Sri Lanka Banking Sector Report - 02 01 2015 PDF

FC Research
SRI LANKA
Sector Report
Analyst: Reshan Wediwardana
SRI LANKA COMMERCIAL BANKING SECTOR

Struggle Ends Prosperity Begins
Stock
Recomme
ndation
Commercial Bank - Voting

Commercial Bank - Non-Voting
Hatton National Bank - Voting
Hatton National Bank - Non Voting
Sampath Bank
National Development Bank
Nations Trust Bank
Seylan Bank - Voting
Seylan Bank - Non-Voting
HOLD
BUY
HOLD
BUY
HOLD
HOLD
BUY
BUY
BUY
Mkt. Cap
(LKR mn)
137,747
137,747
62,504
62,504
39,459
40,299
22,254
16,542
16,542
Price
170.0
124.0
194.1
150.0
235.0
245.0
96.5
94.0
57.5
2 January 2015
Target Upside
Price
(%)
173.0
133.0
198.0
161.0
254.0
248.0
109.0
110.0
66.0
2%
7%
2%
7%
8%
1%
13%
17%
15%
PER (x)
PBV (x)
2014E
2015E
2014E
2015E
DPS
2015E
12.6x
9.2x
9.1x
7.1x
8.5x
11.0x
8.1x
9.2x
5.7x
9.1x
6.6x
7.8x
6.1x
7.1x
8.3x
6.7x
6.8x
4.2x
2.1x
1.6x
1.2x
0.9x
1.1x
1.5x
1.6x
1.3x
0.8x
1.9x
1.4x
1.1x
0.8x
1.0x
1.3x
1.4x
1.1x
0.7x
10.1
10.1
11.1
11.1
13.3
14.8
3.7
3.4
3.4
Dividend
Total
Yield
Return
2015E
6%
8%
8%
15%
6%
8%
7%
15%
6%
14%
6%
7%
4%
17%
4%
21%
6%
21%
FC Research expects the banking sector to have a favorable phase

during 2015-18E with improving credit growth in line with the GDP,
margin improvements through enhancing CASA and growth
stemming from the overseas operations. Hence we expect our
banking sector universe to provide 18% average return for 2015E.
Figure 1: 2014 Price Change
Growing GDP may assist banks to boost lending: We expect above

7% GDP growth to support lending mainly driven by growth in SME
and Construction segments alongside development in trade, valueadded apparel and tourism sectors. We also expect lending growth
flowing in through growth in consumer demand.
(Source: CSE)
Private Sector Credit Growth to grow at a CAGR of 18%: We expect

credit growth to pick up to 18-20% in 2015E while credit growth is
expected to continue at 18% through to 2018E. Credit Growth is
likely to be ignited by the low interest rate regime in the country and
an improvement in the credit to GDP ratio which is likely to reach
35% by 2018E vs. current 29%.
Margins to Bottom-out: The struggling Banking sector margins are
likely to have bottomed out in 2014E as we expect a recovery in the
margins while margins in the medium is likely to be maintained at
3.5%. Enhancement in CASA and re-pricing of FDs are likely adjust
cost of funding downwards improving the margins.
Figure 2: Banking Sector vs. ASPI
Improving Asset Quality through diversified lending base: We

expect sector non-performing loans to decline with improving
economic conditions and expected larger recoveries in selected
banks. Further diversification in loan books may further assist banks
to lower their exposure by expanding the risk appetite.
FC Research Coverage to provide 18% avg. return: We recommend
a BUY on NTB, HNB.X, COMB.X, SEYB.N and SEYB.X counters with
an average return of 18% for 2015E (including dividend yield).
COMB.N, HNB.N, SAMP and NDB are recommended as a HOLD.
(Source: CSE)
FC Research

Banking Sector Report 2015
Table of Contents
1.0 Introduction of Commercial banking sector.................................................................................... 3
1.1 State Banks retain a dominant presence with higher market share ............................ 3
1.2
Banking sector struggle in 2012-14 ........................................................................................... 3
1.3
Pawning Debacle in 2013 attributes to slow private sector credit growth................................ 4
2.0 Growing GDP may assist banks to boost lending ............................................................................ 6
2.1 Continuous progress towards achieving future GDP growth ........................................ 6

2.2
SME and Construction sector drive lending growth .......................................................... 6
2.3
Growth in consumer demand to boost lending ................................................................... 8
3.0 Private Sector Credit Growth to grow at a CAGR of 18% ................................................................ 9
3.1
Low interest rate regime is likely to attract borrowers ................................................ 9
3.2
Private sector credit to reach 35% of GDP ........................................................................ 10
4.0 Margins to Bottom-out .................................................................................................................. 12
4.1
Lower cost of funding due to enhancement in CASA ................................................... 12
4.2
Margins to revert back to 3.5% ........................................................................................... 13
5.0 Selected Banks to thrive through cost management, improved asset quality and regional
presence ............................................................................................................................................... 15
5.1 Effective cost-income management to thrive profitability .......................................... 15

5.2 Improving Asset Quality through diversified lending................................................... 16
5.3 Banks with regional presence may benefit from growing economic conditions in the
region ........................................................................................................................... 18
6.0 FC Research Commercial Banking Sector Coverage to Provide 18% Return for 2015E .............. 19
6.1 Sri Lanka Banks are still cheaper compared to other banks in frontier markets.19
6.2 FC Research Top Banking Sector Buys: NTB, SEYB, SEYB.X, COMB.X, HNB.X.19
6.3 FC Research Banking Sector HOLD List: COMB.N, HNB.N, SAMP, NDB.22
7.0 Appendices ..................................................................................................................................... 24
8.0 Glossary .......................................................................................................................................... 25

2
FC Research
1.0 Introduction of Commercial banking sector

Figure 3: Commercial Bank Assets (LKR Bn)
5,112
Sri Lankas Commercial Banking sector consists of 13 local banks and

