Target Price – Rs.122.

00
Seylan Bank PLC (SEYB)
Recommendation – BUY
Reaching New Heights
Analyst – Viranthi Kumarage
Asset Quality Improves - Gross NPL declined 6.12% from
Date – 09.02.2011 31.12.09 to 30.09.10 to reach 23.17%. Even though the
Share Data NPL ratio is still the highest among its listed peers, we
Bank, Finance and Insurance Sector

Market Pice (Voting) as at 08.02.11 Rs.94.90 believe the worst is over.

Market Pice (Non Voting) as at 08.02.11 Rs.48.50
Intrinsic Vlaue of Share Rs.122.00 The aggressive recovery policy, supported by selective
52 Week Range - Voting Rs.42.75-Rs.118.00 lending is expected to further improve asset quality.
Shares in Issue - Voting 130,000,000 Accordingly we project the Gross NPL to reach 10% by the
Shares in Issue - Non Voting 123,560,000 end of FY12. SEYB’s recovery efforts resulted in the
Average Daily Volume (52 Weeks) 334,084 recovery of approximately Rs.1Bn.
Estimated Free Float 73%
Leadership, from Weak to Strong – We anticipate, the
Main Shareholders As at 30.09.2010 No of Shares % new Board of Directors and the restructured top
Sri Lanka Insurance Corporation Ltd 19,500,000 15.00% management to steer the bank to a growing, financially
Bank of Ceylon 13,000,000 10.00% stable institution and reinforce customer confidence. Fitch
Dr T Senthilverl 13,000,000 10.00% Rating Sri Lanka upgraded the long term rating of SEYB to
Browns Investments (Pvt) Ltd 12,416,966 9.55% “Stable” signifying confidence and the improving financial
LOLC Investments Ltd 12,416,966 9.55% health.
Price Performance
Rs. Volume'000
Value Proposition - We feel SEYB is undervalued at the
160 12,000 current price of Rs.94.50 and overlooked based on its past.
140
10,000
120
100
8,000 At present SEYB trades at a PBV of 2.03 while the industry
80 6,000
PBV is 2.73X.Considering the low PBV and the
60
4,000
40
exceptional profit growth of 104% in FY10, we value the
2,000
20 share at Rs.122.00 which works out to a forward P/E of
0 0
20.36 based on FY11 earnings.
Volume Closing Price Adjusted ASPI

Figures in Rs Mn FY08 (A) FY09 (A) FY10 (E) FY11 (E) FY12 (E)
Net Interest Income 7,281 7,407 8,062 8,390 9,708
Non Interest Income 3,834 2,626 2,270 2,459 2,874
Net Profit Attributable to Equity Holders (143) 569 1,162 1,502 2,030
EPS (Rs) (0.86) 2.97 4.56 5.90 7.98
Forward P/E (X)** 22.93 44.83 26.35 20.36 15.05
DPS (Rs) 0.00 0.50 1.00 1.50 2.50
Dividend Yeild (%) 0.00% 0.24% 0.83% 1.25% 2.08%
BV (Rs) 46.39 43.68 47.26 51.68 57.18
PBV (X) 1.47 4.68 2.54 2.32 2.10
1
ROE (%) 2.22% 6.20% 10.05% 11.94% 14.67%
Tier 1 (%) 8.10% 10.40% 9.83% 9.94% 10.25%
Leverage (X)*** 18.24 10.51 10.73 11.14 11.44
*Aft er deducting preference dividends
**P/Es from FY08-FY09 have been calculated using t he year-end share price, P/Es for FY10-FY12 have been calculated using the int rinsic value
***Deposits+T ot al Borrowings/Shareholders' Funds
Contents

Upturn of Asset Quality 3

Sufficient Capital 4

Fresh Blood 5

Deposits 6

Lending 7

Efficiency 7

Profitability and NIMs 7

Risks 8

Financial Forecast 8

Valuation 9

Financials 10

Appendix 11

2
 Upturn of Asset Quality

Gross NPL expected to fall We expect the asset quality to significantly improve, from a Gross Non
to 10% Performing Loans ratio (NPL) of 29% at the end of FY09 to 10% by the end of
FY12. The recovery will be driven by stringent credit risk management policies
adopted by SEYB and the strict monitoring of the regulator.

Aggressive lending (devoid of an appropriate credit evaluation process) and the

exposure to the Ceylinco Group led to the instability of SEYB in 2008 and high
non-performing loans.

