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Commercial Bank’s 3Q2006 net profit up 8.5% YoY

Sri Lanka’s premier commercial bank, Commercial Bank of Ceylon (COMB) has reported 8.5% YoY growth in net profit to LKR897.3 mn in 3Q2006, raising cumulative 1-3Q2006 earnings by 39.5% YoY to LKR2,371.3 mn, in line with our expectations.
COMB’s 3Q2006 earnings expansion has been driven by sharply higher interest income, moderate growth in non interest income (mainly foreign exchange income), slower increase in operating expenses and a reduction in loan loss provisions.
Interest Income rise by 43.7% YoY. COMB’s 3Q2006 interest income has risen strongly by 43.7% YoY to LKR5,020.6 mn, with the bank’s interest income on loans and advances and interest income on other interest earning assets rising by 40.8% YoY to LKR4,105.5 mn and 58.21% YoY to LKR915.1 mn, respectively.
The increase in interest income was primarily a result of growth in the average balance of COMB’s loan portfolio combined with an increase in the average yield on those assets. Hence, the weighted average prime lending rate (AWPR) increased to 14.7% at the end of September, 2006 from 12.24% at end 2005. Whilst total interest earning assets increased by 16.5% YTD and 31.5% YoY to LKR186,607.9 mn, underpinned by 61% YTD increase in government securities. Strong customer acquisitions resulted in higher lending balances, with net loans and advances growing by 13.5% YTD and 27.1% YoY to LKR134,647.5 mn. Thus, COMB’s total assets increased by LKR30,178.1 mn or 16.8%, to LKR210,313.2 mn as at September 31, 2006.
Healthy 28% YoY growth in net interest income. The increase in interest income was somewhat offset by an increase in COMB’s interest expense. Interest expense for 3Q2006 increased by 56.3% YoY over the comparable 2005 period to LKR3,027.7 mn, with interest expenses on deposits and interest expenses of other interest bearing liabilities increasing by 59.2% YoY to LKR2,274.7 mn and 48.1% YoY to LKR753 mn. However, despite the relatively faster increase in interest expenses compared to interest income, COMB’s 3Q2006 net interest income has increased by a slower but nevertheless healthy 28% YoY to LKR1,992.9 mn.
The rise in interest expense was the result of increases in the average balances of deposits as well as increases in the average rates paid on deposits and borrowings. Accordingly, the weighted average deposit rate (AWDR) increased to 6.89% at the end of September, 2006 from 6.24% at end 2005. Whilst majority of the increase in interest expense, relates to the increase in interest expense on deposits as a result of COMB’s greater focus on attracting time and low cost savings deposits together with strong current account customer acquisition, leading to the rise in deposit balances.
The continuing growth in deposits is also attributed to the market perception of COMB’s superior financial strength, enhanced value added services, continued on-line branch expansion and the establishment of new low cost outlets. In fact, COMB operates the country’s largest computer-linked branch network of 147 branches and 259 automated teller machines. During the period ending September 31, 2006 compared to FY2005, COMB’s deposit balance grew by 15.6% to LKR147,373.9 mn primarily due to the 20.7% growth in higher-rate time deposits to LKR73,068 mn.
Further, the rise in interest expense on other interest bearing liabilities relates to the increase in borrowings. Accordingly, COMB’s total borrowings increased respectively, by 30% YTD and 64% YoY to LKR38,174.2 mn on account of 84.8% YTD rise in borrowings from local banks and financial institutions to LKR7,172.3 mn.
As a result, interest bearing liabilities have risen more steeply by 19.4% YTD and 34.1% YTD to LKR170,850.4 mn.
Net banking income rise to LKR3,054.8 mn (+25.7% YoY). COMB’s non-interest income mainly consisting of commission/fee and foreign exchange gains has increased by 18.7% YoY to LKR3,030.1 mn over the comparable period in FY2005. Thus, enabling COMB’s 3Q2006 net banking income to rise by 25.7% YoY to LKR3,054.8 mn.
The increase in non interest income is largely attributed to the sharp 54.8% YoY rise in foreign exchange income to LKR374.8 mn, due to continued depreciation of the SL rupee after rising sharply in 1Q2005 in the aftermath of the Tsunami devastation on expectation of foreign aid inflows to the Island. Meanwhile, COMB’s greater emphasis on commercial banking activities on account of increased customer numbers, higher transaction volumes and its successful positioning against the back-drop of increased currency volatility has also contributed favorably towards the rise in COMB’s foreign exchange income.
Stringent cost-containment. COMB has been able to curtail the increase in its operating expenses only to a moderate 19.2% YoY in 3Q2006 with the absolute amount reaching LKR3,027.7 mn. COMB’s ability to curtail growth in operating expenses makes it stand apart from the industry and is a reflection of its strategy of delivering banking services through low cost distribution channels and the effectiveness of management.
