Valuing Banks

December 9, 2006

American Appraisal

Structure 1. Introduction
The Value of a Bank The Business of Banking

2. Analysis of a Bank

Industry Analysis Company Analysis

Income Approach

3. Valuation Approaches

Market Approach

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The Value of a Bank

General
Financial Intermediary between depositors and borrowers
Special Information hyposesis Provision of liquidity and payments

Company specific
Market vs. Investment Value Market share Intangible assets
License access to the market Customer relationships (Core deposit base) Brands Assembled workforce Other (software, scoring methodologies)

Banking Frachise - Banks individual characteristics which make it a going concern

Ability to generate a net profit from deposit-related services Ability to generate rents on the asset side as well Franchise Value

Not a collection of assets Going concern vs. Liquidation value

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The Value of a Bank Why value banks?

M&A
Determination of conversion ratios Minority stakes valuation

IPOs Restructuring IFRS Corporate planning

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The Business of Banking

Distinctive characteristics of banks
Financial Structure
Relatively few hard assets The majority of assets are financial The majority of liabilities are deposits No inventory, trade payables, no significant amount of receivables Cash and marketable securities operating asset No clear distinctions between operating and financing activities

Income statement
Income is generated as an interest spread between interest received and interest paid (Marginal business) Revenue = Net interest income + Net commission income + Net trading gains

Regulated Business Importance of Risk Management

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The Business of Banking

Banks Balance Sheet ASSETS
Cash and Due from CBRF Securities Loans and Advances to Banks Loans and Advances to Customers Fixed Assets Other Assets

Financials
Liquidity management + Obligatory reserves

Interest Earning Assets Typically is an insignificant amount

LIABILITIES Amounts Due to Banks

Customer Accounts Securities Issued Other Liabilities Equity

Interest Bearing Liabilities

Source of business growth, minimum level subject to regulation

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The Business of Banking

Banks Profit and Loss Account
Interest Income Interest Expense

Financials
Earned on loans issued and fixed income securities owned Paid on deposits and securities issued Estimate of how well loans are repaid

Net Interest Income

Provision for Losses

Net Interest Income after provision for losses + Non-interest Income = REVENUE OF A BANK Administrative, Staff and Other Fixed Expenses Non-recurring Gains/Losses Pre-Tax Income NET INCOME
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Net Commission Income + Net trading gains on securities and currencies

Shows the efficiency of a banks operations Result of non-typical, oneoff transactions

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The Business of Banking

Criteria Target market

Types of Banks

Types of banks
Retail Corporate Investment State and Quasi-state Private Banks
Independent Captive Foreign

Ownership

Geographic focus Size

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International National Regional Large Small

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Valuation Procedures
Preparatory Stage
Collection of Data Management Interviews

Analysis Stage
Economy and Industry Analysis Understanding the background of the transaction

Calculations Stage
Valuation Approaches

Final Stages
Preparation of the report Presentation to the client
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Analysis of a Bank
Top down approach
Economy, Industry, Subject

Major Analytical Tools

Financial Statements analysis

Ratio analysis
Growth Profitability Capitalization Liquidity

Common-sized financials Peer comparison Non-operating assets (real estate, other) Non-recurring income or expenses
Unusual material transactions Acquisitions and disposals Large write offs of loans

Public companies and transaction analysis

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Analysis of a Bank
Historical Background
General economic recovery

Industry

2006

Growing competition - Entry of new players, incl. International Industry consolidation Importance of retail Financial Crisis Many banks experience losses: Liabilities in USD assets in Roubles Losses on government bonds and derivaties

1998

Borrowers default Massive industry restructuring Growing number of banks Mainly corporate short-term lending, foreign exchange and securities trading A lot of captive, non-market players

1991 1992
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First commercial banks are established on the basis of the branches of state banks

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Analysis of a Bank

Industry

Russian Economy experiencing a steady GDP Growth Banking Industry has been outpacing general economy
Russian Banking Assets and Loans to GDP
50,0% 45,0% 40,0% 35,0% 30,0% 25,0% 20,0% 15,0% 10,0% 5,0% 0,0% 1999 2000 2001 2002 2003 2004 2005 2006

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Total Banking Assets / GDP

Total Loans / GDP

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Analysis of a Bank

Industry

Nevertheless, the penetration of banking services remains low compared to other countries
Lending to GDP
140% 120% 100% 80% 60% 40% 20% 0%
Average Developed Europe

Ukraine

Hungary

Slovak Republic

Kazakhstan

Slovenia

Turkey

Latvia

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Czech Republic

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Romania

Bulgaria

Lithuania

Croatia

Estonia

Russia

Poland

Analysis of a Bank
Fragmented Industry Large number of banks steadily decreasing Majority are small banks
Number of operating banks in Russia 1340