12 foreign banks which account for LKR 5.1bn (USD 40bn) asset base.
From the overall banking sector, Private sector domestic commercial
banks hold 46% of the market share and two of the giant state banks
hold 44%.
Figure 4: Banking Asset Segmentation
1,573
2005
1.1 State Banks retain a dominant presence with higher

market share
2013
Foreign
Commercial
Banks 11%
(Source: CBSL)
SAMP
8%
State Owned
Banks 44%
Private Sector
Commercial
Banks 46%
HNB, 10%
SEYB 4%
COMB 13%
NDB 4%
NTB 3%
UBC 1%
PABC 1%
DFCC
Vardan
a 2%
(Source: CBSL, Company annual & quarterly reports)
1.2 Banking sector struggle in 2012-14

Challenging 2014 with lower loan growth and shrinking margins: In
2014 banking sector core profitability came down drastically due to
narrowing interest margins and subdued loan growth. However the
profitability improved due to one-off profits that arose from the
trading income with lowering interest rate in the economy and lower
impairment charges compared to 2013.
Banking Sector 2005-13 Asset CAGR of 16% despite 2012-14 slow
growth: The Banking sector has been experiencing a higher asset
CAGR of 16% throughout the past 9 years with significant support
from higher interest margins that prevailed in the economy.
However, the latter few years (2012-2014) saw some challenging
conditions in the sector amidst heavy pawning related impairment
write-offs and subdued loan growth which hurt overall profitability.
However, the sector emerged with applying different strategies
which suites for all these issues. Further the current lower interest
rate regime has also caused banks to narrow their margins and this
may lead to short term difficulties.
FC Research

Figure 5: Net Interest Margin Banking Sector
4.7%
4.6%
4.6%
4.5%
4.4%
4.2%
4.1%
3.5%
2.90%
2006
2007
2008
2009
2010
2011
2012
2013
2014E
(Source: CBSL)
Banking Sector New Era of Growth: The current finance sector

consolidation process, innovative strategies of new entrants and a
positive turnaround in the economy have led Sri Lanka Banking sector
enter into a new era of growth.
1.3 Pawning Debacle in 2013 attributes to slow Private

sector credit growth
Impact arising from declining pawning advances: Sri Lankan banks
with higher gold exposure, especially two of the largest governmentowned commercial banks, recorded negative loan growth due to
declining pawning advances. Further, this has led banks to record
higher impairment write-offs which again hurt their profitability.
Impact imminent from global gold price dip: Typically, gold is viewed
as an inflation hedge and safe haven investment by global investors.
Thus, gold prices are to a large extent influenced by a set of related
factors including the macroeconomic outlook for the U.S. and world
economies, the performance of alternative assets such as equities
and the U.S. Dollar, the trajectory of interest rates and geopolitical
uncertainty.
Feb-11
Apr-12
Jun-13
Aug-14
15%
14%
13%
12%
11%
10%
9%
8%
7%
6%
5%
400
350
300
250
200
150
100
2009
2010
2011
2012
2013 Mar-14
Pawning as a % of total loans and advances

(Source: Bloomberg)
Pawning - LKR bn
2000
1900
1800
1700
1600
1500
1400
1300
1200
1100
1000
Dec-09
Figure 7: Pawning vs. Total Loan Exposure
Pawning as a % of Gross loans and

advances
USD/t oz.
Figure 6: Gold Spot Price
Pawning
(Source: CBSL)
FC Research
Figure 9: Loan growth as of 9M2014
40%
Loan growth - .YTD
Private sector Credit Growth - YoY - Monthly
Figure 8: Private Sector Credit Growth - Monthly
35%
30%
25%
25%
20%
20%
17%
15%
15%
20%
11%
9%
10%
6%
15%
5%
10%
0%
3%
4%
2%
SAMP HNB COMB NTB
5%
NDB
SEYB PABC
UBC DFCC V BOC
PB
-2%
-5%
-5%
0%
-10%
(Source: CBSL)_
(Source: Bankss Quarterly Statements)
Figure 10: Loan Book Diversification 9M2014
100%
12%
90%
80%
70%
60%
13%
15%
1%1%
5%
1%
10%
13%
2%
6%
2%
2%
6%
18%
10%
14%
13%
12%
0%1%
6%
0%
2%
3%
6%
19%
6%
1%
3%
10%
7%
1%
27%
5%
0% 1%
9%
11%
3%
4%
7%
18%
27%
15%
30%
14%
17%
50%
7%
1% 1%
24%
1%
1%
17%
40%
19%
30%
49%
20%
47%
46%
44%
33%
10%
40%
36%
27%
0%
COMB
HNB
SAMP
Term loans
Overdrafts
Trade Finance
NTB
Pawning
NDB
SEYB
Lease rentals receivable
Staff loans
PABC
Credit Cards
UBC
Others
(Source: Bankss Quarterly Statements)
FC Research
2.0 Growing GDP may assist banks to boost lending

GDP Growth Forecast
CBSL
World Bank
IMF
Standard Charted
Average
2013
7.3%
7.3%
2014E
7.8%
7.2%
7.0%
7.5%
7.4%
2015E
8.2%
6.9%
6.5%
7.8%
7.4%
We expect above 7% GDP growth to support lending mainly driven

by the expansion of the Industrial and Service sectors. Expansion of
the sectors is likely to lead to lending growth in the SME and
construction segments alongside development in trade, valueadded apparel and tourism sectors. We also expect lending growth
to flow in through growth in consumer demand.
2.1 Continuous progress towards achieving future GDP growth

Figure 11: Quarterly GDP growth (Real)
10.0%
7.9%
8.0%
6.0%
6.3%
6.1%
6.8%
Figure 12: Annual GDP growth (Real)
8.2%
7.6%
7.8%
10.0%
8.0%
8.0% 8.2%
6.8%
6.3%
6.0%
7.3% 7.4% 7.0%
6.0%
4.8%
4.0%
4.0%
2.0%
2.0%
3.5%
0.0%
0.0%
3Q2012 4Q2012
1Q2013 2Q2013
3Q2013
4Q2013 1Q2014
2Q2014
(Source: Department of Statistics and Consensus)
2007 2008 2009 2010 2011 2012 2013 2014E 2015E