The overall increase in non-interest expense was due primarily to increases in personnel costs, the largest component of non-interest expense. Personnel costs including provision for staff retirement benefits increased by 14.9% YoY to LKR680 mn in 3Q2006.
This increase was primarily due the growth in the total number of employees (3,792 vs. 3,463 employees as at September, 2005) as a result of its network expansion (147 vs. 133 branches, a year ago). Whilst premises, equipment and establishment expenses and other operating expenses increased by a modest 15% YoY to LKR335.3 mn and 40% YoY to LKR252.4 mn in 3Q2006 respectively.
Operating Profit up 30.8% YoY to LKR1,787.1 mn in 3Q2006. Efficiency improved with COMB’s pre provision cost to income ratio, which is the lowest amongst local commercial banks declining to 41.5% in 3Q2006 from 43.8% in the previous year. Whilst operating costs to average total assets also declined slightly from 2.6% in FY2005 to 2.4% (annualised) as at September 30, 2006, enabling COMB’s operating profit before provisions to increase by 30.8% YoY to LKR1,787.1 mn in 3Q2006. Hence, COMB’s operating profit to average total assets improved to 3.4% (annualised) as at September 30, 2006 from 2.9% in FY2005.
Conservative provisioning. Importantly, COMB’s provisions for bad and doubtful debts and loans written off have decreased sharply by 50.1% YoY to LKR29.9 mn driven by a steep reduction in general and specific provisions to LKR4 mn (41.2% YoY) and LKR84.9 mn (37.6% YoY), reflecting a further improvement in the quality of its loan book. As a consequence, COMB’s non performing advances to total gross advances declined to 5.6% at the end of September, 2006 against 5.9% in FY2005.
Net profit up 8.5% YoY to LKR897.3 mn. The sharp growth in core operating profit and 5.1% YoY higher income from associates of LKR26.9 mn combined with a decline in provisions for possible credit losses has enabled COMB’s pretax profit to increase strongly by 33.9% YoY to LKR1,784.1 mn in 3Q2006. However, with COMB’s value added tax on financial services (VAT) increasing by 59.6% YoY to LKR298.8 mn and corporate tax rising by 85.1% YoY to LKR587.7 mn, net profit has increased only by a modest 8.5% YoY to LKR897.3 mn in 3Q2006.
Capital Adequacy well above statutory levels. COMB is one of the best capitalised commercial bank’s in the country with a capital adequacy ratio of 9.11% and 12.11% for Tier 1 and Tier 1 & 2 as at September 31, 2006 vs. 9.68% and 12.08% as at December 31, 2005 which are well in excess of the Central bank’s minimum requirement of 5% for Tier 1 and 10% for Tier 1 & 2. Further, COMB’s capital base increased by 13.1% YTD to LKR17,174.9 mn, while shareholder funds increased by 5.23% YTD to LKR16,787.7 mn.
Bangladesh operations a success. COMB’s Bangladesh operations continued to thrive, reporting a profit of USD1.7 mn in 3Q2006. In 2003 the COMB acquired the Bangladesh operations of Credit Agricole Indosuez Bank (CAIB) for USD20.5 mn. The acquisition is in accordance with COMB’s long term strategy of having a visible presence in the region focusing initially on corporate banking and then towards retail banking aimed at tapping the remittance market in Bangladesh with a view of routing a large volume of foreign currency into Sri Lanka via COMB. The bank currently operates 7 outlets, with 5 branches and 2 booths.
2006 Net Profit forecast to grow by 57% YoY to LKR3,329 mn. COMB’s large network of online branches, backed by automated teller machines and service points at retail outlets coupled with internet banking has placed the bank in a strong position to mobilize deposits at lower direct and indirect costs. COMB’s deposits have grown by a CAGR of 28% over the past five years, while the funds have been on-lent with sharp focus on credit quality enabling COMB to maintain the highest interest margin amongst local banks. Therefore, COMB is likely to sharpen its winning operating strategy in the future, which will continue to enable the bank to gain market share both in deposit mobilization and lending. As such, despite macroeconomic uncertainty COMB is well placed to grow strongly by gaining market share and economies of scale.
Consequently, we are projecting COMB’s net profit to grow by 57% YoY to LKR3,329 mn in 2006 and further by 16% YoY to LKR3,872 mn in 2007.
Share offers exceptional value on 8.3X 2006 net profit and 7.2X 2007 earnings. Underpinned by expectations of healthy financial performance, COMB’s share price performed strongly in 2006 in line with the market, rising from LKR130.25 at the beginning of the year to a high of LKR180, before falling subsequently on overall market weakness the counter is now trading at LKR195 per share.
Despite this strong share price performance, COMB trades on only 8.3X projected 2006 net profit and just 7.2X forecast 2007 earnings. There is little doubt that COMB offers exceptional value, given its industry high ROA of 1.6% and ROE of 19.3%, superior asset quality, cutting edge technology, efficient risk management, well balanced lending portfolio, and funding based providing a sturdy foundation to further its strategy of gaining economies of scale, in addition to its impressive performance in Sri Lanka. Hence, we reiterate BUY.

