Bank of Ayudhya (BAY) BAY.BK/BAY TB

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1 Banking Tuesday, March 15, 2011 Bank of Ayudhya (BAY) BAY.BK/BAY TB BUY (upgraded from Hold) Out of transition into growth. Share Price Target Price Target boosted to Bt29; upgraded to BUY. Our view on BAY has turned more favorable. We have become more positive over the medium term (three years) given that the bank has came out of a three-year transition phase ( ) and is now ready for a growth phase starting from this year onward. We boost our target price to Bt29 (from Bt25.5) and upgrade our recommendation to BUY from Hold. Our new target price is equivalent to 1.7x 2011 P/BV, derived from implied P/BV valuation methodology with key assumptions as follows long-term ROE of 16% and sustainable growth of 7% against CoE of 12.4%. Raise earnings forecasts. We lift our net profit forecasts by 8.0% and 10.0%, respectively. This is largely because we fine-tune our key assumptions mainly fee income and credit costs. We feel that management s guidance was a bit too conservative. We now project 2011 net profit of Bt11.6bn, or EPS of Bt1.90, and Bt13.9bn (EPS of Bt2.28) for Key guidance is conservative. Earlier this year, the bank guided for loan growth of 8%, which we think is achievable. BAY expects NIM to decline to 4.75% (from 5.1% in 2010), though we think it could top that. Fee income growth was guided at 10%, which we also believe is too conservative we look for 20% growth. The bank admits that its guidance is very conservative. Entering a growth phase. For BAY, going forward will be a growth phase as it just came out of a transition period. The bank has done a great job cleaning up and it underwent an integration period when GE took over management in It s made a few acquisitions between then and 2009 and has managed to lift itself to become a dominant retail banking player. BAY has shown solid growth in 2010, a trend we expect to continue in the future. Bt24.8 EVENT Company Update Bt29 LATEST KEY DATA SET close 1, No. of shares (m) 6,074.1 Market cap (Btm/US$) 150,639/4,953 12M daily turnover ( 000 shares) 4, week Hi/Lo (Bt) 28.25/18.00 Beta 1.53 PEG FY10-12F (x) 0.37 ROE FY11F (%) 11.3 ROA FY11F (%) 1.3 P/BV FY11F (x) 1.4 SHARE PERFORMANCE (%) 1M 3M YTD Absolute 0.4% 5.1% -3.7% Relative to SET -5.1% 6.6% -2.8% MAJOR SHAREHOLDERS (%) GE CAPITAL INTERNATIONAL HOLDING Thai NVDR Free Float (est.) Foreign Limit Foreign Ownership PRICE CHART Investment summary FY Dec F 2012F Net profit (Btm) 4,896 6,659 8,793 11,560 13,871 Change (%) NM PPOP (Btm) 14,208 17,276 22,055 25,655 29,782 Change (%) EPS (Bt) Change (%) NM P/E (x) DPS (Bt) Yield (%) BVPS (Bt) P/BV (x) ROAA (%) ROAE (%) Source: Company data & IVG estimates BAY 1 of 12 Bt /1/09 11/3/09 11/5/09 11/7/09 11/9/09 11/11/09 11/1/10 11/3/10 11/5/10 11/7/10 11/9/10 11/11/10 11/1/11 11/3/11 BAY Sirianont Srikureja (662) sirianonts@ivglobal.co.th

