Tuesday, June 18, 2013

Will the IPOs of Mongolian banks happen soon?

Will the IPOs of Mongolian banks happen soon?

Mongolian Banking Industry

At its meetings on the 3rd and 5th of April 2013, the Monetary Policy Committee (MPC) of the Bank of
Mongolia decided to cut the policy interest rate by 1.0 percentage point to 11.5 percent for the
purpose of increasing domestic credits and investments, supporting the real sector andstimulating
business activities.
Expected low impact of the government budget on inflation, decline in demand-pull and supply driven
inflationary pressure, and annual inflation outlook in upcoming months to be consistent with the
targeted level have enabled to reduce the policy interest rate.(see the inflation target & projection by
Bank of Mongolia).
The MPC obviously has made the decision concerning prolonged uncertainties in foreign investment
environment and foreign trade.
Now that the BOM has been taking measures to stimulate economy, some investors are starting to
worry about healthiness of financial system and some major banks.
This report is to answer some of the questions below.
1. What are the policies taken by BOM to achieve “Sustainable Growth” of the economy?
2. Are Mongolian banks still healthy? (Highlights of financial statements of major banks as of end of
3. How much will be the current valuation of Mongolian banks? Will it be possible for them to do IPO
in foreign stock exchanges?
Financial Sector and authorities responsible for financial stability
The structure of the Financial Sector in Mongolia
The Mongolian financial sector consists of 14 commercial banks, 188 nonbank financial institutions
(NBFI), and about 207 savings and credit cooperatives (SCCs). The banking sector, which dominates
the financial sector, underwent several crises in the 1990s. Following those crisis, the Government
implemented measures to restructure banks and improve the Bank of Mongolia’s ability to enforce
compliance with prudential regulations, and strengthen market discipline and incentives for sound
bank management.
The following is the Executive summary for the Mongolian banking sector:
 In Q3 2012, non-performing loans as percentage of total outstanding loans declined to around
3%, significantly reduced from the previous year.
 General levels of NPLs were considerably low throughout 2012.
 Real interest rates are going up, due to lower inflationary pressure.
 Business activities have decreased in 2012. Therefore, coping with the potential fundamental
weaknesses of the banking sector in Mongolia could be a top priority for the officials in charge.
 Deposit Guarantee Law has ended December 2012. Hence, consolidation of the industry is
Authorities responsible for financial stability and institutional Coverage
The Bank of Mongolia, Financial Stability Council and Financial Regulatory Commission are
responsible for financial stability and supervision of the financial sector in Mongolia. The BoM is
responsible for supervision of banks while the Financial Regulatory Commission is responsible for
supervision of other financial institutions including insurance companies, securities firms, credit and
savings unions and non-banking financial institutions. The mission of the Council is to contribute to
sustainable economic growth by developing sound and competitive financial infrastructure and
improving financial services in terms of quality and access.

Strategy for Supervision
The objective of the Supervision Department is to reduce financial risk and to increase risk tolerance of
the industry. Within the framework, a new banking law was approved by the Parliament. The
Supervision Department has accomplished preparatory work for establishing arrangements of
consolidated supervision, information technology inspection, proper management monitoring and
amendments on supervisory regulations.
Rating agencies
Based on the strong balance sheet and the long term growth potential of the industry, rating agencies
maintain stable outlook to major banks in Mongolia.

Bank of Mongolia
As Mr. Zoljargal. Governor of Bank of Mongolia has pointed out in a past, the role of BOM is
“Sustainable Growth” of Mongolian Economy. In October last year, when the Governor has made a
presentation to investors in HK, he proudly mentioned that Mongolian economy should be growing at
16.8% this year. However, because of the weaker FDI and problems of OT/TT, the high growth rate
may not be achievable. On the other hand, as you see the chart, the inflation which has peaked 17%
about a year ago has been down to single digit recently coinciding to the target set by the central bank.
Going forward, we expect BOM and MOF will take more coordinated macro policy focusing on
stimulating the economy using both fiscal and monetary policy (see the “coordinated macro policy”
published by BOM).

The situation of NPLs
Even with the declining economic condition, the NPL ratio has been consistently down in the last 3-4
years and has not picked up yet as the system as a whole so far. So, it looks like the situation
concerning the banking industry is quite healthy at this moment.
Performance of major banks in 2012
The audited financial statements of major banks were released by end of March. According to the
reports, the financial performances of major banks (TDB, Khan and XAC) are also doing well. Below
are some of the highlights of the FS of those banks.

Interest income, operating income and net income have risen 48%, 39% and 50% respectively in
2012.The growth of the financial performance was best among major banks. However, we do not know
how much of the growth has come from the organic growth. Also, we have not done any analysis on
quality and sustainability of earnings yet. We should also analyze on proceeds and potential return on
capital of massive financing recently (see below).

XAC Bank
The performance of XAC bank was also reasonably good. The interest income and profit before tax
were up 38% and 25% respectively. Profit before tax of the full year 2012 was 20 bil MNT which is
about 25% more than last fiscal year. However, if you look at quarterly financial statement of the bank,
the trend of the earnings are declining recently. The profits before tax for 1-4th quarter of this year are
4.9bil, 6.6bil, 4.8bil and 3.9bil MNT respectively and the momentum of the growth is diminishing.
Also, given that they have increased capital through issuing new shares by 50% in 2011, the earning
per share of the bank is declining further. I do not think this will cause financial problem of the bank in a
near future. But, the funding conditions for the bank might be tougher in a future.

Challenge of the Banking Sector
Below are challenges of Banking Sector which has been pointed out by Mr. Norihiko Kato, CEO of
Khan Bank. Some of the challenges which have been recognized are improving. For instance, the size
of each banks have become bigger recently. However, the quality of the earnings of banks are
deteriorating. Therefore, we caution investors to pay more attention to the area.

Banking Sector Challenges
 Small size of bank’s capital limits bank’s capacity
 Underdeveloped capital markets and interbank market
 Lack of long term MNT funding source, bank’s maturity gap
 Underdeveloped derivative markets and hedging instruments
 Legal and regulatory framework
e.g. movable assets pledge, non-banking financial services
 Risk management and system investment
 Compliance, AML, KYC

Will the IPOs of Mongolian banks happen soon?

All major banks in Mongolia have been pursuing opportunities to be listed in foreign stock exchanges
in the last few years. But, because of some reasons, they did not go public. Now, most of major
banks’ financial performances are record high and they are still growing. So, it looks like they are
eligible to be listed. However, the qualities of earnings are deteriorating. And, momentum is shrinking.
And, the growth story which has attracted foreign investors in the past does not exist anymore.
Therefore, it is not easy to achieve high valuation any more even if they pursue the opportunities. See
attached valuation of global banking industry calculated by UBS. As of April 13 2013, average PER
of global banks are around 10 times and Price to Book is 1.2. Asia ex-Japan's valuation is a bit higher
with PER of 12 times and Price to book ratio of 1.5 times because of the growth potential. Given the
slower growth rate of Mongolian economy and potential problems, we believe the highest valuation
they can achieve will be in the range of PER of 15-18 times and price to book of 2 times. I am not sure
if those levels of valuation are comfortable for Mongolian banks. Probably, they should wait until better
days come.

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