BSE TRAINING INSTITUTE BANKING - FINANCIAL STATEMENTS ANALYSIS RAGHU IYER OCTOBER 2010 1 How does a bank balance

sheet look 2 What drives its earnings 3 What drives its value NIM, CASA, CA, Business per employee How does the share price look right now - buy / sell / hold / ??? Research brings out the cream from Annual Reports and other analysts meet What are the key issues Are the analysts human beings or super beings Are they right or wrong Are they aware but dont write the right thing - ethical Can the report identify key issues Can it deepen your understanding Can it predict the share market well Who can Understand facts, issues from reports Form your own opinion In this class, we will not conclude whether to buy or sell HDFC BANK CAGR - Compounded Annual Growth Rate My salary was Rs 10 lakhs It grew at CAGR 30% for 5 years 130% 5 Yes Yes Maybe, may be not Nobody

30%

3.71

10.00

Rule of 72

72 divided by the rate of return tells me how many years it will t to double If the rate of return is 8% Your money will double in 72 8 9 NSC rate 12% It used to double in 72 12 6 TRADES AT 4 x P/B FY 12 4x means 4 times P/B means Price to Book Price means Current Market Price (CMP) Book means Book Value per Share Book Value per Share means Net Worth per Share Net Worth means Capital plus Reserves (Shareholders Funds) BV = Net Worth / No of Shares TYPICAL BANK BALANCE SHEET Share Capital (Face Value Rs 10) Reserves & Surplus (accumulated profits) Share Premium Revaluation Reserve (rare) SHAREHOLDERS FUNDS Other Items Cash, cash, cash and cash FD, SA, CA, CD

120 Cash, cash, cash, cash 300 Securities 20 Loans 0 Advances 440 Bonds XYZ 3000

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Reliance Power issued a Rs 10 share at Rs 430 per share The premium here is Rs 420 per share

If you revalue your assets (an asset which appears today at Rs 100 - suddenly you say that your asset goes up by Rs 400 and you increase your Revaluation Reserve by the same Rs

Analysts, banks, credit rating agencies - they dont like Reval Reserve very much We believe this is notional and secondly this is subjective No of shares issued Shareholders Funds Book Value per share 12 440 36.67

HIND LEVER BALANCE SHEET Share Capital (Face Value Rs 10) Reserves & Surplus (accumulated profits) Share Premium Revaluation Reserve (rare) SHAREHOLDERS FUNDS Other Liab - Suppliers Payables, Loans Expenses Outstanding - cash equivalents

120 Fixed Assets - Land, Buildin 300 20 Inventories, Receivables, e 0 440 Little bit of cash also

440

They have fantastic brands Balance Sheet at all The realizable value of the assets will be very very very different from the Bal Sheet car Bal Sheet carrying amount is a historical number

Per Share figures are very popular in the stock market Basically they are meaningless Whether I say that Book value of the company is Rs 440 cr or I say it is Rs 36.67 per share the same thing Rs 36.67 per share is more popular in the share market

Shareholders are able to relate to a per share figure better than the overall company figu Bcoz they buy one share (they dont buy one company) If Aditya Puri looks at the Bal Sheet of CBoP (which he wants to take over), he will look a

EPS, CEPS, BVPS - CMP is per share Smaller numbers are easy to remember, calculate, divide, multiply The share price of a bank should revolve around the Book Value per Share So if the share price is much higher than the Book Value, you should know why

In HDFC Bank, the Report says that the P/B is 4x FY 12 The book value which is expected by March 31, 2012 - the price is 4 times this book value 300% premium over the bookk value

If my wallet has Rs 1,000 today, the analyst is predicting that the wallet will have Rs 1,70 and the price of the wallet today is Rs 6,800

In a simple world, the Price to Book will be 1:1 (of today's Bal Sheet) If my wallet has Rs 1,000, and it is priced at Rs 1,000 - the world is at peace Any deviation might due to human emotions or due to the underlying number being wrong Some of the notes in may wallet may be counterfeit Some may be autographed by Ash

FY 05 - 10, EPS grew at 25% CAGR FY 10 - 12 EPS will grow at 30% CAGR Superior RoA of 1.5% + Return on Assets Assets Liabilities Equity (Net Worth) 100 Loans given 85 Deposits taken 15