Healthy GDP growth above 7% to continue: We expect the economy

to grow above 7% with the main contribution coming from the
Industrial sector. The Manufacturing sector will continue to play a
pivotal role in the countrys economic expansion with further support
from improved value added production from the Agriculture and
Service sectors.
GDP enjoyed strong growth over the last 4 years: Sri Lankas
economy has entered a tremendous growth phase after the end of
civil war in 2009. Since then, the country has been able to maintain
the GDP growth rate above 6% supported by stable economic stance.
The Governments expansionary economic policies and growth in the
Industrial sector is expected to fuel future economic growth.
2.2 SME and Construction sector drive lending growth

Expansionary policies result in more lending: We expect prevailing
economic expansionary polices to continue in the next couple of
years by providing a platform to expand existing major economic
activities (Consumption, Government Expenditure and Investments).
Hence, we expect small and medium entrepreneurship sectors to
play a vital role by expanding their businesses in order to cater higher
demand soar from both locally and internationally. Further,
construction related activities may also drive growth consistent with
the developing tourism industry and enhancing government
infrastructure projects.
FC Research

Figure 14: GDP growth vs. Construction Sector Growth
Figure 13: Annual GDP growth Index

160
150
25%
Industrial Sector growth CAGR of

8.1% compared to diminishing
growth in Agriculture and Service
Sectors.
20%
15%
140
10%
130
5%
0%
120
Construction Sector
110
GDP
40%
10%
35%
8%
30%
6%
25%
20%
GDP Growth - YoY
Figure 15: Private sector credit growth vs. GDP
4%
15%
2%
10%
5%
0%
2013
2012
2011
2010
-5%
2009
0%
2008
2007
Services
Relationship between GDP and the private sector credit growth:

Private sector investment play a key role in an expansionary economy
providing greater support by enhancing the domestic production.
Over the past few decades, Sri Lanka has sighted how Private sector
borrowing helped to achieve intended economic growth by providing
necessary funding.
2006
2012
2005
Industry
2011
2004
2010
2003
Agriculture
2009
2002
2008
2001
2007
2000
2006
PSC Growth - YoY
100
-10%
-2%
-4%
Private Sector Credit Growth
GDP Growth
(Source: Department of Statistics and Consensus and CBSL)
Improving Industrial sector driven growth and related borrowings:

Since 2006 economic growth has been mainly driven by the
construction-led Industrial sector. The Manufacturing and Apparel
sectors too have played a vital role in economic growth during the
recent period.
FC Research
2.3 Growth in consumer demand to boost lending

Growing consumer demand to support growth: We expect
consumer demand to boost in 2015 by main driver stemming from
the borrowings against leasing consistent with the tariff cut granted
from the budget 2015. Further with the increasing per capita income,
credit card related borrowings may also expect to enhance with
changing life style of the consumers buying patterns.
Credit Card Related Loans - LKR mn
There is a 95% correlation between

Percapita Income and credit card
related loans in Sri Lanka with 20042013 CAGR of 20%. Hence along
with our growth targets in GDP, we
expect 2013 to 2016 CAGR of 16% in
credit card related loan segment.
700,000
90,000
80,000
600,000
70,000
500,000
60,000
400,000
50,000
40,000
300,000
30,000
200,000
Per Capita GDP (Nominal)
Figure 16: Relationship between CC Related Loans and Percapita

income
20,000
100,000
10,000
Per capita GDP at market prices (Rs.)
Credit Cards Loans (LKR mn)
(Source: CBSL and FC Research Estimates)
Figure 18: Vehicle import as a % of Total Imports
300
250
200
150
100
50
2009
2010
2011
2012
2013
2014E
Vehicle import as a % of Total Imports
No: of Vehicles - '000
Figure 17: New Motor Vehicle Registration
5.0%
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
Private Cars
Motor Cycles
Three Wheelers
(Source: Department of Motor Traffic and FC Research

Estimates)
2009
2010
2011
2012
2013
2014E
FC Research
3.0 Private Sector Credit Growth to grow at a CAGR

of 18%
We expect credit growth to pick up to 18-20% in FY15E while credit
growth is expected to continue at 18% through to 2018E. Credit
growth is likely to be ignited by the low interest regime in the
country and an improvement in the credit to GDP ratio which is
likely to reach 35% by 2018E vs. current 29%.
3.1 Low interest rate regime is likely to attract borrowers

Declining inflation to steer low interest rate: In 2015E, we expect
inflation to remain at current levels with possible decline in prices of
global energy commodities. In 2014 inflation came below 5% due to
the substantial decline in fuel and energy commodity prices. Hence
occasional policy rate cuts in line with lower inflation to foster
economic growth has resulted a lower interest rate regime.
Figure 19: CCPI (2006/07 =100)
12%
10%
8%
6%
4%
2%
0%
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
YoY
Annual Average
Jul-14
(Source: Department Census and Statistics)
Figure 21: WTI Crude Oil Prices
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1
0.9
0.8
0.7
WTI Crude Oil - USD/ Barrel
Propane - USd/Gallon
Figure 20: LPG Prices
114
104
94
84
74
64
54
44
LPG Prices
WTI Crude Oil

(Source: Bloomberg)
(Source: Bloomberg)
FC Research

Excess liquidity in the market may further support lower interest
rate: Prevailing higher market liquidity and limited investment
alternatives may further support banks to retain lower interest rate
regime for a greater span of time.
300
250
200
150
100
50
0
Jan-07
Apr-07
Aug-07
Nov-07
Mar-08
Jun-08
Oct-08
Jan-09
May-09
Sep-09
Dec-09
Apr-10
Jul-10
Nov-10
Mar-11
Jun-11
Oct-11
Jan-12
May-12
Aug-12
Dec-12
Mar-13
Jul-13
Oct-13
Feb-14
May-14
LKR bn
Figure 22: CBSL Holdings of Government Securities
(Source: CBSL)
3.2 Private sector credit to reach 35% of GDP

