Banking UAE National Bank of Abu Dhabi (NBAD)

Banking – UAE

National Bank of Abu Dhabi (NBAD)

Initiation of Coverage

30 September 2010

May El Haggar Lamia El Etriby

+202 3303 7766 Ext. 2220 +202 3303 7766 Ext. 2209

[email protected] [email protected]

1

Recommendation

BUY

Market Price (AED) 11.8

Fair Value (AED) 15.9

Upside Potential 35%

ADX Index 2,660.9

Stock Data

Reuters Code NBAD.AE

Bloomberg Code NBAD UH

Shares Outstanding (m) 2,392

Market Cap (AEDm) 28,222

Market Cap (USDm) 7,684

Free Float (%) 29.5%

Free Cap (AEDm) 8,331

52-week range (AED) 12.45-11.80

Avg. Trading Volume (’000s) 299,721

Foreign Ownership Limit 25%

NBAD vs. ADX Rebased

Source: Bloomberg, Naeem Research

Safety First – BUY

We initiate coverage on NBAD with a BUY. Our DCF-based

target price of AED15.9/share offers an upside of 35% from

current levels. NBAD has shown more resilience than peers

have during the financial crisis, with its asset quality

holding up and a stable client base. NBAD has the lowest

NPL ratio among peers at 1.5%. Due to its close ties with

the government, NBAD’s recent asset growth was largely

driven by government/public and corporate lending;

however, it is now looking to expand its retail and Islamic businesses, in addition to increasing international presence.

Better placed than local peers. NBAD has not suffered as much

as its peers have from the financial crisis. This is due to its having

a solid client base, largely comprising government and public

sector entities and private corporations, and its diversified loan

book. This helped asset quality to stay intact where, despite an

increase, it still has the lowest NPL ratio among peers. NBAD also

has good access to the wholesale lending market, which helps it to secure diverse sources of funding at reasonable prices.

Well-positioned for future growth. NBAD’s high asset quality,

strong capital base, close relationship with the government, and

good access to funds give it the wherewithal to capitalise on

growth opportunities arising from an economic recovery. NBAD

plans to build exposure along different business lines such as retail, SMEs, and wealth management that will diversify revenue.

Valuation indicates good upside. Our DCF-based fair value (using

an excess equity return model) is AED15.9/share, which offers an

upside of 35% from current levels. On a comparable basis, NBAD

trades at a discount relative to regional peers on a PBV 2011f basis,

but at a premium to local peers. We believe that it deserves this

premium due to its higher asset quality, solid client base, and

potential for growth in new segments such as retail and SMEs.

Financial indicators and valuation multiples

Year to 31 Dec 2008a 2009a 2010f 2011f 2012f

NII (AEDm) 3,608 4,442 4,676 4,984 5,768

Net Profit (AEDm) 3,019 3,020 3,814 4,126 4,859

EPS (Basic) 1.26 1.26 1.59 1.73 2.03

EPS (% YoY) 21% 0% 26% 8% 18%

PER (x) 9.3 9.3 7.4 6.8 5.8

PBV (x) 1.6 1.3 1.2 1.0 0.9

Dividend yield (%) 2.5 0.8 1.3 1.7 2.1

NIM (%) 2.4 2.5 2.3 2.4 2.5

ROAE (%) 23.6 17.4 17.2 16.1 16.5

ROAA (%) 2.0 2.0 1.9 2.0 2.1

Based on NBAD’s closing price as of 29 September 2010.

Source: Company data, Naeem estimates

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NBAD ADX Rebased

Banking – UAE

National Bank of Abu Dhabi (NBAD)

Initiation of Coverage

30 September 2010

May El Haggar Lamia El Etriby

+202 3303 7766 Ext. 2220 +202 3303 7766 Ext. 2209

[email protected] [email protected]

2

Table of Contents

03 Better Placed than Local Peers

03 UAE Banks – Hanging in There

06 NBAD – Highest Asset Quality among Peers

09 Good Access to Funding Supports Liquidity Position

12 Well-positioned for Future Growth

12 Focus on New Services

15 New Services to Diversify Revenue Streams

18 Valuation Indicates Good Upside

18 DCF Valuation

18 Relative Valuation

20 Financial Summary

21 Disclosure Appendix

3

NATIONAL BANK OF ABU DHABI (NBAD)

Better Placed than Local Peers

Tight liquidity – one

of many woes

UAE BANKS – HANGING IN THERE

UAE banks have endured a tough operating environment over the past two

years with market conditions deteriorating well before the global economic

crisis reached its peak. First was a liquidity squeeze in mid-2008 that resulted

from hot money speculating on an AED de-peg from the USD fleeing the

banking system after it became obvious that the peg was to remain.

Approximately AED160bn worth of deposits left banks in 3Q08, resulting in the loan-to-deposits ratio (LDR) surging to 110% from 100% in 2007.

The government intervened to

support liquidity

However, the Abu Dhabi government has since taken several steps to support

banks’ liquidity, the most prominent of which was the c. AED70bn that the

Ministry of Finance injected in the form of deposits and later converted into Tier

II debt, thereby bolstering banks’ capital bases.

The government also injected further capital into large banks in the form of Tier I Perpetual Capital Notes.

Fig. 2: Capital injected by Government (AEDm)

Bank Tier I Capital Tier II Capital

Emirates NBD 3,500 11,502

Abu Dhabi Commercial Bank 4,000 6,617

National Bank of Abu Dhabi 4,000 5,606

First Gulf Bank 4,000 4,510

Mashreq Bank - 3,444

Union National Bank 2,000 3,200

Abu Dhabi Islamic Bank 2,000 2,207

Commercial Bank of Dubai - 1,842

National Bank of Fujairah - 643

Commercial Bank International - 607

National Bank of Umm Al Quwain - 578

Total 19,500 40,756

Source: Banks’ financials, Naeem Research

Fig. 1: The UAE’s LDR

Source: Central Bank of UAE, Naeem Research

100%

102%

104%

106%

108%

110%

200

400

600

800

1,000

1,200

2006 2007 2008 2009 Aug-10

AED (bn)

Loans Deposits L/D Ratio (RHS)

4

INITIATION OF COVERAGE

Liquidity is easing...

