MORGAN STANLEY RESEARCH ASIA/PACIFIC Morgan Stanley & Co. International Joon Seok plc, Seoul Branch+ [email protected] +82 2 399 4934 Gil Woo Lee [email protected] +82 2 399 4935 October 22, 2010 Stock Rating Busan Bank Overweight Industry View BSB Shows There Are Bright Attractive Spots for Korean Banks Key Ratios and Statistics Reuters: 005280.KS Bloomberg: 005280 KS S. Korea Financial Services What's Changed Price target W18,000 Price Target W15,500 to W18,000 Up/downside to price target (%) 25 10E/11E/12E MW EPS Up 10%/13%/18% Shr price, close (Oct 21, 2010) W14,400 52-Week Range W15,100-10,000 Sh out, dil, curr (mn) 187 We have raised our price target from W15,500 to Mkt cap, curr (bn) W2,688 W18,000 and we maintain our OW rating: Busan EV, curr (bn) W2,688 Bank (BSB) has been our preferred small-cap pick but it Avg daily trading value (bn) W11 has outperformed even its larger peers in FY10. We Fiscal Year ending 12/09 12/10e 12/11e 12/12e think BSB deserves a premium, at least 1.2x 2011E P/B. ModelWare EPS (W) 1,313 1,965 2,188 2,458 Prior ModelWare EPS (W) - 1,779 1,939 2,087 BSB posted strong 3Q10 results; NP hit W103bn, a Consensus EPS (W)§ 1,366 1,860 2,006 2,226 historical record-high: The strong results mainly came ModelWare net inc (W bn) 245 367 408 459 from 1) notable loan growth to offset margin P/E 10.6 7.3 6.6 5.9 deterioration, 2) bigger net non-interest income along P/BV 1.2 1.1 0.9 0.8 with reduced losses from NPL sales, 3) minimal impact Div yld (%) 1.1 1.4 4.2 4.9 Unless otherwise noted, all metrics are based on Morgan Stanley ModelWare from tougher PF guideline, and 4) one-off gain on framework (please see explanation later in this note). § = Consensus data is provided by FactSet Estimates. disposal of equity method investments. e = Morgan Stanley Research estimates Strong top line and resilient asset quality: While BSB enjoyed stronger net operating revenues, low level of provisioning supported bottom-line profit. The impact from strengthened PF guideline was very minimal (W4.2bn) for the bank. Gross NPL formation sharply decreased and NPL ratio continued to fall. FHC conversion right on track: BSB is supposed to form a financial holding company (FHC) in March 2011. We believe FHC conversion would bring many advantages to the bank; 1) improved M&A capability, 2) revenue diversification. Morgan Stanley does and seeks to do business with A good pointer for Korean banks: As the regional companies covered in Morgan Stanley Research. As economy recovers, BSB could achieve greater loan a result, investors should be aware that the firm may growth and stabilizing asset quality, especially in the have a conflict of interest that could affect the SME segment. We have asserted that quality SMEs can objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a be a potential driver for growth, and BSB’s results help single factor in making their investment decision. to support this argument. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report. += Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. MORGAN STANLEY RESEARCH October 22, 2010 Busan Bank Busan Bank: Financial Summary Income Statement Balance Sheet (Year to Dec 31, Wbn) 2009 2010E 2011E 2012E (Year to Dec 31, Wbn) 2009 2010E 2011E Interest income 1,683 1,626 1,751 1,943 Total assets 30,477 34,587 37,400 Interbank 19 14 16 17 Cash & due from banks 1,230 1,563 1,686 Securities 266 266 282 312 Securities 5,768 5,964 6,521 Loans 1,393 1,338 1,443 1,604 Net loans 20,199 21,827 23,587 Others 5 8 10 10 (Loan loss reserve) 316 364 417 Interest expense 805 721 784 878 Loans in won 17,843 19,827 21,588 Deposits 485 481 551 638 Credit card accounts 359 403 419 Borrowings 146 94 92 98 Loans in FC 1,380 1,497 1,528 Debentures 167 141 136 136 Fixed assets 363 377 343 Others 7 6 6 7 Other assets 2,918 4,855 5,263 Net interest income 878 905 966 1,065 Interest Earnings Assets (Average) 26,541 28,054 30,579 Net commission income 83 82 83 80 Net other non-interest income -95 1 4 -2 Liabilities 28,358 32,110 34,547 Net non-interest income -11 83 87 78 Deposits 18,511 20,749 22,844 