Ing Tlv Brd Ro Banks 29feb2012

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Romanian banks February 2012

1

Romanian banks

See you next year

EQUITY RESEARCH

research.ing.com SEE THE DISCLOSURES APPENDIX FOR IMPORTANT DISCLOSURES & ANALYST CERTIFICATION

Sector update28 February 2012

Stocks covered

Rating TP

Upside/

downside

potential

(RON) (%)

BRD GSG Hold 12.50 13.6

Banca

Transilvania

Sell 0.95 -7.0

Source: ING

Price-to-earnings ratio

PER (x)

11F 12F 13F

BRD GSG 7.8 7.7 6.3

Banca Transilvania 9.7 10.8 9.5

Peer group 11.3 10.7 9.5

Source: ING

Price-to-book ratio

PBR

11F 12F 13F

BRD GSG 1.2 1.0 0.9


Peer group 1.6 1.5 1.5

Source: ING

Return on equity (%)

ROE

11F 12F 13F

BRD GSG 16.0 14.3 15.4


Peer group 17.1 15.4 15.9

Source: ING

Metrics (%)

Yield

12F

Loan

to dep

ratio 11F

Risk

costs

11F

BRD GSG 1.6 108 2.3Banca Transilvania 0.0 76 3.8

Peer group 1.6 99 1.1

Source: ING

We expect no growth in Romanian banking in 2012. De-risking is costly, and

both top- and bottom-line growth are expected to be affected in 2012. At the

top-line, credit demand is in FX, but supply from banks is currently in RON.

Switching from lower-rate EUR loans to higher-rate RON lending will stifle the

fragile growth seen in 2011. At the bottom-line, banks are bidding up rates for

scarce local savings, in order to plug FX funding and duration gaps. We do not

expect the central banks excess short-term RON liquidity to stop, or address

the FX and duration mismatch. Net interest margins are likely to take a further

hit in 2012 after coming under pressure in 2H11.

Cost cutting is the only way to keep the bottom-line flat: management responds to

lower revenue by cutting internal costs, as this is the only expense under its control.

Exogenous costs (minimum reserves, market risk costs, under-developed financial

markets) cannot be avoided and are unlikely to decrease. As a result, we believe 2012

will be characterised by accelerated layoffs and network closures.

All fundamental upside is in the distant future: banks could achieve flat RoEs in 2012

vs 2011 through good cost efficiency and, arguably less likely, lower risk costs. However:

(a) profitability is on a par with, or below, peer group averages; (b) growth prospects for

2012 and 2013 appear below average; and (c) country risk is higher than the median. Our

fundamental valuations, even using conservative assumptions, suggest there is upside to

current share prices, but we believe there will only be value in the long term. We see no

apparent short-tem reasons for the market to factor this into current prices and reduce the

discounts at which Romanian banks trade to their CEE peer group average multiples.

If there is money and appetite in Romania, energy public offerings will steal the

show: we expect the Romanian government to seek public offerings for large energy

companies (OMV Petrom, Romgaz, Hidroelectrica) in the coming 12 months. Depending

on pricing, we believe these could fetch well in excess of 1bn. However, the Romanian

market sees only 10m a day of trading on average, hence we believe liquidity could

migrate away from banks and into energy.

Catalyst for BRD is lower FX funding gap; for Banca Transilvania, it is BRD: in our

view, BRD could trim its current 30% discount to CEE peers to 20% if it reduces its

funding dependence on Societe Generale by issuing an MTN (medium-term note) in

2Q12. For BT, market behaviour seems to favour a pattern whereby BRD share price

outperformance results in local flows partially recoiling into BT shares.

Share overhang is risk for BRD; risk for Banca Transilvania is under-provisioning:

up to 30% of BRD is held in large institutional stakes, some of which reported significant

unloading in 2011. Overhang risk is mitigated by the fact that large trading volumes in the

shares are executed as block trades. The trading behaviour of the shares explains why

BRD usually lags the wider market dynamics. We believe Banca Transilvania could be

haunted in 2012-13 by its low provision coverage ratio (estimated at 30% in 2011F).

However, BT receives support from the central bank, which provides it with cheapliquidity. This enables it to buy BTs government securities purchased with the money,

thus benefitting BTs interest income and capital ratio (which improves mechanically

through the higher marking to market of its available-for-sale portfolio).

Florin IlieBucharest +40 21 209 1218

[email protected]


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2

Contents

Romanian banks 1Sector overview 3Sector growth ..................................................... ........................................................... .....5FX funding gap...................................................................................................................8QE Romanian style ......................................................... ................................................. 11Banking costs...................................................................................................................14What about Greek banks?................................................................................................15Impact of switch to IFRS ........................................................... ....................................... 16Central bank future policy.................................................................................................18Market forecasts...............................................................................................................18Companies 21BRD Groupe Societe Generale ........................................................... .............................23Banca Transilvania...........................................................................................................37Disclosures Appendix 51


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3

Sector overview

Deleveraging in the Romanian banking sector is proving hard to execute. An FX

funding squeeze is pushing up deposit rates, despite the National Bank of Romania(NBR) providing excess liquidity.

Balance-sheet stagnation, currency and duration mismatch, and high risk costs are

keeping sector profitability in negative territory, although there are significant

differences between individual players.

Asset-quality deterioration shows signs of flattening; however, weak revenue streams

mean that the sector is set for cost-cutting via layoffs and network downsizing in

2012.

A move to international accounting and reporting standards from January 2012

should have a positive impact on capital ratios.

In our view, the central banks policies appear to be designed to: (1) maintain excess

RON liquidity; (2) support vulnerable locally-held operators; (3) stop the relaxation of

minimum reserves; and (4) develop a bridging bank to take over eventual

bankruptcies.

Deleveraging and NPLsThe Romanian banking sector is finding it both difficult and costly to deleverage and

decrease its reliance on parent bank funding. Indeed, the sector leverage ratio has been

hovering at c.8% for much of the current financial crisis. Overall, capitalisation (tiers I and

II) is 650bp above the regulatory minimum, but this sector-wide average figure obscures

significant variations among individual banks.

Euro funding is the main concern, amid a sector EUR loan-to-deposit ratio of 233%,

meaning it is imperative that the reliance on parent banks is reduced. Currency and

duration mismatch between local assets and liabilities burdens the system with market

and, above all, liquidity risk: long-term EUR-denominated assets vs short-term RON-

denominated liabilities. Local long-term savings are scarce, which bids up deposit rates.

Fig 1 Deleveraging is proving hard to execute Fig 2 Funding FX lending is the primary concern

14.513.813.8

7.98.1

15.014.7

8.17.67.3

6.00

7.00

8.00

9.00

10.00

11.00

12.00

13.00

14.00

15.00

16.00

Dec-11

Sep-11

Jun-11

Mar-11

Dec-10

Sep-10

Jun-10

Mar-10

Dec-09

Sep-09

Jun-09

Mar-09

Dec-08

Sep-08

Jun-08

Mar-08

Dec-07

Capital adequacy ratio ( 8%) (%) Leverage ratio (x)

65%

225%

119%

0%

50%

100%

150%

200%

250%

2007 2008 2009 2010 2011

LDR - RON (%) LDR - FX (%) LDR - total* (%)

Leverage ratio = Tier 1 capital/total average assets

Source: NBR

*Total = Non-governmental, residents. LDR = Loan-to-deposit ratio

Source: NBR

Deleveraging is slow and

costly; currency and duration

mismatch is the main risk,

with mid-term EUR funding

the prime concern


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4

Balance-sheet stagnation, currency and duration mismatch, and high risk costs are

keeping sector profitability in negative territory. Over-leveraged banks have suffered

significant losses, while better-off players have recorded positive returns on equity (RoEs)

below their cost of equity. We believe 2012 looks set to be the third consecutive year that

the sector makes a loss as a whole. Note that losses are unevenly distributed across the

sector, with those players marking sizeable losses most likely to need additional capital.

In 4Q11, NPLs flattened out a touch above 14%, but we believe weak economic growth

and earnings forecasts could push them higher still in 2012. Perhaps counter-intuitively,

NPLs have been higher for RON loans than for FX loans. RON loans were previously

sold only to customers with lower bargaining power (riskier consumer lending and small-

and medium-sized enterprises); they also came with a high interest rate differential, due

to the NBRs policy of maintaining high interest rates for the local currency in an effort to

rein in an overheating pre-crisis economy and subsequently reduce FX rate volatility.