Figure 23: Private sector credit as a % of GDP
5,380
CAGR 18%
2.1X
2,534
2013
2018E
(Source: FC Research Estimates and CBSL)
Private sector credit to reach 35% of GDP: We expect Sri Lanka

Private sector credit growth to revive aggressively reaching 35% of
GDP by 2018E. Currently, Credit to private sector stands at 29% in Sri
Lanka lagging behind its peers in lower middle income category
compared to lower middle income average of 35%. Mainly attributing
to subdued loan growth which prevailed in the economy in last
couple of years.
10
FC Research
Figure 24: Private Sector Credit as a % of GDP

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
Vietnam
Ukraine
Morocco
Vanuatu
Mongolia
Cabo Verde
Honduras
India
Bolivia
Samoa
Armenia
Paraguay
Bhutan
Guyana
El Salvador
Moldova
Georgia
Indonesia
Philippines
Kosovo
Papua New Guinea
Solomon Islands
Guatemala
Senegal
Sao Tome and Principe
Djibouti
Sri Lanka
Nicaragua
Egypt, Arab Rep.
Swaziland
Lesotho
Micronesia, Fed. Sts.
Cote d'Ivoire
Ghana
Pakistan
Cameroon
Zambia
Congo, Rep.
Timor-Leste
Sudan
Yemen, Rep.
0%
(Source: World Bank)
Pawning crisis led to the credit growth decline: Private sector credit
declined to the level of 29% of GDP in 2013 in a volatile manner due
to pawning crisis. In 2006, this boosted up to 34% and dipped down
to 25% in 2009 due to political uncertainty that prevailed in the
country. We believe that the current growth momentum has a
possibility for Private sector credit to reach back to previous levels
with favorable macro conditions.
Figure 25: Private sector credit as a % of GDP
34%
33%
33%
31%
31%
31%
29%
29% 28%
29%
29%
28%
27%
25%
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
(Source: CBSL)
11
FC Research
4.0 Margins to Bottom-out

The struggling Banking sector margins are likely to have bottomed
out in 2014E as FC Research expects a recovery in the margins while
margins in the medium is likely to be maintained at 3.5%.
Enhancement in CASA and re-pricing of FDs are likely adjust cost of
funding downwards improving the margins. Improving macroeconomic conditions resulting in the ability to maintain low interest
rate regime is likely prevent margins from reaching high levels of an
average of 4.5% mark.
4.1 Lower cost of funding due to enhancement in CASA
60%
86%
85%
55%
84%
50%
83%
45%
82%
Market Share of CB
CASA
Figure 26: Commercial Bank CASA vs. CB Market Share
81%
40%
35%
80%
79%
1998 2000 2002 2004 2006 2008 2010 2012* Q1,
2014*
CASA
Market Share - CB
(Source: CBSL)
CASA improvement through minor switching effect: We expect cost

of funding to descend from 2015E with improving CASA by making
fixed deposits slighter attractive for depositors due to lower spread
between savings deposits and FDs. Because drastic reduction in fixed
deposit rates may demotivate clients to shift from saving deposits to
fixed deposits which provide higher returns.
Reverting CASA ratio amidst Financial Sector Consolidation: We
expect CASA ratio to reverse back to the positive levels due to lower
competition stemming from the Non-banking and finance sector in
the face of the consolidation process being implemented by the
Central Bank. It will further enable banks to reduce their cost of
funding significantly and CASA ratio has already shown signs of
improvement during 1H2014.
Figure 27: Deposit growth
Figure 28: CASA Improvement
CASA
16.4%
16.1%
11.8%
8.8%
45%
46%
41%
2013
42%
4.5%
41%
37%
35%
6.2%
4.4%
9M2014
39%
40%
8.6%
5.3%
50%
4.1%
30%
25%
-1.5%
29%
27%
29%
26%
20%
20%
15%
(Source: Quarterly reports)
12
FC Research
4.2 Margins to revert back to 3.5%

Figure 29: Banking Sector - NIMs
4.7%
4.4%
4.5%
4.6%
4.6%
4.2%
4.1%
3.5%
3.5%
3.5%
3.4%
3.1%
2.9%
Margins to recover with re-pricing of FDs and higher CASA: With the
steep drop in deposit rates during the last 6 months, fixed deposits
which are a major component of overall bank deposit base are likely
to re-price at lower rates during 2015E resulting in a recovery of
margins. Further, the expected growth in CASA ratio may also
support margins.
Quartarly NIms
Figure 30: Quarterly NIMs

6.5%
6.0%
5.5%
5.0%
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
COMB
HNB
SEYB
SAMP
(Source: Bankss Quarterly Reports)
Margins to recover and maintain at 3.5% in the medium term:

Following the re-pricing adjustment and the recovery in credit
growth, we believe Sri Lanka banking sector margins to reach back to
3.5% and remain at that level in the medium term. Sri Lankas growth
trajectory which creates demand for lending and the current financial
sector consolidation will also help to maintain NIMs around the 3.5%
mark.
13
FC Research

Temporary Distress due to Asset-Liability mismatch: The overall
Banking sector has been experiencing a tough time due to heavy
decline in pawning related loans along with stagnant overall credit
growth which has been a primary reason for the declining margins.
Figure 31: AWPR vs. AWDR (1996 to Present)
25.00
20.00
15.00
10.00
5.00
(5.00)
AWPR
AWDR
Spread
(Source: CBSL)
18%
16%
14%
12%
10%
8%
Jan-14
Jan-13
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
6%
Jan-01
AWFDR - Monthly
Figure 32: AWFDR - Monthly
(Source: CBSL)
14
FC Research
5.0 Selected Banks to thrive through cost

management, improved asset quality and
regional presence
5.1 Effective cost-income management to thrive profitability

