Asia Pacific Equity Research 22 October 2009 Overweight Busan Bank 005280.KS, 005280 KS 3Q09 results review: Solid earnings and extended Price: W14,100 ▲ Price Target: W17,500 visibility Previous: W14,000 • Solid earnings by Busan Bank in 3Q09: Busan Bank (BSB) reported South Korea a net profit of W84 billion for 3Q09, which was substantially higher Banks / Bank-centric FHCs than our forecast of W65 billion and the consensus estimate of W69 Gil Hyung KimAC billion. During the quarter, BSB recognized a one-off gain of ~W3 (82-2) 758-5900 billion from the gain on the sale of investment securities. [email protected] • Scott YH Seo Earnings upside mainly driven by improved asset quality: Credit (82-2) 758 5759 costs for BSB (adjusted for the net loss on loan sales) decreased to [email protected] 80bp over average loans in 3Q09 from 96bp in 2Q09 and 210bp in J.P. Morgan Securities (Far East) Limited 1Q09 due to improved credit quality at BSB (pre-charge off/NPL sale Price Performance delinquency ratio of 1.81% in 3Q09 from 2.06% in 2Q09). The quarterly net interest margin was maintained at 3.1% from a quarter 16,000 ago, when adjusted for one-off items (i.e. credit card fee income of W 10,000 +2bp in 2Q09 and FX impact of 5bp in +3Q09). On the other hand, non-interest income declined by around W10 billion in 3Q09 from the 4,000 previous quarter due to lower fee and securities-related income. Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 005280.KS share price (W KOSPI (rebased) • We maintain OW on BSB: We believe BSB offers high earnings YTD 1m 3m 12m visibility due to: (1) resistant NIM due to its strong deposit franchise Abs 152.8% 7.6% 34.3% 82.7% (stability in low-cost deposit flow); (2) prudent management of Rel 105.7% 10.1% 23.2% 44.4% overhead costs (5% reduction in salaries in 4Q09 and 50% cut on the reimbursement of unused vacations in 2010); and (3) persistent asset Company data quality trend. In addition, we believe balance sheet strength at BSB 52-wk range (W) 14,450-4,840 Market cap (WB) 2,632 stemming from the NPL ratio of 1.39% in 3Q09 (target NPL ratio of Market cap (US$MM) 2,233 1.14% by end-FY09) and estimated TCE ratio of 6.6% after equity Share O/S (MM) 187 issuance in 1Q09 should largely mitigate downside risks (i.e. earnings Free float (%) 95 Avg. daily volume (MM) 1.4MM shares and recapitalization) at BSB. Avg. daily value (WB) 16.6 Avg. daily value (US$MM) 14.1 • We raise our earnings estimates and PT: We raise our earnings Exchange rate(Won/US$) W1,179/US$1 Index (KOSPI) 1654.23 estimates by 14.5% and 16.2% for FY09 and FY10, respectively, Date of price 10/21/2009 largely to reflect the better-than-expected asset quality metrics (lower Year-end Dec NPL formation and delinquency ratio) in 3Q09. Due to the revisions in Source: Bloomberg. our model, we increase our DDM-based (Jun-10) share price target from W14,000 to W17,500. BSB (Bloomberg: 005280 KS; Reuters: 005280.KS): Earnings summary Earnings estimate revisions and valuation Won in billions, year-end December 3Q07 3Q08 2Q09 3Q09 % Y/Y % Q/Q FY09E FY10E FY11E PPOP 118 129129 138 7.0% 6.9% Old EPS (W) 1,209 1,411 1,566 Provisions 6 1533 28 86.5% -15.1% New EPS (W) 1,385 1,639 1,836 Operating profit 112 114 96 110 -3.5% 14.4% % change 14.5 16.2 17.2 Net profit 77 79 70 84 6.4% 18.8% New BVPS (W) 11,393 13,129 15,079 EPS (Won) 2,089 2,135 1,518 1,784 -16.4% 17.5% P/E (x) 10.2 8.6 7.7 Cost/income ratio (%) 46.1% 44.3% 47.9% 43.1% ROE (%) 13.0 13.4 13.0 NPL ratio (%) 0.74% 0.74% 1.58% 1.39% P/BV (x) 1.2 1.1 0.9 Source: Company reports, Bloomberg, J.P. Morgan estimates. See page 9 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Gil Hyung Kim Asia Pacific Equity Research (82-2) 758-5900 22 October 2009 [email protected] Company description P&L sensitivity metrics PPOP EPS FY09E impact (%) impact (%) Busan Bank (BSB) is one of the six Net interest margin assumption