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UAE Research

Investment Banking Division August 2010 Equity Research 1

Abu Dhabi Banks Time to have a re-look

August 12, 2010

Strong macros The Emirate of Abu Dhabi occupies 87% of total land area in the UAE and is the most significant contributor to the economy as a whole; accounts for c55% of nation’s GDP, produces 2.5mn bpd (almost the entire oil production of the country) and has projects worth $550bn (c4x Emirate’s GDP) in the pipeline. In addition, the government of Abu Dhabi has been wisely channeling its oil windfall to ADIA (estimated to manage global portfolio worth $400-$600bn) for over 3 decades now, building huge surpluses. Relatively stronger balance sheets and explicit government backing Whilst there is no denial that all banks in the UAE face similar systemic risks, the absolute amount of exposure specific to Dubai World and other troubled Dubai-based conglomerates varies among UAE banks. Our view is that Abu Dhabi banks have better absorption capacity in the event of further deterioration in credit quality of Dubai names owing to large diversified balance sheets, strong capitalization levels and a shareholding pattern that we presume implies explicit support from Abu Dhabi government. Credit creation will be skewed towards Abu Dhabi banks We believe credit offtake will continue to remain sluggish in the UAE due to shortfall in funding and fear of further NPL build up. However, Abu Dhabi banks should fare better and continue to outpace the credit and deposit numbers of Dubai banks in the medium term. Over Q109-Q110 Abu Dhabi banks (big 5) credit grew 11% whereas Dubai banks (big 4) credit shrunk 2.7% during the same period. We like FGB and NBAD… We initiate on two Abu Dhabi based banks – First Gulf Bank (FGB) and National Bank of Abu Dhabi (NBAD) both with BUY ratings with our top pick being FGB (Dec 2010 target price of AED 25.6, 83% upside). NBAD also offers decent upside of 29.5% in our view (Dec 2010 target price of AED 14.2). Key risks include further slip-ups in Europe, stagnation in deposit mobilization, delay in credit demand pick up and lack of near term catalysts. …both can sail through NPL classification and provisioning rule changes From a regulatory standpoint, two changes are being targeted by the UAE Central Bank. First is to advise banks to classify any loans past 90 days due as NPL and second is to allocate a stipulated percentage as collective provisions. Assuming both changes do take place, we do not see any material impact either on NBAD or FGB although other UAE banks are likely to be stressed if such changes are implemented. FGB: sufficient value even with modest growth outlook FGB’s compelling valuations with a 2010e PB of 0.8x (50% discount to GCC peers) aided by strong capitalization level, stable funding base and potential deal synergies from royal families make us believe that there is sufficient value in the bank even under a scenario of modest credit and deposit growth outlook. NBAD: play on balance sheet strength and shareholding profile NBAD has traditionally been viewed as a conservative play. Its shareholding pattern (70.5% owned by ADIA) and balance sheet strength gives us comfort that capital and fund raising will be relatively easier for this bank as compared to its domestic competitors. Although retail banking has been a drag, the bank is positioned well should there be any revival in the scene. At 2010e P/B of 1.2x, NBAD valuations are not fully reflective of its high ROE potential and scalability in big-ticket lending.

Report Purpose Coverage Initiation

Target Price & Recommendation FGB: AED 25.6 – BUY

NBAD: AED 14.2 – BUY

Sriram Balasubramanian [email protected]

+971 4 2222267

UAE Research


UAE GDP Contribution 2007 (by Emirate)

54.8%31.0%

9.4%

1.9%1.3%

1.6%

Abu Dhabi Dubai Sharjah Ras Al Khaimah Ajman Others

GCC Petroleum activities to GDP (%)Country 2003 2004 2005 2006 2007Bahrain 24.5 22.8 25.0 26.0 24.6Kuwait 40.6 44.7 51.8 55.7 54.5Oman 40.9 42.2 48.7 47.8 45.3Qatar 57.6 54.5 59.6 57.2 56.5Saudi Arabia 41.5 45.6 52.7 54.4 54.9UAE 28.4 31.9 35.7 38.1 38.6Average 38.9 40.3 45.6 46.5 45.7

Degree of openness in GCC countries (%)Country 2003 2004 2005 2006 2007Bahrain 128.5 133.0 145.9 150.7 136.2Kuwait 66.1 69.4 75.1 70.5 76.6Oman 85.5 89.4 89.5 91.3 101.0Qatar 76.9 77.1 83.4 88.9 90.1Saudi Arabia 62.9 69.3 76.1 78.8 84.3UAE 134.0 152.0 145.2 149.7 164.3

LC/LG

-

20

40

60

80

100

120

140

UAE Saudi Oman Kuwait Qatar

$bn

0%

5%

10%

15%

20%

25%

30%

35%

as %

of b

anki

ng a

sset

s

Investment argument

UAE model diversified internally As the second largest economy within the GCC after Saudi Arabia, the UAE economy exhibits a more diversified pattern with lower dependence on oil revenues. Within UAE, the capital city of Abu Dhabi, thanks to its abundant supply of oil resources has advanced through exploration of petroleum products and generates sizeable revenues from exporting oil whilst the more popular city (emirate) of Dubai has spearheaded developments related to the non-oil sectors such as trade, services, real estate, finance and tourism.

The strong logistics infrastructure coupled with easy handling of exports/imports goods naturally attracts many international firms in setting up free zone business in Dubai with the option to use the venue as a spring-board in reaching out to the neighboring MENA countries. The rest of the emirates such as Sharjah, Ras Al Khamiah, etc have largely focused their efforts in building small manufacturing bases such as cement, ceramics, steel conversion and food processing industries with the intent on exporting these goods to surrounding countries. The GDP contribution of each emirate (chart) and the relative contribution of petroleum activities to GDP (table) are shown below.

Source: UAE Central Bank, IFC Bulletin No. 32

Characterized by a high degree of openness UAE leads the pack within the GCC when it comes to trade openness which creates at least two windows of opportunities for the local banks. Openness is defined as {(exports + imports of goods) / GDP}. Firstly, due to higher trade flows as measured by imports and export volumes, banks can easily tap into trade finance activities through LCs/LGs. Secondly, due to large presence of agencies/dealerships selling foreign goods and services in the domestic market; bank treasurers are quite active in executing foreign exchange and derivatives transactions for those who seek to hedge their foreign currency exposure.

Source: GCC Central Banks, IFC Bulletin No. 32

UAE Research


Dubai - Fiscal Revenue (2007)AED 1 = 25.605bn

26%

26%7%

41%

Customs Hydrocarbon Enterprise profits Government services

Abu Dhabi Government’s balance sheet is strong driven by hydrocarbon revenues

Source: IMF, BankMuscat Research As highlighted earlier, Abu Dhabi contributes c55% to the nation’s GDP but has higher significance in government finances since it contributes bulk of nation’s revenues and its share has been edging higher in recent years (ranging from 60%-67% during the period 2003-2007) predominantly driven by hydrocarbon exports. Dubai generates its revenue mostly through non-hydrocarbon sources, specifically through customs and levy on government services such as toll fees, real estate fees and others. Therefore, we would like to point out that during the current economic downturn where the silver lining has been high oil prices; we expect government revenues to remain intact due to Abu Dhabi’s superior positioning in hydrocarbon exports. When it comes to government expenditures, Abu Dhabi again takes the front seat and contributes c70% of the total budget. Besides, Abu Dhabi also makes generous grants as part of its contribution to the federal government. Over the past 3 decades or so, the government of Abu Dhabi has been wisely channeling its surplus from oil receipts to its investment arm, the Abu Dhabi Investment Authority (ADIA). Various estimates have put the AUM of ADIA ranging from $400bn-$600bn though precise figure is difficult to obtain. Assuming a conservative AUM estimate of $400bn for ADIA, the figure amounts to c1.8x 2010e UAE GDP, which is significant. Although it is never clear whether ADIA could fund liquidity support to any of the emirate(s) that seeks financial assistance, rating agencies generally view the balance sheet of ADIA as a proxy to the government of Abu Dhabi. From our point of view, banks that are majority owned by ADIA (or Abu Dhabi Council) such as National Bank of Abu Dhabi, Abu Dhabi Commercial Bank or other Abu Dhabi based banks such as First Gulf Bank, etc are more likely to get capital support from ADIA should the need arise.