...but the UAE’s LDR is still high

Weakening asset quality – the

current concern

LLPs as a percentage of loans

jumped on higher provisioning

UAE banks are no longer in as tight a liquidity position as before, thanks to the

government’s intervention, coupled with a slowdown in lending growth. The

UAE’s LDR fell to 104% in 2009 and 103% in August 2010, but remains high

compared with its neighbouring countries’ average of 75%.

Fig. 3: The UAE’s LDR vs. that of neighbouring countries

Source: Central banks of the relevant countries, Naeem Research

Most banks now maintain their total loans and advances/stable resources ratio,

a broader measure of liquidity set by the Central Bank of the UAE (CBUAE) that

includes, in addition to deposits, shareholders’ equity and interbank liabilities as a base for calculating liquidity, below the 100% cap required by the CBUAE.

With the global financial crisis in full swing, UAE banks faced a further

challenge, that of deteriorating asset quality. Investment write-downs and

higher client default rates forced banks to dramatically increase provisioning.

Aggregate provisions booked by the six largest banks (controlling c. 61% of the

sector’s total assets) almost tripled in 2009 to AED11.6bn cf. AED4.1bn in 2008. Provisions booked in 1H10 rose 56% YoY to AED5.9bn.

This building of provisions led the sector’s loan loss provisions (LLPs) as a

percentage of gross loans to jump from 2.5% in 2008 to 4.1% in 2009, as the

LLP balance surged 73% YoY to reach AED43.3bn in 2009 due to a 65.5%

increase in the specific provisions balance (which are provisions taken on non-

Fig. 4: Provisions, 2008 vs. 2009 Fig. 5: Provisions, 1H09 vs. 1H10

Source: Company data, Naeem Research

20%

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UNB NBAD MASQ FGB ADCB ENBD

AED (bn)

2008 2009

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UNB NBAD MASQ FGB ADCB ENBD

AED (bn)

1H09 1H10

5


Profits hurt by high provisioning

NBAD’s asset quality the least

affected

performing loans – NPLs). In the meantime, the LLPs/gross loans ratio further

increased to 4.7% in 1H10, as both specific provisions and collective provisions increased by 13% and 21%, respectively.

Fig. 6: Quarterly progress of the sector’s LLP ratio

Source: CBUAE, Naeem Research

Tight liquidity, difficult operating environment (which limits growth), in addition

to the weakening asset quality, negatively affected the sector’s profits in 2009,

with two out of the six largest banks slipping into net loss in 4Q09. In 2010,

only one bank turned into net loss in 2Q10, however, banks overall

performance in 2Q10 was much weaker than in 1Q10, due to the booking of higher provisions, to account for the continuous asset quality deterioration.

Fig. 7: Development of net profit of selected banks (2009-1H10)

Source: Bank financials, Naeem Research

Throughout this difficult period, NBAD has been able to hold its ground. Its

asset quality has been the least affected among those of local peers (NPLs at

1.5% in 1H10 – the lowest among UAE banks). Further, its more prudent

growth policy and close relationship with the Abu Dhabi government (NBAD is c.

2.1%2.3%

2.6%

3.1%3.2%

3.4%

0.6%

0.9%0.8%

1.0%

1.3%1.2%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

1Q09 2Q09 3Q09 4Q09 1Q10 2Q10

Specific Provision General Provisions

(1,300) (1,000) (700) (400) (100) 200 500 800 1,100 1,400

UNB

NBAD

MASQ

FGB

ENBD

ADCB

1Q09 2Q09 3Q09 4Q09 1Q10 2Q10

6


Client base mainly comprises

government/public and corporate

sectors

70% owned by the Abu Dhabi Investment Council – ADIC), which, besides

giving it liquidity support, provides it with the ability to tap multiple funding channels, affording it a better liquidity position than peers.

NBAD – HIGHEST ASSET QUALITY AMONG PEERS

A diversified loan book and solid client base

NBAD was more prudent than its peers in growing its loan book over the boom

years (2005-2008) wherein its loan book rose at a three-year CAGR of 29.5%

compared with the sector’s CAGR of 39%. However, due to its close ties with

the Abu Dhabi government, it has a far superior client base, which largely

comprises the government, public and corporate private sectors.

Fig. 8: NBAD’s loan growth vs. peers


NBAD’s 2009 loan growth outpaced

that of the industry

NBAD’s close relationship with the government, the public sector, and large

corporations has helped it to grow its loan book at a faster pace than peers in

down times. In 2009, gross loans grew 18% cf. sector growth of 4%, driven

mainly by the public sector, which contributed 49% to loan growth during the

year. While NBAD’s 1H10 loans growth slowed down to just 2.4%, it still

outpaced the sector’s growth of 1.4%. The corporate sector contributed the

most to loan growth in 1H10, comprising 43% of total loan book. NBAD’s

management has stated that it will continue lending on a selective basis during

2010 in order to maintain its solid relationships with clients. We forecast

NBAD’s loan book to grow 3.4% by 2010 year-end to AED140.2bn.

-20%

0%

20%

40%

60%

80%

100%

2006 2007 2008 2009 1H10

NBAD ADCB FGB ENBD MASQ UNB

7


Exposure to over 10 sectors

High exposure to the real estate and

construction sectors

NBAD’s loan book is also well-diversified across sectors, thereby mitigating

default risk.

Although 23% of NBAD’s loans are to the real estate and construction sectors,

we are not overly concerned, as we believe that the bulk of these loans are

given to government-backed entities (i.e. the Abu Dhabi government that have

a lower sovereign risk than its neighbour Dubai), which would be bailed out if financial difficulties resulted in default of payment.

