Commercial Bank of Ceylon (COMB.N0000)

Transcription

1 Sri Lanka Banks, Finance and Insurance EQUITY RESEARCH Initiation of coverage 3 June 214 Commercial Bank of Ceylon (COMB.N) Committed to efficiency Near-term challenges appear to be clouding the positive structural themes of the Sri Lankan banking sector. We view the current weakness as an adjustment to previous over-lending and believe the stage is set for improving macroeconomic fundamentals, based on a solid underlying economic growth story in the medium to long term. Credit growth stimulation from the current low interest rate regime should gain momentum in 2H14, further supported by tailwinds from favorable policies (e.g., government guarantees for gold loans) and benign inflation. As the third-largest commercial bank in Sri Lanka, with an asset base of LKR649bn and a market capitalization of LKR113bn, COMB has consistently been an industry leader in terms of efficiency and profitability. We expect COMB to continue to post above-industry-average growth in both loans and earnings; loan growth in the mid-teens should sustain EPS growth at an 18% CAGR over 214E-216E. Our P/B- and P/E-based valuation analysis suggests a valuation range of LKR Underlying long-term economic growth story remains intact: Structural factors supporting the banking sector s growth story remain solid, in our view. A simple back-ofthe-envelope calculation supports the case for double-digit loan growth. GDP growth at 7% and inflation at 5% imply nominal economic growth at roughly 12%. Credit growth is typically 2-3ppts higher than nominal growth; 14%-15% is thus feasible. This view is substantiated by Sri Lanka s low private sector credit-to-gdp ratio (29% in 213) compared with peers, low mortgage lending and personal credit levels, indicating further room for growth. Beneficial impact of low interest rate regime yet to gain full momentum: Investor concerns regarding loan growth and asset quality deterioration appear to weigh down sector valuations. Restraints on gold-based loans imposed by the Central Bank of Sri Lanka (CBSL) to rein in over-lending, combined with the timing difference as corporates and investors readjust to the low interest rate regime, are behind the current lackluster environment. Furthermore, although policy rates have been on a downward trend since mid-213, banks have been slow to reduce lending rates. Double-digit prime lending rates at the two public banks that hold roughly 45% of market share as at June 214 explain the stagnating loan books; the sector reported YoY loan book growth of 8.8% in 213 and.6% in 1Q14. We expect credit growth to pick up in 2H14 as the benefits of rate reduction cascade with greater momentum. Furthermore, we expect the downward trajectory in rates to benefit bank asset quality. Industry-leading asset quality and profitability metrics over the past five years: COMB reported ROE, ROA and net profit margins higher than its peer commercial banks over the past five years, due mainly to its strong commitment to efficiency. COMB s cost-toincome ratio (CIR) declined to 4 in 213, down 5ppt since 29, and has consistently been the lowest CIR among peers. COMB also reported the highest CASA ratio among peers (44% in 213) such low-cost funding enables lower lending rates, facilitating loan growth at a faster pace, while maintaining margins. We like COMB for its long-term aim of becoming a LKR1tn bank by 216E, and we believe it has the vision and the clout to grow into a regional player of note; its success in Bangladesh provides proof of concept, Bangladesh now contributes about 13% of net profit. We establish a valuation range of LKR : COMB s voting shares trade at a current P/B multiple of 1.9x, at a slight premium to its two-year historical average of 1.7x. We expect the market to value COMB at a higher multiple as the current concerns ease; however, as a base case, we conservatively value COMB at 1.9x one-year forward BVPS. We crosscheck this value by assigning a P/E multiple of 9.3x, in line with the current multiple of 9.3x, to its one-year forward EPS. A sensitivity analysis against the assigned base-case multiples yields a valuation range of LKR Key statistics CSE/Bloomberg tickers Share price (27 June 214) No. of issued shares (m) Market cap (USDm) Free float (%) 52-week range (H/L) Avg. daily vol. (shares, 1yr) Avg. daily turnover (USD ) COMB.N/COMB SL LKR % LKR14/111 42, Source: CSE, Bloomberg Note: USD/LKR=131. (average for the year ended 27 June 214) Share price movement Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 COMB ASPI S&P SL 2 Source: CSE, Bloomberg Share price performance 3m 6m 12m COMB 17.1% 17.2% 23.7% S&P SL 2 7.5% 8.6% 2.8% All Share Price Index 6.2% 8.3% 4.1% Source: CSE, Bloomberg Summary financials LKRm (year-end 31 December) E 215E Net interest income 25,322 29,111 34,181 Net revenue 35,619 4,34 45,362 Operating profit 16,655 19,481 23,369 PBT 14,693 17,15 2,571 Net income 1,563 12,155 14,87 Recurrent EPS ROE (%) P/B (x) Source: COMB, Copal Amba estimates 1

2 Table of Contents Industry-leading profitability and asset quality metrics... 3 Highest net profit margin, ROE and ROA among commercial banks... 3 Strong profitability due to low cost-to-income and high CASA ratios... 3 Prudent approach to risk management helps maintain asset quality... 4 Targeting an asset base of LKR1tn by 216E... 6 Low-margin, high-volume strategy to enable loan growth at above-industry-average levels... 6 Regional ambitions: Bangladesh provides proof of concept... 7 Strong investor appeal... 8 Highly liquid; average daily turnover double that of peers... 8 Dividend payout ratio of about 5 - highest among peers... 8 Twelve of the top twenty shareholders are foreign funds... 9 Current concerns about the banking sector are short-term... 1 Private sector credit growth rate declined due to a confluence of negative factors... 1 Stimulation from lower interest rate regime yet to gain momentum Pawning portfolio issues managed effectively Industry average measures mask wide variations in individual bank performance Lower SOE borrowings support private credit growth Improving liquidity levels ease pressure on interest rates Banking sector loan book well diversified Macroeconomic factors substantiate private sector credit growth story Credit as a percentage to GDP well below that of regional peer set IMF forecasts Sri Lanka s GDP to be the highest in the region Inflation targeted to remain at mid-single digit levels FDI inflows continue to rise Foreign remittances and exports increasing Exchange-rate stability a strong positive... 2 Fiscal deficit and current account deficit as a percentage of GDP improving... 2 Further improvement in savings necessary to narrow the savings-investment gap Factors that temper a positive outlook on credit growth We establish a valuation range of LKR for COMB s voting shares P/BV analysis yields a valuation range of LKR per share P/E analysis gives a valuation range of LKR per share Share price performance Earnings release focus areas Appendix 1: The Sri Lankan banking sector A competitive landscape Appendix 2: Company overview Appendix 3: Key financial data Fact sheet

3 Industry-leading profitability and asset quality metrics COMB has consistently reported industry-leading profitability measures over the past three years with the net profit margin, ROA and ROE higher than its listed commercial banking peers. Two main factors have contributed to this strong profitability: the lowest cost-to-income ratio (CIR) and the highest current account/savings account (CASA) ratio among peers. Asset quality measures more favorable than the industry average resulted from a prudent approach to risk management. A case in point is the pawning debacle of COMB was one of the least affected as its pawning portfolio as a percentage of total assets never exceeded 5%. This caution has not been at the cost of growth; following asset growth at a 17% CAGR over the past five years to LKR649bn as at 31 March 214, COMB now targets reaching LKR1tn in assets by 216E. Asset growth at an 18% CAGR over the next three years, required to reach LKR1tn, is feasible in our view, given its island-wide footprint and strong brand appeal. COMB s regional ambitions should also enable it to achieve this target, with the further consolidation of its overseas operations in Bangladesh; COMB is also considering expansion into Myanmar, Indonesia and Nepal. Highest net profit margin, ROE and ROA among commercial banks COMB reported a net profit margin of around 3 consistently over the past three years, the highest reported margin among the large private commercial banking peers (Figure 1). Similarly, it reported ROE of around 2, and ROA near 2% consistently over the past three years. We like COMB for this high profitability, as it was achieved while maintaining risk at a manageable level: due more to solid banking ventures such as corporate and high-quality SME loans rather than through low hanging fruits such as pawning. We believe the bank should be able to continue to show such industry-leading metrics due to the inherent advantages built up over the years. Figure 1: Highest net profit margin among peers Figure 2: Among the highest ROE and ROA levels Net income margin COMB HNB SAMP NTB SEYL SEYL NTB SAMP HNB COMB 2.4% 1.8% 1.2%.6%. 6% 12% 18% 24% ROA 213 ROA 212 ROE 213 ROE 212 Source: Bloomberg, Company reports Source: Bloomberg, Company reports Strong profitability due to low cost-to-income and high CASA ratios We attribute this strong profitability to two key features: the very low CIR and the industry leading CASA ratio. Cost-to-income ratio comparable with that of efficient regional banks Between 29 and 213, COMB reduced its cost-to-income ratio by 5ppt to 4.3%. This is at a comparable level with the most efficient regional banks (see Figure 85 on page 36), and indicates a strong commitment to efficiency in all aspects of its business. COMB s reported CIR has consistently been the lowest reported ratio among commercial banking peers; in 213, when COMB reported a CIR of 4, all its commercial banking peers reported CIRs of between 56% and 63% (Figure 3). 3

4 Given the significant improvement in the CIR over the past five years and the high levels of efficiency already achieved, we do not forecast similar levels of CIR reduction going forward. We expect the CIR to decline 2ppt to around 38% by 216E. The CIR decreases usually when non-interest income as a percentage of total income increases however, such an increase in non-interest income raises the volatility of returns. In COMB s case, non-interest income as a percentage of total income has remained stable at around 3 to total income, rendering COMB relatively less vulnerable to return volatility. Figure 3: CIR lowest among peers and improving Figure 4: CASA ratio is the highest in peer group since 29 SEYL NTB SAMP HNB COMB % % % 21 56% 29 48% COMB SEYL NTB HNB SAMP Source: Bloomberg, Company reports Source: Bloomberg, Company reports COMB has the highest CASA ratio among peers since 29 COMB reported a CASA ratio of 44% in 213. The CASA ratio has consistently been the highest reported among all listed commercial banks since 29 (Figure 4). However, the ratio has declined notably from 56% in 21, primarily due to increases in interest rates and the resulting mix-shift toward higher-yielding fixed deposits. During the past few years, COMB has invested heavily to keep increasing its CASA ratio, by continuing to expand its branch and ATM network. We view the bank s efforts to maintain its low-cost deposit base above the industry average level as a positive and as an important factor allowing COMB to weather changes in interest rates and minimize funding costs. Given the downward shift in interest rates, we expect the CASA ratio to start gradually improving over our explicit forecast period, to reach around 46% by 216E. Prudent approach to risk management helps maintain asset quality COMB adopts a conservative approach to new market trends; a case in point in the recent past is the pawning debacle. COMB entered the burgeoning pawning industry in 211 and its pawning portfolio grew to LKR11bn, a fivefold YoY increase, yet pawning as a percentage of total loans remained at 4%. The NPA ratio for the pawning portfolio was low at.38%. Gold prices started declining in 212 and the bank increased the lending rates to 19% (from 13% previously), and brought down the loan-to-value ratios. The portfolio was allowed to run down as NPA levels rose to 3.1%, then to 15.5% by end-213. The pawning portfolio stood at LKR4.9bn, accounting for 1.3% of total loans as at 31 March 214; this is one of the smallest pawning portfolios in the industry. COMB s overall NPA was contained to 3.9%, versus an industry average of 5.6% as at end-213. By 1Q14, COMB s overall NPA ratio had increased further to 4.4%, however, this was still at a lower level than the industry average of 6.2%, and licensed commercial bank (LCB) only average of 5.7%. Given the self-limiting nature of the pawning business (the one-year loan that is usually written off after a further six-month period), and the early steps COMB took to avoid high loan-to-value ratios, we expect COMB to recover from the pawning portfolio-driven increase in NPA levels within the next two to three quarters. We have conservatively factored in a 4 YoY increase in the rupee 4

