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

3. Valuation Method: The very basic one stage DDM

4. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 12 The dividend discount model (DDM) Example – 3 banks

13. Valuation Method: Multi stage DDM

14. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 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. Bank Valuation 15 April 2008 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