We expect selected banking counters to perform exceptionally well
through improved cost management strategies and continuous
progress towards achieving greater core income through developed
marketing abilities and diversity in income generation.
Cost-to-Income
Figure 33: Cost to Income ratio
105%
95%
85%
75%
65%
55%
45%
SAMP HNB COMB NTB NDB SEYB PABC UBC DFCC BOC
V
9M2013
PB
9M2014
Diversity in Income generation: Banks with diversified income

sources where income generation is done through different sources
have greater ability of maintaining stable profitability. Despite the
lowering margins these counters have been able to improve
profitability through other income sources.
Fee Based Income as a % of Total

Income
Figure 34: Fee Based Income as a % of Total Income

30%
25%
20%
15%
10%
5%
V
9M2013
PB
9M2014
15
FC Research
Revenue Per Employee - LKR Mn
Figure 35: Revenue Per Employee

5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
V
PB
Revenue per employee ( Core Income) -9M2013

Revenue per employee ( Core Income) -9M2014
Effective cost management Selected banking counters have

managed to enhance their profitability by enhancing the efficiency of
operations by reducing the cost. Further, implementation of lean
management philosophy has also enabled them to lower cost
through enhancing automation of activities and efficiency of the
routine work.
Cost per Branch -LKR Mn
Figure 36: Cost per branch

60
50
40
30
20
10
V
Cost per branch -9M2013
PB
Cost per branch -9M2014

5.2 Improving Asset Quality through diversified lending base

We expect Banking sector non-performing loans to decline with
improving economic conditions and expected larger recoveries in
selected banks. Further diversification in loan books may further
assist banks to lower their exposure by expanding the risk appetite.
16
FC Research

Economic growth related asset quality: Non-performing advances of
Commercial banking sector has been declining in the past few years
due to favorable macro-economic environment. Therefore, we
expect NPL to increase marginally in 2014 and 2015 due to deprived
growth momentum and reach the lower middle income country
average of 5.7% in 2018E.
16%
10%
Figure
3: CBSL Holdings of Government Securiti
15%
8%
14%
13%
6%
12%
4%
Real GDP growth
Gross NPLs as a % of Lloans
Figure 37: Gross NPLs vs. GDP Growth
11%
10%
2%
9%
0%
8%
-2%
7%
Gross Non-performing Advances Ratio
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
-4%
2000
6%
GDP Growth
Figure 38: Gross NPLs as at 30 September 2014
Gross NPLs
14% 3: Gross NPLs as of 9M20

Figure
12%
10.6%
10%
8.0%
8.2%
8%
6%
4%
5.1%
3.6% 3.9% 3.5%
2.7%
4.3%
4.9%
2.5%
2%
0%
9M2014
2013
(Source: CBSL)
17
FC Research
5.3 Banks with regional presence may benefit from growing

economic conditions in the region
We expect local banks to expand their presence into other growing
regional destinations in order to utilize their potential. Currently
few banks have been able to cater into these markets enjoying with
higher profitability.
Superior Returns with Risk Management: Sri Lankas local
commercial banks have expanded their presence in other countries
in the region which has led to enjoy better economic conditions in
those countries. Hence this has enabled banks to generate superior
returns amidst providing effective geographical risk management
process.
COMB Presence in Bangladesh: Currently COMB holds a
considerable market share in Bangladeshs Banking sector and
recorded a 2003-13 loan growth CAGR of 19%. Currently the
Bangladesh operations provide 13% PAT to the group profitability.
We expect substantial growth to be immense from Bangladesh with
growing Apparel sector (With GSP+) and export oriented Agricultural
sector.
Figure 39: Growth potential in Bangladesh
Figure 3: CBSL Holdings of Government Securiti
Factors
Bangaladesh
Factors
Sri Lanka
Population (Mn)
158.2
Population (Mn)
21.0
GDP (USD mn)
186.6
GDP (USD mn)
71.6
Inflation
7.5%
Inflation
6.9%
GDP Growth
6.0%
GDP Growth
7.3%
18
FC Research
6.0 FC Research Commercial Banking Sector

Coverage to Provide 18% Return for 2015E
6.1 Sri Lanka Banks are still cheaper compared to other

banks in frontier markets
MSCI Frontier Market Index: Sri Lankas banks are still behind most
of the peers in MSCI Frontier Market Index reflecting a potential for
further price upside. This may attract foreign investors providing
greater returns compared to other banks in frontier markets.
Figure 40: PER Comparison with Banks in MSCI Frontier
Markets Index
Figure 41: PBV Comparison with Banks in MSCI Frontier

Markets Index
Figure
3: Gross
NPLs as of 9M20
16.7x
16.5x
16.1x
14.0x
3.1x
Figure 3: Gross NPLs as of 9M20
2.6x
13.0x
11.5x 10.8x
1.9x 1.8x
1.6x
7.2x 7.1x
1.4x
1.2x
5.4x
3.4x
1.0x 1.0x
0.8x 0.7x
2.7x
United Bank for Africa PLC
Al-Salam Bank
Halyk Savings Bank of

Kazakhstan JSC
Zenith Bank PLC
Bank Muscat SAOG
Burgan Bank SAK
Sri Lankan Banks
National Bank of Kuwait

SAKP
Guaranty Trust Bank PLC
Attijariwafa Bank
MCB Bank Ltd
Equity Bank Ltd
United Bank for Africa PLC
Halyk Savings Bank of

Kazakhstan JSC
Zenith Bank PLC
Bank Muscat SAOG
Guaranty Trust Bank PLC
Sri Lankan Banks
Equity Bank Ltd
Al-Salam Bank
MCB Bank Ltd
Burgan Bank SAK
Attijariwafa Bank
National Bank of Kuwait