5 amount of the NPA and expect COMB to end 214 with NPA levels of roughly 4.5%, which should gradually decline thereafter. Figure 5: COMB has one of the smallest pawning portfolios Figure 6: We conservatively forecast NPA levels at around 4% % of total loans LKRm 3, 25, 2, 15, 1, 5, NPA ratio 12% 1 8% 6% 4% 2% COMB HNB SAMP NTB SEYL E 215E 216E NPA (LHS) NPA ratio (RHS) Source: Bloomberg, Company reports Source: COMB, Copal Amba estimates Figure 7: COMB reported lower NPA ratio than peer average Figure 8: NPA ratio is low in segments other than pawning LKRm 3, 25, 2, 15, NPA ratio 12% 1 8% 6% NPA ratio 16% 12% 8% 1, 5, E 215E 216E NPA (LHS) NPA ratio (RHS) 4% 2% 4% Personal banking Corporate Pawning banking International operations Source: COMB, Bloomberg, Copal Amba estimates Source: COMB 5

6 Targeting an asset base of LKR1tn by 216E COMB reached an asset base of LKR649bn in March 214, after displaying asset growth at an 18% CAGR over the past three years. It has a soft target of reaching LKR1tn in assets by 216E. We believe this is a feasible target as it requires growth roughly at an 18% CAGR over the next three years; we expect to see the larger private commercial banks derive credit growth in the midteens as the timing mismatch between investor sentiment pickup and the lower interest regime eases. We also believe COMB has the potential to grow through organic growth expansion into investment banking and insurance businesses locally, as well as through consolidations and joint ventures in the South Asian region. Low-margin, high-volume strategy to enable loan growth at above-industry-average levels COMB reported loan growth and total assets growth in the mid-high teens during ; loan growth slowed down to 1 in 213, as shown in Figure 9. Going forward, we expect to see lower net interest margins, coupled with stronger loan and asset growth. Figure 9: Double digit growth in loans and assets Figure 1: Highly diversified portfolio provides risk minimization Gross loan growth Gross loan growth (LHS) Asset growth 2 15% 1 5% Asset growth (RHS) 3 1 8% 4% 3% 2% 13% 4% 3% 14% 9% Agriculture & fishing Manufacturing Tourism Transport Construction Traders New economy Financial and business services Infrastructure Other services Other customers Source: COMB Source: COMB Currently, the bank s retail and corporate portfolios are almost equally balanced. We believe this is a favorable situation in the current economic scenario as the retail exposure yielding higher margins (though with relatively higher risk), and the corporate portfolio with lower risk and margins. The portfolio is also highly diversified (Figure 1), which helps limit risk. COMB was able to show NIMs consistently higher than the sector average since 21, as shown in Figure 11. However, its NIM has been declining gradually since 212 and we expect this trend to continue in the lower interest rate environment. Supported by this lower interest rate regime, we forecast double-digit growth in gross loans. Our forecasts are based on our expectations of a pickup in the credit growth momentum from 2H14 onwards. Management too stated that they expect to see growth in commercial real estate financing and private housing loans during this prolonged low interest rate environment. We expect non-interest income to grow in line with the mid-teen growth rates as COMB explores new avenues such as investment banking and insurance, as well as proceeds with consolidating operations in the established businesses. For example, COMB believes it handles close to 2 of total inward remittances, and expects further growth in this segment. COMB estimates that it has the largest debit card portfolio in Sri Lanka, at 3 of total debit cards issued. Furthermore, we expect some contribution, though not material at the initial stages, to come from the consolidation of the smaller finance companies. 6

7 Figure 11: COMB achieved NIMs above sector average Figure 12: We forecast flat NIMs and double digit loan growth NIM 5.1% 4.7% 4.3% 3.9% NIM 5.1% 4.7% 4.3% 3.9% Loan growth % COMB LCB sector average 3.5% E 215E 216E NIM (LHS) Gross loan growth (RHS) -1 Source: COMB, CBSL Source: COMB, Copal Amba estimates We forecast EPS growth at an 18% CAGR 214E-216E With loan growth at a 17% CAGR, stable NIMs around 4.7%, lower credit costs and improving CIR, we forecast EPS growth at an 18% CAGR over the next two years. Regional ambitions: Bangladesh provides proof of concept COMB aims to become a regional player, with a presence in most countries in the region through own offices or joint ventures, in the mid to long term. We believe COMB has the vision and the clout needed to grow into a strong regional player. COMB entered Bangladesh through the purchase of the Crédit Agricole Indosuez business in 23 and its Bangladesh operations have been improving significantly with gross loans growing at a 13% CAGR since 21 (Figure 13). Net income grew 25% YoY in 212 and 33% YoY in 213 (Figure 14). Currently, it has 18 branches in Bangladesh, and the country accounted for 13% of the group s net profit in 213. COMB is in the process of setting up a representative office in Myanmar; after such a presence for a few years, it should be able to operate a comprehensive banking unit in the country. The COMB Chairman, in a recent press interview, also disclosed ambitions to enter Indonesia and Nepal, but considered India too high in entry costs and too intense in competition. Figure 13: Bangladesh - Loan book growth at a 13% CAGR, Figure 14: Net profit grew at a 29% CAGR LKRm 4, 3, 2, 1, LKRm 1,5 1, Gross loans Net income Source: COMB Source: COMB 7

8 Strong investor appeal COMB is one of the more appealing tickers in the S&P SL 2 due to features attractive to institutional and foreign investors. Highly liquid; average daily turnover double that of peers The COMB stock is highly liquid with a free float of 99.5%, and as a result it is one of the most traded stocks at the CSE. The average daily turnover for COMB stands at around USD375,; this is against peer average of around USD12,. Figure 15:COMB has the highest liquidity among peers Avg daily turnover (USD') Free float COMB HNB SAMP NTB SEYL Average daily turnover (LHS) Free float (RHS) Source: CSE, Company reports Note: Average daily turnover is for 12m ending 27 June 214. Free float is as of 31 March 214. Dividend payout ratio of about 5 - highest among peers COMB s dividend payout ratio is one of the highest among the listed banks at around 5, and the dividend yield at 5.8%, is starting to look attractive in the current low interest rate environment. Despite the higher multiples the stock is trading at, based on 213 reported numbers, COMB dividend yield was only second to HNB among the listed peers. Figure 16: Dividend payout is the highest among peers Figure 17: Dividend yield starting to look attractive Dividend payout % 44% 34% 23% 33% Dividend yield 8% 6% 4% 2% 5.8% 7.2% 4.2% 3.4% 3.5% COMB HNB SAMP NTB SEYL Dividend payout COMB HNB SAMP NTB SEYL Dividend yield Source: Bloomberg, Company reports Source: Bloomberg, Company reports 8

9 Twelve of the top twenty shareholders are foreign funds Foreign investors hold 36% of COMB s shares and twelve of the top 2 shareholders are foreign funds. On the one hand, this reflects the level of interest and confidence in COMB and its management; on the other hand, it helps reduce price volatility of the stock. Lower price volatility is also supported by the higher level of institutional holdings of COMB; institutional investors account for 82% of the total shareholding. Figure 18: Foreign investors hold 36% of COMB shares. Institutions 82% Individuals 18% Nonresident 36% Resident 64% Source: COMB (as of 31 December 213) Capital adequacy ratios stable no requirements for further fundraising COMB reported a capital adequacy ratio (CAR) of 16.9% in 213, well above the minimum regulatory requirement of 1, and a Tier 1 ratio of 13.3% (also significantly above the stipulated minimum of 5.). In 213, COMB strengthened its capital base further by raising about LKR1bn in subordinated term debt, which qualifies as Tier 2 capital, from the IFC. The CBSL announced capital requirements as a minimum of LKR1bn of Tier 1 capital by 216E, and the Basel III requirement is 4.5% in Tier 1 capital and a capital buffer of a further 2.5%. COMB s capital levels are well within these requirements. Based on our forecasts including RWA growth at a 14% CAGR over 214E-216E, we believe capital adequacy should remain well above the regulatory requirements, with Tier 1 ratios stable at around 13.5% over 214E-16E; we do not expect COMB to raise further equity over the period. 9