Fig. 9: Breakdown of loans by customer type

Fig. 10: Breakdown of loans by economic sector

Note: Breakdown of loans is as of June 2010


NBAD’s NPL ratio was improving until

the financial crisis

Building up provisions

NBAD maintained

the lowest NPL ratio among peers

Manageable exposure

NBAD’s asset quality improved in the years up to 2009, with NPLs as a

percentage of gross loans reaching a low of 0.9% in 2008. However, with the

entire sector hit by the global financial crisis, and default risk, by both

corporate and retail clients, spiking and culminating with Dubai World

requesting a restructuring of its USD24.9bn debt in late-2009, the asset quality

of all banks deteriorated. In 2009, NPLs as a percentage of gross loans jumped to an average of 3.3% for the six largest banks cf. 1.0% in 2008.

This led banks to build up provision levels in anticipation of further

deterioration in asset quality, with aggregate provisions taken by the six largest

banks nearly tripling in 2009 to AED11.6bn cf. AED4.1bn in 2008. Loan loss

provisions (LLPs) as a percentage of loans, which works as an indicator of

future deterioration expected by banks, also shot up to an average of 2.8% for the six largest banks in 2009 cf. 1.7% in 2008.

Despite NBAD’s NPLs rising to 1.3% in 2009, and further to 1.5% in 1H10, its

NPL ratio is still well below the peer average of 3.3% and 3.1% in 2009 and

1H10, respectively. Meanwhile, its provision cover has remained high at 158%

in 2009 and 147% in 1H10 cf. a sector average of 122% in 1H10. This should

ease pressure on the bank’s P&L, not requiring it to take additional provisions

in the event of further deterioration.

Government 13%

Public Sector12%

Corporate 58%

Retail 17%

Agriculture0%

Energy12%

Manufacturing6%

Construction6%

Real Estate17%

Trading4%

Transport4%

Banks and f inancial

institutions

13%

Services8%

Government12%

Retail Consumption

11%

Retail Others 6%

Others1%

8


Fig. 11: NPL ratio and provision cover of UAE's six largest UAE banks, 1H10

Source: Banks’ financials, Naeem Research

Limited exposure to defaulting entities

NBAD’s relative prudence in granting loans in boom years and its superior client

base has paid off in down times, limiting its exposure to high-profile defaulters.

Its exposure to the failed Saudi groups – Saad and El Gosabi – stood at just

USD8.7m (0.02% of loan book), while its exposure to Dubai World is USD225m (0.6% of loan book); these represent the lowest exposures among local peers.

Easing back on

provision building

Asset quality to get worse, before it

gets better

Dubai World creditors approved the restructuring deal in early September 2010,

but there is as yet no clear picture as to how banks are going to treat this

exposure, or the level of impairments that will be charged to P&Ls. Currently,

DW exposures are classified as OLEMs (Other Loans Especially Mentioned), which is a category between performing loans and NPLs

NBAD’s strong asset quality gives it the option to ease pressure on its bottom

line by booking lower new provisions than its peers. This effect is already

evident in 1H10, where provisions booked were c. 7% lower than what was

booked in 1H09, while for peers it increased 65%. NBAD’s management has

stated that it would stick to its policy of maintaining a level of c. 1.25% of credit risk-weighted assets as collective provisions.

We believe that the UAE’s banking sector is not yet out of the woods.

Additionally, due to the lagged effect of credit quality deterioration, we expect

NBAD’s NPL ratio to peak at 2% of gross loans in 2011, before gradually falling

back to 1.5% in 2015. We expect provision cover to remain comfortably above 100%.

Fig. 12: Banks’ exposures to Dubai World and troubled Saudi groups

Bank

Saudi

Group

exp

(AEDm)

Dubai

World

exp

(AEDm)

% of

Loans

NPLs

%

Prov.

Cover

%

Provision

excess

(shortage)

(AEDm)

NPLs

after

adding

DW exp

Additional Provision

needed after

adding exp *

(AEDm)

ADCB 2,238 9,909 9.8% 5.4% 77% (1,531) 15.2% (11,440)

ENBD 1,280 11,010 5.8% 2.9% 117% 1,059 8.7% (9,951)

FGB 202 1,695 1.9% 2.5% 128% 681 4.4% (1,014)

MASQ 771 na 1.9% 4.8% 134% 665 6.6% na

NBAD 32 826 0.6% 1.5% 146% 968 2.1% -

UNB 222 300 1.0% 1.4% 132% 239 2.3% (61)

Note: Includes DW exposure alone. Saudi groups provisions are assumed to have been booked in 2009

Source: Media and banks’ announcements, Naeem Research

1.3% 1.5%2.0%

2.6%

5.2%

8.2%160.6%

117.0%

158.4%

106.1%

67.8%

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NBAD UNB FGB ENBD ADCB MASQ

NPLs Coverage Ratio (RHS)

9


Fig. 13: Development of NPLs, LLPs, and provision coverage


High LDR compared with peers

LDR jumped on the

conversion of the MoF’s deposits

GOOD ACCESS TO FUNDING SUPPORTS LIQUIDITY POSITION

Despite high LDR, NBAD does not compete on deposits

NBAD has one of the highest loan-to-deposits ratios (LDR) in the local market,

i.e. an LDR of 109% in 2009 cf. an industry ratio of 104%. This increased

further to 119% in 1H10, giving it the second-highest LDR after Abu Dhabi

Commercial Bank (130%). Nevertheless, NBAD is maintaining its total loans

and advances/stable resources ratio at or below the 100% cap set by the

CBUAE.

This leap in LDR stemmed primarily from NBAD’s converting the AED5.6bn

worth of deposits placed by the Ministry of Finance (MoF) at end-2008 to Tier II subordinated debt in 1Q10.

Fig. 14: NBAD’s LDR vs. peers’


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LLPs NPLs Coverage Ratio (RHS)

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Deposit growth lagging sector

Not competing for

deposits to preserve margins

Lowest funding cost among peers

Reliance on deposits to wane

further

NBAD’s deposit growth has lagged that of the sector over the past several

years, with its deposit base registering a 19% CAGR over 2005-2009 cf. 24%

for the sector; this resulted in its share of the deposit market falling to 12.3%

in 2009 from 14.5% in 2005.