Industry
Concentrated Industry Significant role of largest banks steadily increasing
Role of the largest banks 75% 70%

1300

65% 60%

1260

55% 50%

1220

45% 1.2005

7.2005

1.2006

7.2006

Share of 30 largest banks in total capital

1180 01.2004

Share of 30 largest banks in total assets

01.2005

01.2006

Share of 30 largest banks in total loans

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Analysis of a Bank

Industry

Role of the international players in the Russian banking sector

16% 14% 12% 10% 8% 6% 60 4% 2% 0% 01.1996 40 20 0 01.1997 01.1998 01.1999 01.2000 01.2001 01.2002 01.2003 01.2004 01.2005 01.2006 180 160 140 120
Number of operating banks with foreign participation Share of non-residents in total charter capital. %

1998 crisis

Russia upgraded to investment grade

100 80

Share of non-residents in the total charter capital

Number of operating banks with foreign participation

15

Source: Central Bank of Russia

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Analysis of a Bank
Trends to watch in the banking industry
Historical and expected growth Penetration Economic and disposable income growth Diversification and new services Competitive Environment Porter Analysis Industry Consolidation Share of foreign banks The role of the State and Staterelated banks Drive for cost-efficiency Increase of the role of brands

Industry
Regulatory environment Licensing Minimum capital and reserves requirements Deposit insurance scheme Risk supervision concentration, capital adequacy Financial reporting requirements

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Analysis of a Bank Company-specific factors

Business profile (model)
Corporate, retail, investment

Company-specific factors Economy and Industry

Clients and Markets Strategy Risk

Concentration Liquidity Capital adequacy / Overcapitalization Size Transparency
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Valuation Assumptions
(Income and Market Approaches)

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Valuation Approaches
Income Approach Market Approach Market Value of Shareholders Equity
Minority / Marketability discounts (if applicable)

Net Asset Position

Allocation for Equity Stakes

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Income Approach
Major Questions
Where the Bank will be 3-5 years from now
What are the Companys Prospects and its Strategy What is the Companys current and target market position Who are the Potential Investors

Financial Future
Major Projection Drivers Reporting standards used Level of uncertainty

Uncertainty of the results

Company-specific risk factors
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Projected Cash Flows

Consider expected operating and financial results of a bank reflected in the Projected Financials
Balance Sheet Income Statement

Represents potential dividends available to shareholders NOT Extrapolation

Depreciation

CAPEX
Increase in reserves with CBRF

Additional Capital Requirements

Net Income Free Cash Flow

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Projected Cash Flows

Typical projection drivers
Total Loans / Customer and Bank Accounts and Securities Issued Deposits (Retail, Corporate) growth rate % Interest income on loans (securities) Loan Loss Provision / Gross Loans and Advances Due to banks / Customer Accounts and Securities Issued Other assets (liabilities) growth rate Equity / Total Assets

Balance Sheet Drivers

Balance Sheet Structure

Growth Drivers

Trading securities growth rate

Profit & Loss Drivers

Return Drivers

% Interest expense on deposits (securities)

Effective tax rate

Growth Drivers

Non-interest income growth rate

Operating Expenses growth rate

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Projected Cash Flows Estimating Projection Drivers

Subjects historical financials Industry Analysis Peer Analysis Companys strategy and competitive position

Special Considerations
Financial reporting standards Fair Value vs. Book Value of Assets and Liabilities Non-recurring operations
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Projection Drivers Industry and Peer Analysis

Deposits Growth
03

115% 95% 75% 55% 35% 15%

03 04 05 06F 07F 08F 03

05

06F

03 06F 07F 04 05 03 04 05 05 07F 08F

05 06F 07F 08F

05 06F 07F 08F

06F

08F

04

03 04

Russian Banking Industry

Largest 30 Banks

Sberbank

VTB

Rosbank

Bank of Moscow

Vozrozhdenie

Source: Company Reports, analyst estimates

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04

06F 07F 08F

04

Projection Drivers Industry and Peer Analysis

Loans / Interest bearing liabilities

03 04 05 04 05 06F 04 05 06F 05 06F 07F 08F 06F 07F 08F 07F 08F 03 03 04 04 05 06F 07F 08F 03 03 04 05 06F 03 03

120% 110% 100%

70% 60% 50% 40%

Russian Banking Industry

Largest 30 Banks

Sberbank

VTB

Rosbank

Bank of Moscow

04

05 06F 07F 08F

Vozrozhdenie

03

80%

05

Russian Standard

Source: Company Reports, analyst estimates

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06F

04

90%

Projection Drivers Industry and Peer Analysis

Equity / Total Assets

21% 19% 17%

04 05

03

03 04 05 06 04 04 04 06 03 05 06 03 04

23%

15% 13% 11%

03

06

03 04

05 06

03

05

04

06

9% 7% 5%

Russian Banking Industry

Largest 30 Banks

Sberbank

VTB

Rosbank

Bank of Vozrozhdenie Russian Moscow Standard

Source: Company Reports, analyst estimates

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05

06

05 06

05

03

Projected Cash Flows Factors to watch for...