2 Valuation & investment rationale Target price boosted to Bt29; upgraded to BUY Sharp retail focus + strong sales culture = sustainable earnings growth May appear pricey at first glance but it s undergoing a growth phase We raise our target price for Bank of Ayudhya (BAY) shares from Bt25.5 to Bt29.0 and upgrade our recommendation to BUY from Hold. The upgrade comes as we fine-tune our earnings forecasts and take a positive view over the medium term (three years). Our new target price is equivalent to 1.7x 2011 P/BV, derived from implied P/BV valuation methodology with key assumptions as follows long-term ROE of 16% and sustainable growth of 7% against CoE of 12.4%. We like BAY for its extremely sharp focus on retail banking, primarily in the auto hire purchase (HP) business. It has a strong used car lending platform, which enables it to command a much higher lending margin. Furthermore, its sales culture has improved substantially a trend we expect to continue. There are still tremendous cross-selling opportunities across its customer base (via a series of retail portfolio acquisitions in ), which should bolster fee income and in turn overall profitability. This should also spell sustainable earnings growth over the longer term. BAY might seem a bit pricey now at least in terms of a P/E comparison. However, the bank is undergoing a solid growth phase given that it has spent three years cleaning up and laying good foundations for. Thus, shortterm richness in valuation will be offset by solid growth going forward. The stock is now trading at 12.9 x 2011F P/E, and this should be reduced to 10.8x in This is not bad for a bank undergoing a growth stage. We forecast solid growth to come from: 1) strong NIM, 2) solid fee income growth, 3) lower cost-to-income ratio on economies of scale, and 4) lower credit costs. Bank valuation comparison Bank Country Mkt cap EPS growth (%) P/E(x) P/BV(x) Yield (%) ROE (%) (US$m) 2011F 2012F 2011F 2012F 2011F 2012F 2011F 2012F 2011F 2012F Siam Commercial Bank* Thailand 11, Bangkok Bank* Thailand 9, Kasikornbank* Thailand 9, Bankof Ayudhya * Thailand 4, Krung Thai Bank Plc* Thailand 6, TMB Bank Plc * Thailand 3, ThanachartCapital Plc* Thailand 1, ICBC Bank China 239, China Citic Bank China 30, ICICI Bank Ltd. India 25, Bank Danamon Indonesia 6, Bank Central Asia Indonesia 19, Malayan Bank Malaysia 20, Public Bank Malaysia 15, United Overseas Bank Singapore 23, DBS Group Singapore 26, Simple average Source: Bloomberg, * IVG estimates (based on 11/03/2011 closing price) BAY 2 of 12

3 One-year forward P/BV band at 0.5x, 1.0x, 1.5x, 1.75x, 2.0x Price x 1.75x 1.50x x x /4/05 1/11/06 1/23/07 1/30/08 2/6/09 2/17/10 3/3/11 Source: Company & IVG estimates Risks to our target price have a lot to do with macro factors Risks Risks to our earning forecasts, recommendation and target price include: 1) a severe economic downturn/sharp drop in consumer and business confidence; 2) a significant rise in credit losses, 3) failure to implement announced growth initiatives, 4) political instability, 5) a serious event that could affect the domestic equity market, and 6) major geopolitical events that could impact the global capital markets. Raising earnings Boosting earnings forecasts by 8% and 10%, respectively We raise our earnings estimates for BAY by 8% and 10% as we think the company s earnings guidance is quite conservative. We lift our fee income growth assumption to 20% for (from 10% growth in 2011 and 15% in 2012) and cut our loan loss provisions (LLP) assumption to reflect the strong economy, which tends to deflate credit losses. Now, we expect BAY to report net profits of Bt11.6bn (EPS of Bt1.90) for 2011 (+32% from 2010) and net profits of Bt13.9bn (EPS of B2.28) for 2012 (+20% YoY). BAY 3 of 12