Despite its high LDR, NBAD has lately not been competing as aggressively as

other banks to attract new deposits, so as not to damage margins by

unnecessarily raising costs of funding, especially given that it has the ability to obtain funding from sources other than customer deposits.

Not competing on deposits has helped NBAD record the lowest funding cost

among peers at 1.5% in 2009 cf. a group average of 3%. The bank’s funding cost further declined in 1H10 to 1.1%.

Fig. 15: Funding cost (NBAD vs. peers)


Although we believe that customer deposits will still be NBAD’s largest source of

funding, we expect its reliance on deposits to diminish to some extent over our

forecast horizon.

Fig. 16: Breakdown of NBAD’s sources of funding


0%

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6%

2007 2008 2009 1H10

NBAD ADCB ENBD FGB MASQ UNB

18% 17% 19% 21% 22%

63% 62% 56% 54% 55%

5% 7%6% 5% 4%

2% 1%4% 4% 3%

9% 10% 12% 12% 12%

3% 3% 4% 4% 4%

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2008a 2009a 2010f 2011f 2012f

Interbank Liabilities Customer Deposits M/LTDs Subordinated Debt Equity Other

11


Deposits to grow at a five-year CAGR of

11.5%

Seeking alternative

funding sources

Successfully launched MYR500m

Sukuk

NBAD’s CAR at 21%

is way above the 12% required by

the CBUAE

We project NBAD’s deposits to grow at a five-year CAGR of 11.5% to reach

AED195bn by end-2015, with market share hovering just above 12%. In

addition, we expect NBAD’s LDR to slightly decrease over the forecast period to

reach 117% in 2015, and the total loans and advances/stable resources ratio to remain below the 100% threshold.

Ability to tap the wholesale market

As NBAD does not compete aggressively on deposits, it is seeking other

channels to build its funding base. NBAD’s solid balance sheet, good asset

quality, and close ties with the Abu Dhabi government afford it access to funds

through alternative funding channels at attractive pricing, thereby providing

further relief to its tight liquidity position.

In the midst of the financial crisis and a tight lending environment, NBAD was

able to raise USD850m worth of five-year medium-term notes in late-2009,

with an interest rate of 4.5%, and a further USD750m in March 2010 priced at 4.25% under its USD5bn EMTN programme.

Additionally, NBAD recently launched a five-year, MYR500m (equivalent to

AED572.5m or USD155.9m) Sukuk (Islamic bond) in June 2010 paying an

interest rate of 4.75%. This is a more favourable rate than the 5.2% interest

rate on Abu Dhabi Commercial Bank’s (ADCB) MYR750m Sukuk launched in

August 2010. NBAD’s low credit default swaps (CDS) spread compared to UAE

peers, vouches for its lower risk profile, thus enabling it to command cheaper rates when lending from the international market.

Fig. 17: CDS spreads

Source: Bloomberg, Naeem estimates

Superior capital base

NBAD has a solid capital base, with equity standing at AED20.4bn in 2009,

+42% YoY, after the government placed AED4bn worth of perpetual, non-

dilutive and non-cumulative capital notes, which resulted in the capital

adequacy ratio (CAR) increasing to 17.4% in 2009 from 13.7% in 2008. The

conversion of the MoF’s AED5.6bn worth of deposits into Tier II subordinated

debt in 1H10 further boosted the CAR to 21.4%, which is well above the 12%

minimum required by the CBUAE, and provides NBAD with a cushion against adverse conditions in this continued difficult operating environment.

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Well-positioned for Future Growth

Retail penetration lower than peers’

Investing in retail business

NBAD’s high asset quality, strong capital base, close relationship with the

government, and good access to funds provide it leverage to capitalise on any growth opportunities arising from an economic recovery.

FOCUS ON NEW SERVICES

NBAD has largely focused on the corporate sector during the past several

years; however, it now plans to build exposure along other business lines, such

as retail and SMEs, in addition to entering new areas such as global wealth management.

A good shot at retail

Although NBAD’s retail loans more than doubled since 2005 to AED25.3bn in

2009, its exposure has declined from 21.1% of total loan book in 2005 to 18.6% in 2009, which falls below the peer average of 24.5%.

NBAD has stated that it would focus more on expanding its retail business, and

has consequently made certain investments to help grow this business, such as

upgrading its IT systems and making new hires, e.g. in June 2010, NBAD hired

a new General Manager for Consumer and Elite Banking. We also believe that

NBAD can leverage on its large branch network (106 branches), which is the

second largest in the UAE, to enhance its client reach and drive more volumes

from retail clients, thus improving income flow to both interest income and fee income.

Growing Islamic business

NBAD is also working on expanding its Islamic banking business. The bank is

relatively new in this field, having launched its Islamic business as a separate

division by end-2007 and obtained its licence for Islamic products in September

2008. In 2009, it launched the service through its subsidiary Abu Dhabi

National Islamic Finance (ADNIF), which started operations in May 2009.

However, since launch, NBAD was able to raise its Islamic loan book to

AED4.4bn in 2009, and further increase it by 32% in 1H10 to AED5.8bn, to

make up 4.2% of total loan book in June 2010. The Islamic business currently contributes 1.9% to total operating income.

Fig. 18: Retail exposure vis-à-vis number of branches


10

30

50

70

90

110

130

150

0%

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10%

15%

20%

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30%

35%

ENBD ADCB NBAD UNB MASQ FGB

Retail Exposure No. of Branches (RHS)

13


Wealth

management – the next step

Expanding asset management and

broking

NBAD is also making a push into the global wealth management business where

it sees strong potential for growth. This business provides an array of wealth

management solutions to high-net-worth individuals from both onshore (UAE)

and offshore (through subsidiaries in sp. Jeresy and Geneva) platforms. To

date, this business’s contribution to operating income has been very small – 0.3% in 1H10.