Total non-performing loans declined to Rs.26,815Mn as at 30.09.10 from

Rs.31,149Mn as at 31.12.09, showing signs of recovery.

Gross NPL of SEYB

35%

30%

25%

20%

15%

10%
FY/09 Q3 FY/09 Q4 FY/10 Q1 FY/10 Q2 FY/10 Q3
Source – Company Data

Although the asset quality remains the weakest compared to the listed peers,
SEYB recorded a 6.12% improvement from 31.12.09 to 30.09.10, higher than the
industry average improvement of 2.96% during the same period.

Gross NPL of Listed Commercial Banks

30%
25%
20%
15%
10%
5%
0%
DFCC HNB COMB NDB NTB PABC SAMP SEYB
31.12.09 30.09.10
Source – Company Data

3
According to the management, the bank has provided for all non performing
loans according to the guidelines issued by the Central Bank.

Provision Cover as at 30.09.10 (including judgmental provisioning)

120%

100%

80%

60%

40%

20%

0%
DFCC HNB COMB NDB NTB PABC SAMP SEYB

Source – NDBS Research

Recoveries over the last 4 quarters add up to approximately Rs.1 Bn as a result of

the aggressive recovery process.

The ongoing recovery measures, screened lending (preventive measure) and low
interest rates are likely to improve asset quality of SEYB. The recovery process
is strictly monitored by the board of directors (BOD) with recovery targets
assigned to the relevant area managers and branch managers.

Sufficient Capital

Following the intervention of CBSL in 2009, the bank balance sheet was
recapitalized with an equity infusion of over Rs.3Bn, bringing the Tier-I capital
adequacy ratio to 10.25% and Tier – II capital adequacy ratio to 12.30% as at
31.12.09 (well above the minimum requirement of 5% and 10%).

4

State ownership increases to
29%
New BOD and a restructured
senior management team
Tier – I CAR of Listed Commercial Banks as at 30.09.10
35%
30%
25%
20%
15%
10%
5%
0%
DFCC HNB COMB NDB NTB PABC SAMP SEYB
Tier-1 (Bank) CBSL Requirement
Source – Company Data
The infusion of new capital saw the ownership of state owned entities (Sri Lanka
Insurance Corporation, Bank of Ceylon and Employees Provident Fund) rising to
over 29% while LOLC/Browns ownership reached 19.1%, diluting the ownership
of Ceylinco Group to less than 4%.
We are of the view that SEYB has sufficient funds required to meet the growth
expectations of FY11. However, with debentures worth Rs,1,419 Mn reaching
redemption in FY11, the bank is likely to issue new debentures over the
forecasted period. Equity capital requirements will depend on SEYB’s new
strategic plan expected to be finalized during FY11Q1.
Fresh Blood
A dynamic management team was much needed to turnaround the troubled entity
to a profitable venture.
With the intervention of CBSL, a new BOD was appointed in December 2008, of
which 3 members serve as independent non executive directors, 5 members serve
as non executive directors while 2 members hold executive positions including
the Chairman (Please refer Appendix for details). The bank was further
strengthened by appointing new members to its senior management team during
2010 and 2011(including a new CEO).
Under the direction of the new BOD and the senior management team, we expect
the new strategic plan to focus on further strengthening the balance sheet while
enhancing public confidence to increase the deposit base and in turn lending.
5
 Deposits

Annual average deposit We expect SEYB to book higher growth in both deposits for the forecasted
growth of 12% period compared to the growth in deposits of 3.01% (industry 6.7%) from Dec 09
to Sep 10. Deposit growth will be supported by improved customer confidence
and the branch expansion. Accordingly we forecast an annual average growth of
12% in deposits from FY10 to FY12.

Deposit growth of SEYB was higher than most listed banks during FY04-FY07
but started to decline in FY08 with eroding public confidence.

Deposit Growth of SEYB and Peers

Rs Mn
250,000

200,000

150,000

100,000

50,000

0
2004 2005 2006 2007 2008 2009
PABC COMB SAMP HNB
SEYB NTB NDB
Source – Company Data

The banking industry witnessed a slow deposit growth with the reduction in
market interest rates. Therefore, we feel, the relatively slow deposit growth of
SEYB should only be partially attributable to the lack of depositor confidence.