UAE - Consolidated Government Finances 2003 2004 2005 2006 2007

Figures in AED bn.Total revenue 100.0 134.9 203.7 299.0 333.4 Hydrocarbon 75.5 99.9 152.8 229.4 234.5 - Contributed by Abu Dhabi 51.8 68.0 104.3 157.1 168.3 - Contributed by Dubai 3.8 4.2 5.9 6.3 6.8 - Contributed by other emirates 19.9 27.7 42.6 66.0 59.5 Non-hydrocarbon 24.4 35.3 50.9 69.6 98.9 - Contributed by Abu Dhabi 9.2 17.6 27.3 37.2 55.7 - Contributed by Dubai 6.3 7.8 11.0 14.1 18.8 - Contributed by other emirates 8.9 9.9 12.6 18.3 24.4Total expenditure and grants 92.0 96.6 104.4 127.7 166.9Overall balance (consolidated) 8.0 38.3 99.3 171.3 166.5

Abu Dhabi - Fiscal Revenue (2007)AED 1 = 223.968bn

74%

1%

21%

4%

Hydrocarbon Customs Investment income Others

UAE Research


UAE banks assets quality – been on a bumpy ride due to global, regional and domestic turbulences Ever since the sub-prime crisis unfolded outside the US, it was apparent that certain GCC banks including ones in the UAE would carry some exposure to SIVs and CDOs through their investment portfolios. Although several UAE banks disclosed small varying degrees of exposure to the sub-prime products, Abu Dhabi Commercial Bank took sizeable provisions during years 2007 and 2008. However, industry analysts and participants left the issue behind widely terming ADCB’s exposure as a one-off type of event and banks continued their focus on domestic lending. Besides, the economic climate during much of 2008 was too benign aided by high oil prices and liquidity flows on strong dirham revaluation rumors that induced a lot of confidence for the banks. As a result, bank credit expanded rapidly even as the loan-deposit ratios were gradually appearing to be a bit stretched. Banks were also too happy in over-extending to the real estate and personal segment with the intent of making higher margins and threat of defaults was perceived to be low. It required a major global systemic event to blow out the rally in the UAE. Thus, the collapse of Lehman was the trigger point, resulting in a chain of events in UAE and more specifically in Dubai. First, the equity and real estate markets went dry devoid of any liquidity as foreign investors pulled their speculative money out of UAE. Suddenly funding became a scarcity and EIBOR-LIBOR spread differential widened substantially. De-leveraging and damage assessment started. As the summer of 2009 set in, the news of Saad/Algosaibi twin default further rocked UAE banks. By this time, banks had already applied brakes on lending and were focusing on preserving their capital. Although not all UAE banks were equally exposed to Saudi corporates, some banks such as Mashreq and ADCB stated higher exposure than others. Perhaps the most dramatic event was the announcement of Dubai World in November 2009 that it was seeking a standstill agreement on its certain debts. Dubai World (DW) – latest developments On May 20, 2010 Dubai World announced it had reached agreement in principle with 60% of its bank lenders to restructure $23.5bn of debt. An agreement of more than 2/3rds of total creditors could finalize this restructuring and appears likely to be the case. The summary of debt restructuring terms is given below: • DW final indebtedness under restructuring would involve a total $14.4bn split into two tranches. Tranche

A of $4.4bn and Tranche B of c$10bn. • Tranche A will have a maturity of 5 years and will pay coupons of 1%, while lenders in UAE dirham are

expected to receive an additional coupon measured as the differential between EIBOR vs. LIBOR capped at 1%. The principal is expected to be paid full on maturity

• Tranche B will have a maturity of 8 years and will pay coupons based on three options: o First option is to pay 1% cash interest and accrues 1.5% interest payable at maturity and a Dubai

government guarantee for a rateable share of $4bn o Second option is to pay 1% and accrues 2% interest for years 1-5 and 2.5% for years 6-8 and a

Dubai government guarantee for a rateable share of $10bn o Third option is applicable only for lenders in UAE dirham – to pay 1% cash interest and the

difference between EIBOR and LIBOR up to a cap of 1% and accrues 1.5% interest payable at maturity. It carries no government guarantees.

The loss in restructuring would depend on the choice of the options. However, since the interest offered on restructured loans is below the market rates and maturities are also extended, the NPV of loans would probably decline by 15%-20% and banks would have to immediately recognize impairment losses. The UAE Central bank also has advised the local banks to book general provisions until its recommendations are ready during the third quarter 2010. Of the total $14.4bn DW debt under restructuring, we estimate foreign banks to have 60% exposure and domestic banks to have 40% exposure. If NPV declines by 15%, this would translate into c$864mn or AED 3.17bn in impairment provisions for domestic banks, which equates to c1.24% of total capital. The impact is not material to dent the Tier I adequacy ratios. However, banks such as Emirates NBD, other Dubai-based banks and ADCB are likely to be more stressed due to their relatively higher share of DW exposures based on preliminary press reports (although none of the banks have provided exact quantification).

UAE Research


UAE Central Bank – Proposed changes We gather from media reports that the UAE Central Bank is advising banks to implement two changes. First is to classify loans that are past 90 days due as NPLs and second is to allocate collective provisions based on certain percentage. The collective provisioning requirement is not clear whether it is to be measured as as percentage of gross loans, or Risk Weighted Assets (RWA) or Credit Risk Weighted Assets (CRWA). However, we have completed scenario based exercise for the top 9 banks in the UAE to show the impact of proposed changes (if any) by the apex body. In our exercise, we assume any loans past due more than 90 days as impaired (even though the bank might have classified the same as non-impaired loans) and also estimate the impact for each of the top 9 banks assuming collective provisioning requirement is set at 1.25% of CRWA.

Source: Company Financials, BankMuscat Research

Source: Company Financials, BankMuscat Research • Assuming 90 day rule for NPLs is implemented, the cumulative NPL ratio will worsen from 3.2% to 4.0%

and coverage ratio will slip from 87.1% to 68.5% • Assuming collective provisions, calculated at 1.25% of CRWA is mandatory; the 9 banks are estimated to

have a shortfall of AED 1.8bn which works out to 6% of FY 2009 pre-provision profits. • The banks worst hit by 90 day rule would be Abu Dhabi Islamic Bank, Dubai Islamic Bank, Commercial

Bank of Dubai and Mashreq. First Gulf Bank has sufficient coverage buffer and even if 90 day rule is incorporated, its coverage ratio would still be at a healthy 81.7% (above the system average of 68.5%). National Bank of Abu Dhabi is least impacted by either of the proposed changes.

• The coverage ratio each of Abu Dhabi Islamic Bank, Dubai Islamic Bank and Mashreq would slip below 50% because of 90 day rule.

• The bank with in-adequate collective provisioning is Union National Bank and it has to make up additional AED 470mn which would equate to 32% of its pre-provision profits recorded in FY 2009.

UAE BANKS - ASSET QUALITY Figures in AED mn.

NPLs as reported

Past due (> 90 days)

NPLs - 90 days

Gross Loans

NPL / G.L. (old)

NPL / G.L.

(revised)Total

Provisions

Coverage ratio -

reported

Coverage ratio - new calculation

National Bank of Abu Dhabi 1,687 - 1,687 139,971 1.2% 1.2% 2,714 160.9% 160.9%First Gulf Bank 1,451 1,647 3,098 92,916 1.6% 3.3% 2,530 174.4% 81.7%Abu Dhabi Commercial Bank 6,242 - 6,242 120,843 5.2% 5.2% 4,232 67.8% 67.8%Union National Bank 793 252 1,046 51,580 1.5% 2.0% 812 102.3% 77.6%Abu Dhabi Islamic Bank 2,527 1,767 4,294 42,225 6.0% 10.2% 1,751 69.3% 40.8%Emirates NBD 5,041 823 5,865 219,679 2.3% 2.7% 5,275 104.6% 89.9%Dubai Islamic Bank 3,107 1,378 4,485 51,873 6.0% 8.6% 1,948 62.7% 43.4%Commercial Bank of Dubai 767 339 1,106 29,114 2.6% 3.8% 738 96.2% 66.7%Mashreq 3,614 643 4,257 47,933 7.5% 8.9% 1,985 54.9% 46.6%Cumulative 25,229 6,849 32,078 796,134 3.2% 4.0% 21,984 87.1% 68.5%Note: All figures end FY 2009

UAE BANKS - PROVISIONS Figures in AED mn.