NBAD aims to strengthen its institutional asset management business to be

among the top three asset management companies in the Middle East and

North Africa (MENA) region. NBAD initiated an ETF programme on the Abu

Dhabi Stock Exchange (ADX) in March 2010 and intends to launch five mutual

funds. Furthermore, it plans to grow its brokering franchise in the UAE and the

region both organically and by acquisition: NBAD acquired 70% of Al Salam

Brokerage in Egypt in August 2008, one of the smaller brokers in Egypt, in

order to gain access to this market. To date, this is its only acquisition.

To benefit from the implementation of Abu Dhabi’s “2030 Economic Vision”…

... although this implies a possible erosion in deposit

base

Share of loans market projected at

c. 15% by 2015

Government-driven business to support market share gains

The Abu Dhabi government’s ambitious plan titled “2030 Economic Vision” to

develop and diversify the economy will play in NBAD’s favour as “banker to the

Abu Dhabi government”. Abu Dhabi’s spending on the development of different

economic sectors is estimated at USD180bn over the next five years, and

NBAD’s close ties with the government suggests that some of these projects

may be financed through the bank, thus supporting loan growth and market share gains.

The government, however, could utilise some of its deposits at banks to finance

these projects, and this would shake up NBAD’s funding base (as government

deposits represent 25% of its total deposit base, and funds 14% of its assets).

Nevertheless, NBAD, as previously mentioned, has the ability to replace deposit

losses by borrowing from the wholesale market. The bank has already proved

that in 1H10, when government deposits (excluding the AED5.6bn converted

into Tier II debt) declined 23% from 2009 level, it was able to make up for this shortfall using other funding sources.

We estimate NBAD’s loans to grow at an 11% CAGR over 2010-2015 to

AED228.9bn by end-2015, with market share increasing to c. 15% from 13% in

2009.

Fig. 19: Development of NBAD’s loans and market share, 2008-2012


10%

11%

12%

13%

14%

15%

16%

100

110

120

130

140

150

160

170

2008a 2009a 2010f 2011f 2012f

Net Loans Market Share (RHS)

14


Has the largest international

presence among

UAE banks

A growing international presence

NBAD boasts the second-largest domestic network in the UAE and the largest

international network among local banks. The bank continues to expand its

international presence, and now has nearly 50 branches operating in 12

countries, i.e. in Bahrain, Egypt, France, Hong Kong, Kuwait, Libya, Oman,

Sudan, Jordan, Switzerland, the UK, and the USA (a subsidiary). NBAD also

plans to gain presence in Algeria, Morocco, Qatar, Saudi Arabia, and Tunisia; in June 2010, it was granted a commercial banking licence in Malaysia.

Fig. 20: NBAD's international presence

Source: Company data

International

business to contribute 15% to

operating profit

In addition, it is planning to expand its network in Egypt to 50 branches (from

the current 28) over the next few years to capitalise on the substantial potential

in this under-banked market, especially in the retail and SME businesses. In

1H10, the international banking business contributed 11.4% of the bank's total

operating profit (cf. 12.1% in 2009), and it is projected to contribute up to 15%

over the forecast years.

Fig. 21: Breakdown of operating profit by business line


Domestic Banking

21%

Int'l Banking

13%

Financial Markets

16%

Corp. & Investment

Banking

49%

Global Wealth

0%

Islamic Business

1%

2009

Domestic Banking

22%

Int'l Banking

11%

Financial Markets

16%

Corp. & Investment

Banking

49%

Global Wealth

0%

Islamic Business

2%

1H10

15


NII lost steam in 2009

Holding up well in 2010 on better cost

control

NIM and spreads to gain momentum in

2010 as the economy recovers

NEW SERVICES TO DIVERSIFY REVENUE STREAMS

Expanding its existing services, such as retail banking, and introducing new

services such as global wealth management will strengthen income flow to all of

NBAD’s main revenue streams, i.e. interest income, Islamic income, and fee income.

Net Interest Income

NBAD’s net interest income (NII) grew at a 29% CAGR over 2005-2008, driven

mainly by a similar increase in loan book. However, in 2009, NII increased at a

slightly slower pace of 23% YoY to AED4.4m, due to a slowdown in loan growth to 18%.

In 1H10, NBAD was able to increase its NII by +11.6% YoY to AED2.41bn,

despite a decline in total interest income to AED3.4bn (-2.2% YoY). However,

this was more than made up for by a 25.2% decline in interest expense,

resulting primarily from a lower cost of funding. Its annualised cost of funds

declined c. 60bps from 1.7% in 1H09 to stand at 1.1% in 1H10; this proves

that the bank’s strategy of not competing on deposit pricing helped it to keep its funding costs in check, thus supporting margins.

NBAD’s annualised net interest margin (NIM) and interest spread were slightly

weaker in 1H10 at 2.4% and 2.7%, respectively, cf. 1H09 (2.5% and 2.9%,

respectively), primarily due to a 76bps YoY decline in interest rate on interest-

earning assets to c. 3.9% in 1H10. We believe that this was a result of weakening credit quality.

We expect NBAD’s NII to reach AED4.7bn (+5% YoY) by end-2010 as it

continues to exert strong cost control, with NIM and interest spread standing at

2.3% and 2.6%, respectively. However, as the economy starts to recover, we

expect NIM and interest spread to regain momentum over our forecast period, to reach 2.7% and 3%, respectively, by end-2015.

Fig. 22: Net interest income and NIM


2.0%

2.1%

2.2%

2.3%

2.4%

2.5%

2.6%

3.0

3.5

4.0

4.5

5.0

5.5

6.0

2008a 2009a 2010f 2011f 2012f

AED (bn)

Net Interest Income NIM (RHS)

16


Good footprint in Islamic services

Increased contribution going

forward

F&C growth supported by asset

management activities

Credit-related F&C replacing AM-

backed F&C

Fig. 23: Funding cost and interest spread


Islamic income

In its first year of operation, i.e. 2009, NBAD recorded net income from Islamic

activities of AED130m. In 1H10, this reached AED102m, with Islamic financing

increasing 32% in 1H10 and constituting 4.2% of total loan book.