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NDB’s 3Q2006 net profit down 41% YoY

Sri Lanka’s premier universal bank, the National Development Bank (NDB) saw its 3Q2006 consolidated net profit slipping by 41.4% YoY to LKR205.8 mn, somewhat below our expectations. The decline in profit was mainly attributable to the part disposal of specialist insurer, Eagle Insurance (CTCE) in 1Q2006 and hence the non-consolidation of NDB Finance Lanka, the holding company of CTCE after February 1, 2006. In contrast, the bank’s unconsolidated net profit has increase strongly by 91.7% YoY to LKR447.8 mn in 3Q2006.
However, cumulative 1-3Q2006 net profit is up 126% YoY to LKR1,716 mn boosted by the sale of an effective 33.56% shareholding in CTCE at a capital gain of LKR1.01 bn in 1Q2006, thus reducing NDB’s effective ownership in CTCE to 32.42% from 65.98%. NDB’s core operating profitability has also recovered strongly in 1-3Q2006, with profit before tax excluding the capital gain on disposal of CTCE rising by 16%% YoY LKR1,562.6 mn.
Net interest income records notable improvement. NDB’s interest income has risen by 21.6% YoY to LKR1,470.1 mn in 3Q2006 following higher lending rates on the back of a gradual rise in overall interest rates. Meanwhile, NDB’s net loans and advances have grown by a moderate 5% YTD and 9% YoY to LKR38,855.9 mn by end 3Q2006 and has assisted in supporting growth in interest income.
Meanwhile, NDB’s interest expenses have risen by a faster 62.8% YoY to LKR823.6 mn in 3Q2006 on higher deposit rates and borrowing costs. Reflecting the higher funding costs, NDB’s interest bearing liabilities have risen only by a moderate 9% YTD and 16.9% YoY to LKR45,526.7 mn at end 3Q2006, with deposits rising by 22% YTD and 26.7% YoY to LKR17,009.2 mn. Consequently, the higher funding costs has caused NDB’s net interest income to decline by 8% YoY to LKR646.4 mn 3Q2006, resulting in the bank’s net interest margin declining slightly from 4.97% in FY2005 to 4.37% as at September 30, 2006. Furthermore, with other income falling by 39% YoY to LKR273.9 mn in 3Q2006, largely due to losses on disposal of marketable securities, NDB’s net banking income has declined by 20% YoY to LKR920.3 mn.