Total Capital

Total RWA

Credit RWA CAR

1.25% of CRWA

Reported Collective Provisions Difference

Pre-Provision

Profits

Diff. as % of Pre-Profits

National Bank of Abu Dhabi 24,894 142,882 128,344 17.42% 1,604 1,604 0 4,501 0%First Gulf Bank 27,636 123,911 114,173 22.30% 1,427 1,946 (518) 5,083 -10%Abu Dhabi Commercial Bank 24,068 138,475 126,294 17.38% 1,579 1,505 74 3,243 2%Union National Bank 13,958 67,293 63,582 20.74% 795 325 470 1,470 32%Abu Dhabi Islamic Bank 8,988 53,011 50,101 16.96% 626 518 109 1,527 7%Emirates NBD 43,690 221,100 204,800 19.76% 2,560 1,858 702 6,978 10%Dubai Islamic Bank 12,503 71,556 64,478 17.47% 806 353 453 2,037 22%Commercial Bank of Dubai 7,181 35,571 32,461 20.19% 406 329 77 1,233 6%Mashreq 16,652 82,507 77,086 20.18% 964 513 451 3,192 14%Cumulative 179,569 936,307 861,321 19.18% 10,767 8,950 1,817 29,263 6%Note: All figures end FY 2009Capital adequacy as per Basel II norms where provided

UAE Research


UAE banking system also faces other challenges 1. Stretched LTD ratio and dependability on inter-bank borrowings Among the six GCC countries, the UAE and Qatar have system wide LTD ratio in well in excess of 100% vs. GCC average of 96.4%. To manage their funding shortfall, both banking systems get active in inter-banking market and many a times end up as net borrowers in the inter-banking market. In Qatar, the high LTD ratio is a more of recent phenomenon that has arisen on account of credit growth outpacing deposit growth but in the UAE, the gap in funding has been a perennial. Besides, the UAE Central Bank has always defined the liquidity criteria differently and advised banks to maintain a minimum ratio of loans & advances to Stable resources of 100% as opposed to the plain vanilla classification of loans & advances to deposits that is advised by the other GCC Central banks.

Source: GCC Central Banks compiled from latest available bulletins For UAE banks, the numerator comprises loans and advances (including inter-banks with placements with +3m remaining maturity); while the denominator comprises free capital and reserves, inter bank deposits received with +6m remaining maturity and 85% of customer deposit. Hence, UAE banks do not depend on deposits as the sole source for funding and often approach international and other regional banks for short-term funding. Whilst lower dependence on customer deposits may work well for the banks at a time of ample liquidity and international markets are in good accord and well integrated, when crisis sets in, the banks usually have to look at home grown sources for funding. Saudi banking system is heavily funded by domestic deposits and limited funding from inter-bank which we view as positive in light of current circumstances. Should there be any revival in credit up-tick, Saudi stands in a better position to fund its loan book merely through customer deposits whereas the same cannot be said of UAE. 2. Widening spread differential between EIBOR and LIBOR and high CDS spreads

Source: Bloomberg. CDS data taken on June 15, 2010

UAE banking system - Loans and Deposits

860880900920940960980

100010201040

Dec-08

May-09

Jun-09

Jul-09

Aug-09

Sep-09

Oct-09

Nov-09

Dec-09

Jan-10

Feb-10

Mar-10

Apr-10

May-10

AE

D b

n

100%101%102%103%104%105%106%107%108%109%

Total Credit Total Deposit LTD

GCC bank data (figures in $bn.) Loans Deposits LTD

Inter-bank Placements

Inter-bank Borrowing

Net inter-bank Position

UAE 278,569 263,274 105.8% 47,119 61,043 (13,925) Saudi 200,620 245,789 81.6% 6,019 7,634 (1,614) Oman 25,996 25,489 102.0% 4,097 4,247 (150) Bahrain 17,582 22,185 79.3% 6,507 4,286 2,221 Kuwait 99,944 97,105 102.9% 25,587 11,630 13,956 Qatar 80,714 75,542 106.8% 15,278 25,977 (10,699) Aggregate GCC 703,426 729,384 96.4% 104,607 114,817 (10,210)

EIBOR vs. LIBOR spreads

0.000.501.001.502.002.503.003.504.004.505.005.50

Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10

%

LIBOR USD 3M EIBOR USD 3M

EIBOR closely tracking LIBOR until Lehman

collapse

Widening Spreads

CDS Spreads - Selective Countries

0

200

400

600

800

1000

1200

Dubai

Abu Dhab

i

Qatar

Saudi

Greece

Hungary

France

U.K.

bps

Sovereign risk perceived differently than Dubai though

some risks are priced-in

UAE Research


Total Credit (USD mn) 2005 2006 2007 2008 2009Qatar 19,158 28,173 44,163 66,744 74,452 Kuwait 44,920 53,315 65,142 82,560 92,435 Saudi 120,667 132,551 158,624 198,614 196,508 UAE 107,512 146,318 195,503 268,828 277,599 Bahrain 7,460 8,670 12,107 17,136 17,301 Oman 10,131 12,228 16,914 24,075 25,569 Total GCC Credit 309,848 381,255 492,452 657,958 683,864

Total Deposits (USD mn) 2005 2006 2007 2008 2009Qatar 23,462 33,093 45,936 58,373 67,819 Kuwait 44,284 53,109 62,877 77,342 96,117 Saudi 130,503 157,669 191,350 225,631 250,813 UAE 111,535 141,248 194,942 248,344 267,514 Bahrain 10,672 12,866 19,449 25,082 25,157 Oman 9,780 12,181 16,878 22,306 23,636 Total GCC Deposit 330,236 410,166 531,432 657,079 731,056

Ever since the Lehman collapse occurred in September 2008, the spread between UAE inter-bank rate (EIBOR) and the US$ LIBOR rates has widened. Under normal circumstances, the spread differential between EIBOR and US$ LIBOR is minimal reflecting the currency peg between the dollar and the dirham that has been in place for many years. Just prior to the collapse of Lehman, industry sources cite around $14bn of bank debt was raised by certain Dubai entities such as DP World, Dubai Dry Docks, etc and with the intent to utilize the debt proceeds in order to fund overseas acquisitions. Foreign banks which were part of the lending consortium sought credit protection in the form of CDS which resulted in both Dubai CDS and EIBOR rates coming under pressure. However, since then Dubai CDS have fluctuated owing to a series of events relating to uncertainties in the domestic real estate sector, Dubai World and other re-financing issues. The case of Abu Dhabi CDS is unique since its pricing seems to have captured some of the Dubai risks but on a stand-alone basis we opine Abu Dhabi CDS should be closer to the levels of Qatar and Saudi since till date there has not been any default by Abu Dhabi based conglomerate or quasi-government entity. Secondly, likelihood of support from ADIA remains strong for any major Quasi-government structure or entities that are owned by direct members of ruling family of Abu Dhabi. 3. Excessive exposure to real estate and consumer lending sectors

Source: GCC Central Banks In our estimates, 49.6% of credit in the UAE flowed to the real estate/contracting sector and personal lending last year, which is at par with the smaller sized Bahraini and Omani banking systems whereas in Saudi, the combined exposure to these two sectors stood at 30% with majority of credit flowing to the corporate sector where collateral backing is quite strong. Given the sheer size of the UAE banking system, we opine that a better diversification model in terms of credit mix will help the cause of the banks in the longer run. However, for that to happen, more industrial/infrastructure projects need to be bank financed. Although this may occur gradually over time and benefit those banks with bigger balance sheets and access to government funding, in the interim we opine the UAE banking model will revolve around the consumer sector due to limited access to funding. This is where Abu Dhabi based banks such as NBAD and FGB are likely to have an edge due to their proximity to the government of Abu Dhabi and other royal families based in the emirate. In short, banks that are able to raise funds in competitive terms are likely to seize initiatives from their competitors and fund big ticket lending items. This year, we have seen instances of Abu Dhabi banks lending to EMAL, Sorouh, etc.

GCC Credit Mix (FY 2009)

-50

100150200250300

UAE Saudi Oman Bahrain Kuwait Qatar

$bn

Govt. Agriculture Mining & Quarrying Manufacturing

Elec. & Water Const. & R.E. Trade Logistics

FI Services Consumer - Business Consumer - Personal

Others Non-residents

UAE Research


NATIONAL BANK OF ABU DHABI

August 12, 2010 CMP: AED 11.00

Target price: AED 14.2 Banking and Financial Services National Bank of Abu Dhabi, incorporated in 1968 is the second largest bank in the UAE and largest bank in Abu Dhabi when measured by assets, credit and deposits. The government of Abu Dhabi via the Abu Dhabi Investment Council owns 70.5% stake in the bank. Branch network includes 103 in the UAE, 27 in Egypt and 20 in other countries. Investment positives

- Best asset quality among UAE banks with Dec 2009 NPL ratio at 1.2% and

coverage at 161%, vs. peer group NPL of 3.2% and coverage average of 87.1%. Majority of credit exposure is to public sector (39%) and corporate sector (41%) where we see limited risks - Income model diversified. In addition to strong domestic franchise, NBAD has

strong footprints in Arab markets and generates c10% of its income from overseas. The bank is also a leader in asset management and brokerage services and its wallet share should increase once the sentiment surrounding equity market improves

- Access to wholesale funding. We believe banks that are able to tap the wholesale

market on cheap terms will have a considerable advantage in funding their loan growth. NBAD is one such bank – due to its government of Abu Dhabi backing and strong balance sheet status has raised issued two bonds YTD even as other banks struggle