Fig 3 Sector profitability remains negative Fig 4 Asset quality deterioration is slowing for now

1.6%0.3%

-0.2% -0.1%

17.0%

2.9%

-1.7% -1.4%

-5%

0%

5%

10%

15%

20%

2008 2009 2010 2011

ROA (%) ROE (%)

6.5

14.114.2

23.3

0.0

5.0

10.0

15.0

20.0

25.0

Dec-11

Sep-11

Jun-11

Mar-11

Dec-10

Sep-10

Jun-10

Mar-10

Dec-09

Sep-09

NPLs ratio (%) Credit risk ratio (%)

Profitability is heterogeneous across sector with big differences among banks

Source: NBR

Please refer to Impact of switch to IFRS section for important explanations.Romanian rules are different from IAS, which can affect the internationalcomparability of data

Source: NBR

NPLs put Romania and Hungary in a different, much riskier league to the Polish and

Czech markets. However, high loan-to-deposit ratios are a common feature in CEE

banking, and Romania is no exception; Romanian banks share the same relative

dependence on external FX funding as their Polish counterparts.

2012 is likely to be the third

consecutive year of negative

overall sector returns

NPLs flattened in 4Q11, but

further increases are likely in

2012 on weak economic

growth and earnings

forecasts

NPLs put Romania in a risky

league with Hungary, but the

loan-to-deposit ratio is in line

with wider CEE region


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5

Fig 5 NPL ratios in CEE (%) Fig 6 Loan-to-deposit ratios in CEE (%)

0

2

4

6

8

10

12

14

16

Sep-09

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

CZE HUN POL ROM

60

70

80

90

100

110

120

130

140

150

160

Jan-08

May-08

Sep-08

Jan-09

May-09

Sep-09

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

CZE HUN POL ROM

Source: National sources, ING estimates Households and non-financial companies loans and deposits

Source: National sources, ING estimates

Sector growthRomanias macroeconomic situation is stable and the primary future concern is meagre

growth, not the fiscal deficit. Banking penetration is at a virtual standstill and growth

prospects for 2012 are in single-digit territory.

Fig 7 Banking penetration is at a standstill Fig 8 Non-government loans are inching up

37%

18%

0%0%

-4%

36%

39%

40%

41%

40%

-10%

-5%

0%

5%

10%

15%

20%

25%30%

35%

40%

2007 2008 2009 2010 2011

33%

34%

35%

36%

37%

38%

39%

40%

41%

42%

Assets real growth (lhs, %) Non gov't loans / GDP (rhs, %)

33%

25%

4%

-3%-3%

1%7%5%

0

50,000

100,000

150,000

200,000

250,000

2007 2008 2009 2010 2011

-10%

0%

10%

20%

30%

40%

Non-gov't loans (RONm) Real growth (%) Nominal growth (%)

Source: NBR, NIS Source: NBR, NIS

Economic growth in 9m11 spurred an increase in corporate lending. However, the

downside is that the Euro funding gap widened with the timid pick-up in lending as clients

continue to seek EUR-denominated loans, given the interest differential and also

emboldened by the continued NBR-vetted relative stability of the exchange rate.

Relative pick-up in corporate

lending, but widening FX

funding gap

Single-digit growth in 2012F


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6

Fig 9 Timid (and fragile) pick-up in corporate lending Fig 10 EUR lending is still outpacing local currency

-10

0

10

20

30

4050

60

70

80

90

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Household lending (% p.a.) Corporate lending (% p.a.)

-20

-10

0

10

20

30

40

50

60

70

80

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

RON lending (% p.a.) EUR lending (% p.a.)

Source: NBR EUR lending growth rate calculated excluding exchange rate effect

Source: NBR

Slow growth rates are a problem also found across the rest of the CEE region. The main

drivers of this trend are the constraints generated by over-dependence on foreign funding

and weakness in local consumption.

Fig 11 Loan growth in CEE (% pa) Fig 12 Deposit growth in CEE (% pa)

-20

-10

0

10

20

30

40

50

60

70

80

Jan-08

May-08

Sep-08

Jan-09

May-09

Sep-09

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

CZE HUN POL ROM

-10

-5

0

5

10

15

20

25

30

35

40

45

Jan-08

May-08

Sep-08

Jan-09

May-09

Sep-09

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

CZE HUN POL ROM

Source: National sources, ING estimates Source: National sources, ING estimates

The prolonged contraction in consumer and SME lending was counter-balanced in 2011by larger corporate loans and government-sponsored mortgage schemes. On the positive

side, penetration of various lending segments in GDP terms is far lower than EU or CEE

averages, which bodes well for the long-term growth perspective. However, convergence

in higher banking penetration rates seen in more advanced economies is unlikely to be

smooth or occur anytime soon. Penetration is tied to the absolute level of discretionary

disposable income in a tradable price-equalisation common market such as the EU; from

this standpoint, we believe Romanian is currently where it should be in terms of banking

penetration in GDP.

Growth rates are in line with

the region

Banking penetration rates arewhere they should be


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7

Fig 13 Chance of growth: corporate and mortgages Fig 14 Corporate lending leads the field (RONm)

11%

6%

21%

14%13%

15%13%

6%5%

4%3%

21%19%

18%18%

0%

5%

10%

15%

20%

25%

2007 2008 2009 2010 2011

Consumer / GDP Housing / GDP Corporate / GDP

0

50,000

100,000

150,000

200,000

250,000

2007 2008 2009 2010 2011

Retail loans Non-financial company loans

Source: NBR, NIS, ING Source: NBR

We expect government-sponsored mortgage schemes to continue for the near future, as

they appear to be politically acceptable across the spectrum and are currently in their

fourth phase.

However, consumer lending is set to slump further, due to strict new restrictions on the

currency and maturity of consumer loans, coupled with weak demand as a result of low

consumption and earnings.

Corporate lending in Romania is a function of the European economy. The most dynamic

corporate segments are multi-national subsidiaries and local medium-sized corporations

(near-abroad sub-contractors of choice for Western European integrators and multi-

nationals), both of which are directly connected to the health of the broader EU economy.

Fig 15 Stalled retail lending hides mortgage growth

(RONm)

Fig 16 Strong exports have spurred investment (RONm)

0

20,000

40,000

60,000

80,000

100,000

120,000

2007 2008 2009 2010 2011

Consumer Housing Other retail

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

2007 2008 2009 2010 2011

Corporate 5yrs

Source: NBR Source: NBR

But, with exports highly dependent on fragile European demand, domestic consumption

appears to be the only substantial source of growth in the future. For the moment, this is

not the case as consumption remains weak. Corporate lending appears most correlated

with new consumer goods orders.

Mortgages schemes are a

function of government

discretion and consumer

lending is falling away;

corporate lending is a

function of EU economy

Weak domestic consumption

is main drag on growth


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8

Fig 17 GDP components show weak consumption Fig 18 Consumer goods orders drive corporate lending

-35%

-25%

-15%

-5%

5%

15%

25%

1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11 3Q11

GDP Household consumption Fixed investment

5.0

0.0

5.0

10.0

15.020.0

25.0

30.0

35.0

40.0

45.0

Aug-10

Oct-10

Dec-10

Feb-11

Apr-11

Jun-11

Aug-11

Oct-11

Dec-11

New manufacturing orders total (% p.a.)

New orders consumer goods (% p.a.)

Corporate lending (% p.a.)

Source: NIS Source: NBR, NIS

In our view, domestic consumption is unlikely to take-off in 2012. Improvements in real

wage growth in 2H11 have been driven by a favourable base effect and soft inflation.

With local elections scheduled for June and general elections for November, the

incumbent government could be tempted to increase pensions and civil servant salaries

in 2Q12, but any such move will be limited by the constraints of Romanias agreement

with the IMF. The growth in salaries has a weak pull effect on household lending, as the

population is still dealing with high leverage ratios and significant loss of revenue in 2009-

10. Improvements in industrial confidence and output have now levelled off, and we

expect further softening, tracking EU sentiment.

Fig 19 Real wage growth is a weak pull on loans Fig 20 Industry provides support for growth

10.0

8.0

6.0

4.0

2.0

0.0

2.0

4.0

6.0

Dec-10

Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Jul-11

Aug-11

Sep-11

Oct-11

Nov-11

Dec-11

Real salary growth 3MMA (% p.a.)

Real household loans growth 3MM (% p.a.)

-25

-20

-15

-10

-5

0

5

10

Jan-07

Apr-07

Jul-07

Oct-07

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

Industrial confidence (sa, lhs)

Industrial output (3MMA, %YoY, rhs)

Source: NBR, NIS Source: NIS, DG ECFIN

FX funding gapDespite international banking groups seeking to reduce FX exposure, a goal shared by

the central bank, the incipient pick-up in lending in 2011 came as FX lending increased.

The FX funding gap and liquidity risk attached to it grew, rather than fell as intended.

Longer maturity loans are overwhelmingly in EUR, while short-term lending facilities have

a stronger RON component, thus adding duration mismatch to currency mismatch.

But there is a silver lining: exposure to exotic currencies (non-EUR, non-US$ foreign

currencies; mostly CHF) is only 9% of the total lending portfolio (rising from 8% at the

2012 has started on a soft

note

FX funding gap, and attached

liquidity risk, grew in 2011

Exposure to exotic

currencies is not a concern;

it is all about EUR


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9

onset of the crisis only because of the statistical effect of RON depreciation against these

currencies). Most FX loans are EUR-denominated.