2010 AWDR Movement

8.00%

7.50%

7.00%

6.50%

6.00%

5.50%
JAN APR JUL OCT Source – CBSL

6
 SEYB deposits grew 1.5% QoQ showing signs of recovering public confidence.
Despite the troubled past, current account and savings account ratio (CASA) of
the bank (42%) remains well above the industry average of 37.5% as at 30.09.10.

Lending

Annual average loan growth We expect SEYB to reach an annual average lending growth of 14% from FY10
of 14% to FY12.

Lending grew 5.80% compared to an industry average 12.2% from Dec 09 to Sep
10.The sluggish lending growth was a result of selective lending and low overall
credit growth. We foresee the monetary easing measures to eventually drive
credit expansion.

Further, we expect gold backed lending (pawning), leasing and margin trading
facilities to record significant growth rates. SEYB is a bank with a high exposure
to SME lending; therefore the expected boom in the SME sector is likely to boost
SME lending. We project an average loan to deposit ratio of 80% for the
forecasted period as a result of higher loan growth compared to the expected
deposit growth.

Efficiency
Cost: Income to fall below
The cost to income ratio of the bank was the highest (68%) in FY09 compared to
65%
the industry average of 55%. However we noted a marked improvement, when
the cost to income reached 62% in FY10/Q3.

We believe the efficiency of the bank would improve significantly over next 3
years. Accordingly we forecast a cost to income ratio of 64.9%, 64.3% and
61.5% for the forecasted period FY10, FY11 and FY12 respectively.

Ongoing efficiency improvement programs and the projected growth in non

interest income is likely to aid the improvements.

Profitability and Net Interest Margins (NIMs)

Profits expected to double in NIMs remain under pressure as a result of the government’s objective to reduce
FY10 market interest rates. We forecast the NIMs to remain at low levels in FY11 and
to pick up slowly in FY12. According to our projections, we expect an average
NIM of 5.44% over the next two years.

SEYB recorded a remarkable growth (PAT – Rs.569 Mn) in FY09 from a loss in
FY08. The turnaround was largely driven by the decrease in operating expenses
and reduction of provision for loan losses of 21.05% and 11.51% respectively.

7
Continuation of the recovery and the growth are evident from the PAT increase
in FY10Q3 compared to the same period last year.

Irrespective of the stress on NIMs we expect SEYB to book a YoY growth in net
interest income. According to our estimate, the relatively high CASA ratio, will
facilitate a faster drop in interest expenses compared to the fall in interest
income.

CASA Ratio as at 30.09.10

60%

50%

40%

30%

20%

10%

0%
DFCC HNB COMB NDB NTB PABC SAMP SEYB
Source – NDBS Research

Considering all the above factors we project the below earnings for the next three
years.

Risks

Our analysis is based on information that has been made available to the public,
thus the assessment of asset quality has been made on the same premise.

Further it could be too early to evaluate the results of the changes made to the
management team. However, we remain optimistic that the bank will be guided
in the right direction.

Financial Forecast

Figures in Rs Mn FY10 (E) FY11 (E) FY12 (E)

Net Interest Income 8,062 8,390 9,708
Non Interest Income 2,270 2,459 2,874
Net Profit Attributable to Equity Holders 1,162 1,502 2,030
EPS (Rs) 4.56 5.90 7.98
DPS (Rs) 1.00 1.50 2.50
BV (Rs) 47.26 51.68 57.18

8
Based on our forecast, we anticipate SEYB to book a growth in net interest
income of 9%, 4% and 16% for the forecasted period. Bank’s loan book reached
Rs.85Bn as at 30.09.10, converting a negative loan growth as at 31.12.09
(compared to the year before) to a positive loan growth, hence a higher net
interest income growth in FY10. Net interest income is again expected to grow
by a higher percentage in FY12 with the projected recovery in NIMs.

Non-interest income is expected drop in FY10 due to lower foreign exchange

income. However the situation is projected to recover in FY11, booking a growth
of 8%. We expect foreign remittances and trade finance activities to contribute
significantly to the non interest income growth.

Further, with the projected upturn in asset quality, we expect a decrease in

provisions for loan losses to contribute to a higher bottom line growth.

Long awaited tax reductions were introduced in the budget proposal for 2011
presented by the government of Sri Lanka. Accordingly banks are to benefit from
two tax reductions, namely; reduction of Financial Services VAT from 20% to
12% and income tax from 35% to 28%. The tax cuts will be effective from
01.01.2011.

Based on the above, we forecast a profit attributable to equity holders of

Rs.1,162Mn, Rs.1,502Mn and Rs.2,030Mn for FY10,FY11 and FY12
respectively.

