becoming clearer in 2H12 on upward revision of energy prices. Figure 2: BBL L&A Composition Credit Staff Loan Bills Cards 1% 0.3% Overdraft Demand loan 2 SME 5 Term loans 24% Lease Receivable 1% Sources: Company Annual Report (As on 4Q10) BBL ensures diversified geographical reach in SME loan disbursement via wide distribution channel. Network of 81 branches are complemented by 22 SME Service Centers, 48 SME/Krishi Branches, and 405 SME Unit offices across the country. 2

3 CASA Ratio Effective Deposit Rate BDT MM GR (YoY) SME is expected to be the key future growth driver of the bank (BBL) and domestic economy as well. SME has been ignored for years but domestic banks have started to add more focus. It can give a thrust to the banks at the moment when there is a declining demand from big clients. BBL s years long SME focused business tactics, strategically located SME centers and employee expertise to serve SME clients are expected to shape the bank s future success. Deposit growth and loan-to-deposit ratio (LDR) We project 2011-deposit GR of 21% YoY, compared to 2010 GR of 18.4% YoY, and 4-year average of 30.6 YoY deposit GR was higher compare to that of 2010 on low stock market liquidity and retail investor confidence as well as high bank deposit rates and declining savings certificate sales. Figure 3: BBL Deposits Composition and GR 120, ,000 55% 6 80,000 60,000 40,000 28% 18% 21% , Current Deposit Savings Deposit Fixed Deposits Other Deposits GR (YoY) BBL offers total 22 deposit products under different segments designed to attract both domestic and NRB clients. We expect 6 CASA ratio in 2011 compared to 58% in 2010, and 4-year average of 4, signaling BBL s ability to grow on low cost deposit base. Following graph shows CASA ratio to effective deposit rate correlation coefficient (CC) of In spite of that, we estimate 8.3 effective deposit rate in 2011 compared to 6.71% in 2010 on attempts to attract fresh deposit following delicate liquidity crisis in the overall sector. Figure 4: BBL CASA Ratio & Effective Deposits Rate % 4% CASA Ratio Effective Deposit Rate Corr

4 NII (BDT MM) Avg Inflation Rate Gross LDR Further, our projection for 2011 assumes 9 gross LDR, noticeably lower than 2010 LDR of 98%. BBL s projected LDR performance is noteworthy in light of multi-year high deposit GR and contractionary monetary policy. Figure 5: BBL Loan-Deposit Ratio (LDR) 10 98% 9 94% % 8 84% % 98% 91% 87% 8 8 Gross LDR Net Interest Income (NII) We project 2011 interest rate spread (IRS) to be 5.75%, higher than peers average because of SME concentration and lower than the 4-year average of 7.07% and 2010 IRS of 6.94%. Net Interest Margin (NIM) is projected at 4.9 compared to a 4-year average of 6.3 and 2010 NIM of 6.4. NIM fell on higher deposit GR and lower IRS. Given above L&A and deposit GR-we project 2011 NII GR of -7.18% YoY (-23% GR in 9M11 YoY) note worthy here, 2010 NII GR was 64.3 YoY, and 4-year CAGR was Figure 6: BBL Net Interest Income & Inflation Rate 6,000 5, % 8.8% , % 7.3% 8% 3,000 2,000 4% 1,000 - Net Interest Income (NII) (BDT MM) Average Inflation Rate BBL s IRS over E shows negative correlation with Inflation rates (annual average), gesturing meager pricing power and the susceptibility of IRS to inflationary pressures. One possible downside of concentrating on SME 4