Fig 21 Foreign currency lending exposure still growing

Fig 22 Positive: small exposure to exotic currencies

0

50,000

100,000

150,000

200,000

250,000

2007 2008 2009 2010 2011

LCY-denominated loans (RONm) FCY-denominated loans (RONm)

46% 43% 40% 34% 34%

47% 49% 52%57% 57%

7%8% 8% 9% 9%

0%

100%

2007 2008 2009 2010 2011

RON loans (%) EUR loans (%) Other ccy loans (%)


The currency structure of the different retail lending segments reflects the bargaining

power of Romanian borrowers vs banks: (1) mortgages have previously been accessed

by much-sought-after more affluent retail clients asking for lower EUR rates; and (2)

consumer loans appealed to lower- and middle-income segments, which had less choice

and took on higher RON rates. Therefore, riskier retail clients received higher-rate RON

loans and generated higher risk costs. Going forward, consumer lending if any is

likely to be almost exclusively in local currency.

Fig 23 Consumer loans: currency structure (Dec 2011)

Fig 24 Housing loans: currency structure (Dec 2011)

RON

42%

EUR

43%

Other

currencies

15%

RON

5%

EUR

82%

Other

currencies

13%


Corporate lending is mostly in RON for short maturities and in EUR for longer maturities,

mirroring the retail lending picture. Indeed, the reasons are similar; longer maturities have

previously been available for larger, more secure borrowers. However, this sort of

adverse selection functioned to the detriment of all parties involved clients and banks.

Riskier retail clients get

higher-rate RON loans and

generate higher risk costs

EUR dominates longer

maturities in corporate

lending with shorter

maturities in RON


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10

Fig 25 Corporate lending five-year currency structure

RON

54%

EUR

41%

Other

currency

5%

RON

26%

EUR

72%

Other

currency

2%


We believe banks are now trying hard to push local currency lending, but recent trends

show that EUR lending is particularly resilient. This is due to the strong client preference

for EUR loans as a result of the still-sizeable interest rate differential, as detailed in the

QE Romanian style section.

Meanwhile, the central bank is trying to narrow the differential (also detailed in the

following section), but to no avail as it currently provides short-term excess liquidity with

little or no bearing on the long-term funding needs of commercial banks lending

portfolios.

Fig 27 Local currency lending needs a push Fig 28 Euro-denominated lending particularly resilient

65,309

80,39876,950

68,10271,847

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

2007 2008 2009 2010 2011

Local currency loans (RONm)

CAGR: +2%

18,653

23,352 23,83926,114

27,914

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

2007 2008 2009 2010 2011

EUR-denominated loans (EURm)

CAGR: +11%

Growth calculated in nominal terms. Only loans specifically reported as RON-denominated are included

Source: NBR

Growth of stock calculated in EUR-equivalent to eliminate exchange rateinfluence. Only loans specifically reported as EUR-denominated included

Source: NBR

Local savings are almost entirely short term, both in local and foreign currency. The

interest rate differential and relatively stable exchange rate continue to make RON more

attractive to savers, hence the widening funding gap vs the structure of the loan portfolio.

High interest differential

continues to favour EUR loan

demand

RON remains the currency of

choice for local savings due

to the interest rate differential

and relatively stable FX rate


11/53


11

Fig 29 Mismatch: local funding is short term (RONm) Fig 30 RON remains attractive for savers (RONm)

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

2007 2008 2009 2010 2011

O/N & 1 yr deposits

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

2007 2008 2009 2010 2011

LCY deposits EUR deposits Other ccy deposits


The spread between Romanian and Eurozone lending rates is on the low side. For

example, the spread between Romania and the Eurozone for new EUR-denominated

loans to households for house purchases on a ten-year initial fixed rate is currently

c.200bp (widening from as low as 100bp in mid-2010 and a negative spread as at end-

2008). This spread is lower than CDS spreads against much of the Eurozone, suggesting

that, if anything, lending costs at least for EUR-denominated loans are set to rise in

the near future rather than moderate down.

Fig 31 Country risk is reflected in funding costs Fig 32 Lending rates reflect funding constraints

0

100

200

300

400

500

600

700

800

900

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Romania 5Y CDS (bps) Hungary 5Y CDS (bps)

0.0

2.0

4.0

6.0

8.0

10.0

12.0

May-07

Sep-07

Jan-08

May-08

Sep-08

Jan-09

May-09

Sep-09

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

Eurozone EUR housing loan rate (% p.a.)

Romania EUR housing loan rate (% p.a.)

Source: Reuters New loans to households for house purchases on a ten-year initial fixed rate

Source: NBR, ECB

QE Romanian styleIn Romania, the central bank is currently enforcing an inflation-targeting policy. The

experience of hyperinflation in the 1990s continues to skew current monetary policy

towards cautious and slow relaxation. Moreover, the NBR is sometimes seen to be

targeting exchange rate stability at the expense of high and volatile local currency interest

rates. Irrespective of the central banks rationale and intentions, this has certainly been

the outcome, which in turn has encouraged EUR borrowing and RON savings.

EUR lending rates are likely

to rise in the near future to

reflect country risk and the

funding gap


12/53


12

The NBR recently engaged in providing excess short-term liquidity in local currency.

While this move cannot alleviate the long-term funding gap, it offers marginal help to the

FX swap market, which we estimate to have daily volumes of 150-200m on 1-3 months.

However, this is just a short-term partial and ineffective solution to the broad long-term

funding gap among Romanian banks.

Fig 33 Slumping inflation allows NBR to pump liquidity

Fig 34 Swapping RON for EUR for FX funding

0

5

10

15

20

25

Dec-05

Jun-06

Dec-06

Jun-07

Dec-07

Jun-08

Dec-08

Jun-09

Dec-09

Jun-10

Dec-10

Jun-11

Dec-11

Interbank deposits rate (%) Policy rate (%) CPI (%)

0

1

2

3

4

5

6

7

8

Dec-1

0

Jan

-11

Feb

-11

Ma

r-11

Ap

r-11

May-1

1

Jun

-11

Ju

l-11

Aug

-11

Sep

-11

Oc

t-11

Nov-1

1

Dec-1

1

Jan

-12

RON FX swap implied yield 1M (%)

RON FX swap implied yield 3M (%)

Source: NBR, NIS Source: Reuters

Instead, the excess liquidity goes mostly into lower yields for government securities

which we feel could also be one of the NBRs targets. In addition, the list of market

markers in the latest government fixings (auctions of government securities) are

predominantly locally-held banks, some of whom received NBR support when they got

into trouble in the past. At the same time, repo market volumes have risen dramatically,

further supporting this assessment.

We believe that NBR support for locally-held banks will continue, thus benefiting players

such as Banca Transilvania and, to a lesser extent, Banca Carpatica. Local banks are

most likely to benefit from current excess RON liquidity because they do not have group-

imposed limits on sovereign exposure to Romanian government debt, as is the case for

foreign-owned banks, for risk management purposes. This means that locally-held banks

are uniquely placed to take on NBR liquidity and place it into government securities,

which we expect to continue for much of 2012.

Fig 35 Extra liquidity helps treasuries, inter-bank rate Fig 36 Treasuries fixing yields vs country risk

0

5,000

10,000

15,000

20,000

25,000

Jan-12

Dec-11

Nov-11

Oct-11

Sep-11

Aug-11

Jul-11

Jun-11

May-11

Apr-11

Mar-11

Feb-11

5.00

5.50

6.00

6.50

7.00

7.50

8.00

Repo volume (rhs, RONm)

ROBOR 3M monthly avg (lhs, %)

3Y Gov't securities fixing latest date of month (lhs, %)

6.8

6.9

7.0

7.1

7.2

7.3

7.4

7.5

7.6

7.7

7.8

7.9

Feb-1

2

Dec-1

1

Nov-1

1

Sep-1

1

Aug-1

1

Jul-11

May-1

1

Apr-11

Feb-1

1

Jan-1

1

0

100

200

300

400

500

600

5Y GS Bid price (lhs, %) Romania 5Y CDS (rhs, bps)

Source: NBR, NIS Source: NBR, Reuters

Excess RON liquidity lowers

inter-bank rates, RON FX

swap yields, government

debt yields; provides support

for locally-held banks

Locally-held banks are

uniquely placed to take on

NBR liquidity and place it into

government securities


13/53


13

The central banks move to provide additional RON liquidity could also be a reaction to

concern about the dampening effect of the banking liquidity squeeze on domestic

consumption. The competition for scarce local savings intensified in 2H11, resulting in

deposit rates being bid up steeply. However, NBR measures have met with limited

success so far on this front, as they have merely slowed the pace of deposit rate growth.