4 Earning revisions 2011F 2012F Previous Revised % Change Previous Revised % Change Net interest income 42,453 41,124 (3.1) 46,097 45,181 (2.0) Provision 13,000 10,913 (16.1) 14,000 11,189 (20.1) Non-interest income 16,662 21, ,844 23, Non-interest expense 30,855 35, ,929 37, Net income (Btm) 10,682 11, ,608 13, EPS (Bt) BV (Bt) (0.9) (0.3) DPS (Bt) Change in key assumptions Total loan growth (%) NIM (%) (14.1) (8.0) Fee income growth (%) , Cost to income (%) (100.4) (190.1) ROE (%) NPL % of total loan (155.3) (120.0) Source: IVG estimates BAY in a nutshell No.5 by market cap, assets/deposits Assets up 34% over the past three years on a series of acquisitions Has been in transition over the past three years now it s a dominant retail-focused bank No.1 in terms of used car lending, credit cards and personal loan Bank of Ayudhya (BAY), with nearly 10,000 employees, is the fifthbiggest Thai commercial bank by assets and deposits after Bangkok Bank (BBL), Krung Thai Bank (KTB), Kasikornbank (KBANK) and Siam Commercial Bank (SCB). It has been 33%-owned by GE Capital since 2006, when GE came in and initially injected c.bt22bn worth of capital (and later another c.bt10bn). This bolstered BAY s capital to the highest in the industry (back then) and allowed the bank to clean up its books and make several acquisitions. BAY went on an acquisition spree between (amid the global financial crisis) when it swallowed GE Capital Auto Lease (GECAL) in late 2007, AIA Retail Bank (AIARB) in 2009, and GE s consumer finance arm in Thailand GE Money Thailand (GEMT) in This, along with organic growth, has boosted BAY s total assets by 34% over the past three years (44% loan growth), not to mention leading to a substantial rise in its customer base. These acquisitions have enhanced BAY s competitiveness, adding significant economies of scale and scope as well as superb lending techniques. The bank has pretty much been in transition between , trying to clean up its books and execute integration. BAY has done a great job discharging NPLs from its books NPLs fell from Bt71bn (15% of total loans) at the end of 2007 to 38bn (5.4%) at end It has managed to lift itself to become a dominant player in the retail banking arena. Furthermore, it has also successfully lowered its funding costs, narrowing the gap with large banks. The integration process was pretty much completed in 2010, and it should bear fruit from this year onward. Today, its retail exposure is one of the highest in the sector (43% of its total loan portfolio) and it boasts the No.1 rankings in the used car lending and credit card business segments (highest number of cards), and personal loans. It ranks No.2 in total auto hire purchase (used and new) and No.4 in new car lending. BAY expects to continue to dominate the used car and credit card segments with the expertise it acquired from both GECAL BAY 4 of 12

5 and GEMT. It also plans to increase its market share in new car lending and mortgage loans earnings grew 32%, share price should outperform this year Strong franchise network should continue to support its business Profits in 2010 were at Bt8.8bn, up a sharp 32% from the Bt6.7bn in BAY s shares performance has been lagging its peers. The counter surged by 14% last year compared with a 34% increase in the SET banking index. We think there is a good chance it will outperform this year. BAY ended 2010 with 590 branches across the country along with c.3,100 ATM machines. Through effective leverage of these franchise networks, along with a solid lending platform, BAY is well positioned as a premier universal bank in the country that can offer a full spectrum of products to both retail and business segments. Strengthening business HP expanding into underexposed businesses Riding on retail segment growth momentum increasing both market share and wallet share Boosting productivity Objectives for 2011 BAY aims to strengthen its dominance in used car lending and it will likely acquire market share in the new car business despite the much lower yield as the bank believes that there are other opportunities to expand wallet share (cross selling products). Furthermore, it also plans to boost its mortgage lending business as it still has very low exposure to this. BAY expects to leverage its non-bank products, ie, trade finance, treasury, and capital markets business to both corporate and SME customers, which would boost fee income. BAY wants to maintain its position as a consumer-centric bank. This year it plans to capitalize on its large customer base by improving its employees motivation, implementing new technology (boosting efficiency), brand visibility and boosting network positioning (synergy and image). This will not only enhance its dominance in the hire purchase business but will enable the bank to grab market share in other segments as well as increase the wallet share of its existing clients. The bank targets a higher level of productivity, bringing out the best from its employees and strong franchise. This means a lot of hard-sell, crosssell, up-sell, etc, to both existing and new customers. Employees have done a great job in the past although management still sees plenty of room for improvement. BAY 5 of 12

6 This year, BAY expect NIM at 4.75% 8% loan growth with 10% fee income growth (we think this is too conservative)..... and cost-to-income at around 56%... and NPLs below 5% Key assumptions guidance Guidance and our expectations BAY guided for what we think were too conservative targets earlier this year. We expect it to soon lift its targets for loans, NIM and fees. The following is the key guidance for 2011 by the bank early this year: 1. Net interest margin (NIM) was guided at 4.75%. It was at 5.1% in NIM will decline despite the rising interest rate environment since the nature of hire purchase (HP) is fixed-rate loans; thus the rising cost of funds should erode NIM. Furthermore, there is also fierce competition in the HP business, particularly in the new car segment in which BAY plans to be more aggressive in We still believe it will top its guidance and achieve 4.9%. 2. BAY targets to grow total loans by 8% this year after 11% growth in This should be achievable, but again it appears to be quite conservative, in our view. 3. The fee income growth target was set at just 10% for 2011 (+38% in 2010). We believe this lacks ambition since BAY should be able to grow fees at a much faster pace given its huge client base. We believe 10% growth should be achieved very easily and our assumption is for 20% growth. 4. Cost-to-income of 56% (57% in 2010). Our cost-to-income ratio assumption is in line with the guidance. 5. NPLs at below 5% (5.4% in 2010) and NPL coverage in the range of 85-95% (89% in 2010). We believe these figures are achievable as we expect further NPL reduction and another Bt11.5bn worth of loan loss provisions to be set aside this year. Source: Company BAY 6 of 12