10 211 Q2 211 Q3 211 Q4 212 Q1 212 Q2 212 Q3 212 Q4 213 Q1 213 Q2 213 Q3 213 Q4 Commercial Bank of Ceylon PLC Current concerns about the banking sector are short-term Private sector credit growth soared in the three years postwar in Sri Lanka: bank loan books grew 24%, 32% and 21% during , respectively. Consumption growth contributed significantly to this growth, fuelled by gold-based borrowing, as gold prices also continued to soar. As a result, the CBSL imposed a mandatory credit ceiling to rein in credit growth in mid-212. This coincided with the collapse of gold prices, prompting banks to downsize their pawning portfolios, and lowered overall private sector credit growth to 7.5% by December 213. As gold prices collapsed, the asset quality of pawning portfolios also declined, raising concerns about asset quality deterioration. Once the excessive credit growth was under control, the CBSL eased monetary policy to restimulate growth. Policy rates started to decline since mid-213; however, lending rates remain high as banks attempt to expand net interest margins (NIMs) at the expense of loan growth. The sharp cutback in pawning is also masking credit growth. Credit growth stimulation should pick up momentum in 2H14 as banks pass on the benefit of lower interest rates to customers and more investments become viable in the lower interest rate regime. We believe the larger commercial banks including COMB, HNB and Sampath Bank are on a more sound footing and are better placed than state banks and smaller private banks to weather shortterm stresses. These banks are early adapters, positioning themselves to cater to the pickup in loan demand by passing on the benefits of lower interest rates to customers and by changing the loan portfolio mix for better diversification. Private sector credit growth rate declined due to a confluence of negative factors The postwar years in Sri Lanka have been characterized by extensive growth in the bank loan books, driven primarily by consumption-based lending. The sector s annual loan growth ranged between 21% and 32% during one of the highest growth rates recorded in the emerging markets. Escalating gold prices supported gold-based lending, which was the key growth driver in lending, as seen below in Figure 19. YoY growth in pawning loans exceeded 5 in 211 and early 212. This rapid credit growth prompted the CBSL to intervene by increasing benchmark interest rates and imposing a mandatory credit growth ceiling of 18% starting mid-212, as part of its policy decision to stabilize inflation and curb excessive credit growth. Rising rates coincided with the collapse in gold prices and drove a significant increase in pawning portfolio non-performing loan levels in most banks. This led to the subsequent reining in of gold-based lending, leading to a deceleration in the private sector credit growth rate. Figure 19: Gold based lending the key driver of exuberant credit growth during now of lesser importance YoY growth Credit to the private sector Pawning loans by commercial banks 1

11 As a result, credit growth slowed (Figure 2) while interest rates rose 454bps during this period, peaking at 14.4% in February 213. Figure 2: Private sector credit growth at a moderate pace Figure 21: Banking sector asset growth 17% CAGR LKRbn 2,6 2,5 2,4 2,3 2,2 2,1 2, Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 LKRbn 6, 14% 5, 14% 29% 4, 14% 24% 14% 3, 25% 16% 3 2, 31% 62% 58% 61% 1, 53% 56% Gross loans Investments Other Banking sector assets have grown at a 17% CAGR over the past five years. However, in 213, the proportion of gross loans as a percentage of total assets declined to 58%, as credit growth eased. The comparatively higher asset growth in 213 was due to an increase in investments made by the banks (mainly in government securities). Investments accounted for 29% of sector assets in 213 versus 24% in 212 (as shown in Figure 21). In line with the sector s credit demand trend, the five largest domestic banks also showed easing credit growth in 213, down from the peak levels seen over However, the three largest private banks (Commercial Bank, HNB and Sampath Bank) continued to show double-digit growth in 213, while the two government banks recorded growth in single digits. Excluding People s Bank, the top five LCBs grew their assets in the mid-teens to high-twenties range in 213. Figure 22: Loan growth of the top five banks eased in 213 YoY growth COMB HNB SAMP BOC PB Industry average Source: Bloomberg, CBSL, Company reports Note: BOC = Bank of Ceylon, PB = People s Bank Figure 23: while total asset growth ranged from mid-teens to mid-twenties YoY growth COMB HNB SAMP BOC PB Industry average Source: Bloomberg, CBSL, Company reports This growth rate moderation can be partly explained by the lag effect of the tight monetary policies and the higher interest rate environment. The CBSL also cited sluggish global economic growth, which led to lower levels of credit being required for international trade-related activities, as a reason for lower growth rates. The ability to access alternative sources of funding, such as domestic debenture issues with tax incentives, and international fund raising at lower rates due to the gradual liberalization of forex regulations further impacted bank lending volumes. 11

12 BOC DFCC AB PB PABC UB SEYL HNB SAMP NDB NTB COMB Commercial Bank of Ceylon PLC Stimulation from lower interest rate regime yet to gain momentum Starting mid-213, the CBSL relaxed its monetary policy stance, and in a string of policy rate amendments revised down its interest rates to mid-single digits with the aim of stimulating economic growth. However, the decline in lending rates has not been as pronounced as the decline in policy rates; banks have been protecting margins at the expense of loan growth. Figure 24: Policy rates started to decline in mid-213; decline in bank lending rates finally gaining some headway in June 214 % May Jul Sep-13 2-Nov Jan-14 2-Mar May-14 BOC PB HNB COMB SAMP SEYL DFCC NDB As shown below in Figure 25, the prime lending rates of the banks remain high, and rates at the two key state banks, Bank of Ceylon and Peoples Bank, with around 45% market share, remained at double-digit figures even as at May 214. Figure 25: Prime lending rates remain high even in June 214 Figure 26: Rate decline supports growth but with a lag % 12% 1 8% 6% 4% AWPLR 2 16% 12% 8% YoY growth % 4% AWPLR Private sector credit growth YoY Partly due to this lag effect, despite the policy rate decline, statistics reveal that credit pick-up has been slow, as shown previously in Figure 2. Private sector credit grew only 7.5% YoY in 213, compared with 17.6% YoY in 212 and an average YoY growth rate of 25.7% during Q214 has been similarly lackluster. The CBSL specified in its May 214 Monetary Review press release that banks were expected to pass on the benefit of eased monetary policy stance to borrowers without further delay. It is only in June that there were some signs of policy rate decline being passed on to creditors; People s Bank brought down prime lending rates to 9.1% in late June 214, from 13% previously and BOC prime lending rates have declined by about 2bps now from over 12% in January

13 Historical data shows that declining interest rate regimes promote lending growth, but with a time lag, as seen in Figure 26 above. Small but clear indications of a pick-up are beginning to appear. After a significant decline in January 214, private sector credit growth has been gradually picking up. Overall credit to the private sector amounted to LKR2,498bn in March 214, a marginal increase from February. The CBSL reported that lending by domestic banking units to the private sector increased by LKR15.3bn in March 214, but that the net credit level dropped due to repayments by BOI companies to offshore banking units. April 214, despite usually being the slowest month for credit due to the long New Year holiday, showed 3.3% YoY growth, though it was a.6% MoM decline. The larger private commercial banks including COMB, HNB and Sampath Bank, have been early movers in this regard; they reduced lending rates relatively early and, as a result, were able to show above-industry-average growth in 213 and in 1Q214. As the lending rate decline gains momentum, we expect investment appetite within the private sector to gradually improve starting 2H14. The CBSL expects overall loan growth at 14% for 214 for the sector. We believe this is quite ambitious for the sector, but expect the larger private commercial banks to reap the benefits of the rate decline and to grow at double-digit rates by leveraging their brand name and strong retail penetration. Pawning portfolio issues managed effectively The significant impact from the pawning portfolio decline has raised the question as to whether banks will be able to grow their loan books amid de-growth in gold-based lending. A large component of the banking industry credit growth in 211 and 212 was derived through gold-based lending, which grew 78% in 211 and peaked in 212 at LKR58bn, accounting for 25.4% of total LCB loans (including loans for purposes other than consumption). As gold prices declined, goldbased lending too declined, by LKR144bn in 213, and the CBSL estimates that gold loans have declined by LKR156bn in total since the peak in 212. The significance of this decline is clear when considered against the fact that total incremental private credit for 213 amounted to LKR176bn. Figure 27: Gold-based lending declined LKR156bn since 212 Figure 28: 2-33% of gold-based loans used to fund SMEs LKRbn % of total loans % 25.4% 25% % 17.5% % % Gold-based loan portfolio As a % of total loans LKRm Total gold based lending Pawning for personal loans 234,8 416,85 58, , , ,99 339, ,873 (%) 71% 68% 67% 8 Pawning for industrial/trading activities 67, , ,62 71,841 (%) 29% 32% 33% 2 The issue is further complicated by a factor specific to Sri Lanka and other South Asian countries: the practice of using gold as collateral for loans to fund small and medium enterprises in the agricultural, fishing and trading sectors, rather than for personal consumption. Pawning is particularly important in the North and East of Sri Lanka. Verification of land ownership is quite difficult following the destruction of land registries in this region; therefore, gold is the one of the few available and acceptable sources of collateral for lending. Industrial activity-related lending as opposed to consumer debt accounted for 33% and 2 of total pawning in 212 and 213, as seen above in Figure 28. As the banks tighten lending criteria, increase interest rates and limit loan-to-value (LTV) ratios, such constraints on gold-based lending affect the ability of rural communities to obtain banking facilities for economic activities and lead them towards informal lending sources. 13

14 COMB HNB SAMP NDB NTB DFCC SEYL PABC UB BOC PB Commercial Bank of Ceylon PLC To counteract this financial exclusion and to enable credit growth at a structured pace, the government introduced a gold-backed loan guarantee scheme in May 214, whereby a government guarantee is available on new pawning loans. The CBSL expects this scheme to allow banks to increase the LTV in gold-based lending to roughly 8, up from the current 65%. The CBSL has allocated LKR5m in initial funding for the new guarantee scheme. The scheme is likely to remain self-funded, as the banks are to contribute a 1% premium annually on their new pawning loans. The interest rate on new pawning advances is capped at 16%. Although this is limited to new loans, the possibility of refinancing old loans through the new finance scheme, which would be at lower rates, should help ease loan quality deterioration and the deceleration of the pawning portfolio of banks. A fine balance is required between risk mitigation for the banks and the provision of access to credit for an important segment. Credit rating agencies have pointed out the risk of banks aggressively pursuing pawning-based business growth; concerns center on the zero risk weighted assets (RWA) for gold, leaving no specific capital buffer for risk in the pawning portfolio and the absence of the requirement to report defaulters on pawning loans to the Credit Information Bureau. Our discussions with the CBSL indicate that while the CBSL will continue to closely monitor the banks pawning business, it is unlikely to raise the RWA on gold loans to avoid further constraints on gold based lending, given the importance of this line of credit. The nature of gold-based lending itself sets an automatic time limit on the concerns regarding pawning portfolios. A pawned article is redeemable within 12 months. Banks are able to realize assets on overdue loans usually after a further six months waiting period. Since pawning loan growth peaked in 212, a significant proportion of overdue loans would already have fallen due and been provided for. Our discussions with the CBSL indicate that it expects the concerns related to the pawning portfolios to recede within the next three to six months. Industry average measures mask wide variations in individual bank performance Asset growth and asset quality vary widely among banks, and this variation is masked when quoting industry average numbers. Although overall industry loan book growth declined to 8.8% in 213, the larger private banks showed significantly higher growth, as seen in Figure 29. Sampath Bank grew roughly 25% YoY in 213 and HNB 17%. DFCC, NDB and Commercial Bank each grew by double-digit numbers. Furthermore, although Peoples Bank s loan book grew only 3.2% YoY in 213, incremental credit to other industries amounted to LKR74bn, close to 1 of its loan book. However, this growth was masked by the LKR54bn decline in its pawning portfolio. Figure 29: Double-digit loan growth in 213 at private LCBs Figure 3: Pawning portfolio as a % of total loans varies widely PB 3.2% BOC 5.7% COMB 1.3% HNB 16.8% SEYL 17. NDB 18.6% SAMP 25.2% DFCC 28. % of total loans Loan growth Source: Company reports, Bloomberg Source: Company reports, Bloomberg Similarly, exposure to gold-based lending varies widely among the banks. Figure 3 shows the pawning portfolio as a percentage of total loans, at 11 LCBs in 212 and 213. The highest exposures are at Bank of Ceylon (BOC) and Peoples Bank, the two largest state banks. Peoples Bank had the largest pawning portfolio of LKR25bn, amounting to 38% of total loans in 212, 14