Fig 37 RON deposit rates reflect liquidity squeeze Fig 38 NBR easing is due to tight funding market

-4

-2

0

2

4

6

8

10

Jan

-07

May-0

7

Sep

-07

Jan

-08

May-0

8

Sep

-08

Jan

-09

May-0

9

Sep

-09

Jan

-10

May-1

0

Sep

-10

Jan

-11

May-1

1

Sep

-11

Real spread RON new loans (%)

Real interest rate RON new deposits (lhs, %)

0

5,000

10,000

15,000

20,000

25,000

Dec-1

1

Nov-1

1

Oc

t-11

Sep

-11

Aug

-11

Ju

l-11

Jun

-11

May-1

1

Ap

r-11

Ma

r-11

Feb

-11

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Repo volume (rhs, RONm)

Real interest rate RON new deposits (lhs, %)


In our view, the NBR can reasonably be expected to continue to provide excess RON

liquidity in 1Q12 and probably 2Q12. The growth of money does not create inflation,

hence avoiding influencing the inflation target in the current environment.

In an economy that has adopted an inflation-targeting framework by using interest rates

as the main instrument of control, the role of monetary aggregates has decreased.

Romanian data show that even very rapid growth of money is not necessarily linked to

higher inflation, and the NBR is clearly aware of this.

Fig 39 Growth of money does not create inflation Fig 40 Policy rate shows still-cautious NBR stance

-20

-10

0

10

20

30

40

50

60

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

M2 (% p.a.) M1 (% p.a.) CPI (% p.a.)

VAT increase

0.00

2.00

4.00

6.00

8.00

10.00

12.00

Jan-0

6

Jul-06

Jan-0

7

Jul-07

Jan-0

8

Jul-08

Jan-0

9

Jul-09

Jan-1

0

Jul-10

Jan-1

1

Jul-11

Jan-1

2

Policy rate (% p.a.) CPI (% p.a.)

VAT increase

Source: NBR, NIS Source: NBR, NIS

To sum up, the funding squeeze will push up local deposit rates despite the NBRs

attempts to counter this by providing excess liquidity. Moreover, monetary policy easing is

likely to be hindered by the central banks strong preference for a stable exchange rate,and a quick look at Romanian inter-bank rates is quite revealing.

NBR intervention has merely

slowed deposit rate growth

Excess RON liquidity set to

continue in 1H12

Easing likely to be hindered

by a strong revealed

preference for a stableexchange rate


14/53


14

If we look more closely, the inter-bank market shows yet another helping hand from the

NBR for more stretched market players: lower rates to fulfil minimum reserve requirement

(MRR) obligations (note that the MRR observation period and the maintenance period are

one-month long and successive, and the observation period lasts from the 24th

day of the

previous month to the 23rd

day of the current month).

Fig 41 Trade-off: stable FX, but volatile interest rates Fig 42 Inter-bank rate follows MRR period

-5

5

15

25

35

45

55

Jan-07

May-07

Sep-07

Jan-08

May-08

Sep-08

Jan-09

May-09

Sep-09

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

Jan-12

ROBOR 3M (%) Spread ROBOR-ROBID 3M (%)

RON under pressure

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Jul-11

Aug-11

Sep-11

Oct-11

Nov-11

Dec-11

Jan-12

Feb-12

ROBID overnight (%) ROBOR overnight (%)

Extra liquidity by NBR


Banking costsThe profitability of Romanian banks is a mixed picture. Some players post deep losses

while others make a profit, although in most cases, the return is less than their cost of

equity. Internal costs represent the difference between these banks, namely risk costs

stemming from varying capacity to perform risk management during high-growth stages.

Several players also suffer from inefficient distribution networks. During the boom time,

most branches were opened in more affluent cities and towns. As banks vied for market

share, they overcrowded areas where eligible clients were located, a problem

compounded by the fact that only 55% of Romanians live in urban areas. Branch

economics show that break-even can be achieved with a minimum of 2,500 active clients,

while current figures imply less than 1,500. As such, we believe further sector

restructuring is likely in 2012.

Fig 43 Top ten Romanian banking operations

Net profit

Rank Bank Parent Country Assets (RONbn) Market share (%) (RONm)

2009 2010 2011 2009 2010 2011 2011

1 BCR Erste Austria 62.9 67.6 71.2 19.1 19.8 20.1 -327

2 BRD Societe Generale France 46.4 47.5 48.0 14.1 13.9 13.6 472

3 Banca Transilvania N/A Romania 19.5 21.6 25.7 5.9 6.2 7.3 146

4 CEC Bank Government Romania 20.8 21.6 24.7 6.3 6.4 7.0 38

5 Raiffeisen Raiffeisen Austria 20.0 21.7 23.6 6.1 6.5 6.7 316

6 Unicredit Tiriac Bank UniCredit Italy 20.3 20.4 22.3 6.1 6.0 6.3 103

7 Volksbank N/A Austria 21.7 19.7 17.7 6.6 5.8 5.0 -635

8 Alpha Bank Alpha Greece 21.2 21.3 16.5 6.4 6.2 4.7 -118

9 ING Bank ING Holland 10.9 12.0 14.3 3.4 3.6 4.0 127

10 Bancpost EFG Greece 14.6 13.5 12.2 4.5 3.9 3.5 17

Source: Company data, ZF

Romanian banks also face relatively high exogenous operating costs, which they cannot

control and which they pass on to clients. Competition among market players does notaffect these costs in client pricing, and higher pricing is a dampener on growth.

A helping hand for vulnerable

players to meet MRR

obligations?

High exogenous operating

costs and rising productpricing stifle growth

A mixed picture in terms of

profitability; differences and

losses are due to risk costs

Over-extended distribution

networks mean the sector is

set for more restructuring in

2012


15/53


15

In addition, recent regulations that impose/affect costs include:

Prohibition of using internal rates when setting lending prices and using fixed rates orfloating rates pegged to a market index.

Scrapping of early repayment fees.

Lending restrictions on FX loans and strict limits on the tenor of consumer loans.

Cost of guarantee funding rising from 0.2% in 2010 to 0.3% in 2011.

However, exogenous costs come in other different forms:

FX rate stability has a price: the FX market is atrophied, which means lower tradingprofits for the banking sector.

Fig 44 FX rate stability has a price: weaker FX market

Fig 45 Cost-to-income ratio reflects weaker revenue

0

500

1,000

1,500

2,000

2,500

3,000

Oct-11

Jun-1

1

Feb-1

1

Oct-10

Jun-1

0

Feb-1

0

Oct-09

Jun-0

9

Feb-0

9

Oct-08

Jun-0

8

Feb-0

8

Oct-07

Jun-0

7

Feb-0

7

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.54.0

4.5

5.0

FX trading volume (rhs, EURm)

EUR/RON avg rate (lhs, RON)

68

56

64 65

45.00

50.00

55.00

60.00

65.00

70.00

75.00

Dec-1

1

Sep-1

1

Jun-1

1

Mar-11

Dec-1

0

Sep-1

0

Jun-1

0

Mar-10

Dec-0

9

Sep-0

9

Jun-0

9

Mar-09

Dec-0

8

Sep-0

8

Jun-0

8

Mar-08

Cost-to-income (%)


What about Greek banks?We believe the Greek fallout for Romania will continue to be significant, but ultimately

manageable, strictly from the perspective of banking asset exposure; this notwithstanding

the collateral effects and contagion risk.

According to publicly-available data, Greek banks owned 13% of total net assets in the

Romanian banking market at end-2011, ie, 10.6bn of total net assets.

Fig 46 Greek banks operating in Romania

Net profitRank Bank Parent Country Assets (RONbn) Market share (%) (RONm)

2009 2010 2011 2009 2010 2011 2011

8 Alpha Bank Alpha Greece 21.2 21.3 16.5 6.4 6.2 4.7 -118

10 Bancpost EFG Greece 14.6 13.5 12.2 4.5 3.9 3.5 17

11 Piraeus Bank Piraeus Greece 9.5 9.4 8.1 2.9 2.7 2.3 44

12 Banca Romaneasca NBG Greece 8.6 7.6 7.4 2.6 2.2 2.1 -122

25 ATE Bank ATE Greece 1.4 1.9 1.6 0.4 0.6 0.4 -160

Total 55.3 53.7 45.8 16.8 15.6 12.9 -340

Source: Company data, ZF

If we assume significantly more stringent ratios for Greek banks in Romania than overall

sector averages, as shown in the hypothetical stress-test scenario in Figure 47, this still

implies a funding gap of 4.0bn. In this example, half of the gap is covered by EUR

funding from parent banks, which represents c.3% of Romanias GDP.

Impact significant, but

ultimately manageable


16/53


16

Fig 47 Stress-test scenario for Greek bank exposure

Indicator Scenario assumption Source

Market share in total banking assets (%) 12.9 Based on publicly-available data

Total net assets (bn) 10.6 Based on publicly-available data

Loans-to-deposits (%) 220 Assumption (119% for the sector)

Loans-to-assets (%) 70 Assumption (64% for the sector)

Deposits (bn) 3.4 Scenario calculationGap (bn) 4.0 Scenario calculation

Note: unless otherwise indicated, the figures used above represent only a hypothetical scenario analysis

Source: ING estimates

The scenario considered in Figure 47 is also based on conclusions drawn from looking at

individual Greek operations in Romania, given available information from parent bank

reports. Figure 48 presents a scenario analysis of Alpha Banks 2010 numbers (the bank

has the largest presence in Romania among Greek banks).

