Bank Valuation Presentation to Háskóli Íslands

2. Bank Valuation Presentation to Háskóli Íslands Haraldur Yngvi Pétursson, Equity Research - Iceland 15 April 2008

3. Valuation Method: The very basic one stage DDM

4. Value Measures – banks equity • Book Value • Reported value of equity, based on the prevailing accounting standards • Economic Value • Difference between market value of assets and liabilities at a given time • Market Value • Current share price multiplied by the number of outstanding shares • Intrinsic Value • Discounted value of future earnings • Analyst's most used tool • DDM the most common valuation model • Analysts may argue for a discount or a premium

5. Premiums and discounts • Discounts • Size (or lack thereof) • Liquidity and free float • Asset quality • Balance sheet structure • Capital raising risk • Ownership, corporate governance and transparancy • Holding company and conglomerate discount • Management quality • Demand

6. Premiums and discounts • Premiums • Wheight of money • Mutual fund inflows • Asset-class allocation • Liquidity and free float • Excess capital • Index issues • Takeove or other speculation

7. The dividend discount model (DDM) • Some DDM Strengths • Communicability and basis • Absolute valuations • Comparability • Simple sensitivity measures • Key assumptions • Cost of Equity • Return on Equity • Long term growth

8. The dividend discount model (DDM) • DDM has various forms • Basic one stage model • Multistage models • The most basic DDM • Fair value P/B multiple = • ROE = return on equity • COE = cost of equity • g = long-run growth • Book value per share * P/B multiple = Fair value per share • Fair value per share * number of shares = Total fair value

9. The dividend discount model (DDM) • Cost of Equity • Risk free rate • Varies by markets • Normally 10yr government bonds are used for base • Market risk premium • Generally 4-5% • The troublemaker – Beta • Historic vs. future • Time period and frequency • Liquidity • Earnings volatility • Judgement

10. The dividend discount model (DDM) • Return on Equity (Net profit / average equity) • Earnings • Trading profits and loss, included? • Goodwill writedown? • Other one-offs? • Place in the economic cycle • Bad debt charges • Numerous other company specific issues • Aim to estimate the "through the cycle" ROE

11. The dividend discount model (DDM) • Growth – long term • A banks earnings growth can not be higher in perpetuity than long term GDP growth • Better to err on the side of caution • Higher growth in developing than developed countries • One of the reasons for a multiple stage models

12. The dividend discount model (DDM) • Example – 3 banks

13. Valuation Method: Multi stage DDM

14. The dividend discount model (DDM) • Underlying assumption in the one stage model • Value of equity grows at the same rate as earnings • Dividend payout ratio therefore must be • A bank can not payout more than this ratio in the long run as capital restrictions will eventually come into place • The payout ratio can be higher, but that would lead to less gearing, lower ROE and actual value of discounted dividends will be lower • Is there an excess capital? • A war chest • A fear factor

15. The dividend discount model (DDM) • Two stage models are common • Give short term flexibility in e.g. • Earnings estimates • Growth • Lets look at one simple example • COE is 10% • Growth is 4% • ROE (long term) is 14,8% • Payout ratio (POR) =>

16. The dividend discount model (DDM) • Our basic assumptions • Equity = last year + earnings – dividends • Equity in perpetuity = Equity last forecast * (1+g) • Earnings in perpetuity = Earnings last forecast * (1+g) • Dividend last year (and perpetuity) according to our POR

17. The dividend discount model (DDM) • The valuation process is in two parts (hence two stage model) • First we calculate the present value of dividends in the forecast period • Discount rate = COE • Then we calculate the PV of perpetuity • Fair value multiple as before • Add PV of dividends over forecast