Valuation

Based on the discounted cash flow method, the share is valued at Rs.122.00. We
assumed an equity risk premium of 6% and considered a nominal risk free rate of
8.20% (3 year Treasury bond rate). Further we assumed a medium term growth
of 15% from FY13 to FY15 while the terminal growth rate was assumed to be
8% in line with the expected GDP growth of 8%.

At this intrinsic value the PBV (at the end of FY10) is 2.54X. The banking sector
trailing PBV as at 30.09.10 is 2.73X. Hence we feel SEYB is currently under
priced by approximately 25%. BUY

9
Income Statement
Figures in Rs Mn FY08 (A) FY09 (A) FY10 (E) FY11 (E) FY12 (E)
Interest Income 23,156 21,796 16,813 18,216 21,289
Interest Expenses 15,876 14,389 8,751 9,826 11,581
Net Interest Income 7,281 7,407 8,062 8,390 9,708
Non-Interest Income 3,834 2,626 2,270 2,459 2,874
Non-Interest Expenses (9,046) (6,872) (6,713) (6,978) (7,743)
Personnel Cost (3,609) (2,500) (2,802) (2,948) (3,450)
Premises, Equipment and Establishement Expenses (1,615) (1,620) (1,324) (1,416) (1,549)
Overheads (Other Operating Expenses) (3,823) (2,752) (2,587) (2,613) (2,743)
Loan Loss & Provisions (2,804) (2,228) (1,048) (1,209) (1,241)
Profit Before Tax (736) 934 2,571 2,662 3,599
Income Tax (64) (485) (1,335) (1,065) (1,440)
Profit After Tax (800) 449 1,236 1,597 2,159
Minority Interest (657) (120) (74) (96) (130)
Profit Attributable to Equity Holders (143) 569 1,162 1,502 2,030

Balance Sheet
Figures in Rs Mn FY08 (A) FY09 (A) FY10 (E) FY11 (E) FY12 (E)
Assets
Cash 5,681 4,692 3,099 2,303 1,757
Statutory Deposit with CBSL & Placement with Other Banks
6,857 5,084 5,529 6,352 7,293
Tbills & Investments 29,916 36,177 45,339 49,547 53,969
Loans and Advances 107,542 80,294 87,361 101,634 118,148
Other Assets 13,287 10,990 10,505 12,069 13,857
Goodwill 25 - - - -
Total Assets 163,308 137,238 151,834 171,905 195,024

Liabilities
Deposits 109,506 104,816 110,583 127,043 145,862
Borrowings 9,209 3,499 4,313 5,717 6,564
Other Borrowings 19,086 4,175 10,505 11,434 11,669
Other Liabilities 12,557 8,636 9,953 11,434 13,128
Debentures 4,254 4,230 3,586 2,167 2,167
154,611 125,356 138,940 157,795 179,390
Shareholder's Funds
Stated Capital 2,542 5,568 5,568 5,568 5,568
Reserve Fund 482 507 553 613 695
Reserves 4,762 5,034 5,895 6,956 8,270
7,787 11,109 12,016 13,137 14,532
Minority interest 911 803 877 973 1,103
Total Liabilities and Shareholders' Funds 163,308 137,268 151,834 171,905 195,024

10
Ke y Ratios FY08 (A) FY09 (A) FY10 (E) FY11 (E) FY12 (E)
Growth Ratios
Interest Income Growth (%) N/A -6% -23% 8% 17%
Interest Expense Growth (%) N/A -9% -39% 12% 18%
Deposit Growth (%) N/A -4% 6% 15% 15%
Loans & Advances Growth (%) N/A -25% 9% 16% 16%
Share Ratios
EPS (Rs) -0.86 2.97 4.56 5.90 7.98
DPS (Rs) 0.00 0.50 1.00 1.50 2.50
Dividend Yeild (%) 0.00% 0.24% 0.83% 1.25% 2.08%
BV (Rs) 46.39 43.68 47.26 51.68 57.18
PBV (Times) 1.47 4.68 2.54 2.32 2.10
Gearing & Capital Adequacy
Leverage (Times) 18.24 10.51 10.73 11.14 11.44

Company Description

Established in 1987, Seylan Bank PLC is a listed commercial bank operating in

Sri Lanka. The company provides a wide range of services including personal
banking, corporate banking, SME banking as well as leasing. At present it has 94
branches island wide.