As the bank plans on expanding its Islamic services over the coming years, we

estimate net income from Islamic activities to grow at a five-year CAGR of 25%

to reach AED634m by 2015 year-end, thus contributing 4.4% to operating profit.

Fees and commissions

Fees and commissions (F&C) contributed significantly to NBAD's profits during

the boom years, growing at a CAGR of 28% over 2003-2008 and contributing,

on average, 28% to the bank's total operating profit over 2003-2008. With the

financial crisis, however, F&C growth stagnated, given that it was underpinned primarily by asset management activities.

To make up for the lost volumes from asset management activities, NBAD

started increasing its credit-related F&C, expanding its lending activities to both

retail and corporate clients. This resulted in F&C remaining flat in 2009.

However, it picked up in 1H10, where NBAD reported F&C at AED628m (+23% YoY) cf. AED510m in 1H09.

We expect F&C to increase at a five-year CAGR of 23% over our forecast period

to reach AED3.5bn in 2015, due to increased transactions from both retail and

corporate clients, in addition to a recovery in asset management and

investment activities.

2.9%

1.5% 1.5% 1.5% 1.7%

2.2%

2.5% 2.5% 2.5% 2.5%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

2008a 2009a 2010f 2011f 2012f

Funding Cost Interest Spread

17


Fig. 24: Breakdown of operating profit by revenue source, 2008-2012


Cost to income to hit 35% cap over

the forecast years

Cost pressure due to ongoing expansions

Ongoing investment to expand within the local market and to build international

presence comes at a cost. Accordingly, we expect NBAD’s general and

administrative expenses to increase at a five-year CAGR of 22% to reach

AED4.9bn in 2015. We also forecast its cost-to-income ratio to increase from its

current level of 28.3% over the forecast years until revenues from newly

opened branches and new services start to filter into the P&L. We believe that

NBAD will be able to maintain its cost-to-income ratio at or below the 35%

medium-term cap it has set.

Fig. 25: NBAD’s cost-to-income ratio, 2008-2012


68% 69% 68% 67% 66%

2% 3% 3% 3%

21% 18% 18% 21% 22%

11% 11% 10% 9% 9%

0%

20%

40%

60%

80%

100%

2008a 2009a 2010f 2011f 2012f

Net Interest Income Net Islamic Income

Fees & Commissions Other Operating Income

20%

25%

30%

35%

40%

45%

50%

2008a 2009a 2010f 2011f 2012f

18


DCF gives fair value of AED15.9/share

Valuation Indicates Good Upside

DCF VALUATION

We valued NBAD using the DCF valuation approach (the excess equity return

model), with a cost of equity of 13.5% and a terminal growth rate of 2%; this

yields a fair value of AED15.9/share, indicating an upside potential of 35% over

the current market price.

Fig. 26: DCF valuation table – excess return model (AEDm)

2011f 2012f 2013f 2014f 2015f

Net Income 4,126 4,859 5,684 6,824 7,928

- Equity Cost (3,236) (3,730) (4,307) (4,915) (5,596)

Excess Equity Return 890 1,129 1,377 1,909 2,332

Terminal Value 19,553

ROAE 16.1% 16.5% 16.8% 17.5% 17.8%

Dividend Payout Ratio 12% 12% 21% 26% 30%

PV of Excess Equity Return – 5 Years 853 953 1,024 1,250 1,345

PV of Terminal Value 12,167

BV of Equity Invested Currently 20,441

PV of Equity Excess Return - 5 Years 5,425

PV of Terminal Value 12,167

Equity Value 38,033

O/s Shares 2,392

Value per Share (AED) 15.9

NBAD is cheaper than regional

peers…

…but trades at a

deserved premium to local peers

The following table shows the sensitivity of the share value at different costs of

equity and terminal growth rate assumptions:

Fig. 27: Sensitivity analysis – value per share

Co

st

of

Eq

uit

y

Terminal growth rate in cash

#REF! 1.0% 1.5% 2.0% 2.5% 3.0%

12.5% 18.1 18.5 19.0 19.5 20.1

13.0% 16.7 17.0 17.4 17.8 18.2

13.5% 15.4 15.6 15.9 16.2 16.6

14.0% 14.2 14.4 14.6 14.8 15.1

14.5% 13.1 13.3 13.4 13.6 13.8

RELATIVE VALUATION

On a PBV basis, NBAD is cheap relative to other banks in the MENA region, with

a PBV 2011f of 0.9x cf. a peer average of 1.8x, and a PER 2011f of 5.9x cf. the

peer average of 10.1x. We believe that the market has severely punished UAE

banks due to the turbulent operating environment, which became more prominent with Dubai World’s request to restructure debt.

On the other hand, both NBAD’s 2011f PBV and PER are higher than the peer

average of 0.7x and 5.6x, respectively. This premium is justified, in our view,

given NBAD’s higher asset quality and superior client base. We also believe that

there is room for NBAD to grow in the higher-margin retail and SME markets to which it is has relatively less exposure.

We argue that NBAD should be trading closer to its regional peer group

multiples, as its asset quality is high and risk of exposure is low relative to other

similar-sized UAE banks.

19

NATIONAL BANK OF ABU DHABI (NBAD) Fig. 28: Relative Valuation

Bank Country Code

Market Cap.