- Potential to achieve higher penetration in consumer banking. For long, NBAD

ignored the retail scene but with management changes in key areas such as investment banking and retail; IT systems and strong distribution network, there is the potential to increase its share in this business

Risk factors

- Margin compressions – as the differential spread between EIBOR and lending rates

tighten and deposit rates get more competitive, NIMs could undergo some compression which could impact the NII

- NBAD has 12% of its loans and 37% of its AFS investments exposed to the European region which we deem as the highest among the UAE banks. Although the crisis in Europe is subsiding, the bank has to remain watchful on these exposures

- Lower oil prices would slowdown government spending and ultimately delay the trickle-down effect on banking credit and deposit numbers

Valuation - We value National Bank of Abu Dhabi using residual income method at AED 14.2 per

share (2010 target price) translating to a potential upside of 29.5% and thus assign a BUY rating


Recommendation BUY

Stock Details Exchange / Code ADX / NBAD Bloomberg Code NBAD AB

Equity Capital AED 2.392bn Face Value AED 1

52-Week H/L AED 12.74 / 9.18 Market Cap AED 26.3bn

Shareholding Pattern Abu Dhabi Investment

Council 70.48%

Other UAE nationals 27.08% GCC & Arab nationals 0.42%

Foreign nationals 2.02%

UAE Research


Loans by customer type - Q1 2010AED 1 = 137.2bn

39%

41%

19%1%

Govt. and Public Sector Corporate Sector Retail Banks

Loans by economic sectors - Q1 2010

12%

6%

16% 12%

6%

19%

13%

5%

5% 6%

Banks and FI Retail Trading EnergyReal Estate Construction Government ManufacturingTransport Services

NBAD has the best asset quality in the UAE –diverse loan book and low NPLs Loan portfolio is less risky and better diversified with majority exposed to the corporate and government/public sector. Retail loan exposure is limited at c19% of loan book.

Source: Company Presentation As we can observe from both the charts above, government and public sector loans comprise 39% of NBAD’s loan book which is the highest among UAE banks. Even within the corporate sector, the bulk of its exposure is to Tier I businesses in Abu Dhabi where we perceive the threat of default to be low. When we analyze the NBAD loan classification by economic sectors, we observe a good diversified mix, despite real estate and construction sectors accounting for combined 22% of the loan book. Earlier in the report, we discussed the loan composition of various GCC banking systems and highlighted that in the UAE, c49.6% of credit flowed to the real estate/contracting sector and personal lending last year, an area attached with significant risks given that decline in housing prices and exodus of expatriate population due to job losses could precipitate into higher loan losses. As per discussions with the management, the loan portfolio of NBAD did not undergo many changes in Q1 2010 as compared to Q4 2009 and its level of exposure to real estate/construction and personal loans stood at 41%, which is below the 49.6% we estimated at the system level.

Lowest NPL ratio among the top 9 banks in the UAE At the end of FY09, the NPL ratio of NBAD was the lowest in the UAE at 1.2% versus peer group average (top 9 UAE banks) at 3.2%. What makes this statistic credible is that NBAD follows the prudent 90 day rule in classification of past due loans whereas some UAE banks do not adhere to the 90 day rule. When we ran a stress test by classifying any loans past 90 days due as NPLs uniformly across all UAE banks, NBAD’s NPL ratio remained intact at 1.2% whereas the peer group average worsened to 4.0%. Secondly, even in terms of provision coverage, NBAD’s coverage stood at 160.9% last year versus peer group average of 87.1%. Strengthening the coverage ratio in NBAD’s case is adequate collective provisions at 1.25% of its CRWA. In the event of UAE Central Bank mandating any changes by advising all banks to allocate collective provisions equating to 1.25% of CRWA, we believe NBAD is least impacted since it already adheres to the proposed ruling. Other banks will be far stressed on account of this.

In our forecasts, we expect NBAD to show net credit growth of 6% in FY10e and 5.3% in FY11e mainly on the back of project financing deals such as EMAL, etc. On the NPL side, we expect the ratio to deteriorate slightly in the coming years particularly as more defaults are likely to be felt in the real estate portfolio. As a result, our expectation is for NPL to worsen to 2.3% by FY 2011e. This would require enhancements to provisioning based on our assumption that coverage ratio is maintained at around 170%.

UAE Research


Income mix

3,6084,571

5,238 5,302 5,640

1,285

1,2411,312 1,391

1,476

408

587

650 701756

-1,0002,0003,0004,0005,0006,0007,0008,0009,000

2008 2009 2010e 2011e 2012e

AE

D m

n.

NII Fee income Other income

Contribution to profits (Q1 2010)

21.4%

10.6%

19.2%49.6%

1.6%-2.4%

Domestic banking Financial markets International bankingCorp. & Inv. banking Islamic banking Head office

We would like to watch out for two areas. First is pertaining to NBAD’s European exposure. As per the company information, 12% of its loan book and 37% of its AFS investments was exposed to Europe at the end of Q1 2010 which we deem as the highest among UAE banks. Although management ascertains that these investments and loans belong to high quality names/issuers, we remain cautious that any further fallout in the European crisis could potentially raise some issues on the quality of these loans/investments in the medium term. The other area pertains to re-negotiated loans worth AED 3.18bn or 2.3% of its loan book at the end of FY09. These loans have been re-structured due to deterioration in borrower’s financial condition and we wait to see if there is any improvement in the health of these loans during the course of the next 12 months. Diversified income model with contribution from financial markets and international operations From the chart below (contribution to profits), we observe that various divisions are contributing towards profits with the major one being corporate and investment banking division. A unique component of NBAD that is virtually absent in the rest of the UAE banks is the contribution from international operations which accounted for 10.6% of profits in Q1 2010 and we expect this share to increase in the coming years as more branches are opened in Egypt, Oman and Sudan. Presently, Egyptian operation is the dominant one accounting for 40% of international banking profits with a loan book of AED 4bn as per management estimates. NBAD has 27 branches in Egypt and 8 branches in Oman. Plans are underway to open 2 more branches in Egypt this year and to have 14 branches in Oman by the year 2014.

Source: Company Financials, Presentation

Financial markets division consists of money markets, debt and capital markets, foreign exchange and portfolio management and this division contributed 19.2% of profits in Q1 2010. Since the start of the year, NBAD has been very active in bringing several senior executives on board in areas such as fixed income, project finance and advisory, wealth management and retail banking and management is hinting that the newly hired individuals are expected to increase the share of fee income business and provide expertise in structuring large complex deals in the area of project finance and investment banking. In our estimates, we opine the contribution from fee income at 19% of operating income and NII share at 72% with the rest 9% likely to come from other sources in our forecasting horizon although in the past, the contribution from fee income has been much higher. We attribute such high fee income in the past due to robust state of the capital markets aided by solid loan growth that resulted in generating fees related to processing of loans and banking charges which may not be sustainable.

UAE Research


Loan growth - historical and estimates

0

50

100

150

200

FY07 FY08 FY09 FY10e FY11e

AE

D b

n.

Government Public sectorBanks Corporate/private sectorRetail sector

Retail loans per branch - Abu Dhabi banks

0

20

40

60

80

100

120

ADCB NBAD FGB UNB ADIB

bran

ches

-

500

1,000

1,500

2,000

2,500

AE

D m

n.

Loans per branch

Access to wholesale funding; is where competition for deposits is severe One of the challenges we identified in the UAE banking system is the high LTD ratio (106% at the end of May 2010) which increases the competition among banks to secure their funding plans. The current scenario is such that it is difficult for the local banks to issue medium-term notes and raise wholesale funds as credit markets continue to be tight but NBAD is one of the few exceptions. Under its existing $5bn EMTN program, NBAD raised $750mn, 5 year term @ 4.25% in March 2010, having already raised $850mn @4.5% in September 2009 under the same program. Very recently, in June 2010, it raised 500mn Malaysian Ringitt or $155.9mn sukuk, 5 year term @4.75%. We believe all three fund raisings have come at a time when most banks in the region and specifically in the UAE are struggling to tap the bond/sukuk market in competitive terms.

As per the Q1 2010 funding breakdown of NBAD, time deposits accounted for 60%, current deposits accounted for 22%, savings and CDs accounted for 6% whilst medium-term funds accounted for 12% of total funding. Majority of NBADs customer deposits typically flow from government and public sector bodies by virtue of its long standing relationship with such entities. Medium-term funds amounted to AED 15.4bn at the end of Q1 2010 of which AED 3.5bn mature during the course of the year with a bullet AED 3bn in December 2010 but we do not foresee any problems for the bank in settling its obligations due to sufficient liquidity held in the form of cash and other investments (19.6% liquidity ratio at the end of Q2 2010). In our forecasts, we expect deposits to grow at 2.5% in FY 2010e and 5% in FY 2011e. The reason for the subdued deposit growth is due to AED 5.6bn customer deposits converted into subordinated notes which forms part of Tier II capital.