Fig 48 Estimate of Alpha Banks Romanian funding gap scenario analysis (m)

2010

Assets Equity 363

Liabilities 4,673

Estimated liabilities from group (based on transactions with group companies by parent) 2,930

Implied loans (assuming 70% of assets, as in scenario above) 3,525

Local liabilities 1,742

Loans/deposits (if all local liabilities are considered deposits) (%) 202

Note: this table reflects scenario analysis by the analyst and does not necessarily reflect the actual situation.

Source: Company data, ING estimates

Romania is targeting a 3% budget deficit in 2012, after ending 2011 slightly above 4%.

On the budget revenue side, even incremental improvements in revenue collection

(currently only 34% of GDP vs 40% in Bulgaria, for example) and EU fund absorption

would visibly help with the deficit. Public debt stands at c.34% and, all things being equal,we believe Romania can, in extremis, absorb costs of the magnitude estimated above.

Impact of switch to IFRSThe Romanian banking sector switched from Romanian accounting standards (RAS) to

international accounting and reporting standards (IFRS) in January 2012.

Based on our analysis, the change in accounting standards will have three material

effects: (a) loan impairment provisions will be lower (profit before tax will be higher, as will

tax on this profit); (b) capital adequacy ratios (CAR) stand to look better; and (c) banks

with sizeable assets available for sale could see noticeable swings in capital.

In Figure 49, we show the key accounting differences between local standards, valid until

December 2011, and international standards, with our assessment of the impact of a

move to IFRS from January 2012.

Switch from RAS to IFRS

starting January 2012 should

give a one-off boost to capital

ratios


17/53


17

Fig 49 IAS/IFRS vs RAS

IAS/IFRS RAS Impact

Impairment (accounting) The portfolio of loans is split into two

categories: significant and non-

significant, based on pre-set criteria.

Impairment is determined individually for

the first category, and collectively for the

second category. Impairment is

determined only on objective proof of an

already existing reason that would justify

the impairment. If a specific reason is not

found for a loan in the significant

category, the loan is classified in the

second category and subject to collective

impairment treatment (based on general

risk assessment: country risk, industry,

etc). Similarly, a non-significant loan that

has a specific individual impairment will

be transferred to the first category

(individually impaired). Impairment is

calculated against the net present value

of the impaired assets cash flow.

Each client is classified into a prudential

category. There are five categories based

on three criteria: (a) financial performance;

(b) debt service; and (c) judicial status. The

five categories are: (1) standard; (2) watch;

(3) sub-standard; (4) doubtful; and (5) loss.

For each category, the NBR regulation sets

a standard impairment coefficient: (1) 0%;

(2) 5%; (3) 20%; (4) 50%; and (5) 100%,

respectively. All loans to a specific client are

impaired based on client classification,

irrespective of the individual situation of

each of the loans granted to that client.

RAS is stricter (and generates higher

impairment than IAS) because, for instance,

if the term is past >90 days, 100%

impairment automatically occurs regardless

of any other criteria or existing collateral or

any cash flow recovery.

Two impacts:

(1) Provisions under IAS are lower (profit

before tax is higher, all things being

equal, vs RAS).

(2) Banks can reduce their FX positions

(by selling EUR) held for net provisions

on impairments on loans denominated in

EUR (much of this occurred in late-

December, but banks may be waiting for

the go-ahead from the NBR, following

January 2012 prudential reporting, before

decreasing FX positions further thus

providing support for the local currency in

the short term).

Impairment (prudential

reporting)

As of January 2012: (a) accounting will be IAS/IFRS; and (b) prudential reporting will be

performed according to NBR regulations. There are two categories of prudential

reporting: (i) impairment (according to NBR Regulation 11/2011); and (ii) indicators

(own capital, solvency ratio, large exposures, etc). Prudential reporting is only done to

NBR, and investors can only see the aggregated indicators for the banking sector as a

whole as reported by the NBR. To calculate own capital, for instance, all inputs (share

capital, reserves, retained profits, etc) are taken from IAS/IFRS accounting, but they are

adjusted for any adverse difference between Regulation 11/2011 P&L net impairment

provisions and IFRS net impairment provisions.

Calculation of the Capital Adequacy

Ratio (CAR) is still different from IFRS,

as bank capital used in the calculation is

not IFRS-determined, but influenced by

NBR Regulation 11/2011. This means

that while the CAR stands to look better

than before, it will not be fully IFRS

compliant and will still be lower than it

would be under IFRS solely.

Hyper inflation adjustments

(IAS 29)

In the event of hyper inflation (eg, in

Romania in the 1990s), a hyper inflation

restatement surplus is calculated and

included in the share capital.

No hyper inflation adjustments to share

capital.

Capital structure changes accordingly

(share capital is higher under IFRS).

Financial assets available

for sale

Any difference from marking to market,

regardless of whether it is positive or

negative, is booked through the balance

sheet (capital) and not through the

income statement.

Only the negative difference from marking

to market is booked via the income

statement. Positive differences are not

booked.

Banks with sizeable AFS could see

significant swings in capital (capital for

solvency is still calculated according to

the local central bank standard, but

starts from IFRS figures, with some

adjustment for impairments, as shown

above), due to differences resulting from

mark to market.

Deferred tax Starting in January 2012, accounting-wise, net provision income/(expense) is booked

according to IFRS, while tax-wise, it is still NBR Regulation 11/2011, which is the norm.

This entails a taxable income difference. As RAS is harsher on net provisions, the fiscal

treatment is more favourable than IFRS, and banks need to book a deferred tax liability.

Deferred tax liabilities will be higher

under IFRS, while current tax will be

lower.

Off-balance-sheet loans Loans held off-balance-sheet under RAS

are taken back on balance sheet under

IAS.

Loans taken off-balance-sheet until July

2007 (on several criteria) and held off-

balance-sheet until recovery or write-off.Loans were no longer taken off-balance-

sheet from June 2007.

Loans on the balance sheet could be

slightly higher under IFRS, depending on

a banks individual situation. There is achance of a small increase in retained

profits (and, consequently, capital) from

this change in accounting.

Amortisation of origination

commissions

IAS only allows effective interest rate

(EIR) for the amortisation of originating

commissions.

RAS allows two alternatives for

amortisation of originating commissions:

(1) linear; or (2) EIR.

Impact depends on accounting policies

enacted by each bank before the

change.

Fixed assets Conditions: (1) life >one year; (2)

generates benefits; (3) useful for

economic activity. No value threshold.

Two conditions: (1) life >one year; (2)

value above government decision-

prescribed level.

Depends on the decision of the

accountant, but not a material impact.

Smaller items formerly treated as neither

expenses or fixed assets will now either

be expensed or be classified as a fixed

asset (plenty of discretion left to

accountant).

Source: ING


18/53


18

Central bank future policyThe central banks policy line, in our view, seems to be: (1) generating excess RON

liquidity; (2) support for locally-held players; (3) no significant relaxation of minimum

reserves; and (4) a bridge bank to take over eventual bankruptcies.

Excess RON liquidity is certainly pushing down short-term inter-bank rates and

government debt yields, while in the process offering a helping hand particularly to

locally-held banks, as detailed in this report. Hence, we expect the NBR to continue to

provide excess liquidity into 2012. However, excess short-term RON liquidity is not

helping to address the FX funding and duration gaps that are stifling growth in the

Romanian banking sector. RON lending fell in January for the first time in the past 12

months, providing further proof that excess liquidity from the NBR does not help private

lending. Our assessment is also supported by the trend in RON deposits, which grew

2.4% in January (14% YoY).

We expect the race for scarce local savings, which manifests itself by pushing up deposit

rates, depressing net interest margins and reducing the scope for growth, to continue for

the foreseeable future. While the NBR could relax the MRR, and we believe it willprobably do so at the margins, significant relaxation appears unlikely. Freeing up FX

funding from foreign parent banks would most likely result in a cancellation of the

corresponding funding line to Romanian subsidiaries to reduce the funding gap. Indeed,

the NBR would only see its FX reserves diminish without any additional benefit to lending

and the economy at large.

Against this backdrop, we anticipate the central bank attempting to negotiate another

(gentlemens) agreement with the foreign banking groups in Romania, modelled on the

one agreed in 2009, to prevent a steep reduction in FX funding for their Romanian

subsidiaries. According to the NBRs deputy governor, meetings to this effect will start in

March 2012. Regardless of the outcome, we do not see these talks as a potential game-

changer.

Romania has c.30 banks with market shares ranging between 0% and 3% these are

particularly vulnerable in a funding squeeze scenario. In this context, the central bank is

reportedly setting up a bridge bank, under the Deposit Guarantee Fund administration.

