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Grupo Financiero : Analysing Argentina´s Financial Sector

Ticker: GGAL Current Price: 53.97 (10/20/2017) Recommendation: SELL 12-m Target Price: Exchange : NASDAQ 12-m Target Price: USD 45.61 Downside: 15.5%

Market Profile Highlights 52 - Week Range (USD) 23.23 - 58.61 52 - Week Change 144.5% 90 - Day Average Volume 509.6 S.A. (NASDAQ: GGAL; BYMA: GGAL.BA) is a Outstanding ADR (M USD) 142.52 vertically integrated holding company which is Market Cap (USD) 7.98 B controlled by EBA Holding. Free Float 80.26% The company occupies a comfortable position in the financial industry Valuation Ratios with a market share of private sector deposits of 7.49% and loans to P/E (TTM) 19.22x private sector of 10.06%. P/BV (MRQ) 4.06x Dividend Yield 0.21% GGAL faces strong competition in most of the areas in which their Financials subsidiaries are active, including among them, recognized international Income Financial Operation (LTM) 973.3 companies. Income Fees & Commisions (LTM) 851.2 Income (LTM) 146.7 Banco Galicia is the main subsidiary of the group and it is 100% controlled by GGAL, which explains the 67% of the income of the group. Net Income (LTM) 435.7 EPS (LTM) 5.18 Banco Galicia has more leverage and less liquidity compared to the Figure 1; Source: Team estimates based on Thompson average of Argentinian’s private banks. Also, Galicia has a more Reuters Data expensive funding cost and charges a lower rate to total loans; consequently, its financial margin and ROA are lower than its peers.

BCRA established three priorities that affect directly this industry: to control inflation; to maintain stability in the financial sector, and to promote the bankarization among the population. In view of the current situation of the Argentine macroeconomy, these goals are too ambitious to achieve in the short- medium term.

Valuation Outcome

We issue a SELL recommendation with a 1-year target price of USD 45.61 per ADR, representing a 15.5% downside from its closing price at October Figure 2; Source: Team estimates 20th, 2017 of USD 53.97. The valuation of Grupo Financiero Galicia S.A was conducted by applying two different methods: a FCFE model and Relative Valuation (see Figure 2).

MERVAL vs. GGAL´s ADR [USD Variation; Jan-14=100] Reasons to SELL:

• The 61% of the price of GGAL’s ADR lays on the present value of growth opportunities (PVGO), this means that Argentina will have to break its historic records for key variables such as Deposits to GPD and Loans to GDP.

• Grupo Galicia's loan portfolio is composed by 50% of consumer loans. This poorly diversified portfolio composition overexposes GGAL’s profits to the evolution of a deteriorating real wage.

Figure 3; Source: Thompson Reuters Data

1 Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

Shareholder´s Structure &Related Companies Business Description:

Grupo Financiero Galicia S.A. (NASDAQ: GGAL; BYMA: GGAL) is a financial services holding company incorporated in 1999 organized under Argentine laws. Classified as a Sociedad Anónima (a Stock Corporation), the holding does not have operations of its own, and conducts their business through its subsidiaries. (Figure 4). It operates in the following segments: banking, regional services, insurance, and asset management (Figure 5). Throughout its subsidiaries, related companies, and a wide variety of distribution channels, services, and products; they provide their financial services to more than 9 million customers along the country. It presents integrated activities within the financial sector, which allows developing economies of scale.

Business Units

Banking: Banco Galicia is the main subsidiary of the group, and is 100% controlled by GGAL since 2014. It is a banking entity whose incomes are mainly originated by the interests gained from loans, fees and commissions. According to information published by Argentina’s (BCRA), Banco Galicia is ranked second in terms of assets, deposits and loans within the private banking sector. Banco Galicia’s customer base comprises mostly individuals from all economic sectors, but also companies, divided into several segments: Large Corporation Banking, Companies, Agricultural and Livestock Sector, Foreign Trade, Capital Markets and Investment Banking.

Regional Credit Cards: Grupo Galicia participates in the regional credit card business through Tarjetas Regionales S.A, as a vertically integrated holding company. Tarjetas Regionales S.A. has the majority of the shares of Tarjeta Figure 4; Source: Company Data Naranja S.A and Tarjetas Cuyanas S.A, Procesadora Regional S.A and Cobranzas Regionales S.A. These business units allow the group to reach a new Income by Business Unit market segment which consists mainly of low-income citizens, and non- bankarized customers from the remaining provinces besides Capital Federal and it suburbs. As a whole, these companies allow the Regional Credit Cards business unit not only to issue credit cards but also to develop its own platform, payment processing system, and branding. Tarjetas Regionales offers its own brand and also offers international credit card brands such as Visa, MasterCard and American Express.

Insurance: Grupo Galicia operates in this activity through Sudamericana S.A. and its subsidiaries, under the branding name of Galicia Seguros. The product lineup includes life, retirement, property and casualty insurance products

Figure 5; Source: Team estimates based on Company Data marketed in Argentina.

Historical Background

Figure 6; Source: Company Data Grupo Financiero Galicia: AInalysing Argentina´s Financial Sector

Other subsidiaries:

• Galicia Administradora de Fondos: its main activity comprises the management of mutual funds under the brand “FIMA”, which are distributed through Banco Galicia’s channel (network of branches, home banking and investment centers, among others). • Net Investment: its purpose was to invest in developing technologies related to the business, communications, internet connectivity and web contents. On May 16th, 2017 shareholders approved the voluntary corporate dissolution and liquidation of this subsidiary. • Galicia Warrants: is a leading company in the deposit certificates and warrants issuance market. It supports medium and large companies with respect to stock custody. • Compañia Financiera Argentina: is a non-banking financial company that provides unsecured personal loans, and credit cards on a limited scale. On January 12th, 2017, shareholders accepted to sell all the shares to Galeno Capital S.A.U. This transaction is pending approval by the regulatory authorities. • Galicia Valores: operates as a stock broker controlled by Banco Galicia.