15 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 COMB HNB SAMP NDB NTB DFCC SEYL PABC UB BOC PB Commercial Bank of Ceylon PLC which it trimmed down to LKR197bn by 213. HNB trimmed its pawning portfolio to 13% of total loans by December 213 and further to 11% by the end of 1Q14. NDB, DFCC and NTB all kept their exposures at below 1 of total loans. Commercial bank had the lowest exposure, with the pawning portfolio brought down to 1.8% of total loans in 213 (from 3.2% in 212). Sampath Bank was the only systemically important private bank with a high pawning exposure at 19.7% of total loans in December 213; its exposure was also reduced to 17% by the end of 1Q14. The industry average NPA level rose to 5.6% in 213, and to 6.2% in 1Q214, from 3.7% in 212, mainly due to pawning-related losses. Given the lower level of residual risk on the new NPAs (being primarily gold-backed), banks made fewer provisions on the new NPAs, resulting in lower levels of provisioning coverage. We believe the increased credit risk as portrayed by lower loan loss coverage ratios (Figure 32), may not be as severe as it appears, due to the low LTV ratio (55%-65%) on new loans and the relative ease of realizing the value of the underlying collateral in gold-backed loans. However, a prudent approach would certainly require higher provisioning. Figure 31: Gross NPA levels rose in 213 Figure 32: Reported loan loss coverage levels fell at most banks Gross NPA ratio 2 16% 12% 8% Provision coverage ratio % Sector average 2 COMB HNB NDB DFCC PABC PB Sector average Source: Company reports, Bloomberg Source: Company reports, Bloomberg Lower SOE borrowings support private credit growth Private sector credit declined to 6 of total domestic credit in 213, from a peak of 66% in 21, as lending to the government and state-owned enterprises (SOEs) increased. Lending to SOEs, primarily to the Ceylon Electricity Board and the Ceylon Petroleum Corporation (CPC), started to ease during 2H13. As these two SOEs returned to profitability, credit growth to SOEs declined, helping to release significant liquidity to the market. This, in turn, led to a milder crowding out impact on private sector credit, and assisted in easing demand-driven pressure on interest rates. SOEs repaid LKR35bn of debt during 1Q14. On the other hand, total credit to the government has been increasing, as the government continues to invest in infrastructure projects. Figure 33: Private sector credit - 6 of total credit in 213 Figure 34: Credit to SOEs declining LKRbn 4,5 3, 1,5 LKRbn Credit to public corporations Credit to the private sector Credit to SOEs Note: Public corporations include govt. and state-owned enterprises 15

16 Improving liquidity levels ease pressure on interest rates Furthermore, we note that liquidity in the banking sector improved in 213, with the liquidassets-to-total-assets ratio improving by 53bps and the liquid-assets-to-deposits ratio by 8bps. This is due to the mix shift towards investment assets on the back of slow loan growth during the year. Figure 35: Liquidity ratios in the banking sector improving Figure 36: portfolio Domestic private sector credit a well-diversified % 8 12% Trading Construction % 12% 11% 6% 4% Agriculture and fishing Consumption Manufacturing Infrastructure Credit to Deposits & Borrowings Liquid Assets to Total Assets Liquid Assets to Total Deposits 16% 19% 3% 3% Financial services Tourism Transport Other Banking sector loan book well diversified Sri Lanka s banking sector loan portfolio is well balanced across a number of sectors, reducing the reliance on any single sector. This lowers the risk of bubbles from unsustainable loan growth in specific segments such as property, personal consumption etc. According to CBSL data, the construction, trading, infrastructure, manufacturing and transportation segments posted double-digit growth rates in 213, while credit growth in the consumption segment declined during the year. 16

17 Sri Lanka India Indonesia Malaysia Thailand Philippines Sri Lanka India Indonesia Malaysia Thailand Philippines Commercial Bank of Ceylon PLC Macroeconomic factors substantiate private sector credit growth story Credit as a percentage to GDP well below that of regional peer set Sri Lanka s private sector credit as a percentage of the GDP is relatively low remaining at an average of 3 over the past three years, as shown below in Figure 37. Private sector credit as a percentage of GDP is an indicator of financial depth and is both a causal factor and a result of economic growth. An excessive, sudden increase in the ratio is also a risk factor for the economy as it can cause inflationary pressures. Household debt as a percentage of GDP also remains at very low levels (Figure 38). Sri Lanka s GDP per capita rose to USD3,282 in 213 and is forecast to rise to USD4, by 216. The projected increase in disposable income that accompanies per capita income growth should allow for significant increase in personal consumption and provide an opportunity for increased personal lending, leading to growth in bank loan books. Figure 37: Private sector credit as a % of GDP stable and low Figure 38: growth Household debt as a % of GDP further room for LKRbn 1, 8, 6, 4, 2, % 26.5% 3.7% 31.1% 29.2% Domestic credit to the private sector (as a % of GDP) GDP (excluding domestic credit to the private sector) LKRbn 9, 8, 7.9% 7, 9.3% 6, 8.8% 7.2% 5, 6.3% 4, 3, Household debt (as a % of GDP) GDP (excluding household debt) Sri Lanka s private sector credit to GDP (Figure 39) and the household debt as a percentage of GDP (Figure 4) ratios are well below that of its regional counterparts, indicating sufficient room for growth as economic growth gains momentum. Figure 39: Private sector credit as a % of GDP Sri Lanka well below regional peers Figure 4: Household debt as a % of GDP Sri Lanka well below regional peers % % 8.3% 1.3% 6.2% % 81.7% Household debt (as a % of GDP) GDP (excluding household debt), Bloomberg, World Bank, Bloomberg, World Bank 17

18 IMF forecasts Sri Lanka s GDP to be the highest in the region We believe there are solid underlying factors supporting the medium- to long-term economic growth story in Sri Lanka. Loan growth generally trends with GDP and is a few percentage points higher in a stable economy. Sri Lanka saw credit growth well above that of GDP growth in the immediate postwar period, explained partly by the pent-up demand for credit following a 3-year war. Figure 41: Loan growth tracks GDP and is usually higher than GDP growth YoY growth YoY growth 13% 1 7% 4% % Sector loan growth (LHS) GDP growth (RHS) We expect economic growth to track around 7%-8%, the CBSL forecasts 7.8% GDP growth for 214E, whereas GDP 1Q14 was reported at 7.6%. The World Bank s Global Economic Prospects report issued in June 214, forecasts Sri Lanka s economic growth to remain broadly stable at 7.2% in 214. It forecasts the growth rate to moderate slightly to 6.9% in 215 and 6.7% in 216. These projections position Sri Lanka as the fastest growing South Asian nation, ahead of the regional average of 5.3% and that of India at 6.3%. The CBSL also targets maintaining inflation at mid-single digit levels; headline inflation has remained below 6% over the past seven months. This implies nominal GDP growth at low doubledigit levels in 214 and beyond. Assuming credit growth at 2-3 percentage points higher than nominal GDP growth levels would still suggest credit growth at mid-teen levels in the near term. We briefly discuss below other factors that support the case for economic growth in the medium to long term in Sri Lanka. Inflation targeted to remain at mid-single digit levels Inflation remained at single-digit levels for the fifth-consecutive year despite supply disruptions, due to adverse weather conditions and fuel price increases. The CBSL targets maintaining inflation at mid-single-digit levels, and such low levels would support a low interest rate regime. 18

19 Figure 42: Low inflation rates enable a low interest rate regime Figure 43: Foreign direct investment nearly tripled over past three years % % 6.7% 6.2% 6.9% % 3.6% (May) Headline inflation USDm 1,6 1,4 1,338 1,421 1,2 1,66 1, Foreign direct investments FDI inflows continue to rise Foreign direct investment inflows, including loans, rose to USD1.4bn in 213, nearly tripling from 21 levels. Originating mainly from China, Malaysia and Hong Kong, 56% of this investment was directed to infrastructure development. We view continued FDI inflows as a vote of confidence in the Sri Lankan growth story. Foreign remittances and exports increasing Foreign remittances rose over 5 from 21 levels to USD6.4bn in 213. This was attributed to an increase in more skilled and semi-skilled Sri Lankans being employed abroad. The Treasury projects foreign remittances increasing to USD7.6bn by 216E. Similarly, revenue from the export of goods showed accelerating growth to USD1.4bn by 213, fuelled primarily by the export of high-value apparel products and a shift in tea exports to valueadded branded products. Figure 44: Foreign remittances rose over 5 during Figure 45: Earnings from export of goods rising USDm 7, 6, 5, 4, 3, 2, 1, 1,414 2,52 4,116 6,47 USDm 12, 1, 8, 6, 4, 5,133 7,64 8,626 1, Foreign remittances 2, Earnings from export of goods 19

20 Figure 46: Earnings from tourism increased Figure 47: services as did earnings from export of IT and Telecom USDm 2, 1,715 USDm ,5 6 1, Earnings from tourism Expon. (Earnings from tourism) Earnings from export of IT and telecommunication services Source: Ministry of Finance Source: Ministry of Finance Revenue from the export of services more than doubled to USD719bn between 21 and 213, with significant contributions from port and shipping-related earnings, tourism and the export of IT services. Such changes in the structure of the economy help to reduce the reliance on traditional exports and to de-risk the economy. Exchange-rate stability a strong positive The Sri Lankan rupee has showed the lowest fluctuation levels compared with the currencies of regional peers during the past twelve months. Such stability is critical to exporters and to encourage foreign investments. We believe the rupee will continue to depreciate at a low-singledigit level going forward as well. Figure 48: Currency fluctuation in LKR the lowest among regional peers over the past twelve months Index Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 LKR/USD INR/USD IDR/USD THB/USD PHP/USD PKR/USD Source: Bloomberg Fiscal deficit and current account deficit as a percentage of GDP improving The fiscal deficit amounted to LKR516bn in 213, as against LKR489bn in 212. However, the fiscal deficit as a percentage of GDP has been improving steadily. The Ministry of Finance stated in its annual review that its target was to reduce the fiscal deficit to below 5%. The current account deficit too has been narrowing continuously, improving to -3.9% of GDP in 213 from -6.7% in