regional banks in Korea. Most of its Impact of each 10bp increase 6.0% 9.0% branches are located in Busan, the Interest earning asset growth assumption second-largest city in Korea in terms of Impact of each 1 percentage point increase 1.8% 2.7% population and economy. BSB also Non-interest income growth assumption competes with Kyungnam Bank, a Impact of each 5 percentage point increase 1.3% 1.9% regional bank subsidiary of Woori Credit cost assumption Impact of each 10bp decrease 4.1% 6.2% Financial Group, in Busan and Kyungnam regions. Source: J.P. Morgan estimates. Price target and valuation analysis Our DDM-based, Jun-10 PT of W17,500 implies 1.3x FY10E P/BV and assumes ROE of 13.5% and CoE of 11.5%. Business portfolio (Net revenue) Key assumptions Risk-free rate: 5.3% Non- Market risk premium: 6.0% interest Beta: 1.0 income NII Sustainable ROE 13.5% 10.6% 89.4% Cost of equity 11.5% Terminal “g”: 5.3% J.P. Morgan estimates. Key risks to our PT: Source: J.P. Morgan. * Based on FY09 estimates. • Unexpected regulatory changes could negatively/positively affect our view on the company. EPS estimates: J.P. Morgan vs. consensus W J. P. Morgan Consensus • Higher-than-expected growth could positively affect our view and FY09E 1,385 1,258 earnings forecasts on the company. FY10E 1,639 1,525 FY11E 1,836 1,728 • Unexpected corporate bankruptcies could negatively affect our view Source: Bloomberg, J.P. Morgan estimates. and earnings forecasts on the company. • If the domestic economy deteriorates more than we expect, our forecasts for provisions and earnings could be negatively affected. Peer group valuation comparison Stock code Price (W) Mkt cap P/BV (x) P/E (x) Rec (Bloomberg) 21-Oct-09 (WB) FY09E FY10E FY09E FY10E KFG OW 105560 KS 62,900 24,302 1.22 1.15 25.72 13.85 SFG OW 055550 KS 48,350 22,928 1.57 1.46 16.71 12.45 WFG N 053000 KS 16,550 13,340 1.03 0.97 19.97 13.54 HFG N 086790 KS 37,250 7,891 0.85 0.82 68.26 11.31 IBK N 024110 KS 15,150 8,236 1.15 1.05 18.44 10.80 KEB OW 004940 KS 14,300 9,222 1.31 1.19 21.04 12.47 DGB OW 005270 KS 16,700 2,206 1.25 1.12 12.05 9.46 BSB OW 005280 KS 14,100 2,632 1.24 1.07 11.21 8.99 JBB N 006350 KS 7,760 414 0.91 0.81 7.15 7.14 Sector average (Weighted by market cap) 1.25 1.17 21.65 12.80 Source: Company reports, Quantiwise, Bloomberg, J.P. Morgan estimates. 2 Gil Hyung Kim Asia Pacific Equity Research (82-2) 758-5900 22 October 2009 [email protected] 3Q09 results review Table 1: BSB—Summary of 3Q09 results Won in billions, year-end December 2007 2008 2009 2009 Y/Y Q/Q 3Q 3Q 2Q 3Q (%) (%) BSB’s net interest income in 3Q09 Income statement (Won in billions) gained 2.1% Q/Q due to a marginal Net interest income 180 204 211 216 5.8% 2.1% increase in reported NIM (+3bp Q/Q). Total non-interest income 39 28 37 27 -3.4% -26.6% The NIM gain was largely due to the Net fees and commissions 25 29 23 22 -25.6% -7.1% strengthening of Won which lowered Securities dealing gains 6 0 9 3 n.a. -60.6% funding costs on FX borrowings. Currency/derivatives dealing gains 8 0 17 9 n.a. -45.0% Other operating income 0 -1 -12 -7 n.a. n.a. Total income 219 232 248 243 4.6% -2.1% Non-interest income declined Operating expense 101 103 119 105 1.7% -11.9% significantly as BSB’s securities-related Administrative expense 77 79 83 81 1.5% -3.4% income lowered in 3Q09 (FX and Depreciation 10 9 7 8 -11.0% 11.5% derivative down by W7.4 billion Q/Q and Other administrative expenses 14 14 28 16 11.6% -44.0% investment securities down by W3.1 Operating profit 118 129 129 138 7.0% 6.9% billion Q/Q). Provisions for bad debts 6 15 33 28 86.5% -15.1% Post Provisioning OP 112 114 96 110 -3.5% 14.4% Due to the stringent overhead costs Other non-operating income/(expense) -5 -5 -3 1 n.a. n.a. policy, labor costs were prudently Pretax profits 107 109 93 111 1.4% 18.7% managed, which helped to reduce Tax 30 31 23 27 -11.5% 18.3% operating expenses.