Industry Overview:

Macroeconomic Policies Target Macroeconomic Outlook:

Since Macri’s administration took office, several bold reforms and turnover policies were conducted in order to stabilize the Argentine economy. This path to normalization was leaded by the dismantling of currency controls; elimination of export taxes (except for soybean) and softening of import Figure 7; Source: BCRA barriers; withdrawing of mistargeted subsidies; and a tax amnesty programme, which led to an extraordinary tax revenue of 1.6% of GDP. Conjointly to these measures, BCRA established three priorities: to control Inflation vs. Spread inflation; to maintain stability in the financial sector, and to promote the bankarization among the population.

Inflation: to continue with the disinflation process, monetary policy is being conducted through the reference interest rate (remaining at its lowest stage since 2016, currently at 26.5%), to accomplish the inflation targets defined until 2019 (Figure 7). Although inflation has begun to decrease, the expectations for this variable, according to the REM survey, are higher than the target, mainly because of the expectations related to utilities’ tariff adjustments. In order to meet the inflation target, the key variables to control are real wage indexation and fiscal deficit, which must achieve the target set on 2.2% of GDP for 2019 (Figure 7).

Figure 8; Source: Team estimates based on Company Data Bankarization: to promote bankarization, BCRA has implemented easier and INDEC ways to access the financial market, including new technologies such as PIM which aims to boost the usage of banking technologies procedures for Deposits/Loans as % of GDP those who are not familiarized with it. To succeed in this subject, financial education is also being promoted. Furthermore, requirements for opening new banks branches were soften in locations with higher informal economy rates.

Financial sector: to accomplish stability and gain access to international capital markets, an agreement was conducted with the holdout creditors of 2001 defaulted debt. This yielded Argentina access to external debt, and thus the augmentation of international reserves stabilized the foreign exchange rate. Efficiency and development is being pursued through the Figure 9: Source: Company Data implementation of new instruments, such as UVA, providing the indexation of personal and mortgage loans by inflation. Since its application in March 2017, the mortgage loans grew 9.2%, accounting 88% for this new kind of Financial Depth (% as GDP) loans. Nevertheless, the financial instruments to diversify the mismatching maturities risk is still being designed. Banks are experiencing a diminish in the financial margin because of lower inflation rates and strong competition, both targets pursued by BCRA. In this matter, BCRA is collaborating to promote efficiency by lowering transactional costs providing new technologies. In order to expand the financial sector and improve corporate governance, adjustments in the capital market law had been made, but are still pending approval by the Congress. Figure 10; Source: Company Data 3

Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

A´s

Argentina´s Financial Sector Financial Industry:

GGAL operates in Argentina’s financial system under a holding structure

as well as the main companies in the local system, facing strong competition in most of the areas in which their subsidiaries are active.

As of June 30th 2017, the Argentine financial system consisted of 78 financial institutions, of which 63 were banks and 15 were financial non- bank institutions (including finance companies, credit unions, and savings and loans associations), as shown in Figure 8. It should be noted that its main direct competitors have a very similar organizational structure and participate in similar industries, among

which we find Santander Rio S.A, BBVA S.A, S.A as the best Figure 8; Source: BCRA positioned together with Grupo Galicia.

BankingBanking Industry Industry:: Banco Galicia operates in the local industry, which concentrates among its top Deposits &Loans Distribution ten banks the 76% of the market share. The bank faces significant competition in its areas of operation from private- sector banks, cooperative banks, Argentine public banks, as well as non- banking financial institutions (Figure 9). This industry is tending towards increasing concentration, declining the total number of banks from 86 in 2001 to 63 in 2017 (see Figure 10). This arises a question of stability and sustainability regarding a banking crisis. This should concern investors when taking into consideration the country’s financial history. Banco Galicia has a strong competitive position in retail banking, providing financial services to individuals, serving the small and medium-sized companies, and also operating in the agriculture and livestock sector (see Appendix II). This factor accompanied by the deregulations that are being held in this sector, could lead the industry towards a financial crisis. The Argentine banking sector Figure 9; Source: BCRA focuses on the transactional business, and lacks of a robust supply of medium and long-term lending instruments; this imposes a temporal mismatching for the banking operation cash flows under the light of the new long-term mortgage instruments which banks are forced to offer, discussed above. Concentration of the Banking Industry

InsuranceInsurance Industry:Industry: the local insurance sector is characterized by presenting high accident rates and having many strong competitors, who tend to cover most insurance segments but specialize in particular items. Galicia Seguros operates in 13 of these segments, owning a higher market share in the following: policies against damages and theft (with a 19.23%), personal accidents insurance (owning a 10.46% of the market share), life insurance policies over the balance with a 7.08% of the market, home protection (with 6.57%), among others. Its subsidiaries face significant competition since the Argentine insurance industry is comprised by 185 insurance companies, including among them, some of the world’s largest insurance companies. Figure 10; Source: Team Estimates based on BCRA Data

RegionalRegional Credit Credit Card Card Industry: Industry: the industry of regional credit cards in Argentina comprises mainly a low-medium income segment which has no access to traditional banking services nor other financial instruments. It is characterized for operating mainly in the regional territory (all the provinces besides ); and for its higher interest rates (due to a higher risk of non-recoverability). The credit card industry is composed by 80 financial institutions, including 64 banks, which compete in the different markets that conform this payment service. Within this general market, Tarjetas Regionales operates in the business of payment processing systems, with its own brand, and in the card issuance market. In the credit card brand market, Visa leads with a 58% of the market share in terms of transactions, followed by MasterCard (11%), American Express (10%), Tarjeta Naranja (9%) and Cabal (2%), among others. In the issuing market there are over 50 issuing organizations, which can be classified into two groups: banking and nonbanking entities. Regional Cards is an important issuer of non-banking cards.