Margins - NIM - Net Interest Margin 4 to 4.2% Whether good or bad - we need to compare with others and with history Fee Income Commissions Mutual Funds, Insurance, etc - third party products Proc Fees, Other Fees Is HDFC Bank a bank? I would call it HDFC Banking and Financial Services and Other Product Sales Ltd Banking means borrowing at x% and lending at y% Everything else is advisory or wealth management etc

Banking strength comes from availability of funds If you have Rs 5 lakh cr and I have Rs 2 lakh cr, I am smaller than you in almost all ways

Advisory strength is not fund based - it depends on people skills, right people, right mana It is not banking

Fund based Income and Non-fund based Income - break up is important Dena Bank will be 98% fund based You go to Dena Bank and ask them which mutual fund should I apply for Their reply will be - come tomorrow You go to HDFC Bank - they will come to your house, fill up your telephone a and your neighbour's form also HDFC income break up could be 50% from funds and 50% from non funds

Market valuation will not conform to traditional PBV Cost to Income ratio will fall by 1 to 2% (100 to 200 bps)

Unsecured Loans yield is higher, but risk is also higher CASA Ratio - Current Accounts and Savings Accounts 50% of deposits are from these sources Fantastic Current Accounts costs zero Savings Account costs 3.5% Bank - Equity to Liabilities is generally 16:84 to 12:88 For an individual - it should be 1:1 or 0.7:1 - more debt is more risk Equity = Capital plus Reserves Equity is not free money - that is a myth There is no free lunch Equity holders expectations have to be met - they dont "charge" you x percent, but they

Preference capital for all practical purposes is debt (liabilities) Generally, these are redemeed (Indian Co Law does not recognize irredeemable preferen If they are convertible, then answers are complex If they are optionally convertible (at the option of the holder), then DEBT If compulsorily convertible, then whether fixed price or variable price Fixed price - they are similar to equity Variable price -This Rs 10 pref share will be converted into x num and x = y multipled z and cube root of r or may be s and may be

LTCM - Long Term Capital Management - derivative disaster - their debt equity was 100:1 A higher CASA will straight away on the NIM Over the last years the peak PBV one year forward was 5 times The average was 3.3 times 3.3 15% 0.5 3.80 Merited PBV But not more than this

Already trading at 4 times All the positives have been discounted in the price PBV is the right metric (price to book value) History - max level has been 5 times Average level has been 3.3 times Today's level is 4 times Analyst is saying that a max reasonable level could be 3.3 times + 15%, i.e. 3.8 times Market Cap = CMP x No of Shares PAT - Profit After Tax EPS = Earnings per Share = PAT / No of Shares 29487 457.7 64.4 EPS Gr 64.4 52.8 22.0% Price Earnings Ratio = Price / EPS 2460 64.4 Price is the Current Price and Earnings are for those respective years This PE column is not very helpful especially for the past Capital Adequacy Ratio High debt means high risk Higher equity means lower risk Banks are at the epicenter of risk - they should carry some min capital That min capital is measured thro this Capital Adequacy Ratio On Bal Sheet exposures Off Bal Sheet exposures Both are captured On Bal Sheet means loans and advances as appearing on the Bal Sheet Off Bal Sheet could mean guarantees, letters of credit, derivatives, etc

SBI has guaranteed Barclays London that Star TV will pay Sky TV of London GBP 10 mio by ICICI Bank Has invested in ICICI Prudential, ICICI Lombard, ICICI Mutual Fund, etc SBI has invested into SBI Life, SBI Capital Markets, SBI Home Finance

ICICI Bank - Net Worth is say Rs Less : ICICI Prudential, etc Book Value of the Investment Revised Net Worth ICICI Bank Market Cap Less : Value of ICICI Prudential, etc Value attributable to the bank alone Adjusted PBV

Net Income Operating Exps

88403 47226 53% 59209 29195 88404 41177 37989 3188

181700 Int Income - Int Exp + Othe 84418 46% Operating Efficiency Impro 67% 33% 131617 50083 181700

Net Interest Income Other Income

Simple PPP Core PPP Non Core Income

Net Worth Debt

137892 10% Risk Weighted Assets, CAR 1225776 90% 1363668 Simple

Provision is a payable which is 'estimated' If you have recd an electricity bill of Sept for Rs 3,287 which you have not paid, that is a If you have been fighting with the Elec Co for the last 2 years and they have sent you 24 b believe are wrong, then you need to PROVIDE your estimate of that liab in your Bal Shee Judgement and Estimate - good words Discretion and Manipulation - bad words