Non interest expenses decline 22.2% YoY

NDB’s core operating expenses have decreased by 22.2% YoY to LKR445 mn in 3Q2006, with both personnel costs and premises, equipment and establishment expenses declining by 18.8% YoY to LKR190.7 mn and 46.8% YoY to LKR160.7 mn respectively. NDB has been able to curtail its operating expenses due to the reduction in its stake in CTCE to 32.4% accompanied by proactive measures undertaken by the management to improve productivity levels and cost efficiencies through solutions such as enhancing asset quality, automating routine processes, reducing staff costs and outsourcing non-essential services. Hence, NDB’s pre provision cost to income ratio has declined to 48.3% in 3Q2006 from 49.6% in 3Q2005. Nevertheless, the reduction in net banking income has caused NDB’s operating profit before provisions to decline by 18.2% YoY to LKR475.3 mn in 3Q2006.

Portfolio quality to improve

NDB’s 3Q2006 provisions for loan losses has increased by 290.4% YoY to LKR75.4 mn, following a 96.3% YoY decline in recoveries. Whilst general and specific provisions has declined by 61.2% YoY and 49.6% YoY to LKR2.6 mn and LKR78 mn, on account of NDB’s sharp focus on improving the quality of its assets. NDB’s credit risk has declined, with a reduction in NPL volumes and NPL ratios due to its transition form high risk project finance to commercial banking, enhanced recovery procedures and through utilizing credit risk mitigation techniques, while achieving an expansion in lending. As a consequence, NDB’s gross non performing advances ratio declined to 2.4% as at September, 2006 from 4.1% in FY05. Non performing assets, decreased by 40% YTD to LKR970.3 mn at end 3Q2006 as against LKR1,619.9 mn in FY05 and are believed to be adequately provided.
Moreover, benefiting from the stability in the equity market during 3Q2006, NDB has been able to release LKR5.7 mn (+39.6 YoY) as a reversal for the decline in value of investments.
Net profit down 41.4% YoY to LKR205.8 mn. Income from NDB’s associate companies have increased by 1002.7% YoY to LKR13.8 mn (mainly from CTCE) in 3Q2006 thus resulting in the group’s pretax profit declining less sharply by 25.9% YoY to LKR419.4 mn. However, with value added tax on financial services (VAT) rising by 120.9% YoY to LKR83.3 mn, NDB’s post-tax earnings have fallen by 41% YoY to LKR231.5 mn despite a reduction in corporate tax to LKR104.7 mn (-23.1% YoY). Nevertheless, in spite of minority interest declining by 38% YoY, NDB’s 3Q2006 net profit has fallen 41.4% YoY to LKR205.8 mn.

Net profit forecast revised downward

We have revised down NDB’s 2006E net profit forecast by 16% to LKR2,100 mn to reflect the restated gross capital gain of LKR1.34 bn in 3Q2006 on the sale of a controlling stake in CTCE to Aviva International Holdings Limited from LKR1.64 bn in 1Q2006. Similarly, we have also revised down NDB’s forecast 2007 earnings by 10% to LKR1,800 mn as we believe that the prevailing high interest rate environment would impinge on the bank’s cost of funds.

Under priced on 7.8X 2006 earnings

Following the decline in the share price due to overall market weakness the counter is now available on 7.8X projected 2006 net profit. Looking ahead, NDB is poised to gain substantially from the implementation of its universal banking strategy, benefiting from access to lower cost retail deposits and expansion of its commercial banking loan book. Hence we reiterate BUY.