7 Key growth drivers going forward will be strong NIM with lower credit costs solid fee income growth potential and a lower cost-toincome ratio Key growth drivers As mentioned above, BAY has entered a growth phase which will be fuelled by: 1) strong NIM, 2) lower credit costs going forward, 3) solid fee income growth, and 4) lower cost-to-income via economies of scale. BAY should continue to command a NIM higher than its peers, bolstered by higher-yielding used car lending coupled with consumer-related loans. Note that BAY s current NIM is highest among the seven banks under our coverage, but its credit cost is above peers as well. This erodes interest margin when risk is adjusted to it in the form of net NIM (NIM-credit costs). Going forward, as credit costs decline, BAY should enjoy higher risk-adjusted margin in terms of net NIM. The bank should also enjoy solid growth in fee income since we still think its fee income is sub-optimal when compared with its customer base/assets/loans. Our analysis indicates that BAY s fee income is still c.15% below the optimal level. This is derived via a comparison of SCB s fee-generating capability fee income per customer and fees to total loans and total assets. SCB is a good comparison given a similar retailoriented loan portfolio. We are also projecting lower cost-to-income ratio from BAY from 2011 onward. Our analysis indicates that cost-to-income cost should drop to 52% by 2014 from 56% in 2010 to be more in line with peers. BAY s fee income to total assets & loans indicates room for improvement as well as fees per customer, which are still 25% below SCB s % Fee % of total asset SCB BAY Fee % total loan (Bt) SCB Fee per customer BAY Source: Company and IVG estimates (end-2010) BAY 7 of 12

8 BAY s cost of deposits has improved substantially; the spread has narrowed Lower credit costs will still improve BAY s net NIM further % (BP) Q06 4Q07 4Q08 4Q09 4Q10 % (0.50) KBANK SCB BBL TCAP KTB BAY TMB Source: Company (4Q10) Avg 3 big banks (LS) BAY (LS) Spread (RS) Net NIM Credit cost BAY s credit costs should normalize at 120bp (of total loans) by 2014F Cost-to-income should decline to a normalized level of 52% by 2014F (Bp of total loans.) (Btm.) 20,000 16,000 12,000 8,000 4, % 65.0% 60.0% 55.0% 50.0% 45.0% 0.80 FY06 FY07 FY08 FY09 FY10 FY11F FY12F FY13F FY14F F 2012F 2013F 2014F 40.0% Credit cost Source: Company and IVG estimates Net profits Cost-to-income Done a very good job of discharging NPLs as well as raising its NPL coverage ratio 14% 12% 10% 8% 6% 4% 2% 170% 150% 130% 110% 90% 70% 50% 0% % TMB BAY KTB TCAP BBL SCB KBANK SCB BBL TCAP KBANK TMB BAY KTB Source: Company BAY 8 of 12

9 The higher the retail loan portfolio the higher the avg yield on earning assets % KBANK SCB BBL KTB BAY TMB TCAP 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% KBANK SCB BBL TCAP KTB BAY TMB Corp SME Retail 4Q08 4Q10 Source: Company (end-2010) The higher the CASA (current and saving account) mix. the lower the average cost of funds (interest earnings liability) (%) % 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% KBANK SCB BBL TCAP KTB BAY TMB KBANK SCB BBL KTB BAY TMB TCAP Saving&Demand Time 4Q08 4Q10 Source: Company (end-2010) BAY 9 of 12