PBV PER

USDm 2010e 2011f 2010e 2011f

First Gulf Bank UAE FGB 5,578 1.0 0.9 6.9 5.4

Emirates NBD UAE ENBD 4,131 0.8 0.7 6.5 5.3

Abu Dhabi Commercial Bank UAE ADCB 2,750 0.7 0.7 nm 8.3

Union National Bank UAE UNB 2,082 0.8 0.7 6.5 5.3

Abu Dhabi Islamic Bank UAE ADIB 1,687 0.5 0.5 7.6 4.6

Average

0.8 0.7 7.1 5.6

Median

0.8 0.7 7.3 5.3

Al Rajhi Bank KSA RJHI 30,997 3.7 3.3 16.3 13.5

Qatar National Bank Qatar QNBK 16,667 2.6 2.3 11.4 10.2

National Bank of Kuwait Kuwait NBK 16,387 2.5 2.2 16.2 14.4

SAMBA Financial Group KSA SAMBA 15,118 2.2 2.0 12.1 10.3

Banque Saudi Fransi KSA BSFR 9,449 2.1 1.9 12.9 11.1

Saudi British Bank KSA SABB 9,419 2.4 2.1 14.9 11.0

Arab National Bank KSA ARNB 7,366 1.7 1.6 12.5 10.5

Commercial Bank of Qatar Qatar CBQK 4,740 1.5 1.4 10.4 8.8

Commercial International Bank Egypt COMI 4,148 2.8 2.4 11.6 9.7

Ahli United Bank Bahrain AUB 4,008 1.5 1.3 12.2 9.4

Saudi Hollandi Bank KSA AAAL 3,122 1.9 1.6 15.1 11.1

Bank Muscat Oman BKMB 3,025 1.5 1.3 13.5 10.4

National Societe Generale Bank Egypt NSGB 2,283 2.0 1.7 10.3 7.3

Credit Agricole Egypt Egypt CIEB 640 1.9 1.8 9.6 8.2

Overall Average

2.1 1.8 14.7 10.1

Median

2.0 1.8 12.2 10.3

National Bank of Abu Dhabi UAE NBAD 7,684 1.0 0.9 6.9 5.9

Note: Multiples are based on closing prices as of 21 September 2010

Source: Bloomberg, Naeem estimates

20


FINANCIAL STATEMENTS PERFORMANCE RATIOS

Year to 31 Dec 2008A 2009A 2010E 2011E 2012E Year to 31 Dec 2008A 2009A 2010E 2011E 2012E

Income statement AED mn Growth and margins

Interest income 7,383 6,697 7,044 7,617 8,954 Net interest income growth (%) 50.0 23.1 29.6 6.6 15.7

Interest expense (3,776) (2,256) (2,368) (2,633) (3,186) Net fee and commission income growth (%) 27.8 0.4 9.9 25.9 21.1

Net interest income 3,608 4,442 4,676 4,984 5,768 Net Income from Islamic financing (%) NA NA 62.0 9.4 30.8

Fee and commission income 1,131 1,136 1,244 1,566 1,896 Other non interest income growth (%) 49.8 23.1 26.0 (6.8) 18.6

Net income from Islamic financing - 130 210 230 301 Total operating income growth (%) 44.6 20.7 29.0 8.8 17.6

Other non-interest income 562 692 708 660 783 Operating expenses growth (%) 41.6 27.1 32.7 18.7 23.4

Operating income 5,301 6,399 6,838 7,441 8,749 Net operating income growth (%) 45.8 18.2 27.6 4.8 14.9

Operating expense (1,493) (1,898) (1,981) (2,351) (2,901) Provisions growth (%) 1,620.0 96.3 32.1 (9.3) 0.8

Operating profit before provisions 3,808 4,501 4,857 5,089 5,847 Net income growth (%) 20.5 0.0 26.3 8.2 17.8

Provisions (717) (1,408) (948) (859) (866) Customer deposits growth (%) 26.6 17.1 9.3 6.0 17.3

Operating profit 3,091 3,093 3,909 4,230 4,981 Gross loans growth (%) 39.6 17.7 21.7 4.3 15.4

Share of profit of associates - - - - - Total assets growth (%) 18.1 19.6 23.4 9.5 14.6

Non-operating income/(expenses) - - - - - Net interest income % operating income 68.1 69.4 68.4 67.0 65.9

Extraordinary item - - - - - Non interest income % operating income 31.9 30.6 31.6 33.0 34.1

Net profit before taxation 3,091 3,093 3,909 4,230 4,981 Liquidity

Income tax (72) (73) (96) (104) (122) Liquid assets % total assets 16.7 19.6 17.5 17.0 16.3

Net profit after taxation 3,019 3,020 3,814 4,126 4,859 Gross loans % total assets 70.0 68.9 69.0 65.7 66.2

Less: Minority interests - - - - - Customer deposits % total funding 72.6 72.2 69.4 67.3 68.5

Net Profit (loss) 3,019 3,020 3,814 4,126 4,859 Liquid assets % customer deposits 26.6 31.9 31.3 31.6 29.6

Net loans % customer deposits 108.0 109.1 120.4 118.7 117.0

Balance sheet AED mn RWA % total assets 77.1 67.4 109.4 102.8 102.9

Cash & balances with the central bank 19,433 18,057 14,701 16,303 19,128 Interbank ratio (%) 26.3 63.4 55.4 46.3 40.2

Interbank assets 6,789 19,521 19,934 20,378 21,097 Profitability

Reverse repurchase agreements - 557 4,045 4,288 5,031 Net interest margin (%) 2.4 2.5 2.3 2.3 2.4

Trading investments 1,296 1,094 811 1,199 1,406 Net non-interest margin (%) 0.1 0.0 0.1 0.0 0.0

Gross loans 115,225 135,574 140,226 146,242 168,778 Interest on avg. interest earning assets (%) 6.2 4.3 4.0 4.1 4.3

Loan loss provisions (LLP) (1,550) (2,658) (3,365) (3,217) (3,376) Funding cost (%) 2.8 1.4 1.4 1.5 1.6

Interest suspended (1,911) (658) (701) (731) (844) Interest spread (%) 3.4 2.9 2.6 2.6 2.7

Non-trading investments 14,983 18,954 19,872 29,248 33,756 Interest income % interest expense (%) 195.5 296.9 297.4 289.3 281.1

Investment in affiliates - - - - - Net operating income % avg. total assets (%) 2.5 2.5 2.4 2.4 2.4

Investment properties - - - - - Provision charges % preprovision income (%) 18.8 31.3 19.5 16.9 14.8