Subsidiary

Seylan Development PLC – Engaged in property development

Board of Directors

Mr.Eastman Narangoda – Chairman

Mr. R. Nadarajah - Executive Director
Mr.Nihal Jayamamme – Independent Non Executive Director
Mr.Lalith Withana - Independent Non Executive Director
Rear Admiral (Rtd) B.A.J.G. Peiris - Independent Non Executive Director
Mr.Ajith L. Devasurendra - Non Executive Director
Mr.Ishara C.Nanayakkara - Non Executive Director
Mr.Samantha P.S.Ranatunga - Non Executive Director
Mr.A.M.Mohan De Alwis - Non Executive Director
Mr.Priyadasa Kudabalage - Non Executive Director

11
 Ceylinco Group and the Relationship with SEYB

Ceylinco Group was the parent company of approximately 250 affiliated

companies involved in diverse business operations.

Until end of 2008, Ceylinco was the principal shareholder of Seylan Bank PLC.
However it ceased to be the largest shareholder with the state intervention in
December 2008.

Glossary

· Gross Non Performing Loan Ratio (Gross NPL) – Non performing

loans expressed as a percentage of total loans and advances.

· CASA – Deposits in the form of current accounts and savings accounts

as a percentage of total deposits.

· NPL Cover – Total provision for bad and doubtful debts as a percentage
of nonperforming loans before discounting for provision for non
performing loans.

· Net Interest Margin (NIM) – Net interest income as a percentage of

interest earning assets.

· AWDR - Commercial Bank Average Weighted Deposit Rate

Industry Data
Rs Mn **DFCC HNB COMB NDB NTB PABC SAMP SEYB
30/09/10 30/09/10 30/09/10 30/09/10 30/09/10 30/09/10 30/09/10 30/09/10
Deposits 25,321 221,238 252,562 52,120 48,050 18,917 143,072 108,598

Gross Loans 54,550 188,763 204,527 66,143 46,097 18,241 118,272 97,781

Net Interest Income (9 months) 2,589 11,456 11,705 3,242 3,435 1,130 6,444 6,143
Non Interest Income (9 months) 5,053 5,407 4,063 2,301 1,632 390 2,742 1,671

Profit Attributable to Equity Holders* 3,892 2,918 3,736 1,542 848 280 2134 820

Tier-1 (Bank) 32.30% 10.49% 10.85% 12.68% 10.47% 15.26% 9.81% 9.58%
Tier-2 (Bank) 30.70% 12.25% 12.56% 1485.00% 13.12% 15.84% 12.26% 11.29%

ROE (Bank)* 35.00% 14.99% 16.68% 12.83% 19.03% 15.88% 21.28% 10.25%

Gross NPL Ratio (Bank) 10.50% 5.94% 5.02% 2.08% 4.52% 7.69% 5.47% 23.17%
Interest Margin (Bank) 5.40% 5.28% 4.57% 4.03% 5.46% 6.34% 5.08% 5.90%
* Including expceptional gains ** 6 months results
12
 NDB Stockbrokers (Pvt) Ltd
5th Floor
# 40, NDB Building
Nawam Mawatha
Colombo 02
Tel: +94 11 2314170 (Hunting)
Fax: +94 11 2314180
+9411 2314181

Prasansani Mendis
prasansini@ndbs.lk

Sales
Research
Gihan R. Cooray
Waruna Singappuli gihan@ndbs.lk
waruna@ndbs.lk

Aroos Faleel
Viranthi Kumarage aroosfaleel@ndbs.lk
viranthi@ndbs.lk

Channaka Munasinghe
Ranmini Vithanagama channaka@ndbs.lk
ranmini@ndbs.lk

Auburn Senn
Damith Wasantha auburn@ndbs.lk
damith@ndbs.lk

Jayantha Samarasinghe
jayantha@ndbs.lk

Sidath Kalyanaratne
sidath@ndbs.lk

Uditha De Silva
uditha@ndbs.lk

Taamara De Silva
taamara@ndbs.lk

This document is based on information obtained from sources believed to be reliable, but we do not make any representations as to its accuracy, completeness
or correctness. Opinions expressed are subject to change without notice. Any recommendation contained in this document does not have regard to the specific
investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of addressees only and is not
13
to be taken as substitution for the exercise of judgment by addressee. N D B Stockbrokers (Pvt) Ltd and its associates, their directors, and/or employees may
have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other
banking services for these companies.