Deposits in won 15,705 17,693 19,683 Total operating income 867 987 1,053 1,143 Deposits in FC 162 184 199 Operating expenses 388 391 404 423 Certificates of deposit 2,643 1,569 1,633 Other deposit 0 1,303 1,329 Pre-Provisioning Operating Income 478 597 649 720 Borrowings 3,745 3,516 3,586 Provision for loan losses 161 127 119 123 Debentures 2,646 2,602 2,551 Other liabilities 3,456 5,243 5,566 Operating Income 317 470 530 597 Non-operating items 1 14 9 8 Interest Bearing Liab. (Average) 24,762 25,884 27,924 Ordinary Income 318 484 539 605 Shareholders' equity 2,120 2,477 2,853 Pre-tax Income 318 484 539 605 Paid-in capital 933 933 933 Income tax 73 117 130 146 Capital surplus 0 0 0 Retained earnings 1,157 1,493 1,864 Net Income 245 367 408 459 Capital adjustments 29 51 55 Valuation Key Operating Indicators (Year to Dec 31, %, X, KRW, Wbn) 2009 2010E 2011E 2012E 2009 2010E 2011E Preprovisiong income 478 597 649 720 Profitability ratio (%) Net income 245 367 408 459 Preprovisioning profit margin 55.2% 60.4% 61.6% Net interest margin 3.31% 3.23% 3.16% EPS (won) 1,313 1,965 2,188 2,458 Net interest spread 3.08% 3.02% 2.92% EPS growth (%) -30.0% 49.7% 11.3% 12.3% Non-interest income/total income -1.3% 8.4% 8.2% P / Preprovisioning profits (x) 5.6 4.5 4.1 3.7 Asset quality (%) P/E (x) 11.0 7.3 6.6 5.9 Net loan growth 4.0% 8.2% 8.2% LLR / total credit 1.55% 1.65% 1.75% BPS (won) 11,354 13,271 15,280 17,161 NPL ratio 1.09% 1.07% 0.98% P/BV (x) 1.27 1.09 0.94 0.84 Coverage ratio on NPLs 141.8% 152.6% 176.2% ROAA (%) 0.83% 1.11% 1.13% 1.17% Efficiency (%) ROAE (%) 12.59% 15.93% 15.41% 15.36% Loan / depositis 115.1% 108.0% 106.1% Cost / income 44.8% 39.6% 38.4% DPS (won) 160 200 600 700 Yield (%) 1.11% 1.39% 4.17% 4.86% Stability (%) Equity / assets 6.6% 7.0% 7.4% Period-end common shares (mn) 187 187 187 187 Tier 1 ratio 10.4% 11.2% 11.8% Market Cap 2,688 2,688 2,688 2,688 Capital adequacy ratio 14.7% 15.6% 15.9% E= Morgan Stanley Research Estimates Source: Company data, Morgan Stanley Research 2 MORGAN STANLEY RESEARCH October 22, 2010 Busan Bank Risk-Reward Snapshot: BSB (005280.KS, W14,400, OW, PT W18,000) Risk-Reward View: A Good Benchmark for Korean Banks Why We Are Overweight ₩25,000 • BSB has been able to maintain ₩21000 (+46%) higher-than-industry average ROE 20,000 owing to advantages held as a ₩18,000 (+25%) provincial bank in relation to funding ₩ 14,400 and lending. 15,000 • The Busan/Kyongnam area has ₩12500 (-13%) relatively more robust industrial activity 10,000 owing to healthy automotive and machinery industries. • BSB has announced plans to convert 5,000 into an FHC and expand its scope of business in non-banking. 0 • We believe BSB would be better Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 positioned than peers to benefit from Price Target (Oct-11) Historical Stock Performance Current Stock Price WARNINGDONOTEDIT_RRS4RL~005280.KS~ industry consolidation. Price Target W18,000 Base-case scenario, Gordon Growth model. Key Value Drivers • Advantage in funding and loan pricing Bull 1.37x Bull Local economy shows stronger recovery than expected; Case Case 11e diversification of business base: Stronger lending demand and owing to relatively more loyal customer W21,000 P/B increased productivity levels enable BSB to enhance base. fundamentals. Conversion into an FHC followed by regional bank • Core deposit base benefits from BSB’s consolidation could present substantial benefits. strength in corporate deposit-taking and local retail deposit operations. Base 1.18x Base Normalization of operations: Expected ROE for the base case is • Local industrial activity key to growth. Case Case 11e 14.3% for 2011. Credit costs continue to stabilize while operating W18,000 P/B costs are kept under control. Potential Catalysts Bear 0.82x Bear Stalled recovery and increased competition: Credit costs • Positive news flow on capital Case Case 11e expected to rise in a delayed recovery scenario. Increased management (dividends). W12,500 P/B aggressiveness by competitors could have negative impact on NIM • Regional economies pick up robustly.