4 Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

A´s Porter´s Forces Analysis GGAL´s Competitive Positioning To analyze players within the industry, we conducted a Porter's Forces Analysis (see Figure 11, and Appendix III). The industry is characterized for strong rivalry among their competitors, with local and international players, and it is trending towards increasing concentration. Elevate costs of operation and strict regulations confers the industry strong barriers of entry, which benefits the holding, however, this represents an operational challenge for the group due to the tariffs adjustments that will take place in the near future, as discussed above. As regards the bargaining power of suppliers, we identify players with moderate influence and power over the Figure 11; Source: Team Analysis different business units; and concerning the bargaining power of buyers, it depends on the segment and product offered. Finally, we also took into consideration “complementary” Banco Galicia´s Competitive Positioning products and services for the different businesses.

Since Banco Galicia is responsible for the 67% of the net income of the group, we conducted a benchmarking analysis focusing on this business unit. For this study, we have identified the following main competitors: Banco Santander Rio, BBVA, Macro and Patagonia. The benchmarking analysis lays on a competitor's assessment and taking into consideration certain key success factors and weighted each one by importance. The purpose of the assessment is to measure the overall competitive strength for each rival in this field (see Figure 12 & Appendix IV). Our presented key factors are: Client´s quality (non-recoverability risk), Brand Reputation, Industry Positioning, Employment Satisfaction, Employees per branch/office, CSR (Corporate Social Responsibility), Presence & Availability of Facilities, Online Services & Digital Platform. According to our analysis Banco Galicia enjoys a comfortable position in the market, ranked second after Santander Rio.

Qualitative Benchmarking Results McKenzie Matrix

Figure 12; Source: Team Analysis Figure 13; Source: Team Analysis

Regulations

Legal Reserve: Under BCRA’s regulations, each year banks must allocate a percentage of their net profits that currently amounts between 10% and 20% of the yearly income. Limitations on Types of Business: among other limitations, financial institutions are not allowed to engage directly in insurance activities or hold more than a 12.5% interest. Profit Distribution: Financial institutions are subject to The Superintendency approval to distribute dividends. Credit line for production and financial inclusion: is defined by semester. For the end of 2017, financial institutions must have a balance of financing equivalent to at least 18% of deposits of non-financial private sector in pesos. The line has a 17% annual interest rate, implying a negative real interest rate. Foreign Currency Positive Global Position (defined as the assets and liabilities arising from financial intermediation and securities denominated in foreign currency) is limited to 15% of the RPC or liquid equity, each as of the previous month to which corresponds.

5

Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

Investment Summary: Forecasted Income by Business Unit (thous. USD) We issue a SELL recommendation on Grupo Financiero Galicia, with a 12-month price of USD 45.61 per ADR meaning a 15.5% downside, which arises from an overvaluation driven by extremely positive macroeconomics expectations. We derived our target price using the Free Cash Flow to the Equity (FCFE) model applied to financial institutions, and triangle our target price with Relative Valuation, Sensitivity Analysis and Monte Carlo Simulation. All these results are consistent with our SELL recommendation. Promising Macroeconomics? Argentina returns to the international stage, gaining international credibility by normalizing the economy after 15 years of discretional usage of macroeconomic policies and reforms. Expectations of growth are stronger than ever, but debt levels have increased. Targets of inflation rates and fiscal deficit had been defined, however, we find them hard to achieve. December is around the corner and the inflation target of 17% has already been surpassed, Figure 17; Source: Team estimates although the fiscal target (4.2% of GDP) remains possible. Despite the fact that the economic authorities are aiming to develop the financial sector, in order for the stock not to be overvalued, the levels of bankarization and efficiency in this market must grow more than the Galicia´s Interest Rates Evolution & Projections historic maximums, which is highly questionable regarding the unemployment, informality and poverty levels. Dwarf Margins: Along with increasing competitiveness and, disinflation, the spread has started to compress, reflected in lower margins. (Figure 18) Just a great deal? Although, pending BCRA’s authorization, Grupo Galicia has sold CFA (deal that includes Cobranzas y Servicios S.A). Likewise, it has purchased an additional 6% of Tarjetas Regionales valued at USD 817M. That valuation implies a P/BV of 2. The whole Galicia Group is trading at a P/BV of 4.06 (after some adjustments discussed below). This could indicate that Galicia did a great deal or that the management thinks that the stock is overpriced. If we also take into consideration that Galicia has just issued new shares, we believe that these facts are consistent and support our SELL

Figure 18; Source: Company Data & team estimates recommendation. The majority of this changes will be effective from January 2018.

Valuation:

We assessed the value of Grupo Financiero Galicia’s ADR by applying two different methods: a DCF model and Relative Valuation. Our target price is obtained only from the intrinsic value derived from the DCF model, and being supported by the Relative Valuation results.

FCFE Model Approach:

We applied the FCFE model adjusted for financial entities. On account of the complexity of the financial structure that arises in the financial industry, there is consensus in focusing the valuation on the equity value. Although DDM could be used to assess the investment, we decided not to follow this path due to the regulations that were imposed over earnings distribution according to Argentina’s Central Bank and the debt restructuring after 2001 financial crisis. As a consequence of the business integration between the holding subsidiaries, the sum of the parts method overestimates the equity value. To avoid a misleading valuation, five years cash flows and a terminal value were estimated considering the holding’s consolidated income. In order to build a consistent model, the growth rate of loans was forecasted at an aggregated level considering macroeconomic trends and assuming an increase in the firm’s market share. To keep consistency, the same methodology was applied to estimate the deposits growth rate. The main factor considered to model financial risk was the allowance on loans to customers. Finally, earnings were projected considering an interest rate based on macroeconomics trends. The interest spread is impacted by several factors, for example, the market’s competitiveness level. All cash flows were computed in ARS and converted into USD using team estimates on inflation and foreign exchange rate. Our DCF model includes forecasts up to 2022. For cash flows beyond 2022, we computed a Terminal Value using Argentina’s GDP long-term growth rate, at 3%. We assay our model with an insolvency risk measure calculated with a recalibration of the Z-Score technique (See Appendix V). This method shows that the average probability of filing for bankruptcy is below 0.2%, which shows congruity with the industry regulation and the assumptions introduced in our model.