21 Figure 49: Fiscal deficit as a % of GDP improving Figure 5: Current account deficit improving -5.9% % % % % % 211 LKRbn USDm -5, -4, -3, -2, -1, Source: Ministry of Finance and CBSL Source: Ministry of Finance and CBSL Further improvement in savings necessary to narrow the savingsinvestment gap Gross domestic savings as a % of GDP rose to 2 in 213, rising from multi year lows of 15.4% in 211. The savings-investment gap too has been improving consistently as seen in Figure 52. Sustaining high levels of economic growth requires further increase of the savings rate in Sri Lanka, failing which Sri Lanka would have to depend excessively on foreign investment for growth. Figure 51: Gross domestic savings on the rise Figure 52: Savings investment gap started to improve in 211 % 25% 2 15% 15.4% 16.9% 2. % % 1 5% -8% Gross domestic savings -12% Savings - investment gap Source: Ministry of Finance and CBSL Source: Ministry of Finance and CBSL 21

22 Factors that temper a positive outlook on credit growth We also note some concerns within the sector that could temper our positive credit growth outlook. Firstly, the trend for deleveraging following bubbles of credit growth (as was the case during ) typically leads to credit growth contraction in subsequent periods. We note that some larger corporates, which are over-leveraged due to acquisitions, have started to reduce their debt exposure. This could limit overall credit growth. Secondly, credit growth could also be restrained by the cautious attitude banks are likely to take, given the high NPA levels in the sector. The sector s NPA reached a four-year high of 5.6% in 213, and rose further to 6.2% in 1Q214. Another factor that could affect the overall NPA quality of bank loan books is the increasing disintermediation. Blue chip corporate clients are now venturing in to debt raising at capital markets: for example, Hayleys Plc raised LKR2bn through a debenture issue at the CSE in 213 and John Keells Ltd appointed bankers to raise medium term finance through foreign debt in May 214. Further momentum in corporate debt markets would force banks to look for alternative means of growth, seeking growth in riskier sectors and client segments. Therefore, we expect to see a moderate pick-up in credit growth towards 2H14 and overall sector credit growth to come in at the low- to mid-teens range in 214. Furthermore, we believe sector credit growth in the low teens allows a favorable balance between growth and risk management. 22

23 We establish a valuation range of LKR for COMB s voting shares We establish a 12-month valuation range of LKR per share, based on our current outlook for COMB shares, compared with the current share price of LKR14 as of 27 June 214. We arrive at our valuation range by applying a sensitivity analysis to a P/BV valuation, and validate it further by cross-checking against a P/E multiple-based valuation. We also compare COMB s valuation levels relative to a domestic peer group. Figure 53: Valuation range analysis provides a range of LKR per share (current share price: LKR14) P/B P/E week range Source: COMB, Bloomberg, Copal Amba estimates P/BV analysis yields a valuation range of LKR per share Our primary valuation for COMB is on a P/BV basis. At peak valuations, COMB traded at a trailing 12-month P/BV of 2.9x in January 211; trading multiples have declined since then and after December 211, the stock has been range bound at 1.4x to 1.8x P/BV. Figure 54: COMB has traded at between 1.4x-2.9x on a P/BV basis since January 211 LKR/share Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 May-13 Aug-13 Nov-13 Feb-14 May x 1.8x 2.2x 2.5x 2.9x MPS Source: COMB, Bloomberg, Copal Amba estimates The stock currently trades at a P/BV multiple of 1.9x (based on our forecasts) at a premium to both its two-year historical average of 1.7x, and to domestic peers (Figure 55). We believe the market has assigned a premium valuation to COMB to account for the higher ROE and ROA consistently displayed (Figure 56) and expect valuation to remain at a premium as COMB continues to report industry leading return metrics. 23

24 Figure 55: P/E and P/BV comparison with domestic peers Company P/BV P/E E 215E E 215E COMB 1.8x 1.6x 1.7x 1.7x 1.5x 1.1x 8.5x 9.7x 9.3x 7.6x HNB 1.1x.9x.8x 1.x.9x 6.9x 5.9x 6.1x 6.3x 5.2x SAMP 1.3x 1.2x.9x.9x.8x 8.5x 6.2x 7.9x 6.2x 5.x SEYL 1.3x 1.x 1.x NA NA 3.6x 9.1x 9.5x 8.2x NA NTB 1.5x 1.3x 1.2x 1.2x 1.x NM 6.7x 6.7x 6.5x 5.7x Source: Bloomberg, Copal Amba estimates for COMB and HNB Figure 56: ROE and ROA analysis of domestic peer set Company ROE ROA E 215E E 215E COMB 2.2% 2.8% 18.5% % % 1.9% 1.8% 1.9% HNB 19.1% % 14.3% 1.9% 1.9% 1.6% 1.4% 1.5% SAMP 16.2% 21.3% 12.2% 15.1% % 1.9% % 1.6% SEYL 4.4% 11.4% 11.4% NA NA.4% 1.2% 1.2% NA NA NTB 2.8% 2.8% 19.5% 19.4% 19.6% 1.7% 1.7% 1.6% NA NA Source: Bloomberg, Copal Amba estimates for COMB and HNB Our P/B-based valuation range is derived considering the sensitivity of the stock price to changes in the base-case P/B multiple of 1.9x, based on the current trading multiple, which yields a one year forward valuation of LKR16 for the share. We believe investors would look beyond the immediate weakness in the sector and assign a higher trading multiple to COMB as it continues to deliver above industry average earnings and profitability growth. Valuing COMB at a conservative 2.x P/BV multiple on a one year forward basis yields a value of LKR166. Our bear case scenario considers the valuation for COMB in a situation where the valuations further decline; trading at a 1.7x one year forward P/BV multiple would result in a price of LKR141. Thus our P/B multiple based valuation range stands at LKR141-LKR

25 P/E analysis gives a valuation range of LKR per share We cross checked our P/BV valuation by valuing COMB on a P/E basis too, as a secondary measure. The one-year forward P/E multiple range of COMB has shown a wide variation since January 211 ranging from 18.x at peak levels in 211 to lows of 7.5x in 212. The stock currently trades at a 214E multiple of 9.3x (based on our forecasts) at a 13% premium to its twoyear historical average of 8.2x. Figure 57: COMB has traded at between 7.5x and 18.x on a P/E basis, since January 211 LKR/share Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 May-13 Aug-13 Nov-13 Feb-14 May x 1.1x 12.8x 15.4x 18.x MPS Source: COMB, Bloomberg, Copal Amba estimates We use the one year forward P/E multiple COMB has been trading at over the past two years, 9.3x as our base case multiple, yielding a P/E based price of LKR145. Our bear case assigns an 8.8x 214E EPS multiple to COMB, and the bull case a 1.5x 214E EPS multiple, yielding a price range of LKR Non-voting shares currently trade at a 24% discount As shown in Figure 58, COMB s non-voting shares currently trade at LKR16, a 24% discount to the voting shares. COMB s non-voting shares have traded at a discount of 2 to 4 to the voting counter over the past five years. Figure 58: COMB s non-voting shares have generally mirrored the movement of its voting shares LKR Jun-9 Nov-9 Apr-1 Sep-1 Feb-11 Jul-11 Dec-11 May-12 Oct-12 Mar-13 Aug-13 Jan-14 Jun-14 Voting share price Non-voting share price Source: CSE, Bloomberg 25

26 Share price performance COMB voting-shares closed at LKR14 on 27 June 214, LKR27 higher than 12 months earlier, an increase of 24%, compared to a 3% increase in the S&P SL 2 and a 4% increase in the All Share Price Index (ASPI). Figure 59: COMB.N share performance over the last three years Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 Jun-14 COMB ASPI S&P SL 2 Source: CSE, Bloomberg Figure 6: COMB vs. key indices over m 6m 1 year 2 years 3 years COMB 17.1% 17.2% 23.7% 44.4% 17.7% S&P SL 2 7.5% 8.6% 2.8% 23.7% -3.3% ASPI 6.2% 8.3% 4.1% 27.4% -7.7% Source: CSE, Bloomberg 26

27 Earnings release focus areas Following is a checklist of items that investors should track in the next quarterly earnings release and subsequent releases. We will closely track COMB s performance across these key areas, revise our forecasts and update our valuation range in future earnings update notes. Focus areas on company specific data 1. Loan book growth: total loan book growth rate QoQ and YoY, segmental growth rates particularly corporate loans, SME loans and the pawning portfolio; composition of the loan book 2. Change in funding structure: CASA ratio, change in bank borrowings and debentures, if any 3. Net interest margin and net interest spread; composition of the net interest margin 4. Impairment levels: overall impairment and impairment levels in key segments and the provision coverage level 5. Cost to income ratio 6. Profit margins: operating profit margin and net profit margin 7. Dividend payout ratio 8. Capital adequacy levels Tier 1 and Tier 2 ratios 9. Change in branch and ATM network 1. Operations in Bangladesh, and ventures in to other regional countries 11. Any announcements regarding the acquisitions of NBFIs to be undertaken in view of the CBSL proposed consolidation program. Focus areas on macroeconomic data 1. CBSL imposed policy changes policy rates, repo rates, lending ceilings, rate ceilings etc. 2. CBSL monthly data issues - Domestic private sector credit levels, inflation, sector loan growth data etc 3. CBSL weekly data issues - LCB prime lending rates 4. GDP, FDI inflow, Fiscal and Current Account deficits as disclosed periodically by the CBSL 27