5 Composition of Operating Income Interest Rate Spread & NIM Avg Inflation Rate sector is the relatively less flexibility of loan re-pricing, as most of the clients are not worthy that much. So, linear adjustment of loan rate with incremental deposit rate is quite difficult. Figure 7: BBL Interest Rate Spread, NIM & Average Inflation Rate 9% 8% 14% 7% 1 5% 4% 3% 1% Interest Rate Spread NIM Average Inflation Rate In spite of NIM shock in a particularly difficult year for banks BBL s core earnings driver is expected to be its IRS and deposit GR in IRS income contributed 49% to 2010 total operating income and 44% in 2011 is expected. However, we anticipate NIMs to be condensed for conventional commercial banks over time amid increasing competition. Figure 8: Operating Income Composition % 0.3% 1% 2 15% % % 31% % % 44% Net Interest Income Commission Income Invetsment Income Other Income BBL s new avenues in business Bangladesh bank sector has been enjoying higher IRS than that of other frontier market banks. In the longer run, competition would drive domestic banks NII down, and eventually profitability. Bangladesh Bank (BB) has recently issued a directive to bring the IRS to 5%, lower than historical level. 5

6 Table 1: Interest Rate Spread Comparative Analysis Countries 5 Yr Avg Inflation Interest Rate Spread over Time Bangladesh Indonesia 7.84% Kuwait 5.44% Malaysia Oman 5.68% Pakistan Philippines Qatar 6.68% Sri Lanka 11.54% Vietnam Sources: World Bank Database In this reality, BBL has concentrated on searching for alternative avenues of revenue generation that is linked to mobile technology- possible growth driver of domestic banking sector. bkash bkash is a joint venture between BBL and US-based Money in Motion that aims to serve the 83% of the population living on less than $2 a day. bkash s one of the distribution partners is BRAC, an NGO with a large geographic footprint and more than 8 million microfinance group members in Bangladesh, enabling bkash to offer services where they are most needed. While only 9% of Bangladeshis are banked, more than 44% of population owns a mobile phone, making Bangladesh an ideal market for the introduction of mobile financial services. EL DORADO EL DORADO is a web based remittance and payment processing system for BDT payments. A key issue facing the Bangladesh remittance delivery network is the lack of electronic interconnectivity between banks, which is an important factor if one bank has the obligation to deliver remittance proceeds to a customer of another bank. Non-Interest Income Non-interest income constitutes 55.6 of BBL s 2011E total operating income. As per 4-year average, its proportion was 49.45% of total operating income, with investment income at 20.58% and commissions & fees income at 27.84%. Commission income and Exchange gains are expected to have GR at 5 and 4 respectively in Foreign currency comes from export and remittances. After meeting the internal needs like financing import clients, excess currency are sold in the local market to the other banks. Profit from foreign exchange dealings comes from the rate spread between position taken and position sold. Over last 1 year, when BDT depreciated around 1 against US$, that is expected to be the basic driver behind 4 GR in 2011 exchange gain. 6

7 BDT MM Composition of Operating Income from foreign exchange dealings comes from the rate spread between position taken and position sold. Over last 1 year, when BDT depreciated around 1 against US$, that is expected to be the basic driver behind 4 GR in 2011 exchange gain. Figure 9: Comparative Analysis of Operating Income Composition (As on 9M 2011) % 18% 3 24% Prime Bank National Bank 5% 3% 3% 23% 29% Southeast Bank 28% 24% 38% 43% Eastern Bank 2 28% 3 35% 1% 68% 3 37% NCC Bank Islami Bank BRAC Bank Bangladesh Net interest Income Investment Income Fee Income Other Income Figure 10: BBL Non-Interest Income Composition 7,000 6,000 5,000 4,000 3,000 2,000 1, ,531 2,259 1, ,745 2, , , , Commission Income Fees Income Investment Income Other Income Investment Income As a non-pd, BBL is not expected to be substantially affected by 2011 government borrowing. Higher government borrowing (BDT 69.3 billion in Jul- Sept11, a 23x rise YoY) is not expected to directly affect BBL s 2011 treasury investment portfolio. However, increased Statutory Liquidity Reserve (SLR) requirements since December 2010 are expected to raise BBL s treasury investments by 2 in 2011 compared to 4-year average GR of 31%. 7