Income generation ability
Target vs. Existing Client Base

Corporate Banks

Market position and competitive advantages Large non-recurring transactions Non-interest income generation Cost-efficiency

Risks
Concentration of clients (industry, individual clients) Operations with related parties (critical factor for captive banks) Non-performing loans (history and expectations)
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Projected Cash Flows Factors to watch for...

Income generation ability
Business profile

Retail Banks

Collateralized lending (autoloans and mortgages) Uncollateralized lending (consumer finance)

Penetration of services rendered on the target market Market share: retail network Brand power: sales and promotion channels Quality of execution commodity business Risks Determined by business profile and quality of risk management Growing competition Deteriorating quality of loan portfolio
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Lack of funding for growth

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Projected Cash Flows

Special Consideration: Fast Lending Growth

Retail Banks

Increasing bad loans (especially for non-collateralized lending) makes risk management extremely important Lack of cheap and long term funding Fast growth requires significant equity injections from shareholders Increasing competition with foreign market players
Share of overdue loans to individuals grows to 2.7%

9 000

3,0%

8 000 2,5% 7 000

6 000

2,0%

RUR bln

5 000 1,5% 4 000

Share of Loans to Individuals 22%

3 000

1,0%

Share of Loans to Individuals 7%

2 000 0,5% 1 000

01.2003 01.2004 Total Loans 01.2005 Total Loans to Individuals 01.2006

0,0%

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Share of Overdue Loans to Individuals

Source: CBRF

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Discount Rate Development CAPM

Risk free rate Beta Company specific risk

re = rf + MRP + CSR

Size Uncertainty of projections

Historical Adjusted Betas for Guideline Companies

1,2 1

Average beta for Guidelines = 0.975

0,8

0,6

0,4

0,2

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Sberbank

ING Bank Slaski

BRE Bank

Komercni banka

OTP Bank

Garanti Bank

Finansbank

AKBank

Unibanco

Banco Bradesco

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Terminal Value
How to determine the terminal value
Gordon stable growth model
Sustainable long-term growth rate Long-term profitability and capital structure

Applying market-derived ratios

Checking the terminal value for consistency

Stabilization of cash flows Consistent return on equity and total assets Sustainable capitalization levels Potential sale considerations
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Market Approach Two major variations

Guideline Companies Analysis Guideline Transactions Analysis

Applicability varies with

Availability of guidelines
Size Business profile Risk profile

Availability of data
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Market Approach
Major Industry Valuation Metrics: PB and PE Multiples PB (Price to Book)
Market Capitalization / Book Value of Shareholders Equity Usually Exceeds 1.0 Growth of PB multiples with time - Recent Trend in the Emerging Markets
Sberbank's share price
600%

Price to Book 06F

500%

4.3

Price to Book 04

400%

1.75

300%

200%

100%

0% 01.2005

07.2005

01.2006

07.2006
Source: RTS

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Market Approach
PB vs. ROE

Price to Book 2006

Why PB multiples for banks are usually above 1.0?

Technical explanation: Actual Return exceeds Required Return on Equity

4,0 3,5
Finansbank

3,0 2,5 2,0 1,5 1,0 10% 12% 14% 16% 18% 20% 22% 24%

Sberbank Banco Bradesco BRE Bank Komercni Bank ING Bank Slaski Garanti Bank Unibanco

AKBank

OTP Bank

26%

28%

30%

Other factors:
High Expected Growth (Industry and Company) Fair Values vs. Book Values

ROE (2005-2007F)

Intangible Assets not registered on the balance sheet

Price to Book alone not sufficient other value indicators (ratios) and approaches should also be used:
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PE, Price to Total Assets, Price to Gross Operating Profit, Price to Cash Flow American Appraisal

Market Approach
Publicly Traded Guidelines
Lack of actively traded bank stocks in Russia
Average daily trading volume, 000 USD 2005 2006