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Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

Current Cost of Equity:

Using the Capital Asset Pricing Model (CAPM) to compute the cost of equity (Ke) in emerging markets (EM) companies with highly regulated environments, can yield misleading results. Several regressions were run between the S&P 500 index and GGAL’s ADR, combining different periods and periodicities in order to validate CAPM. These regressions yielded poor results, with low R2 ratios, non-significant coefficients, and Betas with high standard deviation, ranging from -1.29 to 2.85 as shown in Appendix VI. We believe this is clear evidence of CAPM not being a proper approach to compute GGAL’s Ke. Another alternative would be proxying CAPM’s market portfolio with the Merval Index, however, this would not be a proper approach since it lacks liquidity and has a bias toward the energy industry, thus it would skew the estimation. Consequently, we applied an alternative model developed for EM by Goldman Sachs. In our model, the Ke depends on three variables:

• Risk Free Rate (Rf): the YTM of the 10-year US Treasury Notes was used as KE = Rf + ERP * {(1 – ρE,B) * (σARG / σUS)} + CRP proxy, currently 2.3%. • Modified Beta Multiplied by the US Equity Risk Premium (ERP): we Ke Composition (2017) computed the US ERP with data obtained from historical series provided by Kenneth French (Darmouth College), obtaining an ERP of 6.15%. 2017 Following the Goldman Sachs approach, the Modified Beta was defined Equity risk premium 6.15% as the ratio between the standard deviations of Argentina’s Merval index Volatility Ratio 2.744 (1 - Correlation Coeficient) 0.591 (σARG) and the S&P 500 index (σUS); this ratio yielded a value of 2.74. This was multiplied by a factor that eliminates the correlation between Market Factor 10% Argentina’s equity and bond markets (ρE,B), with a value of 0.59, to prevent EMBI+ 368 bp from double counting the risk already reflected in the CRP, as defined Risk free 2.26% next. The obtained Modified Beta was 1.12. Cost of equity 15.92% • Country Risk Premium (CRP): We used JPMorgan’s EMBI+ index for Figure 19; Source: Team estimates Argentina as proxy of the CRP, with a month average of 368 bps. Interest Rate Sensitivity (USD) The above-mentioned model yielded a Ke of 15.92% for 2017 (Figure 19). Sensitivity Liable Rate -0.50% -0.25% 0.00% 0.25% 0.50% Cost of Equity for 2018 and Subsequent Years: -0.50% $43.49 $42.77 $42.05 $41.33 $40.61 For 2018 and beyond, we assumed an increasing Rf rate, as we expect the -0.25% $45.27 $44.55 $43.83 $43.11 $42.39 Sensitivity 0.00% $47.04 $46.32 $45.61 $44.89 $44.17 US Federal Reserve to gradually lift reference interest rates. This upward trend asset rate was forecasted using a Cox-Ingersoll-Ross (CIR) mean reversion mode. In the 0.25% $48.82 $48.10 $47.38 $46.66 $45.94 case of Argentina’s EMBI+, we envisage a downward trend, and used a 0.50% $50.59 $49.87 $49.16 $48.44 $47.72 second CIR model to account for a gradual reversion towards its Latin Figure 20; Source: Team estimates American peers. This is based on our expectations of more market-friendly policies (Appendix VII). TV: Growth and Ke Sensitivity (USD) Montecarlo Simulation and Sensitivity Analysis:

To comprehend our model’s sensitivities regarding the assumptions included in it, we conducted 100,000 Monte Carlo simulations (Figure 22) considering changes in our main variables (GDP Real growth rate, loan growth rate, deposits growth rate, market share and allowance for loan loss). Consequently, we can conclude that our key variables are inflation and allowance for loan loss, as shown in Figure 23. We developed a sensitivity analysis based upon changes on terminal value, discount rates and growth. The Ke was allowed to range from 13.2% to 17.2%, while the annual growth was allowed to range from 1% to 5%. (Figure 21) In addition, we performed a second sensitivity analysis based on changes in Figure 21; Source: Team estimates the lending interest rate as well as in the deposit interest rate (Figure 20).

2018E´s Net Income: Key Factors Response Analysis (thous. USD) Monte Carlo Simulation Outcome (USD)

Figure 23; Source: Team estimates Figure 22; Source: Team estimates 7 Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

Relative Valuation:

Relative Valuation: GGAL vs. LATAM Countries As discussed above, our valuation exercise and target price are based on a DCF model. However, we also conducted a Relative Valuation, based on the P/BV multiple. We compared GGAL’s ratios with other Latin American comparable banking companies and with the average multiples of Latin America’s financial sector (Figure 24 and 25). First, using the average P/BV for the five major private banks in Argentina (without considering Banco Galicia), we arrive at a relative price of 49.49 per ADR, as shown Figure 26. Relative Valuation (USD) It is possible to notice that the ratios of the Argentine banks include a high valuation of Figure 24; Source: Team estimates the future opportunities of growth, which explains the 50.3% of the P/BV ratios, on average. Hence our proposal to deploy an alternative valuation approach towards a Relative Valuation: GGAL vs. Argentinian Peers more impartial comparison, we consider the marginal growth of the P/BV for implicit growth (Gi) point as the comparison variable. The approach was implemented as follows: first, we estimated the underlying Gi of the above-mentioned ratio and proceed to disaggregate the P/BV ratio Figure 26; Source: Team estimates into non-growth present value (NGPV) and the present value of growth opportunities (PVGO) of each firm. Finally, we computed the PVGO/Gi ratio, contrasting this information between peers. This allowed us to Figure 25; Source: Team estimates notice that the market is paying different prices per unit of Gi among the financial industry firms (Figure 25). By this approach we arrive to the conclusion that GGAL´s PVGO/Gi is the most expensive one. With the average PVGO/Gi casts a price of 44,13 per ADR to be aligned with its competitors. Hence, these results are consistent with our sell recommendation. It is important to highlight that GGAL´s P/BV was estimated considering September´s shares issuance and the IFRS impact. Financial Analysis:

This financial analysis was carried out with data published by the BCRA, SSN, Grupo Galicia’s Financial Statements (and of its subsidiaries); and the company’s public data. All the information was gathered as of June 2017.