Provisions Provisions Provisions Provisions Provisions Provisions

for Bad Debts (NPAs) for Court Cases for Warranties and Guarantees for Indemnities for Retrenchment Related Losses for Environmental Restoration (BP)

PROVISIONING FOR NPAs Provisioning is dictated by RBI There are elaborate rules Graded system depending on overdue days (90, 180, 365, etc) Standard, Sub-standard, Doubtful, Suit Filed, W/off Banks and NBFCs have little discretion in this process Gross NPA - the NPA as per these Rules You may or may not provide for the entire Gross NPA My Gross NPA is Rs 2,000 cr I am providing for Rs 1,500 cr The balance not provided for is the Net NPA - Rs 500 cr Gross NPA indicates credit quality - how good the bank is in lending The Net NPA indicates accounting quality Gross NPA High High Low Low Net NPA High Low High Low Comment Bad lending, aggressive accounting Bad lending, good accounting Good lending, bad accounting Great

The RBI has stated that you have to provide for at least 70% of the Gross Non provided NPAs cannot be more than 30% of the Gross Year Loans given Gross NPA as per RBI Rules 1 20000 800 2 24000 925 3 29500 1107

Provisioning Bad Debts recovered Net NPA Amount charged in the P&L GNPA % NNPA % NNPA/GNPA - Not provided Provided

610 3 193 607 4.0% 1.0% 24.1% 75.9%

703 5 227 698 3.9% 0.9% 24.5% 75.5%

1008 7 106 1001 3.8% 0.4% 9.6% 90.4%

Had I provided for these NNPAs, my profit would have been lower My net worth would have been lower Published Net Worth Adjustment for NNPAs Adjusted Net Worth 2000 193 1807 2227 227 2000 2508 106 2402

If the NNPA is high, you need to be careful This is where a wallet apparently containing Rs 1,000 may be sold for Rs 900 (and justifia 9070 796089 1.14% 2985 796089 0.37%

0.76%

Slippage ratio is during the year - how much did the Gross NPA rise 9070 19881 10811 796089 1.36% Gross NPA Net NPA

1.14% 0.37% Not provided 0.76% Provided 67.1% PCR - Provision Coverage (Provided/Gro The RBI has mandated that this should

raghuiyer@riassociates.co.in deadpresidentsblog plethora - googlegroup

ysts meet

37.13

ow many years it will take for my money

years years

h, cash, cash, cash

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- suddenly you say that it is worth Rs 500) eserve by the same Rs 400

rve very much

d Assets - Land, Building, Plant

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ntories, Receivables, etc

e bit of cash also

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y have fantastic brands which do not appear on the lance Sheet at all from the Bal Sheet carrying amount

it is Rs 36.67 per share - I am saying

he overall company figure

ke over), he will look at Rs 440 cr

d know why

4 times this book value

wallet will have Rs 1,700 by March 31, 2012

at peace ng number being wrong

10% 6%

10.00 Interest Income 5.10 Interest Expense 4.90 Net Interest Income

3.00 Operating Costs 0.25 Provisions 1.65 PBT 0.70 Tax 0.95 PAT 1.0% RoA 6.3% RoE

s and with history

products

uct Sales Ltd

you in almost all ways

ght people, right management, culture

should I apply for

ill up your telephone application form

0% from non funds

ou x percent, but they expect 2x from you

irredeemable preference shares)

holder), then DEBT or variable price

be converted into x number of equity shares or may be s and may be also divided by a debt equity was 100:1

15%, i.e. 3.8 times

38.2

London GBP 10 mio by Dec 2011

75000 cr 10000 65000 161000 cr 35000 126000 1.9

ncome - Int Exp + Other Income

rating Efficiency Improvement 72% 28% Still very very high - strength

Weighted Assets, CAR

12%

ave not paid, that is a Liability they have sent you 24 bills which you at liab in your Bal Sheet

Has not come into the financials

for Rs 900 (and justifiably so)

67.1%

Coverage (Provided/Gross) dated that this should be at least 70%