Fixed assets 1,319 2,085 2,274 2,924 3,356 Pre-tax income % operating income (%) 81.2 68.7 80.5 83.1 85.2

Intangibles - - - - - RoAA (%) 2.0 1.7 1.9 1.9 2.0

Other assets 9,071 4,317 5,316 5,827 6,676 RoRWA (average) (%) 2.9 2.3 2.1 1.8 2.0

Total assets 164,654 196,845 203,112 222,460 255,009 RoAE (%) 23.6 17.4 17.2 16.1 16.5

Interbank Liabilities 25,797 30,777 35,994 44,040 52,537 Net profit margin (%) 56.9 47.2 55.8 55.5 55.5

Repos 4,535 2,570 3,072 3,364 3,856 Dividend payout ratio (%) 1,964.35 719.98 940.75 1,159.36 1,230.67

Customers' Deposits 103,481 121,205 113,086 119,871 140,648 Asset Quality and Efficiency Measures

Medium-term Debt 8,594 13,237 10,908 10,908 8,377 Cost-to-income ratio (%) 28.2 29.0 31.6 33.2 35.3

Euro Commercial Paper 74 175 - - - Operating expenses % average total assets 1.0 1.1 1.1 1.2 1.4

Subordinated Debt 3,051 2,852 2,684 2,684 2,684 LLP % Gross Loans 1.3 2.4 2.2 2.0 1.9

Other liabilities 4,765 5,588 7,386 8,090 9,273 LLP % Total Assets 0.9 1.7 1.4 1.3 1.3

Total liabilities 150,298 176,404 179,262 195,088 223,507 NPLs % gross loans 0.9 1.9 2.0 1.8 1.5

Shareholders' equity 14,357 20,441 23,851 27,372 31,502 NPLs coverage ratio (%) 144.6 126.3 110.0 111.1 126.7

Minority interest - - - - - Provision Charges % avg. Gross Loans 0.7 0.7 0.6 0.6 0.5

Total capital funds 14,357 20,441 23,851 27,372 31,502 Earning assets % total assets 93.7 94.3 94.1 94.1 94.1

Total liabilities & capital funds 164,654 196,845 203,112 222,460 255,009 Capital adequacy

Shareholders' Equity % Total Assets 8.7 11.7 12.3 12.4 12.6

off-balance sheet items 107,662 113,778 103,587 111,230 140,255 Capital Adequacy Ratio (%) 13.7 9.0 10.2 7.2 7.6

Asset Leverage (x) 1.1 1.1 1.1 1.1 1.1

Financial Leverage (x) 10.5 7.5 7.1 7.1 7.0

PROGRESSIVE QUARTERLY RESULTS SNAPSHOT FOR YEAR SHARE DATA/VALUATION 2008A 2009A 2010E 2011E 2012E

Qtly Income statement (AEDm) 3Q09 4Q09 1Q10 2Q10 1H10 Share Data

Net interest income 1,181 1,098 1,191 1,223 2,414 Issued Shares (m) 1,977 2,174 2,392 2,392 2,392

Total operating income 1,708 1,604 1,772 1,776 3,548 Weighted Average Shares (m) 1,784 2,075 2,181 2,392 2,392

Reported net profit 914 429 1,031 1,001 2,032 Fully Diluted Shares (m) 1,977 2,174 2,392 2,392 2,392

Basic EPS (EGP) 0.4 0.2 0.4 0.4 0.8 Basic EPS - weighted avg (AED) 1.3 1.3 1.6 1.7 2.0

QoQ change (%) 1% -53% 118% -3% YoY change (%) 20.5 0.0 26.3 8.2 17.8

Fully Diluted EPS (AED) 1.5 1.4 1.6 1.7 2.0

YoY change (%) (3.0) (9.1) 14.8 8.2 17.8

BVPS 7.3 9.4 10.0 11.4 13.2

OTHER INFORMATION DPS (AED) 0.30 0.10 0.15 0.20 0.25

Top two major shareholders 12-mth High/Low: 12.45 - 11.85 Valuation

1) Abu Dhabi Investment Council Avg. daily vol: 299,721 PER (Basic) (x) 9.3 9.3 7.4 6.8 5.8

2) NA Latest results: 2Q 2010 PER (FD) (x) 7.7 8.5 7.4 6.8 5.8

Free float (%) 29.5% Next results: 3Q 2010 PBV (x) 1.6 1.3 1.2 1.0 0.9

Reuters code NBAD.AD Major business: Banking Dividend yield (%) 3% 1% 1% 2% 2%

Sources: NBAD, Naeem Research

21

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Disclosure Appendix

Disclaimer

This report is based on publicly available information. It is not intended as an offer

to buy or sell, nor is it a solicitation of an offer to buy or sell the securities

mentioned. The information and opinions in this report were prepared by the

Naeem Research Department (“Naeem”) from sources it believed to be reliable at

the time of publication. Naeem accepts no liability or legal responsibility for losses

or damages incurred from the use of this publication or its contents. Naeem has

the right to change opinions expressed in this report without prior notice.

Stock Ratings

Naeem believes that an investor’s decision to buy or sell a stock should depend on

individual circumstances (including, but not limited to the investor’s existing

holdings and financial standing) and other considerations. Different securities firms

use a range of rating terms and rating systems to describe their recommendations.

Investors should carefully read the definitions of the ratings used in each report. In

addition, since Naeem’s research reports contain complete information about the

analyst’s views, investors should read Naeem reports in their entirety, and not

infer the contents from the ratings alone. Ratings (and/or research) should not be

relied upon as an investment advice.

Naeem assigns ratings to stocks on the following basis:

Rating Upside/Downside potential

BUY >20%

ACCUMULATE >10% to 20%

HOLD +10% to -10%

REDUCE <-10% to -20%

SELL < -20%

Rating Distribution

As of 30 September 2010, the ratings distribution for all published ratings is as

follows:

BUY 65%

ACCUMULATE 13%

HOLD 22%

REDUCE 0%

SELL 0%

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Banking UAE National Bank of Abu Dhabi (NBAD)