Sberbank Promstroibank Rosbank Bank of Moscow Vozrozhdenie

16,900 675 70 29

75,100 486 218 118 45

Guidelines from other markets may be used

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Market Approach

Public Guidelines

1. Analysis of ratios indicated by guidelines

Price to Shareholders' Funds
Market Capitalisation : Price to Shareholders' Funds Guideline Companies Sberbank ING Bank Slaski BRE Bank Komercni banka, a.s. OTP Bank Garanti Bank Finansbank AKBank Unibanco (Uniao de Bancos Banco Bradesco S.A. Country Russia Poland Poland Czech Hungary Turkey Turkey Turkey Brazil Brazil 4 Yr Avg 2004 to 2007 3,5 2,2 2,3 2,4 2,6 1,9 3,6 2,1 2,0 3,2 2,6 0,6 0,2 Previous Year 2005 4,2 2,3 2,7 2,7 2,9 2,1 3,9 2,2 2,1 3,7 2,9 0,8 0,3 Current Year 2006 3,1 2,1 2,2 2,2 2,5 1,8 3,5 2,3 1,8 2,8 2,4 0,6 0,2 Forecast Year 2007 2,4 2,0 2,0 2,0 2,2 1,6 2,6 1,8 1,6 2,3 2,0 0,3 0,2 Concluded Weights 15% 11% 7% 11% 7% 8% 10% 8% 15% 10% 100,0%

Average Std Deviation Std Deviation / Average

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Market Approach 2. Weighing procedure

Public Guidelines

Price to Shareholders' Funds

4 Yr Avg 2004 to 2007 Sberbank ING Bank Slaski BRE Bank Komercni banka, a.s. OTP Bank Garanti Bank Finansbank AKBank Unibanco (Uniao de Bancos Brasileiros SA) Banco Bradesco S.A. Sum of Weighted Multiples Percent of Weight Used "Comparably" Weighted Multiple 0,5 0,2 0,2 0,2 0,2 0,1 0,4 0,2 0,3 0,3 2,6 100,0% 2,6 Multiples times Weights Previous Year Current Year 2005 2006 0,6 0,0 0,2 0,3 0,2 0,2 0,4 0,2 0,3 0,4 2,7 89,5% 3,0 0,5 0,2 0,2 0,2 0,2 0,1 0,4 0,2 0,3 0,3 2,4 100,0% 2,4 Forecast Year 2007 0,4 0,2 0,1 0,2 0,2 0,1 0,3 0,1 0,2 0,2 2,0 100,0% 2,0

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Market Approach

Public Guidelines

3. Applying concluded multiples to the Subject

Period Concluded Multiples Subject Company US$ 000,000 1 000 1 600 2 000 2 200 Indicated Value US$ 000,000 2 624 4 816 4 890 4 508 Concluded Weights Weighted Conclusions US$ 000,000 525 963 2 445 451 4 384 100% 4 384

4 Yr Average 2004 to 2007 2005 2006 2007

2,6 3,0 2,4 2,0

20% 20% 50% 10%

Sum of Weighted Streams Percent of total Weight Used Indicated Market Capitalisation

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Market Approach 4. Reconciliation of the results

VALUATION SUMMARY

Public Guidelines

Approach

Detailed in Table

Concluded Equity Value

Selected Value Weights (g)

Weighted Conclusions

US$ 000,000 Price to Shareholders' Funds Price to Net Income Price to Total Assets 1 2 3 4 384 4 039 3 126 70% 20% 10%

US$ 000,000 3 069 808 313

Total Rounded to

0,0%

4 189 4 200

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Market Approach
Target Date Buyer Stake purchased Transaction Value, USD m Investsberbank 07-2006 OTP 96% 477 Promstroibank 12-2005 VTB 50% 480 Impexbank 07-2006 Raiffeisen 100% 550 07-2006 SocGen

Guideline Transactions
Rosbank Vozrozhdenie 07-2006 Inst. Investors 10% 54 Texaka-bank, Kazakhstan 07-2006 Sberbank 80% 50 Aval, Ukraine 10-2005 Raiffeisen 94% 1 036 Mriya, Ukraine 01-2006 VTB 98% 70

10% 317 PB'05 Ratios

6,0 5,0 4,0 3,0 2,0 1,0 Investsberbank Promstroibank Impexbank Rosbank Vozrozhdenie Texakabank Aval Mriya

Special Considerations in analyzing transactions

Intent of the purchaser / Potential synergies Market Entry Overheated market Inter-group transactions (portfolio optimization)
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Source: Companies press-releases, financial statements

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Reconciliation
Bankss size and business profile Reliability of information Relevance of information

Income Approach

Guideline Companies

Reconciled Value

Continuous Process...
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