8 Portfolio Investment as % of Deposit Investment Income (BDT MM) GR (YoY) Figure 11: BBL Investment Income 3, , ,000 73% 8 1, ,000 31% % Investment Income (BDT MM) GR (YoY) 9M11 investment income posted a strong 76.94% GR YoY, derived from trading profit of held-for-trade (HFT) and available-for-sale treasury bonds. 85% of total investment income in 9M11 was drawn from treasury securities. Total return from treasury operation was around 18%- composed of 11% from interest and 7% from capital gain. We expect investment income from treasury securities GR of 56.47% YoY in 2011, compared to 4-year CAGR of 44%. Figure 12: Portfolio Investment as % of Deposits as of % 8.9% 8% 7% 5.3% 5. 5% 4% % 3% 2.3% 1. 1% 0. AB Bank PBL NBL Southeast Bank EBL City IBBL BRAC Bank Commission and fees income BBL secured 4 th position in total inward remittance market share among all the domestic private commercial banks (PCBs) and 7 th position among all the domestic banks in In the same period, BBL received of total inward remittance flow. In 2010 BBL commenced 8 new exchange house relationships that are expected to facilitate the future growth in remittance flow. s We estimate 2011 commission, exchange and brokerage income GR at 15% YoY, compared to 22.27% YoY in 2010 and 2-year average GR of 18.97%. Radical fall in income from merchant bank-brokerage subsidiaries is accounted as the key reason of this lower GR in Commission income is expected to 8

9 Cost- to-income Cost- to- Assets BDT MM GR (YoY) grow 5 YoY, fees income 2, YoY, exchange gain 4 YoY, and merchant bank-brokerage subsidiaries operation by -4 YoY. However, the bank s remittance flow grew at a compound rate of 29.28% over the last 4 years. We estimate 1 growth in remittance flow YoY in Figure 13: BBL Commission, Exchange & Brokerage Income 3,500 3,000 2, % , ,500 1, % Commission, Exchange & Brokerage Income (BDT MM) GR (YoY) Cost-to-Income ratio is above industry average BBL 4 years average cost-to-income ratio was 48%, 4%-5% higher than that of the industry peers. BBL s SME focused business model, composed of large number of small clients and associated logistic support facilities, basically drove this above industry average cost-to-income ratio. However, higher than industry average IRS (7.07% VS 4.59% over ) mitigated the impacts of higher cost-to-income ratio. Figure 14: BBL Operating Efficiency Ratios 54% % 4 44% % 4.8% 4.7% % 4.4% 4.3% % % Cost-to-Income Cost-to-Assets Cost-to-income ratio was 53% up to 9M11, higher than 4-year average of 48% and 47% in 2010, on more employees dedicated to rigorous and systematic loan processing and collection. We project 2011 cost-to-income ratio to be also 53%. 9

10 Average Inflation Rate GR in Incomes (%) Diluted EPS GR Moderate growth in EPS in spite of macro shocks The year 2011 has been severe on the bank sector. High inflation and government borrowing cut IRS income whereas a 44%-market correction eroded portfolio gains from 2010 DGEN appreciation of near 83%. We expect BBL EPS stream and GR to be as follows. Figure 15: BBL EPS Trend % % % % Diluted EPS GR BBL lower but positive income GR in 2011 is owing to combined outcome of macro shocks, lower IRS and lower income from non banking operation, moderate commission and fees income GR, profit booking from treasury operation and higher costs. We project 2011 EPS to be BDT 6.95, against BDT 6.28 in 2010, 10.7% higher YoY. EPS 4-Year average GR is 58.61% as of Dec10. EPS grew % YoY in 9M11. Inflation and BBL s profit growth EPS GR YoY averaged 58.61% over Inflation and net profit GR exhibit negative correlation coefficient (CC) of Below graph depicts higher net profit YoY GR despite rising average inflation rate. Below graphs also depict CC of non interest income YoY GR to average inflation rate of and NII GR to average inflation rate CC of This is unexpected since negative Figure 16: Correlation between Inflation & BBL Income Components % 4% -4% % Average Inflation Rate GR in Non Interest Income GR in Net Interest Income Sources: BRAC EPL Research 10