28 Appendix 1: The Sri Lankan banking sector A competitive landscape The Sri Lankan government envisages an USD1bn economy in the country over the medium term. The CBSL is implementing structural changes to the country s banking sector in an effort to further strengthen it and make it globally competitive, so that the financial system will be able to support such a large economy. At present, the Sri Lankan banking industry is an oligopoly dominated by two government banks (Bank of Ceylon and People s Bank) and three large private commercial banks (Commercial Bank, Hatton National Bank and Sampath Bank), which collectively control nearly two-thirds of total banking-sector assets. The remainder is fragmented, leading to intense competition. We also believe the sector needs to increase in size so as to take on big-ticket transactions. The structure of Sri Lanka s banking sector There is a fair amount of over-banking in the sector, with 34 banks accounting for LKR5.9tn (roughly USD45bn) in assets. The banking sector (excluding Central Bank assets) accounts for close to 58% of total financial-sector assets, while the sector s assets as a percentage of GDP stood at roughly 68% in 213. Figure 61: 12 domestic licensed commercial banks are they key players in the industry BOC PB COMB NTB DFCC Vardhana NDB SAMP SEYL HNB Amana UB PABC Note: Excludes Cargills Agricultural and Commercial Bank which commenced operations in May 214 Figure 62: 12 Foreign LCBs operate in Sri Lanka Axis Bank Citibank Deutsche Bank Habib Bank ICICI Bank Indian Bank Indian Overseas Bank MCB Bank Public Bank Berhad Standard Chartered Bank State Bank of India HSBC The 25 licensed commercial banks (LCBs) accounted for roughly 85% of total banking-sector assets and 9 of gross loans in 213. The nine licensed specialized banks (LSBs) focus on savings and development activities, and are not authorized to accept demand deposits (current accounts) or deal in foreign currency; these banks accounted for 15% of total banking-sector assets and 1 of gross loans in 213. Of the 25 licensed commercial banks (LCB), the two largest are the government banks, Bank of Ceylon and Peoples Bank, cumulatively accounting for nearly 5 of total commercial banking sector credit as at December 213. The largest private LCB is Commercial Bank of Ceylon, accounting for roughly 14% of total commercial banking sector credit. 28

29 Figure 63: State- and privately owned LSBs (circles denote asset size) HDFC Lankaputhra Development Bank Regional Development Bank Sanasa Development Bank DFCC Bank NSB As Figure 64 shows, only 5 of the 22 domestic banks have an asset base greater than LKR5bn (USD4bn), while most banks have an asset base less than LKR5bn. Foreign banks accounted for roughly 1 of the sector s assets, and most have an asset size less than LKR5bn. Figure 64: Five domestic banks hold a market share of 66% Figure 65: Most foreign banks have an asset base < LKR5bn Asset size Number of banks Total assets (LKRbn) Market share More than LKR5bn 5 3, % LKR25bn to LKR5bn % LKR1bn to LKR25bn % LKR5bn to LKR1bn % Less than LKR5bn % Asset size Number of banks Total assets (LKRbn) Market share LKR25bn to LKR5bn % LKR1bn to LKR25bn % Less than LKR5bn According to our calculations, the top five LCBs accounted for roughly 66% of total banking-sector assets (Figure 66) and 76% of gross loans in 213 (Figure 67). Owing to this concentration, we focus on these five banks in our sector discussion to depict industry growth trends. Figure 66: The top five LCBs accounted for 66% of total banking-sector assets Figure 67: and 76% of gross loans 6.6% 8.8% 24.4% 8.4% 1.8% 36.4% 1.2% 11.1% 2.6% 17.4% 22.7% 22.6% SAMP HNB COMB PB BOC Other SAMP HNB COMB PB BOC Other Source: Bloomberg, CBSL, Company reports Source: Bloomberg, CBSL, Company reports 29

30 Loan book growth in the banking sector set to pick up in 2H14 We discuss the factors that in our view should drive the pick-up in credit growth in pages Funding Sourced primarily through retail deposits Deposits made up roughly 7 of the banking sector s funding in 213, while the remainder was sourced through domestic and international borrowing. For domestic commercial banks, deposits accounted for 84% of total liabilities. However, deposit growth in domestic commercial banks moderated to 16%, while borrowings growth decelerated to 1 in 213. This was in line with the slowdown in credit growth owing to the lag effect of the high interest-rate environment during 212. After the CBSL relaxed regulatory limits on foreign borrowing for LCBs in 212, several banks raised dollar-denominated debt, increasing the level of foreign funding as a percentage of total borrowings within the system. For example, National Savings Bank (NSB) raised USD75m in September 213 and DFCC bank raised USD1m in October 213. The BOC also raised USD5m through the issuance of a five year bond overseas. Furthermore, both banks and non-banking financial institutions (NBFIs) showed a significant increase in sourcing funding through the local debt capital market, after the government incentives offered in the 213 budget. During 213, 21 banks and NBFIs raised LKR57.3bn through listed debentures on the CSE. The banking sector s CASA ratio continues to decline; it decreased to 34% in 213 from a high of 44% in 21, increasing the cost of funding. We believe the declining CASA ratio will negatively affect the sector s net interest margins (NIMs). Figure 68: Deposit and borrowings growth declined in 213 Figure 69: CASA ratio declining; foreign borrowings on the rise YoY growth 22% % 2 16% 14% 12% Deposit growth (LHS) Borrowings growth (RHS) CASA ratio Foreign borrowings as a % of total borrowings Sri Lankan banking sector NIM - one of the highest in the region Sri Lanka s banking sector reports the second-highest NIM (5.2%) among regional peers (peer average: 3.78% in 213). We believe this is mainly due to the combination of high-yielding loan portfolios and cost-effective funding structures. However, we note that the NIM has continued to trend downwards the current average is well below the historical five-year average of 5.69%. We believe this is mainly attributable to intense competition within the sector and the lower interest rate regime. The CBSL aims to maintain lower interest spreads and requires that banks narrow their NIMs over the coming years. The CBSL s soft target is NIMs of 3-4%, versus the current 5-6%. We believe declining NIMs will continue to pressure the industry s overall profitability if transaction volume does not pick up. 3

31 Figure 7: Sector-average NIM of 5.2% is the second-highest among regional peers Figure 71: Sri Lankan banks NIMs range from 3.9% to 6.3% NIM 8% 6% 4% 2% India Philippines Thailand Indonesia Malaysia Sri Lanka NIM 7% 6% 5% 4% 3% 2% 1% COMB HNB SAMP NTB SEYL BOC PB Source: Bloomberg, Company reports Source: Bloomberg, Company reports For regional peer comparison, we use the largest five/six banks in a country based on asset size. In some countries (e.g., Malaysia and India), the asset base of some banks is considerably greater than those of Sri Lankan banks. High NIMs are not translating into high profitability due to high cost structure The high NIMs Sri Lankan banks currently enjoy do not always translate into high profitability. This is because of both structural issues, such as the relatively large number of small banks, and bank-specific inefficiencies. Compared with regional peers, the Sri Lankan banking sector s average cost-to-income ratio was relatively high at 5.3% in 213. Although DFCC and Commercial Bank posted cost-to-income ratios in the mid-4s, the very high ratios (7-8) reported by smaller banks create an upward bias on the overall average. Figure 72: High cost-to-income ratio impedes profitability (Sri Lankan peers) Figure 73: Sri Lankan banks have the highest cost structure among regional peers Cost-toincome Cost-toincome COMB HNB DFCC NDB SAMP NTB SEYL UB PABC India Philippines Thailand Indonesia Malaysia Sri Lanka Source: Bloomberg, Company reports Source: Bloomberg, Company reports The burden of high cost-to-income ratios is further exacerbated by high provisioning costs, due to high NPA ratios at some local banks. In 213, the sector s gross NPA ratio stood at 5.6%, and rose to 6.2% in 1Q214, a five year high, due to increasing NPAs in the pawning portfolio and slow credit growth. Of the LKR74bn increase in NPAs in 213, LKR56bn was related to pawning 31

32 advances. Furthermore, the sector posted a decline in the coverage ratio in 213. The total provisions-to-npa ratio for the sector came in at 4.4% in 213, having steadily declined from 6.9% in 28. Figure 74: NPA ratios are at their highest in four years Figure 75: The sector s total provisions-to-npa ratio declined LKRbn 2 NPA ratio 1. LKRbn Gross NPA volume (LHS) Gross NPA ratio (RHS) Net NPA ratio (RHS) General provisions (LHS) Specific provisions (LHS) Total provisions to NPA ratio (RHS) The CBSL stated that the decline in the coverage ratio was mainly due to lower provisioning against new NPAs, which mostly relate to gold-backed loans. Most banks considered residual risk for gold-backed assets to be low and therefore made lower provisioning against their gold-based lending portfolios. We believe the apparent increase in credit risk, as indicated by lower provisioning cover, may not be as severe as it appears, as LTV ratios are lower in the more recent loans against which impairments are now being recorded. However, a prudent approach would require closer monitoring of the provision levels of each bank. Some smaller banks report higher NPAs than the sector average; however, their impact on the overall system is low, as they account for less than 5% of total sector assets. NDB, HNB and Commercial Bank record the lowest NPA ratios, at below 4%. They also have healthy coverage ratios. The two state banks have reduced their NPA levels to below the sector average and maintain strong coverage ratios. Figure 76: High NPAs concentrated in a few banks, with most large banks reporting healthy provisioning Gross NPA ratio Provisioning cover 16% % 8 8% 6 4 4% 2 COMB HNB DFCC NDB SAMP NTB SEYL UB PABC BOC PB Gross NPA ratio 212 Gross NPA ratio 213 Provisioning cover 212 Provisioning cover 213 Source: Bloomberg, Company reports, Copal Amba estimates 32

33 ROE and ROA have headroom to improve We believe measures of efficiency, such as ROE and ROA, have room for improvement. The sector s ROE has been trending downwards since 21 and is now at 16%. Similarly, the sector s ROA declined to 1.3% in 213 from 1.7% in 211. Commercial Bank and NTB report the highest ROEs at around 19%; they also report ROAs higher than the sector average. Figure 78 compares listed Sri Lankan banks in terms of ROE versus P/B values. Figure 77: ROE and ROA of domestic banks Figure 78: Listed Sri Lankan banks P/B vs. ROE, % 1.8% 1.2%.6% ROA 213 ROA 212 PABC UB SEYL NTB SAMP NDB DFCC HNB COMB. 6% 12% 18% 24% ROE 213 ROE 212 P/B 1.8x 1.6x COMB 1.4x 1.2x UB PABC NDB NTB 1.x SEYL DFCC HNB.8x SAMP 5% 1 15% 2 25% ROE Source: Bloomberg, Company reports Source: Bloomberg, Company reports There is further room for improvement in terms of profitability for Sri Lankan banks, when compared with regional peers. Thailand and Indonesia, for example, report ROEs of over 2; Indonesia reports an ROA over 2%. One of the targets of the proposed consolidation measures is for larger Sri Lankan banks to report returns similar to those of larger regional peers. Figure 79: Sri Lankan banks need to improve further on ROE Figure 8: and ROA levels ROE 3 25% 2 15% 1 5% India Philippines Thailand Indonesia Malaysia Sri Lanka Source: Bloomberg, Company reports ROA 3% 3% 2% 2% 1% 1% India Philippines Thailand Indonesia Malaysia Sri Lanka Source: Bloomberg, Company reports 33