Main Financials (thous. USD) 2014 2015 2016 2017E 2018E 2019E 2020E 2021E 2022E Total Assets $ 8,995 $11,815 $15,255 $19,423 $22,201 $24,903 $27,197 $29,215 $31,012 Total Liabilities $ 8,071 $10,676 $13,973 $17,195 $19,634 $21,902 $23,715 $25,198 $26,414 Shareholders Equity $ 924 $ 1,139 $ 1,282 $ 2,228 $ 2,568 $ 3,001 $ 3,482 $ 4,017 $ 4,598 Loans to assets 64.5% 63.0% 58.7% 59.8% 66.8% 70.2% 72.5% 74.2% 75.5% Loans to deposits 107.0% 101.9% 93.7% 87.3% 98.0% 104.0% 107.5% 109.6% 110.6% Cash to Deposits 6.8% 7.3% 4.9% 11.0% 7.6% 7.7% 7.7% 7.7% 7.6% NPL / loans 3.6% 3.1% 3.3% 3.2% 3.1% 3.1% 3.0% 3.0% 2.9%

NI Financial Operation $ 597 $ 747 $ 807 $ 1,192 $ 1,192 $ 1,200 $ 1,178 $ 1,199 $ 1,222 NI Commissions & Fees $ 478 $ 572 $ 675 $ 901 $ 948 $ 1,020 $ 1,086 $ 1,148 $ 1,209 NI Insurance Activities $ 104 $ 132 $ 154 $ 147 $ 148 $ 156 $ 165 $ 175 $ 185 Net Income $ 280 $ 317 $ 378 $ 547 $ 585 $ 625 $ 650 $ 694 $ 742 ROAE 38.8% 35.1% 34.5% 30.3% 25.6% 23.6% 21.5% 20.4% 19.4% ROAA 3.5% 3.2% 3.0% 3.1% 3.0% 2.8% 2.7% 2.7% 2.8% Spread 9.1% 7.9% 7.1% 7.9% 7.6% 7.3% 6.8% 6.7% 6.5% Efficiency ratio 55.8% 58.8% 59.9% 54.0% 53.7% 50.9% 49.0% 47.0% 45.3% Figure 27; Source: Company Data &Team estimates Capital Requirement: BCRA established the minimum capital requirement represented by the Tier 1 Capital Ratio (Tier 1 Capital / Risk Weighted Assets) of 8% and a legal buffer of 3.5%. Banco Galicia is and has been above this minimum, being currently at 11.8%; and the bank estimates that with the implementation of new accounting rules (IFRS) and the sale of CFA, it will reach 13.3%.

Asset quality:

Every year, about a quarter of the net financial income gets provisioned. For FY16 this figure was 24% and it was well below its

peak which occurred in 2008 (during the global financial crisis) when Grupo Galicia provisioned 41% of its net financial income to cover expected losses. Between 3% to 4% of the loans portfolio has historically been provisioned. About 50% of the loans in the portfolio of Grupo Galicia are individuals so the quality of its loans relies heavily on the real wage evolution. According to the company’s data, the group’s NPL is at 3.5% and it is highly heterogeneous among the group’s subsidiaries. Banco Galicia has a NPL Ratio of 2.1% while Tarjetas Regionales and CFA have a NPL Ratio of 9.3%. 8

Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

Funding structure: GGAL´s Funding Structure

The funding structure of the group is dominated by deposits which represents 62% of the assets. Other important sources of financing are equity at 9% and financial debt which was at 8%. The rest of the financing comes from other kind of liabilities (Figure 28). The financial debt to equity ratio is 0.8 and is the lowest in the last 10 years. In comparison, this ratio was 2.5 in 2004 when GGAL was recovering from the 2001/2002 financial crisis. Time deposits in the last quarters represented only about 35% of total deposits, this situation is very different from its historical levels which are about 50% of total deposits. Tax amnesty is the direct cause of this abnormality. This will reverse to its historic mean in the following years. Figure 28; Source: Company Data Banking:

We did a comparison between Banco Galicia and its private banks peers Loans Portfolio (Figure 30). Banco Galicia had more leverage and less liquidity (cash over net assets). Also, Galicia had a more expensive funding cost and charged a lower rate to total loans, consequently its ROA was lower, but Galicia achieved a higher ROE due to its higher leverage, which also means riskier cash flows. One concerning issue about banks is its liquidity, because its main liabilities are deposits which can be withdrawn instantly. Banco Galicia has a total liquidity ratio of 36% which compares to a 48% from private banks. This ratio is the coverage of deposits with cash and marketed securities.

Regional Credit Cards:

Tarjetas Regionales holds 88% of its assets in loans. As it is not a bank, it cannot fund its lending with deposits. The primary source of financing is commercial debt (40%), followed by financial debt (33%) and equity (22%). This business unit Figure 29; Source: Company Data is considerably less leveraged (4.5x) in comparison to the bank. Tarjetas Regionales income comes from two activities: fees (61%) it charges to its credit cardholders; and lending (39%) which consists of personal loans and credit cards loans. The combined gross margin from those activities is 64%, the operating margin drops to 22% and finally its net margin stands at 15%. Over the past years, these margins have remained fairly stable.