Retail loans – potential to achieve a higher market share NBAD fully understands that its retail market position is not as strong as where it should be (its retail loans per branch was AED 252mn last year vs. AED 475mn average for Abu Dhabi-based banks and well below that of FGB). In the past, the bank has concentrated on corporate and government sectors but going forward, the management is mindful that retail banking scene offers opportunities and hence is willing to focus on the same. The bank recently hired a veteran banker in-order to revamp its retail operations, improve its turn-around time and introduce new products.

Despite the fact that UAE has high percentage of expatriates and typically during a period of economic uncertainty, expatriate job losses can trigger loan defaults but we remain optimistic that among all the emirates Abu Dhabi should fare relatively better due to large number of expatriates employed in the government, oil and gas and essential services sectors such as utility, etc where job losses are fewer. NBAD has 103 branches of which 73 are located in the emirate of Abu Dhabi and hence already has the necessary branch infrastructure in place to achieve higher penetration in retail. Also we believe that once the capital market sentiment improve, the extensive branch network could be utilized to sell IPOs, insurance products, etc and bolster the cross-sell ratio overall. In our forecasts, we expect NBAD retail loans to show high single digit growth (8%-10%) even though statistics from UAE Central Bank has revealed flattish trend in personal loans offtake YTD.

Source: Company, BankMuscat Research

UAE Research


Valuation: Residual Income based target price (2010e) of AED 14.2 per share We value National Bank of Abu Dhabi using a residual income approach in which the intrinsic value of a bank is the sum of current NAV and the present value of future excess earnings. We use a risk free rate of 5% and a risk premium of 7% and apply a beta of 1x. Our cost of equity estimate therefore works out to 12%. We further assume a sustainable ROE of 18% and a terminal growth rate of 1.5% to arrive at a terminal value. Based on our assumptions, we value NBAD at AED 14.24 per share implying a potential upside of 29.5% and thus assign a BUY Rating.

NBAD trades at 8.8x 2010e earnings and 9.9x 2011e earnings. The P/BV (2010e) works out to 1.2x, which is at a 25% discount to the regional banks average of 1.6x. Our target price implies a P/E (2010e) and P/BV (2011e) of 11.4x and 1.6x respectively which is far closer to the regional peer group average.

The strength in capital adequacy (Total CAR of 21.4% and Tier I CAR of 14.9%) as well as high ROE (last 5 year average in excess of 25%) makes NBAD a rare low-leverage, high return play and hence we opine that the bank should command premium valuation over its competitors. Whilst we agree that the high ROE may not be sustainable over the next two to three years as provisions are likely to bear on profits, nevertheless pre-provisioning profit will remain strong in the medium-term which will assist in absorbing credit impairments. In summary, we favor NBAD due to the following reasons: 1) superior asset quality with NPLs likely remaining at subdued level relative to its domestic peers; 2) access to government business in the form of deposits and deal underwriting through private-public partnership initiatives; 3) diversified income model attributable to balance sheet related activities, international expansion; 4) potential enhancements to fee income should there be any bounce in capital market activities due to strong track record and recent strengthening of human resources; and 5) under penetrated retail franchise with opportunities to leverage from extensive branch network by focusing on turnaround time and customer satisfaction.

UAE Research


FINANCIALS AND FORECASTS– NATIONAL BANK OF ABU DHABI

Source: Company financials, BankMuscat Research

UAE Research


FIRST GULF BANK (FGB)

August 12, 2010 CMP: AED 14.00

Target price: AED 25.6 Banking and Financial Services First Gulf Bank (FGB) was established in 1979 and initially headquartered in the emirate of Ajman, but in late 1990’s, majority of its shares changed hands and came under the control of members of ruling family in Abu Dhabi. A new management team immediately came on board that since has played a key role in transforming the bank to profitability and growth purely through organic means. Investment positives

- FGB leads the pack in terms of efficiency among all UAE banks – cost-income,

profit per employee, retail loans per branch are all favorable due to its low-cost base

- Management adopts proactive approach - benefited significantly during the real estate boom but now looking to consolidate its balance sheet and enhance its share in relatively safer segments such as government and corporate sector. Board of Directors has been stable since 2006 and understands the current economic challenges well

- Low gearing, high ROE play – Capital adequacy is among the highest in the UAE

banking sector yet does not dilute the proposition to generate above average ROE due to higher yielding retail assets supported by stable funding structure

- Support from Abu Dhabi royal family remains high – Even though the

government of Abu Dhabi has limited direct ownership in the bank, members of Abu Dhabi ruling family own 2/3rd stake in the bank giving sufficient advantage to FGB to procure business from government/public sector and UHNWIs

Risk factors

- Aggressive retail loans build-up in recent years could haunt asset quality in the

future years though the mitigating factor is that majority of loans are disbursed to UAE nationals (82%), a demographic segment where we see fewer job losses

- Of the total investment properties amounting AED 6.6bn (5% of assets at the end Q2 2010) only 20% is generating rental income with the rest 80% comprising development properties/ land potentially facing mark-downs if prices wilt further

- Weaker investment banking franchise relative to its competitors such as NBAD and

ENBD would make it difficult for FGB to execute complex deals in the project finance/syndication space should such opportunities arise

Valuation - We value First Gulf Bank using residual income method at AED 25.6 per share (2010

target price) translating to a potential upside of 83% from current market price and thus assign a BUY rating


Recommendation BUY

Stock Details Exchange / Code ADX/FGB Bloomberg Code FGB

Equity Capital AED 1.375bn Face Value AED 1

52-Week H/L AED 19.45 / 12.60 Market Cap AED 19.25bn

Shareholding Pattern Ruling family members 66.7%

Other UAE nationals 19.48% GCC & Arab nationals 5.44%

Foreign nationals 8.38%

UAE Research


Cost-income ratio (FY 2009)

0%5%

10%15%20%25%30%35%40%

NBADADCB

FGB

UNBADIB

ENBDDIB

Mash

req CBD

FGB C-I lowest in the industry

Profit per employee - FY 2009

(1,000)(500)

-500

1,0001,5002,0002,5003,0003,5004,000

NBADADCB

FGB

UNBADIB

ENBDDIB

Mashreq CBD

Prof

it in

A

ED

mn.

(1)

-

1

2

3

4

Prof

it pe

r em

ploy

ee

AE

D m

n.

FGB clear winner

FGB is clearly the most efficient bank in the UAE FGB is the most efficient bank, in our view, in the UAE. The cost-income ratio of FGB stood at 18% at the end of FY 2009 and well below the average of 29% taken across the top 9 UAE banks. Even in terms of employee efficiency, FGB is again superior with profit per employee at AED 3.4mn last year as against the same peer group average of AED 793k. Part of FGB’s success can be attributed to outsourcing of its sales representatives and gaining retail market share through the direct sales representatives as opposed to aggressively opening new branches, which is the common distribution channel adopted by most banks. This has helped FGB to achieve the highest branch utilization with personal loans per branch recorded at AED 2bn last year. By outsourcing its retail sales function and limiting the number of branches, FGB is also able to save considerable costs relative to its competitors. Secondly, the same strategy works well during economic uncertainties particularly in a weakening outlook for personal loans. FGB now has the flexibility in planning its staffing requirements based on the level of demand it perceives whereas other banks would be burdened with relatively rigid staff costs besides incurring branch running costs. At the end of Q2 2010, FGB had 19 branches and staff strength of 895. Outsourced sales agents include 1,250.


Management proactive – enjoying a decade of success Although FGB has been in existence since 1979, the turnaround started happening only in late 1990s when the ruling family of Abu Dhabi took a majority stake in the bank who then appointed a new management team. Currently, ruling family owns 67% of the bank. The bank is headed by H.H. Sheikh Hazza Bin Zayed Al Nahyan as the Chairman and H.H. Sheikh Tahnoon Bin Zayed Al Nahyan as the Vice-Chairman, two very influential members of the royal family. In addition, quite a few board members have representation in prominent Abu Dhabi institutions such as ADNOC, ALDAR, Dolphin, Mubadala, ADIA, etc. through board seats or as senior management personnel. The existing board of FGB has been stable since 2006 and the support from Abu Dhabi royal family is very high. Mr. Abdul Hamid Saeed, a veteran banker with over 26 years experience in banking, 18 years of which were with Citibank heads the management team as MD.