11 Tier- I & Tier- II Capital Net Profit GR Avg Inflation Rate Figure 17: Inflation & BBL EPS Growth % % 57.4% 6.7% 7.3% 41.1% 8.8% 50.9% % % 4% Net Profit GR (YoY) Average Inflation Rate Sources: BRAC EPL Research Comfortable capital adequacy ratio (CAR) Given that BBL has been maintaining CAR above regulatory requirement since 2003, we expect the trend to continue. The minimum CAR prescribed by the Bangladesh Bank is 5% for Tier-I and 1 for total capital. BBL exceeded these minimum ratio thresholds with a Tier-I capital ratio of 8. and total capital ratio of 13.3% in Note worthy here, low risk grading for SME loan facilitates attaining Basel II requirement. We expect that total CAR will remain around 13.0 in 2011 with Tier-I capital ratio of 8.0. Figure 18: Regulatory Capital Composition 14% % 2.3% 3.3% 5.1% 5. 8% 4% % 9.1% Tier-I Tier-II Improvement in asset quality We expect 2011 NPL ratio to improve to 5.6 in 2011 from 5.9 in Higher than comparable banks NPL ratio is an outcome of SME concentration. Impressive improvement is less likely in a setup of infrastructural bottlenecks and power shortage average provision adequacy ratio was However, operation of Regional Credit Risk Management Centers has already been started to maintain quality underwriting and bring the NPL ratio down. 11

12 ROE & ROA Gross NPL Ratio However, operation of Regional Credit Risk Management Centers has already been started to maintain quality underwriting and bring the NPL ratio down. Table 2: BBL Asset Quality Asset Quality NPLs to total loans and advances 6.04% 5.85% Provision for classified loans,mm 2,587 2,996 Sources: Company Annual Report Figure 19: BBL Gross NPL Ratio 7% % 5. 5% 4.5% 4.7% 4% 3% 1% Gross NPL Ratio Increasing return-roe is increasing We project ROE and ROA for 2011 to be 23. and 1.7%, respectively, up from 21.4% and down from 1.9% in Higher ROE is driven by moderate earnings growth and gradual paying off of preference share. Figure 20: BBL ROE & ROA Trend 35% % % % % 1 5% 1.9% % 1.7% ROE ROA 12

13 ROE (%) BBL in comparison to leading frontier market banks A quick look at the some of the largest listed banks in frontier markets such as Pakistan, Sri Lanka, Nigeria and Oman indicates how BBL fares in relation to its frontier market peers. Table 3: BBL in Comparison to other Frontier Market Banks (as on Dec 31, 2011) MCAP Frontier Market Banks Country (USD mn) P/E P/B ROE ROA BRAC Bank Habib Bank (HB) Pakistan 1, x 1.3x National Bank of Pakistan (NBP) Pakistan x 0.6x Commercial Bank of Ceylon PLC (CBC) Sri Lanka x 2.2x Banca Transilvania (BT) Romania x 0.8x Bank Muscat (BM) Oman 3, x 1.4x Access Bank (AB) Nigeria x 0.5x Sources: BRAC EPL Research, Capital IQ (As on Dec 31, 2011) Bangladesh x 1.4x 22.99% 1.7 With regards to profitability ratios BBL outperforms most of the leading banks in Pakistan, Sri Lanka, Oman and Romania. Among the 7 tabulated above, BBL is carrying below median P/E ratio and slightly above median P/B ratio. Considering its ROE (highest among the above banks) and ROA, undoubtedly BBL has further scope to appreciate in market. Figure 21: BBL in Comparison to other Frontier Market Banks (as on Dec 31, 2011) 25% 2 BRAC Bank HB CBC 15% BT BM NBP 1 AB 5% 0.8% % % ROA (%) Sources: BRAC EPL Research, Capital IQ (As on Dec 31, 2011) 13

14 Rating Our rating considered 2012E EPS and BVPS, 2012-outlook for the banking sector and other related factors. Considering the estimated EPS of BDT 8.70 and BVPS of BDT for 2012, we estimate a fair value of BDT per share with an OUTPERFORM rating. This fair value implies an 8.4x potential P/ E and 1.45x potential P/B of the company s Stock and 35.5 price gain over next 10 months investment horizons. 14