Insurance:

Galicia Seguros has more credits as part of its assets in comparison to the average of the other insurers but more liquidity to face debts with its insured (cash plus securities to debts to insured). Regarding its solvency, it has a small surplus above the required capital established by SSN. Just 2% of the premiums issued are transferred to a reinsurer compared to the mean of 11%. Finally, Galicia Seguros has lower sinistrality but worst efficiency (expenses as percentage of premiums issued); despite this fact, it achieves a better net Insurance and Banking: Key Ratios margin. (Figure 30) Banco Private Galicia Insurance Galicia Banks Seguros companies IFRS Impact: Liquidity 15% 18% Liquidity to Insurers Debt 383% 167% Effective January 1st, 2018, Banks will have to elaborate its financial statements Total Liquidity 36% 48% Credits to Assets 44% 31% according to the IASB accounting rules (IFRS). Grupo Galicia has issued along Funding Cost 8% 7% Surplus over Required Capital 16% 90% its Q2 financial statements, an attachment detailing how would look the same Loans Rate 20% 23% Reinsurance 2% 11% financial statements using IFRS instead of Argentine GAAPs. ROA 3% 3% Sinistrallity 14% 54% Assets would shrink 3% and liabilities 5% resulting in an equity increment of 18%. Leverage 8.6x 6.76x Efficiency 61% 43% The biggest changes in the investment side are, a reduction of the valuation of ROE 33% 28% Net Margin 15% 8% securities (-40%) and of intangible assets (-42%); and the increments of equity Figure 30; Source: Team estimates investments (+2554%) and equipment (+116%). In the other side of the balance sheet, provisions would be smaller (-25%) and while the non-controlling interest is considered a liability under GAAP, is part of the equity under IFRS.

Investment Risk: Given that our SELL investment recommendation is based on a mispriced due to high macroeconomics expectations, the investment risk associated to our thesis are mostly related to positive macroeconomic outcomes.

Macro Risks:

Economic Growth (M1): given the positive correlation between GDP growth and the banking industry, a significant GDP growth would positively affect the banking industry by increasing the credit demand as well as deposits. Nevertheless, the highly cyclical nature of this sector could boost advantage from the expected growth of the country. 9 Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

Risk Matrix Macro Risks:

Inflation (M2): Another variable that could affect GGAL’s operating performance is inflation. If not successfully achieved the 5% expected for 2019 according to economic authorities, the operating profits of GGAL could benefit from this situation by widening spreads again. Political uncertainty (M3): Due to the legislative elections held in October, Argentina’s political atmosphere is under great uncertainty. This uncertainty affects the economic reforms that can be pursued. If the Macri’s administration wins more seats in the parliament, it could pass more economic reforms that promote the liberalization of the markets and also a tax reform. These reforms could mean higher profits for the Holding. Labor reform (M4): since the 2001 economic crisis, several labor reforms were introduced in order to discourage unemployment which tends to protect the employee. These reforms empowered Labor Unions. However, due to Brazil’s Labor reform, it is highly possible that Argentina pass a labor reform so as not to lose competitiveness regarding its neighbor and major trading partner. This would mean lower labor costs, and more freedom Figure 31; Source: Team Analysis regarding employment negotiations. If this reform is wisely defined, it could imply a competitive advantage regarding Brazil, luring more foreign investment, ergo a positive impact in Argentina’s economy and thus in the firm's operating profits. Long term market liquidity (M5): As a result of Argentina’s financial crisis in 2001 and the economic volatility, there is no liquidity in the long term financial market. Since the current administration took office, efforts had been made in order to address this issue. One policy aimed to solve this problem is the creation of new UVA indexed instruments.

Strategic Risks: Informal Employment (S1): If the economic policies applied to solve informal employment are more efficient than expected, the banking market could be expanded in Argentina. Ergo, GGAL’s will be able to set forth a more aggressive strategy than smaller banks and so it could expand its market share easily. Emerging competition (S2): Argentina has a new non-regulated market for economic web transactions. This is the case of Mercado Pago which could be consider as a substitute for the banking system in the low – middle income stratum. If regulated, GGAL could widen its market share and thus, the operating income.

Corporate & Governance:

Grupo Financiero Galicia’s Board of Directors is composed of nine members, all of whom have vast experience in the financial field, highlighting GGAL's Chairman, Eduardo Escasany, whose ancestors founded Banco Galicia over a century ago. The controlling families have taken five key places in the Board of Directors, which is also comprised by the GGAL’s CEO. Only three members of the Board of Directors are considered to be independent, which represents a third of the board (see Appendix X). The Board of Directors established an Audit Committee with three members: Silvestre Vila Moret, Antonio Garcés and Enrique Martin. Both Garcés and Martin are considered independent, but Silvestre Vila Moret is not, under CNV and Nasdaq recommendations. There is no compensation committee; the compensation of the Board of Directors is defined by the audit committee, for later approval at the shareholders’ meeting once the fiscal year has ended. Social Responsibility is highly rewarded in the group, for more information see Appendix XI.

The Management: Pedro Alberto Richards is the holding’s Chief Executive Officer and member of the Board of Directors, former director of the National Development Bank, associated with Banco Galicia since 1990. Jose Luis Ronsini is the Chief Financial Officer, former Chief Credit Risk Auditor of Tarjetas Regionales and General Accountant at Banco Galicia. The Management compensation policy consists of a fixed salary and a bonus based on individual performance. The holding does not maintain stock-options, profit-sharing, or pension plans for the benefit of the managers. Ownership

Ownership: The capital structure is composed of class A shares, entitled to five votes, and class B shares, entitled to one vote. As of October 24, 2017, the holding had 1,425,240,673 (considering the 124,976,076 new shares issued in September 2017) shares outstanding, 281,221,650 class A shares and 1,144,019,023 class B shares. The controlling shareholders owned 100% of class A shares through EBA Holding and 12.4% of class B shares, therefore owning 29.7% of outstanding shares and having 63.2% of total votes. The percentage of outstanding shares held by institutions and mutual funds are shown in Figure 32. Figure 32; Source: Thompson Reuters 10 Grupo Financiero Galicia: Analysing Argentina’s Financial Sector