FGB benefited immensely from real estate and personal lending during the recent years which resulted in rapid expansion of its credit book. It created subsidiaries and associates – Mismak (100% owned property development company), Green Emirates (40% owned property management and real estate brokerage) and Aseel Finance (40% owned Islamic mortgage finance provider) so that it could fully leverage from the real estate boom in the UAE. However, management is mindful of the current economic situation and discussions with management seem to indicate that in the short-term the core focus is on balance sheet management through appropriate liquidity and capitalization levels and improving the asset quality.

UAE Research


Income by segments - FY 2007

0%

23%

26%29%

3%

19%

Corporate Retail Treasury & Inv.Subs & Assoc. Real Estate Others

Income by segments (Q1 2010)

37%

40%

8%

13%2%

Corporate Retail Treasury & Inv. Subs & Assoc. Others

Despite the rapid credit growth, NPL ratio of FGB (2.5% at the end of Q2 2010 and 1.6% at the end of FY09) is below the peer group average. In the event UAE Central bank mandates banks to follow 90 day NPL recognition, NPL ratio though would worsen to 3.3%, coverage ratio would still be healthy at 81.7% (above the system average of 68.5%), an exercise we did based on FY 2009 statements of UAE banks. Assuming the apex body also makes it mandatory for banks to allocate 1.25% of CRWA as collective provisioning, FGB is likely to benefit since it is the only bank in the peer group with more than adequate collective provisions and hence will not be impacted by this ruling.

Strategy flexible to suit economic cycle yet concentration on core business remains high The following two charts present drastic differences in the revenue pattern of FGB. In FY07, whilst FGB was still building its loan book and developing the infrastructure needed for retail banking penetration, it became active in treasury & investments and real estate segments (quicker sources of revenue generation) which together accounted for 48% of its total revenue.


However, the revenue pattern since then has shifted towards core-income with Q1 2010 revenue mix clearly highlighting the core business strength of FGB where retail and corporate banking segments together accounted for 87% of total revenue. Although the contribution from real estate is classified under the subs & associate category, core banking activities nevertheless remains strong, accounting for nearly 80% of the net profit. This is as a result of the aggressive build up in its loan book during the years 2006-2008 even as FGB cashed-in from robust capital markets and buoyant domestic real estate market which offered interim opportunities. For reference, net loans grew by 85% in FY06, 76.5% in FY07 78.7% in FY08 before slowing to 13.9% growth in FY09. In our forecasts, we opine a credit growth of 8.2% in FY10e but this should settle in the range of high single digits during the years FY11e and FY12e as the bank evolves from high growth phase to a matured phase. Secondly, the economic cycle itself might not be as vibrant as in the past which means FGB and other banks in Abu Dhabi might have to contend with lower growth rates in the medium term.

Funding mix steady over time Despite changes on the revenue composition, the liabilities and funding mix has remained relatively steady over time with customer deposits typically accounting for 68-69% of all funding sources since 2008 through Q1 2010. The top 5 depositors accounted for 32% of all deposits at the end of FY09 (similar level in FY08) indicating that deposit concentration remains high but these deposits sources have remained ‘sticky’. Importantly, these deposits flowed in from members of royal family with the intent on providing funding support for the bank and hence we do not perceive any threats to the liquidity or shortfall in deposits. We forecast deposit growth at 8% in FY10e and 8.5% in FY11e given that funding is less of a challenge to address for FGB than some of the other UAE banks.

UAE Research


Loans by sector - Q1 2010Total loans = AED 93.3bn

39%

5%8%17%

23%

4%3% 1%

Personal Share financing Govt. & PublicServices Real Estate & Const. TradingManufacturing Transport

Property portfolio - Q1 2010Total = AED 6.3bn

6%

31%12%

30%21%

Dev. Prop. Abu Dhabi Dev. Prop. Dubai Land - Abu DhabiLand - Dubai Rental Prop.

Firstly, should a genuine up tick arise in the credit environment, we believe FGB along with NBAD are in a better position to fund their loan book due to their proximity to their respective shareholders and other stakeholders in Abu Dhabi and therefore should raise funds more easily than their. Secondly, FGB can offer more competitive rates to lure deposits given that it’s NIM are at the higher end in UAE banking sector at 3.6% last year. Therefore, it has the capacity to undergo compressions in margins for the sake of achieving higher credit growth and/or gaining market share from its competitors as the case may be. With regards to FGB’s term loans, it successfully repaid $750mn and raised $650mn ($150mn loan from a foreign bank @2.85% and $500mn @4% payable semi-annually) last year which ensured its wholesale borrowings remained in balance. Additionally, as with several Abu Dhabi banks, customer deposits worth AED 4.5bn from government were re-categorized as subordinated loan. Although majority of FGB’s term loans mature in FY11e and FY12e, we do not see the bank having any difficulties in settling its obligations given that the size of repayments is not material.

Real estate and retail – two areas where we remain watchful Personal loans or retail banking assets comprised nearly 44% of total loans at the end of Q1 2010 and contributed 40% to the revenue line which we regard as high, particularly as queries on asset quality could arise in the future as the job and business environment could get murkier in the UAE. There are however two mitigating aspects to this. First, nearly 82% of retail loans are extended to UAE nationals and only 18% to expatriates, an inverse proportion to UAE’s demographic mix which is comprised of 80% expatriates and 20% UAE nationals. We do not foresee any job losses or discontinuity in loans extended to UAE nationals since majority are typically employed in the oil and gas companies or other public sector enterprises where job security is typically high. Second, nearly 25% of retail loan portfolio consists of housing loans to UAE nationals under a joint program between Abu Dhabi government and FGB. Essentially this program is to fund interest-free housing loans for UAE nationals but the framework allows FGB to cross-sell other banking products and increase the proportion of its mortgage loans to the same clients. Despite the mitigating factors, we believe retail portfolio could pose challenges and therefore envisage NPLs to increase to 4.4% in FY10e (the other reason for upward projection in NPL is to classify loans past due 90-180 days but performing into non-performing category) and 5.8% in FY11e. With regards to property portfolio worth AED 6.6bn at the end of Q2 2010, more than 60% value is concentrated in Abu Dhabi where supply-demand mismatch is not as pronounced as Dubai but nevertheless, the portfolio is subject to price adjustments and hence mark-downs could impact profitability going forward. Source: Company, BankMuscat Research

UAE Research


Valuation: Residual Income based target price (2010e) of AED 25.63 per share Similar to National Bank of Abu Dhabi, we value First Gulf Bank using a residual income approach in which the intrinsic value of a bank is the sum of current NAV and the present value of future excess earnings. We use a risk free rate of 5% and a risk premium of 7% and apply a beta of 1x. Our cost of equity estimate therefore works out to 12%. We further assume a sustainable ROE of 18% and a terminal growth rate of 1.5% to arrive at a terminal value. Based on our assumptions, we value FGB at AED 25.63 per share implying a potential upside of 83% and thus assign a BUY Rating. However, our target price estimate is sensitive to both cost of equity and terminal RoE assumptions. At a higher cost of equity (14%) and lower terminal RoE (14%), the target price estimate drops to AED 17.45 which is closer to the current market price implying little upside based on the two sensitive parameters. FGB trades at 6.3x 2010e earnings and 6.7x 2011e earnings. The P/BV (2010e) works out to 0.8x, which is at a 50% discount to the regional banks average of 1.6x. The implied P/E (2010e) and P/BV (2010e) work out to 11.5x and 1.5x respectively which is closer to the regional peer group average.

Capital adequacy for FGB is among the highest in the UAE at 23.3% (Q2 2010) yet RoE has averaged 20% in the past three years. The profitability in the near term could be dented by higher provisioning as quality of retail assets is tested, a likely consequence of rapid credit expansion in recent times. Despite that challenge, revenue generation is still likely to be strong and will absorb any impairment within the credit portfolio. The high RoE is a result of higher yielding retail assets supported by a stable funding structure and low cost base. Overall, we like the positioning of FGB and the support it enjoys from royal family, securing its business connections.

