Topics: Capital requirement, Tier 1 capital, Stock market Pages: 7 (2726 words) Published: October 8, 2014

In this report, I will analyze the financial performance of SDB by comparing it with its industry peers. SDB’s asset quality, earnings capability and capital adequacy are the three aspects I will pay attention to when evaluate its financial performance. Then I will discuss whether it is appropriate for Newbridge to pay 1.6 times book value for 18% shares in SDB. And what is appropriate range for the price Newbridge can offer. The objective of this report it to assist Newbridge to make right decisions on whether to invest SDB or not and if invest what is appropriate price to pay for each share.

Part 1 SDB’ financial performance

In order to analyze the financial performance of SDB, there are three aspects we should consider. And they are asset quality, earnings capability and capital adequacy of SDB. I will exam its asset quality first. Asset quality

First of all, the asset quality of SDB seems in a big problem. There are two important asset quality measures that managers and analysts should pay attention to, they are NPL ratio (NPL/Gross loan) and NPL coverage ratio (LLR/NPL). Here, NPL means nonperforming loan, it is a sum of borrowed money upon which the debtor has not made his or her scheduled payments for at least 90 days. Based on the data from Exhibit 10 (Jin, Xuan, & Bai, 2009), NPL ratio for SDB is 11.6% in 2002 and the average NPL ratio is 7.3% for other joint-stock banks in china. Higher NPL ratio indicates SDB got a worse quality of the loan portfolio, which means the SDB got more nonperforming loan compare to industry peers. Moreover, I think the NPL number SDB reported is likely to be too low. Because Newbridge conduct the due diligence and they think the actual NPL is higher. In details, SDB was a government-controlled bank. And as a result, SDB has poor governance and risk management issues. For example, same as other banks in china, officers may trend to lend loan to their favorite clients due to poor governance. Moreover, government may force bank to provide loan to under performing state owned company at a low interest rate. Furthermore, the credit management is not transparency in China. These reasons will cause significant increase in NPL without disclosure it precisely. Therefore, the SDB’s NPL is more likely to be too low and asset quality is lower than benchmark. When examine SDB’s asset quality not only amount of NPL will be considered but also we should consider LLR level of SDB. The actual LLR levels for SDB is lower than the SDB’s own reserve ratio guidelines. LLR stands for reserve of each loan, also called loan loss reserve. Higher LLR level indicates company will less likely suffer from capital shortage due to loss from NPL. According to SDB guidelines, it categories loans into five classes which are normal, special mention, substandard, doubtful and loss. And the last three classes are counts to NPL. The reserve ratio for substandard loans is 25%, doubtful loan is 50% and loss loan is 100% respectively. Based on the table below, we know the NPL for SDB is $1180MM (400+740+40=1180). And if we follow the company guideline, the LLR should be $603.4MM, therefor the LLR/GL ratio should be 5.94% which is higher than actual ratio 3.9%. Moreover, the NPL coverage ratio is 51.14% that is also higher than actual 33.2%.

According to article, SDB’s LLR/GL ratio is slightly higher than industry peer’s average ratio 3.8% (Jin, Xuan, & Bai, 2009). However, the NPL coverage ratio of SDB is much lower than industry peer average ratio 55.3% (Jin, Xuan, & Bai, 2009). Lower LLR level means SDB gives a lower provision for potential credit losses in the future. At the same time, as the NPL ratio of company is high. The loan loss of SDB is likely to be high. So it more likely there will not be enough capital to cover the loan loss, as the LLR is low. And lower actual LLR levels will have implications on SDB’s capital adequacy in the future as well....
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