Appendix I: Glossary

ADR: American Depositary Receipt. ARS: Argentine Pesos. Bankarization: the process of including more population into the financial system BCRA (Banco Central de la República Argentina): Argentina’s Central Bank BYMA (Bolsas y Mercados Argentina): Argentina’s new and most important . CEO: Chief Executive Officer. DCF (Discounted Cash Flow): intrinsic valuation model. EBA (Escasany, Braun & Ayerza): society registered by the relatives of the founding members of Banco Galicia. EBITDA: Earnings before Interest, Taxes, Depreciations & Amortizations. EV/EBITDA: Enterprise Value to EBITDA FCFE: Free Cash Flow to the Equity. FY: Fiscal Year. GAAP (Generally Accepted Accounting Principles): accounting standards currently in use and set (in Argentina) by the BCRA. GDP: Gross Domestic Product HHI (Herfindahl-Hirschman Index): It is an index used to measure market concentration. Scores above 1500 indicate a moderate concentrating market. It is built by summing the square of the market shares of market participants. The highest score is 10,000 which indicates a monopoly. IASB (International Accounting Standards Board): committee that evaluates changes to the IFRS rules. IFRS (International Financial Reporting Standards): accounting standards used around the world. IMF: International Monetary Found. Interior: Argentina’s provinces excluding the city of Buenos Aires and its outskirts. NASDAQ (National Association of Securities Dealers Automated Quotation): second largest exchange in the United States. P/BV: Price to Book value Ratio PIM: Virtual Wallet for non bankarized citizens. QoQ: Quarter over Quarter. REM (Relevamiento de Expectativas de Mercado): monthly survey made by the BCRA about forecasts of key macroeconomic variables. Recognized analyst are the participants of this survey. RO(A)A: Return on (Average) Assets RO(A)E: Return on (Average) Equity. S.A (Sociedad Anonima): Stock Corporation SAU (Sociedad Anónima Unipersonal): secretary type that allows someone to own 100% of the shares. SSN (Superintendencia de Seguros de la Nacion): Argentina’s Insurance Regulator. SWOT (Strength, Weaknesses, Opportunities & Threats): model that reflects organizational characteristics. USD: United State Dollars. UVA (Unidad de Valor Adquisitivo): an inflation adjusted measurement unit. YoY: Year over Year.

1111 Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

Appendix II: SWOT Analysis

Strengths Weaknesses

• The group has the structure in terms of branches, number of employees and technology to absorb a significant increase in volume. • Operates exclusively in the Argentine industry, • Well positioned in terms of online banking services which is characterized for its volatility. and digital platforms. • Local brand; does not have international presence • Autonomous businesses give the group great flexibility nor backup. to react to market trends. • Not diversified outside the financial sector. • Strong brand reputation and image. • A poor Efficiency Ratio. • Economies of scale and synergies among its business • Capital Ratio minor than competitor´s. units. • Grupo Galicia has a higher Non-Performing Loans • Its subsidiaries manage to capture diverse segments, Ratio than competitor´s. achieving its presence among different sectors of the market.

Threats Opportunities

• Operates in a strictly regulated sector. • Lead time to correct fiscal, monetary and external imbalances. • Growth is highly dependent on the Brazilian • Low level of financial depth. economy. • Increase in concentration. • Strong competitors, some with international • Online payment systems development. presence and back up. • Increasing levels of individuals accessing the banking • Fintech as a potential new competitor. system. • Some residual distortive regulations such as the • Elimination of distorting regulations. “Financing Line for Production and Financial • An increasing demand of mortgage loans. Inclusion “(subsidized by banking entities). • Positive effects of the implementation of IFRS. • The regional credit card business unit is being • Cross-selling opportunities in growing markets. heavily controlled, and the application of new measures aims to reduce the maximum allowed to charge in concept of fees and commissions.

Source: Team Analysis 12 Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

Appendix III: Porter´s Six Forces Analysis Six Forces Model: The Porter’s Five Forces analysis has been reinterpreted from The Delta Model (Hax and Wilde), adding a sixth factor that comprises complementary enterprises & products to the business unit under analysis.

0 No threat

1 Very low threat

2 Low threat

3 Moderate threat

4 High threat

5 Very high threat

THREAT OF NEW ENTRANTS: Very Low Threat

• Banco Galicia: VERY LOW THREAT. High operating costs and very strict regulations regarding the financial sector. Additionally, there is a tendency for concentration in the financial local market. • Tarjetas Regionales: VERY LOW THREAT. Although this business unit is not subject to regulations as strict as the banking sector, its high costs of entry and operation make this item one of difficult access for new competitors. • Galicia Seguros: VERY LOW THREAT. High operating costs and strong regulations and restrictions in the insurance sector. BARGAINING POWER OF BUYERS: Moderate/High Threat

• Banco Galicia: MODERATE-HIGH THREAT. Its power depends and varies according to the rating obtained by risk assessment companies, their inherent risk and credit history. Furthermore, it is low cost and easy to close accounts or withdraw cards. • Tarjetas Regionales: LOW THREAT. Most of the cardholders are unbanked individuals who have few alternative options to access other financing instruments. • Galicia Seguros: HIGH THREAT. High power of clients due to the simplicity of the procedure to cancel policies and the fact that most of offered are not mandatory. Possible presence of moral hazard.

THREAT OF SUBSTITUTE PRODUCTS OR SERVICES: Moderate Threat

• Banco Galicia: MEDIUM THREAT. PSL: (Personal Signature Line of Credits): even though they are subject to higher interest rates, they offer lower amounts and are focused on riskier segment. Lebacs: operate indirectly as a substitute product for other private investment instruments, such as time deposits. Pre-construction housing: a viable alternative for mortgage loans. Credit cards may be replaced through commercial financing of retails. There are no apparent substitutes in the argentine financial system for products such as salary account, debit cards, checking account and insurance or warrants, among others. • Tarjetas Regionales: MEDIUM THREAT. Considering among its possible substitutes private financing entities for low-middle-class individuals, with emphasis on the unbanked segment. • Galicia Seguros: LOW THREAT. They are not apparent substitutes products for the insurance business unit. BARGAINING POWER OF SUPPLIERS: Moderate Threat

• Banco Galicia/ Tarjetas Regionales/ Galicia Seguros: HIGH THREAT. Workers have great bargaining power due to the strong trade union presence in the industry. MEDIUM-HIGH THREAT. Regarding the transport service, credit record providers, risk rating companies, credit card providers, the market is presented as an oligopoly led by few companies.