10 BAY s capital is strong BAY s customer base has surged over the past three years 4Q10 18% 16.7% 16.4% 15.8% 16% 14.0% 15.5% 14.7% 15.7% 14% 12% 11.4% 10.0% 10% 9.4% 11.6% 12.5% 11.5% 11.7% 8% 6% 4% 2% 4.6% 3.9% 5.3% 5.8% 3.9% 4.3% 3.0% 0% KBANK SCB T MB BBL T CAP BAY KT B (m) BBL KT B SCB KBANK BAY T MB T CAP Tier II Source: Company (end-2010) Tier I Ranking by total assets and loans Ranking by total deposits (Btbn) 2,000 1,800 1,600 1,400 1,200 1, BBL KT B KBANK SCB BAY T CAP T MB Total loan T otal assets Total assets Source: Company (end- 2010) (Btbn) 1,600 1,400 1,200 1, BBL KTB KBANK SCB TCAP BAY TMB Deposits 2010 BAY 10 of 12

11 Balance sheet FY Dec 31 (Btm) F 2012F Assets Cash 20,419 20,090 22,461 21,123 28,200 Interbank and money market 84,854 53,668 74, , ,772 Investment, net 57,229 68,063 79,089 90,964 95,289 Net Loans 526, , , , ,028 Properties foreclosed, net 21,371 18,017 14,727 12,727 10,727 Premises and equipment 16,085 17,370 13,347 14,562 15,838 Other assets 19,065 35,806 48,953 48,340 47,740 Total assets 745, , , ,625 1,065,593 Liabilities and SH's equity Deposits 537, , , , ,634 Interbank and money market 20,003 47,415 43,788 48,272 52,106 Long term borrowings 72,843 45,596 49,239 86,302 86,302 Other interest bearing liabilities 11,351 48,614 65,742 66,352 72,441 Other liabilities 18,558 25,407 35,482 35,523 35,572 Total liabilities 660, , , , ,056 Shareholders equity 85,367 92,585 99, , ,537 Total liabilities and SHs' equity 745, , , ,625 1,065,593 Source: Company data & IVG estimates Profit & Loss FY Dec 31(Btm) F 2012F Interest and div income 41,163 39,457 48,726 57,246 65,250 Interest expenses 14,595 11,040 10,492 16,122 20,069 Net interest income 26,568 28,417 38,234 41,124 45,181 Fee income 7,487 9,410 13,005 15,606 18,727 Other non-interest income (1,317) 4,314 6,333 5,916 4,394 Total non-interest income 6,170 13,724 19,338 21,522 23,121 Total income 32,738 42,141 57,571 62,646 68,303 Non-interest expense 21,224 23,764 32,840 35,219 37,299 Pre-provision profit 11,514 18,377 24,731 27,427 31,004 Provisions 6,060 10,216 12,391 10,913 11,189 Taxes 560 1,504 3,524 4,954 5,945 Minority interest (1) (2) Net profit 4,896 6,659 8,793 11,560 13,871 Source: Company data & IVG estimates BAY 11 of 12

12 Ratio analysis F 2012F Profitability indicators ROAA (%) ROAE (%) Net earnings growth (%) NM PPOP growth (%) Non-interest income / total income (%) Cost to income (%) Interest margins Net interest Spread (%) Gross yield (%) Funding cost (%) NIM (%) Balance sheet Net loan growth (%) Deposit growth (%) 7.6 (3.1) Net loans / deposits (%) Total CAR (%) Tier 1 CAR (%) Asset quality Total NPLs (Btm) 55,137 52,080 38,149 30,519 24,415 Total NPAs (Btm) 109, ,706 75,296 65,435 55,112 NPL / loans (%) NPL / LLR (%) NPA / LLR (%) Others Effective tax rate (%) Source: Company data & IVG estimates Key assumptions F 2012F Net loan growth (%) NIM (%) Provisions (Btm) 6,060 10,216 12,391 10,913 11,189 Fee income growth (%) NPL (Btm) 55,137 52,080 38,149 30,519 24,415 Source: Company data & IVG estimates 18 th Floor, Mercury Tower, 540 Ploenchit Road, Lumpini, Pathumwan, Bangkok Telephone: +66 (0) Fax: +66 (0) The opinions and information contained herein are based upon sources believed to be reliable but their accuracy, completeness or correctness are not guaranteed. This information is not to be construed as an offer, invitation or solicitation to buy or sell the securities covered herein by this report. I V Global Securities Plc. ( IVG ) accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or its content. BAY 12 of 12