SAKP
(Source: Bloomberg and MSCI)
0.5x
(Source: Bloomberg and MSCI)
6.3 FC Research Top Banking Sector Buys:

NTB, SEYB.N, SEYB.X, COMB.X, HNB.X
Stock
Recomme
ndation
Commercial Bank - Voting

Commercial Bank - Non-Voting
Hatton National Bank - Voting
Hatton National Bank - Non Voting
Sampath Bank
National Development Bank
Nations Trust Bank
Seylan Bank - Voting
Seylan Bank - Non-Voting
HOLD
BUY
HOLD
BUY
HOLD
HOLD
BUY
BUY
BUY
Mkt. Cap
(LKR mn)
137,747
137,747
62,504
62,504
39,459
40,299
22,254
16,542
16,542
Price
170.0
124.0
194.1
150.0
235.0
245.0
96.5
94.0
57.5
Target Upside
Price
(%)
173.0
133.0
198.0
161.0
254.0
248.0
109.0
110.0
66.0
2%
7%
2%
7%
8%
1%
13%
17%
15%
PER (x)
PBV (x)
2014E
2015E
2014E
2015E
DPS
2015E
12.6x
9.2x
9.1x
7.1x
8.5x
11.0x
8.1x
9.2x
5.7x
9.1x
6.6x
7.8x
6.1x
7.1x
8.3x
6.7x
6.8x
4.2x
2.1x
1.6x
1.2x
0.9x
1.1x
1.5x
1.6x
1.3x
0.8x
1.9x
1.4x
1.1x
0.8x
1.0x
1.3x
1.4x
1.1x
0.7x
10.1
10.1
11.1
11.1
13.3
14.8
3.7
3.4
3.4
Dividend
Total
Yield
Return
2015E
6%
8%
8%
15%
6%
8%
7%
15%
6%
14%
6%
7%
4%
17%
4%
21%
6%
21%
19
FC Research
Figure 42: Forward PER of FC Research Coverage
Figure 43: Forward PBV of FC Research Coverage

1.9x
9.1x
8.3x
7.8x
1.4x
7.1x
6.6x
6.7x
1.3x
1.1x
6.8x
0.8x
6.1x
1.4x
1.1x
1.0x
0.7x
4.2x
(Source: FC Research Estimates)
Figure 44: Dividend Yield 2015E

8.1%
7.4%
5.9%
5.7%
5.7%
6.0%
5.9%
3.8% 3.6%
Expected NTB price for 2015E

PER based target price
Justified PBV based target price
Average Target Price
107.3
110.3
108.8
Nations Trust Bank (Target Price: 109, Total Return: +17%): NTBs
high yielding market leadership in credit card business and leasing
portfolio is expected to maintain its NIM above its peers despite
operating in a lower interest rate regime. Further, higher fee based
income may also expect to assist bank to thrive its topline. [Refer
Figure 10 & 34 for detailed analysis]
P/E 31 Dec
2011
2012
2013
2014E
2015E
2015E
Net Interest Income (LKR mn)
4,404
5,755
7,675
9,013
10,144
12,325
Net Profit (LKR mn)
1,607
1,935
2,136
2,750
3,300
4,366
EPS (LKR)
7.0
YoY % Growth
8.4
9.3
11.9
14.3
18.9
20%
10%
29%
20%
32%
11.5x
10.4x
8.1x
6.7x
5.1x
Valuations
PER (x)
13.8x
PBV (x)
3.3x
2.6x
2.2x
1.9x
1.6x
1.4x
Dividend Yield (%)
2.1%
2.2%
2.2%
3.2%
3.9%
5.1%
NAVPS
37.4
43.8
50.9
59.7
70.3
84.3
2.0
2.1
2.1
3.1
3.7
4.9
29%
25%
23%
26%
26%
26%
Adjusted DPS (LKR)

Dividend Payout
20
FC Research
Expected COMB.X price for 2015E

PER based target price - Voting
Justified PBV based target price - Voting
Voting non-voting Spread
187
157
172.2
23%
133
Commercial Bank Non-Voting (Target Price: 133, Total Return:

+15%): We expect COMB to register a higher profitability by
expanding its loan books in both its Sri Lanka and Bangladesh
operations. Higher CASA base may also assist the bank to maintain its
cost of funding at a lower level compared to other banking counters.
With COMBs strong market position in Bangladesh higher
contribution from the growing Bangladesh market is an added
advantage for the Group. COMB now looks at Myanmar as its next
location of regional expansion. [Refer Figure 9 & 35 for detailed
analysis]
P/E 31 Dec
Net Profit (LKR mn)
EPS (LKR)
2011
2012
2013
2014E
2015E
2016E
18,678
22,852
25,322
25,742
31,740
39,149
7,932
10,080
10,563
11,703
16,220
19,397
9.2
11.6
12.2
13.5
18.7
22.4
27%
5%
11%
39%
20%
5.6x
YoY % Growth
Valuations
Non-Voting - PER (x)
13.8x
10.8x
10.3x
9.3x
6.7x
Non-Voting - PBV (x)
2.5x
2.1x
1.8x
1.6x
1.4x
1.2x
Non-Voting - Dividend Yield (%)
4.5%
5.0%
5.0%
5.8%
8.0%
9.6%
NAVPS
51.0
61.2
71.0
79.2
90.6
104.3
5.7
6.3
6.3
7.3
10.1
12.1
62%
54%
51%
54%
54%
54%
Adjusted DPS (LKR)

Dividend Payout
Expected HNB.X price for 2015E

197
198
197.6
20%
159
Hatton National Bank Non-Voting (Target Price: 151, Total Return:

+16%): HNBs higher CASA base and improving core profitability may
assist bank to improve its profitability while maintaining higher
dividend payout ratio. [Refer Figure 26 & 28 for detailed analysis]
P/E 31 Dec
Net Profit (LKR mn)
EPS (LKR)
2011
2012
2013
2014E
2015E
2016E
16,920
22,424
25,050
25,078
27,713
32,586
6,819
8,111
7,650
8,530
9,933
13,023
17.0
20.2
19.0
21.2
24.7
32.4
19%
-6%
11%
16%
31%
4.8x
YoY % Growth
Valuations
9.2x
7.7x
8.2x
7.3x
6.3x
1.5x
1.2x
1.1x
1.0x
0.9x
0.8x
4.7%
5.4%
5.4%
6.1%
7.1%
9.4%
NAVPS
Adjusted DPS (LKR)
Dividend Payout
103.5
129.6
143.3
159.4
177.4
202.8
7.3
8.4
8.4
9.6
11.1
14.6
43%
42%
44%
45%
45%
45%
21
FC Research
Expected SEYB price for 2015E

PER based target price
Justified PBV based target price
124
95
109
40%
66
Seylan Bank Voting (Target Price: 110, Total Return: +21%) and NonVoting (Target Price: 66, Total Return: +21%): SEYBs improving costto-income ratio and possible recovery in selected large default loan
base and aggressive lending stance may assist the bank to register a
higher return in 2015E. [Refer Figure 9, 33 & 35 for detailed analysis]
P/E 31 Dec
2011
2012
2013
2014E
2015E
2016E
8,605
9,034
9,861
10,818
12,775
16,068
Net Profit (LKR mn)
676
2,075
2,326
3,472
4,714
6,200
EPS (LKR)
1.9
6.1
6.8
10.2
13.8
18.2
207%
12%
49%
36%
32%
5.2x
YoY % Growth
Valuations
Voting - PER (x)
48.7x
15.5x
13.8x
9.2x
6.8x
Voting - PBV (x)
1.8x
1.7x
1.4x
1.3x
1.1x
1.0x
Voting - Dividend Yield (%)
0.8%
1.0%
2.1%
2.7%
3.6%
4.8%
29.6x
9.4x
8.4x
5.6x
4.1x
3.2x
1.1x
1.0x
0.9x
0.8x
0.7x
0.6x
1.3%
1.7%
3.4%
4.4%
6.0%
7.9%
NAVPS
51.7
56.2
65.7
73.2
83.5
97.0
0.7
1.0
2.0
2.5
3.4
4.5
38%
16%
29%
25%
25%
25%
Adjusted DPS (LKR)

Dividend Payout
6.2 FC Research Banking Sector HOLD List:

COMB.N, HNB.N, SAMP, NDB
Commercial Bank - Voting (Target Price: 173, Total Return: +8%)
P/E 31 Dec
Expected COMB.N price for 2015E

187.3
157.0
172.2

Net Profit (LKR mn)
EPS (LKR)
2011
2012
2013
2014E
2015E
2016E
18,678
22,852
25,322
25,742
31,740
39,149
7,932
10,080
10,563
11,703
16,220
19,397
9.2
11.6
12.2
13.5
18.7
22.4
27%
5%
11%
39%
20%
7.6x
YoY % Growth
Valuations
Voting - PER (x)
18.6x
14.6x
13.9x
12.6x
9.1x
Voting - PBV (x)
3.3x
2.8x
2.4x
2.1x
1.9x
1.6x
3.3%
3.7%
3.7%
4.3%
6.0%
7.1%
NAVPS
51.0
61.2
71.0
79.2
90.6
104.3
5.7
6.3
6.3
7.3
10.1
12.1
62%
54%
51%
54%
54%
54%
Adjusted DPS (LKR)

Dividend Payout
Hatton National Bank - Voting (Target Price: 198, Total Return: +8%)
P/E 31 Dec
Expected HNB price for 2015E

197
198
198

Net Profit (LKR mn)
EPS (LKR)
2011
2012
2013
2014E
2015E
2016E
16,920
22,424
25,050
25,078
27,713
32,586
6,819
8,111
7,650
8,530
9,933
13,023
17.0
20.2
19.0
21.2
24.7
32.4
19%
-6%
11%
16%
31%
6.0x
YoY % Growth
Valuations
Voting - PER (x)
11.5x
9.7x
10.2x
9.2x
7.9x
Voting - PBV (x)
1.9x
1.5x
1.4x
1.2x
1.1x
1.0x
3.7%
4.3%
4.3%
4.9%
5.7%
7.5%
NAVPS
Adjusted DPS (LKR)
Dividend Payout
103.5
129.6
143.3
159.4
177.4
202.8
7.3
8.4
8.4
9.6
11.1
14.6
43%
42%
44%
45%
45%
45%
22
FC Research

Sampath Bank (Target Price: 254, Total Return: +14%)
Expected SAMP price for 2015E

266.2
240.8
253.5
P/E 31 Dec
2012
2013
12,039
15,095
15,591
16,657
19,911
5,437
3,635
4,755
5,907
7,418
33.4
21.7
27.6
33.3
40.3
-33%
31%
24%
26%
Net Profit (LKR mn)

EPS (LKR)
YoY % Growth
2014E
2015E
2016E
Valuations
PER (x)
7.2x
11.0x
8.7x
7.2x
5.9x
PBV (x)
1.4x
1.2x
1.1x
1.0x
0.9x
Dividend Yield (%)
5.0%
NAVPS
4.9%
4.6%
5.6%
6.7%
172.9
197.3
215.8
238.7
267.6
Adjusted DPS (LKR)
12.0
11.6
11.1
13.3
16.1
Dividend Payout
36%
54%
40%
40%
40%
National Development Bank (Target Price: 248, Total Return: +7%)