We view this as a positive step for the sector; introducing an efficient and effective

instrument to deal with any extreme situations should these arise in the future. The risk is

that should the bridge bank be put to use in the future, the state be tempted to prolong its

ownership of these banking operations, thus increasing the states presence in the

banking sector, which could affect competition and distort market incentives.

Market forecastsBased on our analysis, Figure 50 shows the macro and market assumptions we use as

the basis of our company financial forecasts.

Excess liquidity, support for

locally-held banks, no MRR

relaxation, bridge bank


19/53


19

Fig 50 Macro and market assumptions

2007 2008 2009 2010 2011F 2012F 2013F 2014F

Macro

Nominal GDP (RONbn) 416 515 498 514 570 610 680 731

Real GDP growth (%) 6.3 7.3 -7.1 -1.3 2.5 0.8 2.5 3.0

CPI (average %YoY) 4.8 7.9 5.6 6.1 5.8 3.0 5.6 4.3

3-month rate (ROBOR) 7.9 13.0 11.3 6.8 5.8 5.5 6.5 6.03-month rate (EURIBOR) 4.3 4.6 1.3 0.9 1.4 1.1 0.9 1.0

5-year yield (%) 7.5 10.6 10.8 7.3 7.3 7.0 7.4 7.2

Banking assets

Total net assets (RONm) 251,426 314,442 330,184 341,946 354,009 364,629 390,153 421,366

Assets growth rate (%) 46 25 5 4 4 3 7 8

Assets/GDP (%) 60.4 61.1 66.3 66.5 62.1 59.8 57.4 57.7

Loans

Loans, gross - total (RONm) 148,181 198,056 199,887 209,294 223,034 234,185 252,920 275,683

Loans growth rate (%) 34 1 5 7 5 8 9

Loans/GDP (%) 35.6 38.5 40.1 40.7 39.1 38.4 37.2 37.7

Loans/assets (%) 59 63 61 61 63 64 65 65

Loans/deposits (%) 115 131 119 118 119 119 117 116

DepositsTotal deposits (RONm) 129,063 151,439 168,076 178,088 188,188 197,598 215,382 236,920

Deposits growth rate (%) 17 11 6 6 5 9 10

Deposits/GDP (%) 31.0 29.4 33.8 34.6 33.0 32.4 31.7 32.4

Minimum reserves (MRR)

Regulatory MRR RON (%) 20 18 15 15 15 15 10 5

Regulatory MRR FX (%) 40 40 25 25 20 20 20 20

Source: NBR, NIS, ING estimates


20/53


20

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21/53


21

Companies


22/53


22

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23/53

BRD Groupe Societe Generale Romanian banks February 2012

23

BRD Groupe Societe Generale

Steady as she goesBRD will likely focus on downsizing, deleveraging and cost-cutting in 2012. With

expected profitability in line with CEE peers, BRD operates in a riskier environment

with a wide FX funding mismatch and a low provision coverage ratio. We

downgrade to HOLD (from Buy) and cut our TP to RON12.5 (from RON15.0).

Downsizing, deleveraging and cost-cutting likely to dominate 2012. Given the weak

economic backdrop, management will likely focus on those items under its control (costs,

risk management) while also seeking to reduce its funding exposure to Societe Generale.

We expect continued growth in NPLs, although a 43% cost-to-income ratio should help to

keep the net result flat YoY. In 2012-13, we expect growth to continue to be affected by

the large FX funding gap, compounded by the widening loan duration mismatch. BRDs

profitability is in line with its CEE peer group average due to its better cost-efficiency.

Valuation: conservative forecasts justify upside, but risks are high. Our target price

implies a 2011F PBR of 1.2x, which we believe is justified as: (1) it reflects an estimated

100bp RoE spread over the cost of equity for the year and higher spreads going forward;

(2) more upside implied by the DDM and relative valuations is likely to be limited by the

share overhang risk stemming from large institutional stakes in the company; and (3) a

higher country risk would prevent BRD from losing its discount to safe haven Polish

banks, while posting similar mid-term RoEs.

Share overhang could be main drag on stock. BRD is a closely-held stock, despite its

seemingly generous 39% free float. SIFs have been gradually selling down their holdings

in BRD, but we estimate that up to 30% of its shares are still held in large institutional

stakes. Based on SIFs reporting, we estimate that they sold a net 2% of BRD in 9m11,

which is equivalent to the shares total trading volume over the past three months.

Overhang risk is partially mitigated by the fact that large trading volumes in the company

occur as block trades. However, BRDs shareholding structure and trading behaviour

mean the company usually lags wider market dynamics.

Three-year EUR MTN planned for 2Q12 is catalyst for lower discount to peers.

BRDs operating cost efficiency and higher net interest margins counter its increased cost

of equity and greater cost of risk. We believe the shares could trim the current 30%

discount to peers to 20% if BRD reduces its funding dependence on Societe Generale estimated to be 1.9bn, ie, 19% of liabilities as at December 2011F by issuing an MTN

(medium-term note) in 2Q12.

Forecasts and ratios

Year end Dec (RONm) 2009 2010 2011F 2012F 2013F

Revenues 3,693 3,664 3,510 3,544 3,718

Pre-provision profit 2,056 2,111 1,965 2,020 2,119

Net profit 1,146 1,008 982 996 1,211

Normalised EPS (RON) 1.65 1.45 1.41 1.43 1.74

Dividend per share (RON) 0.73 0.28 0.18 0.17 0.50

Normalised PER (x) 6.7 7.6 7.8 7.7 6.3

Dividend yield (%) 6.6 2.5 1.6 1.6 4.5

Price/book (x) 1.6 1.3 1.2 1.0 0.9Normalised ROE (%) 25.2 19.0 16.0 14.3 15.4

Source: Company data, ING estimatesFlorin IlieBucharest +40 21 209 1218

[email protected]

Hold (previously Buy)Price (23/02/12)

RON11.00

Target price (12-mth)

RON12.50 (RON15.00)

Forecast total return

15.2%

Banks

Romania

Bloomberg: BRD RO

Reuters: ROBRD.BX

Share data

Avg daily volume (3-mth) 223,524

Free float (%) 39.0

Market cap (RONm) 7,666

Dividend yield (12F, %) 1.6

Source: Company data, ING estimates

Share price performance

8.0

10.0

12.0

14.0

16.0

01/11 05/11 09 /11 01/12

BRD RO

BET-XT rebased

Source: Bloomberg


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Valuation

BRDs operating cost efficiency and higher net interest margins counter its increased

cost of equity and greater cost of risk. We believe BRD has room to trim its discount

to peers if it reduces its funding dependence on Societe Generale by issuing an MTN

in 2Q12.

We use a blended valuation methodology (DDM and relative valuations, using price-to-

earnings and price-to-book, respectively) to calculate a valuation range and a

fundamental average valuation. The valuation range for each of the two methods is

provided by: (a) scenario analysis in the case of the DDM model; and (b) the minimum

and maximum value yielded by a range of peer group multiples in the case of the relative

valuation. Our target price is the average valuation with a liquidity discount.

Fig 51 Valuation output Fig 52 Implied multiples

0.0

5.0

10.0

15.0

20.0

25.0

Multiples DDM

15.4

14.3

11.0

Market price

Target price

12.5

1.5x

10.9x

1.0x

7.7x

1.2x

8.7x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

PER PBR PER PBR PER PBR

Target price Current price Peer group

2011F 2012F 2013F

Source: ING estimates Source: ING estimates

The assumptions used in our base-case DDM model are those reflected and discussed in

the Operations and Financials sections, in conjunction with the main Sector overview.

Fig 53 DDM model assumptions (base-case scenario)

Assumptions 2012F 2013-17F Avg 2018F+ Comment

Cost of equity (%) 13.2 13.1 11.9 Risk-free rate = Yield on five-year government bonds (mostly l iquid) using macro assumptions, risk

premium = 6%. Reported preference risk premium could be up to 200bp higher for differentinvestors.

Asset growth (CAGR, %) -0.1 6.6 9.2 Downsizing unt il 2015F, fol lowed by marginal reclaim of market share.

DPS CAGR (%) 186.0 24.9 8.4 Significant increases in first phase are due to base effect (very low dividend payout in 2010-11).

ROAA (avg %) 2.0 2.6 2.3 Bottom-up calculation (see Financials section).

ROAE (avg %) 14.2 15.7 17.8 Migrating from a depressed state to a steady profi tabil ity level.

Dividend payout (avg %) 35.0 56.1 63.6 Payout level allows a capitalisation of 400-700bp in excess of the regulatory minimum, and leverage

of the 2011F maximum level for the entire forecast period.

Equity/assets (avg %) 14.1 16.6 12.7 Deleveraging until 2015F, followed by a conservative marginal re-leveraging in a steady state.