15 Balance Sheet, MM BDT E 2012E 2013E Property & Assets: Cash 4, , , , , ,138.0 Balance with Other Banks & F.I 3, , , , , ,383.3 Money at call.0 1, Investment 8, , , , , ,587.1 Loan & Advance 52, , , , , ,789.8 Fixed Assets 1, , , , , ,172.1 Other Assets 2, , , , , ,173.8 Total Assets 72, , , , , ,244.0 Liabilities & Equities: Liabilities: Borrowing from other banks, F.I 2, , , , , ,411.0 Deposits 58, , , , , ,979.1 Other Liability 6, , , , , ,579.3 Total Liabilities 67, , , , , ,969.3 Shareholder's Equity: 5, , , , , ,274.6 Total Liabilities & Equities 72, , , , , ,244.0 Income Statement, MM BDT E 2012E 2013E Interest/Investment Income 8, , , , , ,659.2 Interest/profit paid on deposit 4, , , , , ,374.0 Net Interest Income 3, , , , , ,285.3 Income from investments , , , , ,194.4 Commission, Excng & Brok 1, , , , , ,437.5 Other Income Total Operating Income 6, , , , , ,458.7 Operating Expense 2, , , , , ,956.4 Profit Before Provision 3, , , , , ,502.3 Provision 1, , , , , ,003.5 Pre-Tax Profit 2, , , , , ,498.7 Tax 1, , , , ,794.5 Profit After Tax , , , , , E 2012E 2013E Total Assets Growth 56.18% 30.61% 29.79% 17.91% 23.11% 24.1 L & A Growth 62.28% 21.78% 34.95% Deposit Growth 55.23% EPS GR 57.43% 41.08% 50.95% %

16 IMPORTANT DISCLOSURES Analyst Certification: Each research analyst and research associate who authored this document and whose name appears herein certifies that the recommendations and opinions expressed in the research report accurately reflect their personal views about any and all of the securities or issuers discussed therein that are within the coverage universe. Disclaimer: Estimates and projections herein are our own and are based on assumptions that we believe to be reasonable. Information presented herein, while obtained from sources we believe to be reliable, is not guaranteed either as to accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation of the purchase or sale of any security. As it acts for public companies from time to time, BRAC-EPL may have a relationship with the above mentioned company(s). This report is intended for distribution in only those jurisdictions in which BRAC-EPL is registered and any distribution outside those jurisdictions is strictly prohibited. Compensation of Analysts: The compensation of research analysts is intended to reflect the value of the services they provide to the clients of BRAC-EPL. As with most other employees, the compensation of research analysts is impacted by the overall profitability of the firm, which may include revenues from corporate finance activities of the firm's Corporate Finance department. However, Research analysts' compensation is not directly related to specific corporate finance transaction. General Risk Factors: BRAC-EPL will conduct a comprehensive risk assessment for each company under coverage at the time of initiating research coverage and also revisit this assessment when subsequent update reports are published or material company events occur. Following are some general risks that can impact future operational and financial performance: (1) Industry fundamentals with respect to customer demand or product / service pricing could change expected revenues and earnings; (2) Issues relating to major competitors or market shares or new product expectations could change investor attitudes; (3) Unforeseen developments with respect to the management, financial condition or accounting policies alter the prospective valuation; or (4) Interest rates, currency or major segments of the economy could alter investor confidence and investment prospects. BRAC EPL Stock Brokerage Capital Markets Group Sajid Huq Amit Senior Research Analyst sajid.huq@bracepl.com Parvez Morshed Chowdhury Research Analyst parvez@bracepl.com Ali Imam Investment Analyst imam@bracepl.com Khandakar Safwan Saad Research Associate safwan@bracepl.com Aasim Tajwaar Matin Research Associate tajwaar.matin@bracepl.com M M Shahnewaz Kabir Shawon Research Associate shahnewaz@bracepl.com Farjad Siddiqui Research Associate farjad.siddiqui@bracepl.com Institutional Sales and Trading Delwar Hussain (Del) Head of Institutional Sales and Trading del.hussain@bracepl.com BRAC EPL Research 121/B Gulshan Avenue Gulshan-2, Dhaka-1212 Tel: Fax: research@bracepl.com