34 The sector is attractive due to relatively high dividend yields One of the reasons driving the higher demand and the consequent higher liquidity of listed banks is the relatively high dividend yield. This would appear more attractive in a lower interest rate scenario. Figure 81: Dividend yields of domestic listed banks remain relatively high Dividend yield 12% 1 8% 6% 4% 2% COMB HNB DFCC NDB SAMP NTB SEYL Source: Bloomberg, Company reports The sector is well positioned in terms of risk-mitigation measures Sri Lankan banks maintain capital at well above the regulatory requirements of Tier 1 capital ratio of 5% and capital adequacy ratio (CAR) of 1. Sri Lankan banks are among the best capitalized in the region, with an average CAR of 14.1% against a regional average CAR of 12.5%. Figure 82: Most banks maintain Tier 1 capital well above regulatory requirements Figure 83: the region Sri Lankan banks are among the best capitalized in 25% 2 15% 1 5% Tier 1 capital 2 15% 1 5% COMB HNB DFCC NDB SAMP NTB SEYL UB PABC Tier 1 capital ratio CAR India Philippines Thailand Indonesia Malaysia Sri Lanka Source: Bloomberg, Company reports Source: Bloomberg, Company reports Additionally, Sri Lankan banks measure up well in terms of loan-to-deposit ratios (LDR). With the exception of DFCC and NDB, development banks which are funded by large project loans from local and international funding institutions, the other banks report LDR between 8-9, a health range within which the liquidity risk is well managed, while maintaining profitability. 34

35 Figure 84: Loan-to-deposit ratios are relatively low Loans to deposits COMB HNB DFCC NDB SAMP NTB SEYL UB PABC Source: Bloomberg, Company reports Sector consolidation could propel Sri Lankan banks to the next level of profitability In comparison with regional peers, Sri Lankan banks face the disadvantage of small size. The country s largest bank, Bank of Ceylon, is the only bank with assets of over LKR1tn (close to USD1bn), while the three largest private commercial banks have assets of roughly USD3.bn- 4.5bn. This makes it difficult for Sri Lankan banks to take on large-ticket transactions to achieve greater operating efficiency, and impedes the sector s competitiveness in the global market. Sri Lankan banks target both organic and inorganic growth to increase asset size. However, rapid internal growth is generally viewed as a high-risk strategy due to the risk associated with the potential diminishing quality of the asset base. Sri Lanka aims to establish a strong, globally competitive and dynamic financial sector through a regulator-driven consolidation process. The CBSL targets reducing the number of banks and non-banking financial institutions (NBFIs) in the system, and creating at least five banks with an asset size of LKR1tn each. It has directed domestic banks with asset sizes of less than LKR1bn to increase their size through organic or inorganic growth. The CBSL also aims to create one large regional bank to focus on regional activities. We believe this will narrow the gap in development activity between the Western Province and the other parts of the country. As a first step in this process, two development banks, NDB and DFCC, are moving toward consolidation. The consolidation of these two groups [comprising NDB, DFCC and DFCC Vardhana Bank (DFCC s commercial-banking arm)] will likely result in a bank with an asset size of roughly LKR38bn (USD3bn). Consolidation in the NBFI sector has already commenced. The sector accounts for roughly 7% of total financial-sector assets, and comprised 58 NBFIs as of end-213. The sector is dominated by a few large NBFIs 1 companies have asset sizes greater than LKR2bn (accounting for roughly 62% of market share), 7 companies have between LKR8bn and LKR2bn, and the remaining 41 have less than LKR8bn. The CBSL aims to reduce the number of NBFIs to around 2 and strengthen the balance sheets of these players in order to improve stability. It has also directed that smaller NBFIs should be acquired by large NBFIs or banks, or merge to reach an asset size of over LKR8bn. The regulator expects this consolidation process to be market-driven and be completed by March 215. The first acquisition under this program came about at the end of June 214, with Assetline Securities, a subsidiary of the David Peiris Motor Company acquiring Lisvin Investments Ltd. The uncertainty over the consolidation process has also been weighing on Sri Lanka s banking sector. However, we believe this will be a low-impact event for larger banks, as the asset size of the NBFIs to be acquired is less than LKR8bn (well below 5% of the banks overall asset sizes). Many countries in the region (including Malaysia, Singapore, Indonesia, Thailand and Taiwan) faced similar regulator-driven consolidation processes, particularly following the Asian financial 35

36 crisis in the late 9s. Several international rating agencies have viewed this consolidation process as positive, as they concur with the CBSL that it will produce stronger players in the financial sector and enhance development in the long term. Figure 85 lists the key profitability metrics of some regional banks; we believe Sri Lankan banks have the potential to achieve performance in line with regional peers once they show a significant increase in asset size. Figure 85: Key metrics of some regional banks Name of bank Country NIM CIR ROE ROA CAR Asset size (USDm) Tisco Financial Thailand 2.6% 39.5% 2.6% 1.3% NA 1,983 Bank Mandiri Indonesia 5.4% 4.6% 22.5% 2.7% 14.9% 6,238 Siam Commercial Thailand 3.3% 38.3% 21.8% 2.1% 14.5% 77,47 Public Bank Malaysia 2.1% 3.4% 21.2% 1.4% 13.8% 93,166 Source: Bloomberg Although we are largely positive about the consolidation process, we believe there are challenges that the industry has to overcome. Initially, the sector has been instructed that there can be no retrenchment of staff during the consolidation process: only a voluntary retirement scheme (VRS) may be enforced. We believe this will cap any material cost synergies achievable during the process, and are also concerned about the relatively short timelines. In addition to the proposed consolidation, the CBSL has increased capital requirements for the existing banks and NBFIs. LCBs will have a minimum capital requirement of LKR1bn each by 216 and LSBs a minimum requirement of LKR5bn (due to increase by 218). Furthermore, NBFIs will be required to have minimum capital of LKR1bn by 216 and LKR1.5bn by 218. Banks would be required to adopt Basel III capital standards, increase the quality and quantity of capital, introduce a capital conservation buffer and a counter-cyclical buffer to reduce pro-cyclicality, and to prevent excessive credit growth. We believe these development initiatives will help Sri Lanka build a strong financial sector over the medium to long term. 36

37 Appendix 2: Company overview Commercial Bank of Ceylon PLC (COMB) is the largest listed banking and finance institution on the S&P SL 2 index, with a market capitalization of LKR113bn as of 27 June 214, and the fourthlargest listed company overall. COMB was incorporated in 1969, and is a licensed commercial bank offering a multitude of banking services to both personal and corporate clients. The bank accounted for 12% of asset market share in the banking sector, and 14% of loans in 213. COMB s banking segment is the mainstay of its operations, contributing 87% of revenue in 213, while its leasing activities remain the fastest-growing segment, accounting for 8% of revenue in 213. COMB operates one of the largest and most extensive branch and ATM networks in the country, comprising 235 branches and 585 ATMs island wide, and has the largest asset base among all domestic listed banks, at LKR649bn as at March 214. COMB has the distinction of being the sole Sri Lankan bank in the Top 1 World Banks for the past three years, as chosen by UK-based The Banker magazine. US-based Global Finance Magazine has also acclaimed COMB as the best bank in Sri Lanka for the past 16 years. COMB has also ventured outside Sri Lanka, in to Bangladesh, which accounted for about 8% of revenue and assets in 213. The bank ventured into Bangladesh in 23 when it bought over the operations of Crédit Agricole Indosuez, a French bank, and currently operates 18 branches and 19 ATMs in the country across four districts. The bank recorded growth in loans and advances at a 15% CAGR over , although YoY growth has been declining since 21, reflecting COMB s conservative lending strategy. Meanwhile, deposits grew at a 17% CAGR, with time deposits being the key growth driver. Figure 86: Loan growth at a 15% CAGR over Figure 87: while deposits increased at a 17% CAGR LKRm YoY growth 4, 25% 3, 15% 2, 1, 5% % Long-term loans (LHS) Overdrafts (LHS) Trade finance (LHS) Short-term loans (LHS) Housing loans (LHS) Others (LHS) YoY growth (RHS) Source: COMB LKRm YoY growth 5, 25% 4, 2 3, 15% 2, 1, % Time deposits (LHS) Savings deposits (LHS) Current deposits (LHS) Other deposits (LHS) YoY growth (RHS) Source: COMB In 213, COMB recorded 11% YoY growth in its net interest income (NII) to reach LKR25.3bn, at a 14% CAGR, during The bank s net interest margin (NIM) grew to 5. in 212 (from 4.3% in 29), and subsequently contracted 29bps to 4.7% in 213, as the bank started reducing lending rates in line with the policy decline in rates. COMB s continuous efforts to improve efficiency has yielded favorable results, with the cost-to- income (CIR) ratio visibly improving, contracting about 5bps since 29 to 4.3% in 213. This has translated into enhanced profitability with the ROE widening 321bps from 15.3% in 29 to 18.5% in

38 Figure 88: NII grew at a 14% CAGR over ; NIM compression seen as lower interest rate regime takes effect Figure 89: CIR ratio has continued to improve since 29, supporting ROE growth over the period LKRm 3, NIM 5.2% CIR ratio 46% ROE 25% 25, 2, 15, 1, 5, Net interest income (LHS) NIM (RHS) % 4.6% 4.4% 4.2% % 45% 44% 43% 42% 41% CIR ratio (LHS) ROE (RHS) 2 15% 1 5% Source: COMB Source: COMB COMB s key business units COMB offers many banking and financing services through the following strategic business units (SBUs). Personal banking This division primarily caters to individual and small and medium-sized enterprises (SMEs), in addition to managing COMB s branch and ATM network. Services offered by the unit include deposit products (such as current and savings accounts), advances (personal, housing and auto loans) and fee-based services (debit/credit cards, internet and phone banking, and utility bill payments). Corporate banking This unit provides enterprise clients with corporate services such as term loans, leasing and factoring, term deposits, and savings and current accounts, among others. COMB also offers corporate finance products (managing IPOs and private placements, syndicated loans and project financing - a division the bank plans to expand in the future) and trade finance services (import/export financing and shipping guarantees). The bank additionally provides Islamic banking, bullion trading and internet banking facilities to its corporate clients. Treasury COMB s treasury operation is a standalone profit center within the bank and overlooks the management of its liquidity, funding, interest rates, capital health and foreign exchange exposure. Products offered by this unit include derivatives, interest rate products and foreign exchange products. Profits from foreign exchange products are the main source of income for this division. International operations This SBU comprises primarily of COMB s operations in Bangladesh, where it offers a range of deposit products and advances, as well as the bank s range of remittance services; COMB holds a 17% market share of total worker remittances to Sri Lanka. The bank s offshore banking operations in the Maldives also fall under this category. 38