BRD could trim its trading

discount to peers by

reducing dependence onparent funding

DDM reflects downsizing,

deleveraging, cost control


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Fig 54 DDM valuation (base-case scenario)

Dividend discount model 2012F 2013F 2014F 2015F 2016F 2017F

DPS (RON) 0.50 0.87 1.05 1.21 1.34 1.52

Discount rate (%) 13.2 13.4 13.2 13.2 13.0 12.9

PV of DPS (RON) 0.44 0.68 0.72 0.74 0.72 0.73

PV of LT DPS (RON) 10.26

Cumulative PV per share (RON) 14.29


Fig 55 Model and forecast changes vs last published

Old New Comment

2012F RoE (%) 22.4 14.3 Distressed market, bank affected by NPLs and FX funding gap

LT RoE (%) 19.0 17.8 Less friendly regulatory framework, less leveraged model

2012F equity/assets (%) 9.4 14.6 Deleveraging and downsizing already well under way

LT equity/assets (%) 6.3 12.7 Structurally less leveraged model

2012F dividend payout (%) 49.7 35.0 Lower profitability, need to deleverage

LT dividend payout (%) 68.4 63.6 Move towards a structurally less leveraged model

2012F risk-free rate (%) 10.5 7.2 Country risk comes off

LT growth rate (%) 6.0 5.0 Paradigm shift leads to a more conservative growth pattern


Fig 56 DDM valuation sensitivity analysis (RON)

Risk premium (%)

5.00 6.00 7.00

4.00 14.99 13.13 11.65

5.00 16.57 14.29 12.53LTG 2018+ (%)6.00 18.70 15.79 13.63


Fig 57 Valuation output and target price calculation (RON)

Relative valuation DDM valuation

Max 21.6 18.3

Min 7.4 11.0

Avg

Valuation output (base case) 15.4 14.3

Target price 12.50 (15% liquidity discount)


BRD trades at an average 30% discount in PER and PBR terms against its peer group

median. Our target price implies reducing this discount to 20%.

Fig 58 Relative valuation

Bloomberg

code Rating

Target

price Mkt cap PER (x) PBR (x) ROE (%)(lc) (US$m) 11F 12F 13F 11F 12F 13F 11F 12F 13F

Komercni KOMB CP Hold 3,720.0 7,244 9.4 10.4 9.6 1.7 1.6 1.5 18.5 15.4 15.9

OTP OTP HB Buy 4,100.0 5,035 11.2 9.6 6.3 0.8 0.7 0.7 11.4 9.9 12.1

BRE BRE PW Buy 314.3 4,011 11.3 10.9 8.9 1.6 1.4 1.2 14.9 13.5 14.6

BZ WBK BZW PW Sell 203.2 5,380 13.6 13.0 11.7 2.3 2.0 1.8 17.1 16.4 16.2

Handlowy BHW PW Buy 86.5 3,252 14.8 13.3 11.2 1.6 1.5 1.5 10.8 11.7 13.2

PKO BP PKO PW Buy 41 13,752 11.5 10.7 9.5 1.9 1.7 1.6 17.1 17 17.4

Garanti GARAN TI Buy 8.5 15,449 8.6 8.1 6.2 1.4 1.3 1.1 17.9 16.8 19.2

Peer median 11.3 10.7 9.5 1.6 1.5 1.5 17.1 15.4 15.9

BRD GSG BRD RO Hold 12.5 2,343 7.8 7.7 6.3 1.2 1.0 0.9 16.0 14.3 15.4

Prices as at 23 February 2012

Source: Bloomberg, Company data, ING estimates

We believe BRD is riskier than its peers; the companys country risk is reflected in ahigher cost of equity and a greater cost of risk. However, BRDs return on assets is in line

with its CEE peers, as is its yield, while we do not consider the companys capitalisation

to be an issue even in a pessimistic scenario. This is because the bank makes up for its

BRD trades at an average

discount of 30% to peers

We believe BRD is riskierthan its peers, but more cost-

efficient due to higher

margins


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higher risk through better cost efficiency and, to some extent, higher net interest margin.

In our view, BRD needs to deleverage faster, given that it is more dependent on parent

funding than its peers, and that this dents short-term growth.

Fig 59 Peer group valuations (%)

Rf rate

3yr EPS

CAGR

Mkt cap/

dep Yield

Loan/

deposit Cost/income Risk costs ROA Equity multiplier (x)2012F 2012F 2011F 2011F 2012F 2011F 2012F 2011F 2012F 2011F 2012F

Komercni 3.4 2.3 24.2 7.2 77 41 42 0.5 0.7 1.4 1.7 9.0 9.0

OTP 8.5 13.6 18.8 0.0 109 47 48 3.0 3.0 1.0 1.1 7.0 7.0

BRE 5.5 30.1 23.9 0.0 132 49 48 0.6 0.7 1.2 1.2 12.0 12.0

BZ WBK 5.5 14 36.3 0.0 84 48 47 1.1 1.1 2.2 2.3 8.0 7.0

Handlowy 5.5 5.8 44.7 3.4 58 60 58 0.7 0.7 1.9 2.0 6.0 6.0

PKO BP 5.5 12.2 28.3 4.4 100 40 40 1.4 1.2 2.1 2.1 8.0 8.0

Garanti 9.6 12 29.9 1.6 99 43 43 1.1 1.2 2.3 2.1 8.0 8.0

Peer median 5.5 12.2 28.3 1.6 99 47 47 1.1 1.1 1.9 2.0 8.0 8.0

BRD GSG 7.2 10.7 22.8 1.6 108 44 43 2.3 2.3 2.0 2.0 7.6 6.7

Source: Bloomberg

In our view, BRD deserves to trade at a discount to Komercni (also owned by Societe

Generale), given its lower risk (risk costs, cost of equity and loan-to-deposit ratio).

Fig 60 PER ranking Fig 61 PBR ranking

0

2

4

6

8

10

12

14

BRDGSG

Garanti

OTP

Komercni

BRE

PKOBP

Handlowy

BZWBK

PER 2012F

0.0

0.5

1.0

1.5

2.0

2.5

OTP

BRDGSG

Garanti

BRE

Handlowy

Komercni

PKOBP

BZWBK

PBR 2012F

Source: Bloomberg (prices as at 21/02/12), ING estimates Source: Bloomberg (prices as at 21/02/12), ING estimates

BRD has a strong management team, good cost control and the second-largest

distribution network in Romania (and the most effective one). With several competitors in

a state of distress, we believe BRD could consolidate the market over the medium term;

however, it is too early for this expectation to be reflected in the companys share price.

Risks and catalystsBRDs shares are subject to systemic risks that can affect the market as a whole. We

focus on BRDs company-specific idiosyncratic risks.

We feel BRD should trade at

a discount to Komercni

Share overhang is main drag

and MTN plan is the main

potential catalyst for shares


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Fig 62 Risks and catalysts

Type Item Comment

Risk Share overhang We estimate that up to 30% of stock is still held in large institutional stakes. Based on SIFs reporting, we

estimate that they sold a net 2% of BRD in 9m11, which is equivalent to the shares total trading volume over

the past three months.

RiskParent funding With an FX loan-to-deposit ratio of 153%, BRD is dependent on Societe Generale for EUR funding. The

company needs to reduce its dependency due to pressure to downsize and deleverage.

Risk Low coverage provision BRDs 2011 IFRS coverage ratio will only be known in April 2012, but the company ended 2010 with a

coverage ratio of c.37% under IFRS (40% under RAS, which, according to management, rose to 60% at the

end of 2011), which implies the strong possibility of further significant expenses. In our assumptions, we factor

in continued high NPLs and cost of risk.

Risk Political risk From a political perspective, there are currently no specific plans for legislative measures targeting banks.

However, 2012 is an election year in Romania (general elections are due to be held in November). As such,

we believe any aggressive government position against banks over the next few years could be a risk, and

upside potential could be reduced via increased taxation or changes in regulations. In our view, BRD has a

better chance of being able to cope with change than local peers thanks to its economies of scale and cost

efficiency.

Catalyst MTN According to management, BRD intends to issue a 1-1.2bn three-year note by mid-2012, depending on the

evolution of Societe Generale CDS vs the local cost of funding in FX. This would substantially reduce liquidityrisk and BRDs scope for downsizing.

Source: ING


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Operations

Downsizing and deleveraging

In 2012, BRD will likely focus on downsizing, deleveraging and cost-cutting. We

believe management plans to focus on those items under its control and reduce its

exposure to its parent company.

BRDs downsizing is a direct result of Societe Generales need to reduce its exposure to

Romania. We expect BRD to pursue a strategy of continued moderate downsizing of its

business in the medium term in light of the weak economic outlook. Hence, we anticipate

a CAGR of only 3.4% over the next three years, but any resulting decrease in market

share is likely to be mostly due to a reduction in non-core assets.