RIVALRY AMONG EXISTING COMPETITORS: High Threat

• Banco Galicia: HIGH THREAT. SANTANDER: for high-income, agro and corporate clients (best positioned in “Great Place to Work 2017” and owner of a greater market share). BBVA: for clients with medium-high income, agro and corporate. STATE OWNED BANKS: low and middle- income segments. STOCK BROKING COMPANIES: strong competitors for investment products in the capital market. BANCO PROVINCE AND NATION: compete in the industry. Fintechs. • Tarjetas Regionales: LOW THREAT. Few direct competitors and is comfortably positioned as a leader in this market • Galicia Seguros: HIGH THREAT. Presence in the market of 185 insurance companies, some with strong brand reputation and international support and recognition. • COMPLEMENTARY PRODUCTS/SERVICES: No Threat

• Banco Galicia/Tarjetas Regionales: debit balance life insurance, capitalization insurance, life insurance, card brands (Visa, Master, Tarjeta Naranja), electronic payment systems (Monedero, etc.), platforms that support the bank´s web services, among others. • Galicia Seguros: savings accounts, bank accounts, online payment systems (Monedero, etc), platforms that support their web services, among others. 13 Source: Team Analysis Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

Appendix IV: Qualitative Benchmarking

Benchmarking Analysis

Source: Team Analysis

Benchmarking Comparative Results

Source: Team Analysis

14 Grupo Financiero Galicia: Analysing Argentina’s Financial Sector

Appendix V: FCFE Valuation Model

ROE Forecasted Path

Source: Team estimates

ROA Forecasted Path

Source: Team estimates Z-Score Approach:

The Altman Z-Score is a risk measure used to assess over the probability of a firm filing for bankruptcy. Lepetit and Strabel (2015) redefine this method to give a more accurate probability for financial sector firms, where Z= (1+µROE) /σROE.; and the improve insolvency probability bound is set as (1+Z2)-1. Under this analysis the result shows that the insolvency risk is kept low in our projections, as shown in table XX1. Z-Score Estimated Evolution

Source: Team estimates

15 Grupo Financiero Galicia: Analysing Argentina’s Financial Sector

Appendix VI: CAPM: Misleading Beta Calculation

16 Grupo Financiero Galicia: Analysing Argentina’s Financial Sector

Appendix VII: Cost of Equity

2017 2018 2019 2020 2021 2022 2023 Equity risk premium 6,15% 6,15% 6,15% 6,15% 6,15% 6,15% 6,15% Volatility Ratio 2,744 2,744 2,744 2,744 2,744 2,744 2,744 (1 - Correlation Coeficient) 0,591 0,591 0,591 0,591 0,591 0,591 0,591 Market Factor 10% 10% 10% 10% 10% 10% 10% EMBI+ 368 bp 303 bp 260 bp 230 bp 210 bp 195 bp 185 bp Risk free 2,26% 2,64% 2,86% 3,05% 3,20% 3,31% 3,40% Costo del equity 15,92% 15,65% 15,44% 15,33% 15,28% 15,23% 15,23%

Source: Team estimates

EMBI+ Evolution Risk Free Rate Evolution

EMBI+ Risk Free Year Average Std Dev Year Average Std Dev 2018 3,03% 0,076% 2018 2,64% 0,107% 2019 2,60% 0,090% 2019 2,86% 0,146% 2020 2,30% 0,083% 2020 3,05% 0,154% 2021 2,10% 0,086% 2021 3,20% 0,177% 2022 1,95% 0,090% 2022 3,31% 0,202% 2023 1,85% 0,075% 2023 3,40% 0,185%

Source: Team estimates

17 Grupo Financiero Galicia: Analysing Argentina’s Financial Sector

Anexo VIII: Forecasted Income Statement

Forecasted Balance Sheet

Source: Team estimates

18 Grupo Financiero Galicia: Analysing Argentina´s Financial Sector

Appendix IX: Relative Valuation

Relationship between Gi & P/BV: GGAL vs. Latin-Americans Countries

Source: Team Estimates

Relative Valuation: GGAL vs. Latin-Americans Peers (USD)

Source: Team Estimates

19 Grupo Financiero Galicia: Analysing Argentina’s Financial Sector

Appendix X: The Board of Directors Source: Team Estimates

Source: Company Data

20 Grupo Financiero Galicia: Analysing Argentina’s Financial Sector

Appendix XI: Corporate Social Responsibility

Grupo Financiero Galicia denotes a high social commitment, considering Corporate Social Responsibility a core part of its business, focusing in education, employment and preserving the environment. The group voluntarily adheres to Equator Principles, committing Banco Galicia to undergo an environmental risk evaluation before granting investments credits. Together with its sustainable development goals, and fostered by United Nations Global Compact, GGAL strengthen its market position in Argentina, promoting its economic and social development by featuring their own programs and, in alliance with Civil Society Organization, implementing other programs. GGAL uses a Social Investment Analysis Matrix in order to assess their social impact and identify the needs of those civil social organizations allied with. This matrix compares Social Return on Investment (comprising a 70%), which focuses on the program management and the Organizational Performance (consisting of 30%). Under this metrics, 78% of the programs were rated as “Very Good”, and the remaining 22% was rated as ”Good”.

Social Investment Analysis Matrix

Source: Company data

22112 3

Disclosures:

Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report.

Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue.

Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company.

Market making: The author(s) does not act as a market maker in the subject company’s securities.

Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with Grupo Financiero Galicia S.A. (Grupo Galicia, or GGAL), CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.

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