39 Shareholding structure Domestic investors own 64% of COMB s voting shares as of 31 December 213, while institutional shareholders (both Sri Lanka-based and international) hold 82%. DFCC Bank PLC is the largest shareholder, with a 14.8% stake of voting ordinary shares, while the top 2 shareholders accounted for 69% of the total shareholding as of 31 December 214. COMB s directors hold less than 1% of total voting shares. Figure 9: Institutional investors hold a majority stake of 82% of COMB s voting shares Figure 91: while resident shareholders own 64% of the bank with the top 2 investors accounting for 69% Institutions 82% Individuals 18% Nonresident 36% Resident 64% Source: COMB (as of 31 December 213) Source: COMB (as of 31 December 213) The top five shareholders as of 31 March 214 are presented below: Name of shareholder Description Stake DFCC Bank A/C 1 A leading domestic development bank 14.83% Employees Provident Fund The largest pension fund in Sri Lanka 9.75% HSBC INTL Nominees Ltd JPMCB Franklin A prominent global asset management group 6.48% Templeton Investment Funds Mr. YSHI Silva A domestic high-net-worth investor 5.53% Sri Lanka Insurance Corporation Ltd Life Fund The largest government-owned insurance company in Sri Lanka 5.6% Source: COMB Board of directors As of December 213, COMB s board comprised eight directors. Their details are provided below: Name of Director Mr. Dinesh Weerakkody Mr. Dharma Dheerasinghe Mr. Ravi Dias Prof. Uditha Liyanage Mr. Lakshman Hulugalle Description Chairman. He was appointed to COMB s board in July 25, and has held the position of chairman since December 211. He was formerly a director of DFCC Bank PLC, as well as an advisor to the Sri Lankan prime minister during Deputy chairman. He has held this position since December 211 and is a prominent economist with 39 years of experience in the banking sector. Prior to joining COMB, he was the senior deputy governor of the Central Bank of Sri Lanka (CBSL). Managing director/ceo. He was initially appointed to the board in December 21 and has occupied this position since April 212. He was previously the COO of the bank for four years. He is also the managing director of Commercial Development Company PLC, a COMB subsidiary. Independent non-executive director. He is the chairman of the board s technology committee and holds several directorships in domestic companies in various sectors. Independent non-executive director. He has been on COMB s board since March 211 and serves in several government committees and posts. 39

40 Mr. Preethi Jayawardena Mr. S. Swarnajothi Mr. Jegan Durairatnam Source: COMB Independent non-executive director. He was appointed to the board in December 211 and holds board positions in several public and private companies. He is also a member of the CBSL s monetary policy consultative committee. Independent non-executive director. He is the chairman of COMB s audit committee and has been on the board since August 212. He was formerly the auditor general of Sri Lanka during Executive director/coo. He has held this position since April 212, having previously served in numerous management positions within COMB. Figure 92: Corporate holding structure Source: COMB 4

41 Appendix 3: Key financial data Summary group financials (LKRm) INCOME STATEMENT E 215E 216E (For the year ended 31 December) Net interest income 18,678 22,852 25,322 29,111 34,181 41,128 Net revenue 25,764 33,14 35,619 4,34 45,362 52,84 Operating profit 12,492 16,288 16,655 19,481 23,369 28,179 Earnings before income taxes 1,98 14,313 14,693 17,15 2,571 24,84 Net income available to equity holders 7,932 1,8 1,563 12,155 14,87 17,732 BALANCE SHEET E 215E 216E (As at 31 December) Assets Cash and dues from banks 24,69 35,915 18,395 27,34 29,554 31,99 Treasury bills 1,125 12,926 18, , , ,995 Net loans 278,43 33, ,45 417,94 494,1 59,452 Premises and equipment 8,616 9,59 9,286 9,472 9,691 9,916 Goodwill and intangible assets Total assets 441, ,221 67, ,31 817, ,458 Liabilities Total deposits 323,698 39, ,99 524, ,456 78,929 Bank borrowings 19,942 2,717 32,26 36,257 4,88 46,113 Other borrowings 42,193 32,718 47,42 64,767 7,16 75,885 Total liabilities 397, ,22 545,77 651,189 74, ,763 Equity Common share capital 16,474 18,9 19,587 21,194 21,194 21,194 Retained earnings 2,588 4,173 4,36 6,236 14,936 25,132 Minority interest Total equity 44,169 53,1 61,485 66,842 76,746 87,695 Total liabilities and equity 441, ,221 67, ,31 817, ,458 41

42 Key ratios KEY RATIOS E 215E 216E Growth Loan growth (%) 28.3% 18.8% 1.1% % 19.5% Net interest income growth (%) 14.1% 22.3% 1.8% % 2.3% Operating profit growth (%) 4.1% 3.4% 2.3% % EBT growth (%) 18.1% 3.4% 2.7% 15.8% 2.9% 2.6% Net profit growth (%) % 4.8% 15.1% 21.8% 19.7% Recurrent diluted EPS growth (%) 31.8% 28.3% 2.8% 14.1% 2.9% 19.7% Margins and profitability Net interest margin (%) 4.8% % 4.6% 4.6% 4.8% Operating profit margin (%) 48.5% 49.3% 46.8% 48.7% 51.5% 53.3% PBT margin (%) 3.8% 3.5% 29.7% 3.4% 32.7% 33.6% Net profit margin (%) 3.8% 3.5% 29.7% 3.4% 32.6% 33.6% ROE (%) 2.2% 2.8% 18.5% % 21.6% ROA (%) % 1.9% 1.8% 1.9% 2. Capital adequacy and allocation Tier 1 ratio (%) 12.1% 12.6% 13.3% 12.9% 13.3% 13.5% Tier 2 ratio (%).9% 1.2% 3.6% 3.2% 2.8% 2.4% Total CAR ratio (%) % 16.9% 16.1% % Total equity/total assets (%) % 1.1% 9.3% 9.4% 9.3% Leverage ratio (%) 8.6% 8.8% 8.5% % 8.3% Asset quality and liquidity NPA ratio (%) 5.5% 3.2% 3.7% 4.5% 4.3% 4.2% Reported loan loss coverage ratio (%) 39.5% 45.5% 45.4% Loans to deposit ratio (x) 89.5% % 83.1% 83.4% 86.2% Deposits to interest bearing funding ratio (x) 83.9% % 83.8% 84.7% 85.3% Valuation P/BV (x) 1.8x 1.6x 1.7x 1.7x 1.5x 1.3x P/E (x) 1.1x 8.5x 9.7x 9.3x 7.6x 6.4x Dividend yield (%) 6.4% 6.7% 5.8% 5.1% 5.4% 6.7% PER SHARE DATA E 215E 216E Reported diluted EPS (LKR) Common dividend per share (LKR) Book value per share (BVPS) Source: COMB, Copal Amba estimates 42

43 E 214E E 214E 215E E 215 E 216 E E Commercial Bank of Ceylon PLC Fact sheet Sri Lanka investment environment overview Sri Lanka s economy has been on an upward trajectory since the end of the three-decade civil war in May 29. Sri Lanka currently boasts South Asia s highest GDP growth, conducive fiscal and monetary policy, and favorable socio-economic conditions, which together create an attractive investment destination. Figure 93: 214E Sri Lanka's GDP projected to increase to 8% by Figure 94: GDP per capita to increase 22% by 216E % USD 5, 4, 3, 2, 2 1,, Department of Census and Statistics Figure 95: Annual core inflation post-war has averaged 6.7%, government targeting mid-single digit levels in the medium term Source: Central Bank of Economic and Social Statistics of Sri Lanka 212, Road Map CBSL Figure 96: CBSL expects the rupee to stabilize in the medium term despite recent volatility % Jan-7 Jan-8 Feb-9 Mar-1 Apr-11 Apr-12 May-13 Jun-14 LKR/USD LKR/EUR LKR/GBP Source: Department of Census and Statistics, CBSL Source: Bloomberg Figure 97: Fiscal deficit target of 5.2% of GDP for 214E Figure 98: Debt-to-GDP to fall to 71% by 215E LKRbn % 8% 4% % Fiscal Deficit LKR bn As a % of GDP 43

44 Banks, Finance & Insurance Beverage, Food & Tobacco Chemicals & Pharmaceuticals Construction & Engineering Diversified Hotels & travels Investment Trusts Land & Property Manufacturing Plantations Power & Energy Services Telecommunication Trading Banks, Finance & Insurance Beverage, Food & Tobacco Chemicals & Pharmaceuticals Construction & Engineering Diversified Hotels & travels Investment Trusts Land & Property Manufacturing Plantations Power & Energy Services Telecommunication Trading Commercial Bank of Ceylon PLC The Sri Lankan equity market offers a rare and attractive alternative to investors in an investment era impacted by economic growth worries. Backed by the country s robust economic growth, the Sri Lankan capital market is well set to offer attractive returns to investors who are keen to be a part of this emerging market success story. There are several strong incentives for entering the Sri Lankan capital market. Figure 99: Post war, the ASPI has significantly outperformed global and developed market indices Jul-9 Mar-1 Nov-1 Aug-11 Apr-12 Jan-13 Sep-13 Jun-14 ASPI Dow Jones FTSE 1 MSCI World Source: Bloomberg *Note: All figures re-based to 1 July 29 DAX Figure 1: Post war, the ASPI has also outperformed some of the best-performing regional indices Jul-9 Mar-1 Nov-1 Aug-11 Apr-12 Jan-13 Sep-13 Jun-14 ASPI Bombay (BSE 5) Jakarta (JCI) Philippines (PASHR) Thailand (SET) Hanoi (VNINDEX) MSCI Emerging Market Index Source: Bloomberg *Note: All figures re-based to 1 July 29 Figure 11: 29 The CSE s market capitalization has doubled since Figure 12: The government anticipates FDI inflows to reach USD2bn in 214 LKRbn 2,8 2,4 2, 1,6 1, ,92 2,211 2,214 2,168 2,418 2, (June) USDm 1,6 1,338 1,42 1,4 1,2 1,66 1, Source: Bloomberg, CBSL Figure 13: Most sector P/Es are below market average and historical valuations Source: Ministry of Finance and Planning, Board of Investment of Sri Lanka Figure 14: Trend is similar on a P/BV multiple Average market P/E Average market P/BV Source: Colombo Stock Exchange Source: Colombo Stock Exchange 44