Fig 63 Downsizing Fig 64 Deleveraging

0%

5%

10%

15%

20%

25%

30%

2007A

2008A

2009A

2010A

2011F

2012F

2013F

2014F

2015F

50%

60%

70%

80%

90%

100%

110%

Mkt share assets (lhs, %) Mkt share loans (lhs, %)

Mkt share deposits (lhs, %) LDR total (rhs, %)

0.0

5.0

10.0

15.0

20.0

25.0

2007A

2008A

2009A

2010A

2011F

2012F

2013F

2014F

2015F

Total capital adequacy ratio (%) Leverage (x)

Positive impact from introduction of IAS/IFRS in

Jan 2012 but local prudential rules will still apply

Source: Company data, ING estimates Source: Company data, ING estimates

In our view, BRDs need to reduce its FX funding gap (almost entirely in EUR) is of

paramount importance; however, this has not yet happened (the companys loan-to-

deposit ratio actually increased in 2011 vs 2010). In a bid to procure local savings, banks

have been bidding up deposit rates. BRD joined the race in 2H11, thus eroding its net

interest margin for the year, and we expect this to again be the case in 2012.

Fig 65 Funding gap Fig 66 Competition for deposits

85% 83%

147%153%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

2010A 2011A

Loans/deposits RON Loans/deposits FX

4.0

4.2

4.4

4.6

4.8

5.0

5.2

5.4

2007A

2008A

2009A

2010A

2011F

2012F

2013F

2014F

2015F

Net interest margin (%)

Source: Company data (RAS) Source: Company data, ING estimates

Downsizing and deleveraging

already well under way

Net interest margin has

suffered from competition to

procure local savings and the

need to reduce funding gap

Downsizing, deleveraging

and cost-cutting


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From a liquidity risk perspective, BRDs currency structure worsened in 2011, as was the

case with the rest of the market (FX loans grew faster).

Fig 67 Currency structure of loans Fig 68 Currency structure of deposits

Loans in RON

45%

Loans in FX

55%

Deposits in

RON

60%

Deposits in FX

40%

Source: Company data (RAS), Company management Source: Company data (RAS), Company management

Based on previous annual reporting of transactions by related parties and what can be

inferred from subsequent quarterly reporting, we believe that as at end-2011, funding

from Societe Generale made up c.1.9bn, or 19%, of BRDs total liabilities (from 21% in

December 2010).

The liquidity risk was much worse at end-2010 compared with the previous year. Indeed,

a large swing in deposit maturity terms in 2010 resulted in a wide funding gap in the 1-5

year bracket, on top of the existing long-term gap. We expect BRDs annual report, due in

April 2012, to shed some light on the development of this duration mismatch over the

past year.

Fig 69 Funding from Societe Generale Fig 70 Liquidity risk Duration funding gaps (RONm)

0

500

1,000

1,500

2,000

2,500

2003A

2004A

2005A

2006A

2007A

2008A

2009A

2010A

2011F

0%

5%

10%

15%

20%

25%

Borrowings from related parties (lhs, EURm)

Related parties/total liabilities (rhs, %)

-15,000

-10,000

-5,000

0

5,000

10,000

2009A 2010A

Gap 5 yrs

Source: Company data, ING estimates Source: Company data

Cost-cuttingIn our view, BRDs operating environment will probably worsen in 2012. However, the

companys pre-provision profitability is relatively high and should provide a buffer against

higher provisions, although this needs to be reinforced through cost-cutting. Cost-cutting

is likely to arise as a result of revenue weakness triggered by a combination of factors, all

of which are exogenous to BRD managements control:


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Shrinking net interest margins due to faster re-pricing of deposits.

Weak credit demand, which continues to favour EUR over domestic currency.

Atrophied FX market due to tight control by the central bank.

Currency mismatch between assets and liabilities is partially and temporarily mitigated

by RON FX swaps, which hit financial market results.

In our view, the FX minimum reserve requirement is unlikely to be lowered in the near

future, while political risk looms large in this electoral year. As such, we expect high

exogenous costs (as discussed in previous sections) to remain constant at best with risk

to the upside. In addition, we believe managements focus will likely be on controllable

costs:

General expenses: further layoffs (on top of 5% net layoffs in 2011) and a possiblemarginal reduction in the number of outlets (flat at 937 in 2011).

Risk management to bring down risk costs.

Fig 71 ROAA by component Fig 72 Asset quality

(8)

(6)

(4)

(2)

0

2

4

6

8

10

12

14

2004A

2005A

2006A

2007A

2008A

2009A

2010A

2011F

2012F

2013F

2014F

2015F

Net interest/assets (%) Non-interest/assets (%)

Opex/assets (%) Risk cost/assets (%)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

2007A

2008A

2009A

2010A

2011F

2012F

2013F

2014F

2015F

Impaired loans/gross customer loans (%)

Credit loss expense/avg gross customer loans (%)

Source: Company data, ING estimates Source: Company data, ING estimates

According to BRDs management, non-performing loans (NPLs) are equivalent to

impaired loans as reported in the annual IFRS statements; namely loans that do not

perform according to the contract, and for which an impairment allowance is booked. As a

result, the ratio of impairment allowance to impaired loans can be considered to fairly

represent the IFRS provision coverage ratio (36.8% as at December 2010), while

impaired loans to gross customers loans reflect the weight of NPLs in BRDs totallending portfolio.

While the value of its provision coverage ratio is a useful starting point when forecasting

BRDs IFRS income statement going forward, it is not necessarily the appropriate

measure to use when calculating the banks future CAR. According to management, the

provision coverage ratio in December 2011 under RAS and NBR prudential regulations

was 60% for doubtful and loss (rising from 40% at end-2010) and 90% for loss (>90

days), respectively. We believe these figures are relevant from a capitalisation

standpoint, given the NBRs Regulation 11/2011 when calculating own capital, all

starting inputs are taken from IFRS accounting. However, these are adjusted for any

adverse difference between net impairment provisions under Regulation 11/2011 and net

impairment provisions under IFRS.

Based on annual reporting data, we calculate that restructured loans represented 3% of

total gross loans as at end-2010, rising from 2.5% a year earlier. However, BRD has


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provided no disclosure on the level for 2011, or indeed what proportion of restructured

loans go on to become NPLs.

Fig 73 Gross loan structure (RONm) Fig 74 Provision coverage ratio

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2007A 2008A 2009A 2010A

Loans neither impaired nor overdue

Overdue but not impaired loans

Impaired loans

0.0

20.0

40.0

60.0

80.0

100.0

120.0

2007A

2008A

2009A

2010A

2011F

2012F

2013F

2014F

2015F

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

Impairment allowance/Impaired loans (lhs, %)

Impaired loans/gross customer loans (rhs, %)

Credit loss expense/avg gross customer loans (rhs, %)

Source: Company data Source: Company data, ING estimates

We estimate NPLs will continue to grow at a marginal rate in 2012, while risk costs could

see a continuation of the softening that was visible in 2011, unless the low coverage ratio

generates a surprise on this front.


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Preliminary 2011 RAS results

BRD reported preliminary 2011 results on 14 February 2012 based on Romanian

accounting standards (RAS). Unless otherwise specified, all financials used and forecast

in this report are based on IFRS reporting. Note that all prudential figures (CAR, NPL,RWA) are based on local regulations and will remain so, even after the switch to

international standards from January 2012.

We include analysis identifying material differences between local and international

standards, which can be found in the Impact of switch to IFRS section. Looking at the

mechanics of these differences, we can infer BRDs IFRS results with a margin of error,

which can be significant for certain items on the balance sheet and income statement.

The 2011 estimates in this report are derived from preliminary RAS figures, based on our

understanding of the accounting differences.

Fig 75 Income statement (RAS, selected lines, RONm)

2010 2011 %ch

Net interest income 2,336 2,279 -2

Net fee & commission income 660 680 3

Net trading income 547 334 -39

Other income 92 105 14

General operating costs (1,129) (1,152) 2

Tangibles & intangibles depreciation (129) (139) 8

Other operating costs (230) (261) 13

Net provisions (1,549) (1,289) -17

Profit before tax 604 562 -7

Tax (103) (97) -6

Net income 501 465 -7

Source: Company data

Fig 76 Balance sheet (RAS, selected lines, RONm)

2010 2011 %ch

Treasury bills 3,861 4,781 24

Loans and advances to customers, net 29,755 30,447 2

Total assets 47,494 48,028 1

Amounts owed to credit institutions 10,419 10,968 5

Amounts owed to customers 29,625 30,078 2

Total liabilities and equity 47,494 48,028 1



4Q10 4Q11 %ch

Net interest income 617 576 -7

Net fee & commission income 170 171 1

Net trading income 97 124 28


General operating costs (294) (290) -1

Tangibles & intangibles depreciation (33) (36) 11

Other operating costs (64) (73) 14

Net provisions (503) (420) -16

Profit before tax 32 99 207

Tax (6) (16) 171

Net income 26 83 215


Prudential indicators are

calculated according to

stricter local (non-international) regulations

Our 2011 IFRS estimates are

based on recently-reported

preliminary RAS figures


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3Q11 4Q11 %ch

Net interest income 578 576 0

Net fee & commission income 177 171 -3

Net trading income 42 124 198


General operating costs (285) (290) 2Tang. & intangible depreciation (34) (36) 6

Ing Tlv Brd Ro Banks 29feb2012

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