P/E 31 Dec
Expected NDB price for 2015E

198.9
296.8
247.8
2011
2012
2013
2014E
2015E
2015E
4,909
5,819
7,012
6,906
8,735
10,988
Net Profit (LKR mn)
2,527
8,854
2,642
3,652
4,873
5,727
15.4
53.9
16.1
22.2
29.7
34.9
250%
-70%
38%
33%
18%
7.3x
EPS (LKR)
YoY % Growth
Valuations
PER (x)
16.5x
4.7x
15.8x
11.4x
8.6x
PBV (x)
2.5x
1.7x
1.7x
1.5x
1.3x
1.2x
Dividend Yield (%)
3.0%
5.9%
3.9%
4.4%
5.8%
6.9%
NAVPS
Adjusted DPS (LKR)
Dividend Payout
103.1
151.5
149.3
167.3
193.3
218.4
7.5
15.0
10.0
11.1
14.8
17.4
49%
28%
62%
50%
50%
50%
23
FC Research
Appendices
Appendix: 1
Appendix: 2
Capital adequacy ratios are well above the minimum

requirements by CBSL
Higher branch network may assist banks to improve their

profitability by maintaining higher deposit base
Figure 45: Tier 1 and Tier 2 as at 30 September 2014
Figure 46: Number of Branches

728
60%
50%
571
40%
30%
250
216
256
20%
155
86
82
137
78
61
10%
0%
V
Tier 1
PB
Tier 2
Appendix: 3
Appendix: 4
Net interest margins for foreign banks in Bangladesh are

still higher than domestic banks
Sector-wide reduction in pawning exposure
Figure 47: NIMs in Bangladesh
Figure 48: Pawning exposure as a % of total loans

28%
20%
18%
13%
11%
11%
7%
2%
6% 7%
3% 3% 4%
2%
1%
Dec-13
(Source: Financial Stability Report Bangladesh)
11%
11%
3%
7% 7%
4%
Sep-14
2013)
24
17%
FC Research

Glossary
DFCC DFCC Bank

DFCC V DFCC Vardhana Bank PLC
SEYB Seylan Bank PLC
PABC Pan Asia Banking Corporation PLC
NDB National Development Bank PLC
NTB Nations Trust Bank PLC
SAMP Sampath Bank PLC
UBC Union Bank of Colombo
COMB Commercial Bank of Ceylon PLC
CB Commercial Banks
HNB Hatton National Bank PLC
BOC Bank of Ceylon
CB Commercial Banks
PB Peoples Bank
ASPI All Share Price Index
BFI Banking and Finance Industry
CBSL Central Bank of Sri Lanka
CAGR Compound Annual Growth Rate
SME Small and Medium Enterprises
GDP Gross Domestic Product
CASA Current and Savings Deposits as a Percentage of Total Deposits
AWPR Average Weighted Prime Lending Rate
AWDR Average Weighted Deposit Rate
AWFDR Average Weighted Fixed Deposit Rate
NIM Net Interest Margin
NPL Non-Performing Loans
PAT Profit After Tax
PER Price-Earnings Ratio
PBV Price-Book Value
25
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Sri Lanka Banking Sector Report - 02 01 2015 PDF

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Sri Lanka Banking Sector Report - 02 01 2015 PDF

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FC Research

Analyst: Reshan Wediwardana

SRI LANKA COMMERCIAL BANKING SECTOR

Commercial Bank - Voting

FC Research expects the banking sector to have a favorable phase

Figure 1: 2014 Price Change

Growing GDP may assist banks to boost lending: We expect above

Private Sector Credit Growth to grow at a CAGR of 18%: We expect

Figure 2: Banking Sector vs. ASPI

Improving Asset Quality through diversified lending base: We

Struggle Ends Prosperity Begins

Banking sector struggle in 2012-14 ........................................................................................... 3

Pawning Debacle in 2013 attributes to slow private sector credit growth................................ 4

2.0 Growing GDP may assist banks to boost lending ............................................................................ 6

2.1 Continuous progress towards achieving future GDP growth ........................................ 6

SME and Construction sector drive lending growth .......................................................... 6

Growth in consumer demand to boost lending ................................................................... 8

3.0 Private Sector Credit Growth to grow at a CAGR of 18% ................................................................ 9

Low interest rate regime is likely to attract borrowers ................................................ 9

Private sector credit to reach 35% of GDP ........................................................................ 10

4.0 Margins to Bottom-out .................................................................................................................. 12

Lower cost of funding due to enhancement in CASA ................................................... 12

Margins to revert back to 3.5% ........................................................................................... 13

5.1 Effective cost-income management to thrive profitability .......................................... 15

7.0 Appendices ..................................................................................................................................... 24

8.0 Glossary .......................................................................................................................................... 25

Struggle Ends Prosperity Begins

Banking Sector Report 2015

1.0 Introduction of Commercial banking sector

Sri Lankas Commercial Banking sector consists of 13 local banks and

1.1 State Banks retain a dominant presence with higher

(Source: CBSL, Company annual & quarterly reports)

1.2 Banking sector struggle in 2012-14

Struggle Ends Prosperity Begins

Banking Sector Report 2015

Banking Sector New Era of Growth: The current finance sector

1.3 Pawning Debacle in 2013 attributes to slow Private

Pawning as a % of total loans and advances

Figure 7: Pawning vs. Total Loan Exposure

Pawning as a % of Gross loans and

Figure 6: Gold Spot Price

Struggle Ends Prosperity Begins

Banking Sector Report 2015

Figure 9: Loan growth as of 9M2014

Loan growth - .YTD

Private sector Credit Growth - YoY - Monthly

Figure 8: Private Sector Credit Growth - Monthly

SAMP HNB COMB NTB

UBC DFCC V BOC

(Source: Bankss Quarterly Statements)

Figure 10: Loan Book Diversification 9M2014

Lease rentals receivable

(Source: Bankss Quarterly Statements)

Struggle Ends Prosperity Begins

Banking Sector Report 2015

2.0 Growing GDP may assist banks to boost lending

We expect above 7% GDP growth to support lending mainly driven

2.1 Continuous progress towards achieving future GDP growth

Figure 12: Annual GDP growth (Real)

7.3% 7.4% 7.0%

(Source: Department of Statistics and Consensus)

2007 2008 2009 2010 2011 2012 2013 2014E 2015E