Peer valuation

Source: Bloomberg Consensus Estimates; BankMuscat Equity Research Note: 2010e and 2011e numbers for Omani Banks (excl. BKMB); SABB; RIBL and SHB are our estimates while others are consensus estimates

2010e 2011e 2010e 2011e 2010e 2011e 2010e 2011e 2010e 2011e 2010e 2011eQat. National Bank 10.6x 9.1x 2.4x 2.1x 23.8% 23.3% Bank Muscat 10.6x 8.3x 1.5x 1.3x 14.6% 15.7%Qat. Islamic Bank 9.2x 7.8x 1.9x 1.7x 17.9% 20.0% Bank Dhofar 17.0x 14.9x 2.6x 2.3x 15.0% 15.4%Comm. Bank Of Qatar 9.5x 7.9x 1.4x 1.3x 13.9% 15.9% Nat. Bk. Of Oman 9.9x 8.5x 1.4x 1.3x 14.3% 15.5%Rayan 12.1x 10.7x 1.5x 1.5x 13.7% 14.2% Oman Int. Bk. 11.5x 11.0x 1.5x 1.5x 12.9% 13.4%Doha Bank 8.2x 6.8x 1.5x 1.3x 17.7% 19.5% Bank Sohar 17.9x 14.4x 1.9x 1.7x 11.2% 12.5%Intl. Islamic Bank 9.6x 7.7x 1.6x 1.5x 16.6% 19.8% Ahli Bank 15.7x 12.2x 1.9x 1.8x 13.5% 16.3%Mean 9.9x 8.3x 1.7x 1.6x 17.3% 18.8% Mean 13.8x 11.6x 1.8x 1.7x 13.6% 14.8%Median 9.6x 7.8x 1.6x 1.5x 17.2% 19.7% Median 13.6x 11.6x 1.7x 1.6x 13.9% 15.5%

2010e 2011e 2010e 2011e 2010e 2011e 2010e 2011e 2010e 2011e 2010e 2011eAl Rajhi Bank 16.4x 13.1x 3.8x 3.3x 23.6% 26.7% National Bank of AD 8.0x 6.7x 1.4x 1.2x 18.4% 19.0%Samba Financial Group 11.5x 9.7x 2.1x 1.9x 19.5% 19.9% First Gulf Bank 6.0x 4.6x 0.9x 0.9x 16.0% 18.6%Riyad Bank 13.7x 12.3x 1.4x 1.3x 10.6% 10.9% Emirates NBD 5.9x 3.7x 0.5x 0.5x 7.6% 12.0%The Saudi British Bank 15.2x 12.4x 2.3x 2.1x 16.1% 17.7% Dubai Islamic Bank 7.9x 6.2x 0.8x 0.7x 11.0% 11.2%Banque Saudi Fransi 11.1x 9.7x 1.9x 1.7x 17.7% 18.2% AD Commercial Bank - 5.7x 0.5x 0.6x 0.3% 8.3%Arab National Bank 11.5x 9.7x 1.6x 1.5x 15.2% 15.5% Union National Bank 5.7x 4.7x 0.7x 0.6x 12.8% 13.8%Saudi Hollandi Bank 20.0x 16.2x 1.9x 1.7x 9.6% 11.0% AD Islamic Bank 6.8x 4.5x 1.1x 0.9x 15.2% 20.6%The Saudi Investment Bank 18.8x 11.7x 1.2x 1.1x 6.7% 10.1% Mean 6.7x 5.2x 0.8x 0.8x 11.6% 14.8%Bank AlBilad 46.4x 23.6x 1.9x 1.7x 4.2% 7.6% Median 6.4x 4.7x 0.8x 0.7x 12.8% 13.8%Bank AlJazira 33.5x 13.6x 1.1x 1.1x 3.4% 8.0%Mean 19.8x 13.2x 1.9x 1.7x 12.6% 14.5%Median 15.8x 12.4x 1.9x 1.7x 12.9% 13.2% 2010e 2011e 2010e 2011e 2010e 2011e

Ahli United Bank 11.5x 8.9x 1.4x 1.3x 12.4% 14.8%National Bank of Bahrain 10.0x 9.4x 2.0x 1.8x 18.9% 18.4%

2010e 2011e 2010e 2011e 2010e 2011e Bahrain Islamic Bank 18.2x 9.4x 0.8x 0.8x 4.0% 7.2%National Bank Of Kuwait 12.5x 11.1x 2.0x 1.8x 16.5% 18.3% Gulf Finance House - - 0.7x 0.7x -5.0% -1.5%Commercial Bank Of Kuwait 38.7x 15.6x 2.4x 2.2x 4.3% 13.9% Mean 13.2x 9.2x 1.2x 1.1x 7.6% 9.7%Al-Ahli Bank Of Kuwait 16.0x 13.4x 1.6x 1.5x 11.4% 11.3% Median 11.5x 9.4x 1.1x 1.0x 8.2% 11.0%Burgan Bank 17.2x 11.3x 1.1x 1.0x 7.2% 9.5%Kuwait International Bank 30.1x 17.7x 1.2x 1.1x 4.5% 7.2%Mean 22.9x 13.8x 1.6x 1.5x 8.8% 12.0% Combined Mean 14.9x 10.4x 1.6x 1.4x 12.3% 14.5%Median 17.2x 13.4x 1.6x 1.5x 7.2% 11.3% Combined Median 11.5x 9.7x 1.5x 1.4x 13.6% 15.1%

BAHRAIN BANKS PE PB

PE PB ROE %

ROE %

KUWAIT BANKS PE PB ROE %

UAE BANKS

QATAR BANKS

SAUDI BANKS PE PB ROE %

ROE %ROE %PE PB PE PBOMAN BANKS

UAE Research


FINANCIALS AND FORECASTS – FIRST GULF BANK

Source: Company financials, BankMuscat Research

Income Statement (AED mn) FY08 FY09 FY10e FY11e

Interest income 4,957 6,490 6,585 6,946

Y-o-Y Growth 37.6% 30.9% 1.5% 5.5%

Interest expense 2,377 2,656 2,560 2,877

Y-o-Y Growth 4.6% 11.8% -3.6% 12.4%

Net Interest income 2,581 3,834 4,025 4,069

Y-o-Y Growth 93.8% 48.6% 5.0% 1.1%

Fee Based Income 1,152 1,211 1,456 1,354

Y-o-Y Growth 130.5% 5.1% 20.3% -7.0%

Fees from banking services, net 1,114 1,207 1,274 1,350

Other operating income 38 3 182 4

Investment & Trading Income 809 1,090 725 756

Y-o-Y Growth -12.3% 34.8% -33.5% 4.2%

Total Fee Based Inc. Incl. Inv.& trading 1,961 2,301 2,181 2,110

Y-o-Y Growth 37.9% 17.4% -5.2% -3.3%

Total Income 4,542 6,135 6,207 6,180

Y-o-Y Growth 65.0% 35.1% 1.2% -0.4%

Total Operating Expenses 1,135 1,081 1,140 1,200

Y-o-Y Growth 85.8% -4.8% 5.5% 5.3%

Total Operating Income 3,407 5,054 5,067 4,980

Y-o-Y Growth 59.0% 48.4% 0.2% -1.7%

Share in earnings of associates 157 29 5 5

Profit before LLP and Inv Impairments 3,564 5,083 5,072 4,985

Y-o-Y Growth 60.9% 42.7% -0.2% -1.7%

Provision for credit losses, net 566 1,680 2,021 2,123

Impairment of other financial assets - 90 - -

PBT 2,997 3,313 3,052 2,863

PAT 2,997 3,313 3,052 2,863

Y-o-Y Growth 49.3% 10.5% -7.9% -6.2%

Shares 1,375 1,375 1,375 1,375

EPS on Current Shares 2.18 2.41 2.22 2.08

Balance Sheet (AED mn) FY08 FY09 FY10e FY11e

Cash and balances with Central Bank 5,005 5,547 8,892 13,200

Due from banks and other financial institutions 2,837 4,627 3,933 4,129

Investments, net 9,980 13,482 16,178 16,502

Y-o-Y Growth -1.3% 35.1% 20.0% 2.0%

Loans and advances, net 79,363 90,386 94,217 98,551

Y-o-Y Growth 78.7% 13.9% 4.2% 4.6%

Investment in associates 553 561 567 572

Investment properties 3,991 6,000 6,600 6,600

Property and equipment, net 2,012 639 664 689

Other assets 3,780 4,231 5,161 6,194

Total assets 107,522 125,473 136,213 146,437

Due to banks and other financial institutions 7,313 1,941 1,979 2,108

Customer deposits 73,963 86,422 93,336 101,269

Y-o-Y Growth 41.5% 16.8% 8.0% 8.5%

Debt securities in issue - - - -

Borrowings 5,785 9,820 11,293 11,293

Other liabilities 3,842 4,387 4,541 4,518

Total liabilities 90,903 102,570 111,149 119,188

Share capital 1,375 1,375 1,375 1,375

Treasury shares (45) (199) (413) (413)

Capital notes - 4,000 4,000 4,000

Statutory reserve 5,305 5,305 5,305 5,305

Mandatory convertible bonds 3,600 3,600 3,600 3,600

Retained earnings 4,546 6,835 9,209 11,395

Proposed Dividends 477 677 677 677

Total shareholders’ equity 16,245 22,518 24,679 26,864

Minority interest 374 385 385 385

Total liabilities and shareholders’ equity 107,522 125,473 136,212 146,437

Ratios FY08 FY09 FY10e FY11eGrowth Ratios (Y-o-Y)Total Assets 46.9% 16.7% 8.6% 7.5%Net Loans 78.7% 13.9% 4.2% 4.6%Customer Deposits 41.5% 16.8% 8.0% 8.5%Net Profit 49.3% 10.5% -7.9% -6.2%Equity/Assets 15.1% 17.9% 18.1% 18.3%MarginsOperating profit/NII 132.0% 131.8% 125.9% 122.4%PAT/NII 116.1% 86.4% 75.8% 70.3%EarningsROAA 3.3% 2.8% 2.3% 2.0%ROAE 22.7% 17.1% 12.9% 11.1%LiquidityNet Loans/Customer Deposits 107.3% 104.6% 100.9% 97.3%Customer Deposits/Equity 4.6x 3.8x 3.8x 3.8xCustomer Deposits/Total assets 68.8% 68.9% 68.5% 69.2%Liquid Assets / Total Assets 13.9% 15.2% 18.4% 20.3%Due from Banks/Due to Banks 38.8% 238.4% 198.7% 195.9%EfficiencyCost to Income 25.0% 17.6% 18.4% 19.4%Credit QualityNPL/Gross Loans 0.6% 1.6% 4.3% 5.7%Provision Coverage Ratio 232.9% 174.4% 100.0% 100.0%Cost of risk 0.9% 1.9% 2.1% 2.1%Provisions / Gross Loans 1.4% 2.7% 4.3% 5.7%ValuationP/E 6.3x 6.7xP/BV 0.8x 0.7xImplied P/E 11.5x 12.3xImplied P/BV 1.5x 1.4x

25.6 14.0% 16.0% 18.0% 20.0% 22.0%10.0% 25.51 29.55 33.58 37.61 41.6411.0% 22.39 25.69 28.98 32.28 35.5712.0% 20.18 22.90 25.63 28.35 31.0813.0% 18.59 20.87 23.14 25.42 27.7014.0% 17.45 19.37 21.29 23.21 25.12

Terminal Return on Equity

Cos

t of E

quity

UAE Research


Regulatory framework for UAE banks Capital adequacy Minimum capital adequacy of 8% is required as per Basel norms and 10% is required as per UAE Central Bank norms. However, this was changed recently with UAE Central Bank raising the minimum CAR to 11% in September 2009 (7% on Tier I) and further increasing the same to 12% by the end of June 2010 (8% on Tier I). Loans to Stable Resources Ratio Minimum ratio of loans and advances to stable resources is 100%. The numerator comprises loans and advances (including inter-bank placements with greater than 3 months in maturity); while denominator comprises free capital and reserves, inter-bank borrowings with greater than 6 months remaining maturity and 85% of customer deposits. The UAE Central Bank is contemplating change on this and could possibly advise banks to adhere to plain vanilla advances to deposit ratio, as is the case with other GCC Central Banks. Classification of loans The UAE Central Bank advises banks to categorize loans into classified and unclassified ones. Classified loans include sub-standard, doubtful and lost loans. Sub-standard and doubtful loans require partial provisioning whilst lost loans require full provisioning. Non-classified loans include normal risk and medium risk loans and no provisions are required for such loans. Although majority of UAE banks adhere to the 90 day NPL policy, UAE Central Bank is targeting a change which will make it compulsory for banks to classify loans past 90 days due as NPL. Along with this targeted change, UAE Central Bank also may advise banks to allocate collective provisions at a stipulated percentage of RWA or CRWA.

Single Party Limits For personal loans, capped at AED 250k or 40% of salary, whichever is lower. Personal loans are defined as those backed by salaries or end of service benefits. Unsecured personal loans such as cards and consumer loans secured by non-salary items are not limited. Funded exposures to public sector commercial companies may not exceed 25% of bank’s equity. This limit is 7% for private sector borrowers (although banks often seek exception to this regulatory constraint) Cash Reserve Ratio 14% of current, saving and call amounts, 1% on time deposits. Reserve requirement is reported on a 6 day average and at the end of the month. In addition, banks are also required to keep with the UAE Central Bank 30% of their AED deposits held abroad with non-resident banks (including head offices and branches, in the case of foreign banks) Related party exposures Funded exposures to shareholders who hold more than 5% of equity should not exceed 7% of a bank’s capital. Lending to individual bank directors is restricted to 5%, with the sum of all lending to 25% of capital Proprietary Investments - Limits Bank securities holdings are restricted to 25% of equity, unless acquired in settlement of debt in which case the excess must be sold within 2 years. Banks also differentiate between investment in affiliates, held till maturity, available for sale and trading investments. Government securities are exempted from this limit. Real Estate – Lending Limits Lending for the purpose of construction (commercial, residential or administrative building) is capped at 20% of bank’s total deposits (although banks often seek exception to this regulatory constraint).

UAE Research


Stock Purchases – Lending Limits Banks may lend up to 70% of the book value of shares for newly established companies (existence for 5 years or less) and 80% of the market value of the shares for companies in existence for more than 5 years. Swap arrangements Swaps involve an outright foreign exchange sale by a commercial bank at spot price and the injection of equivalent AED liquidity. The foreign exchange assets is to be repurchased at a specified future date for a period of 1 week, 1 month or 3 months. Swap facility is only available to those banks that maintain a net long AED position in the previous month Certificates of Deposits CDs are issued by the UAE Central Bank as a liquidity management tool which is driven by the bank’s demands with excess liquidity in short-term maturities. Statutory Reserve As per UAE Commercial Companies Law No. 8 of 1984 (post amendment), banks are required to transfer 10% of their annual profit until it equals 50% of the paid up capital and is not available for distribution to shareholders. Special Reserve As per Union Law No. 10 of 1980, 10% of net profit is to be transferred to the special reserve until it equals 50% of the paid up capital and is not available for distribution to shareholders. Basel II accord Implementation will be phased, with banks expected to be compliant with the standardized approach for credit risk by 31 December 2007. All banks are expected to be IRB compliant by 1 January 2011. Disclosures All publicly listed banks are bound by the disclosures of the federal law no. 4 of 2000 (post amendment). With regards to stock market exposures, banks report their direct and indirect exposure to the UAE Central Bank on a quarterly basis. IPO Finance Loans extended to subscribers in IPOs against an undertaking to pledge their shares should not exceed 10% of the nominal value of the shares, except in the case where the receiving bank undertakes to refund the excess funds directly to the lending bank. In such case, lending may be extended to 5x the amount contributed by subscriber. Anti-Money-Laundering measures Banks must obtain maximum information on account holders and borrowers and report any unusual and suspicious banking transactions to the UAE Central Bank, in accordance with the Financial Action Task Force (FATF) guidelines. Over Drafts for Banks UAE Central Bank can provide banks with advances for up to 7 days without collateral and for up to 6 months against collateral. The penalty on overdrafts in current accounts is set at a rate equivalent to prevailing 3 months inter-bank rate + 5% p.a. with a minimum of AED 250/day.

UAE Research


Appendix 1: Major projects ongoing and planned in Abu Dhabi (Source: Zawya)

UAE Research


Disclosure The author(s) certifies(y) that the opinion(s) on the subject security (ies) or issuer(s) and any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report. We also certify that neither the analyst nor his/her spouse or dependants (if relevant) hold any beneficial interest in the security (ies) mentioned in this report.

Disclaimer This report is not directed to, or intended to or use by, any person or entity who is a citizen of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject BankMuscat (SAOG) to any registration or licensing requirements within such jurisdiction. This report is provided for information purposes only. The report is based on information generally available and is deemed reliable but no assurance is given as to its accuracy or completeness. BankMuscat (SAOG) is not accountable for any decision based on the contents of this report. The investor will indemnify BankMuscat and its directors, officers, employees and staff against any loss or damage or other liabilities (including costs), which they may suffer as a result of reliance on such reports. Neither the information nor the opinions contained are to be construed as an offer to buy and sell securities mentioned above. This report is not to be relied upon in substitution for the exercise of independent judgment. Investors should judge the suitability of the securities to their needs. BankMuscat makes no representation that the preparation or distribution of this report is in compliance with the legal requirements or regulations of any jurisdiction, and it disclaims all liability in case the preparation or distribution of this report is found to be non-compliant with any such legal requirements or regulations. BankMuscat (SAOG), may to the extent permitted by law, participate or invest in financing transactions with the issuer(s) of these securities referred to in this report, perform services for or solicit business from such issuers, and/or have position or effect transactions in the securities or option thereon. In addition, it may make markets in the securities mentioned in the material presented in the report. BankMuscat (SAOG) may, to the extent permitted by law, act upon or use the information or opinions presented herein, or the research or analysis on which they are based, before the material is published. BankMuscat (SAOG) may have, within the last three years, served as manager or co-manager of a public offering of securities for, or currently may make a primary market in issues of, any or all of the companies mentioned in this report.

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