Banking UAE National Bank of Abu Dhabi (NBAD)

[Pages:21]Banking ? UAE

National Bank of Abu Dhabi (NBAD)

Initiation of Coverage 30 September 2010

Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10

Recommendation

Market Price (AED) Fair Value (AED) Upside Potential ADX Index

BUY

11.8 15.9 35% 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

Price (AED) 14 13 12 11 10

9

NBAD

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 NII (AEDm) Net Profit (AEDm) EPS (Basic) EPS (% YoY) PER (x) PBV (x) Dividend yield (%) NIM (%) ROAE (%) ROAA (%)

2008a 3,608

3,019 1.26 21% 9.3 1.6 2.5 2.4 23.6 2.0

2009a 4,442

3,020 1.26 0% 9.3 1.3 0.8 2.5

17.4 2.0

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

Source: Company data, Naeem estimates

2010f 4,676

3,814 1.59 26% 7.4 1.2 1.3 2.3

17.2 1.9

2011f 4,984

4,126 1.73 8% 6.8 1.0 1.7 2.4

16.1 2.0

2012f 5,768

4,859 2.03 18% 5.8 0.9 2.1 2.5

16.5 2.1

May El Haggar +202 3303 7766 Ext. 2220

Lamia El Etriby +202 3303 7766 Ext. 2209

1

may.elhaggar@

lamia.eletriby@

Banking ? UAE

National Bank of Abu Dhabi (NBAD)

Initiation of Coverage 30 September 2010

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

May El Haggar +202 3303 7766 Ext. 2220

Lamia El Etriby +202 3303 7766 Ext. 2209

2

may.elhaggar@

lamia.eletriby@

NATIONAL BANK OF ABU DHABI (NBAD)

Better Placed than Local Peers

UAE BANKS ? HANGING IN THERE

Tight liquidity ? one of many woes

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.

Fig. 1: The UAE's LDR

AED (bn) 1,200

110%

1,000

108%

800

106%

600

104%

400

102%

200 2006

2007

2008

Loans

Deposits

2009

Aug-10

L/D Ratio (RHS)

100%

Source: Central Bank of UAE, Naeem Research

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 Emirates NBD Abu Dhabi Commercial Bank National Bank of Abu Dhabi First Gulf Bank Mashreq Bank Union National Bank Abu Dhabi Islamic Bank Commercial Bank of Dubai National Bank of Fujairah Commercial Bank International National Bank of Umm Al Quwain

Total

Source: Banks' financials, Naeem Research

Tier I Capital 3,500 4,000 4,000 4,000 2,000 2,000 -

19,500

Tier II Capital 11,502 6,617 5,606 4,510 3,444 3,200 2,207 1,842 643 607 578

40,756

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INITIATION OF COVERAGE

Liquidity is easing...

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

...but the UAE's LDR is still high

120%

100%

80%

60%

40%

20%

Lebanon Egypt

Jordan KSA

Bahrain Kuwait

UAE Qatar

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.

Weakening asset quality ? the

current concern

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.

Fig. 4: Provisions, 2008 vs. 2009

Fig. 5: Provisions, 1H09 vs. 1H10

AED (bn) 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

UNB

NBAD MASQ

FGB

ADCB ENBD

AED (bn)

2.0

1.5

1.0

0.5

0.0 UNB NBAD MASQ FGB ADCB ENBD

2008

2009

1H09

1H10

Source: Company data, Naeem Research

LLPs as a percentage of loans

jumped on higher provisioning

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-

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NATIONAL BANK OF ABU DHABI (NBAD)

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

5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

0.6% 2.1%

0.9% 2.3%

0.8% 2.6%

1Q09

2Q09

3Q09

Specific Provision

1.0% 3.1%

1.3% 3.2%

4Q09

1Q10

General Provisions

1.2% 3.4%

2Q10

Source: CBUAE, Naeem Research

Profits hurt by high provisioning

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)

ADCB

ENBD

FGB

MASQ

NBAD

UNB

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

1Q09

2Q09

Source: Bank financials, Naeem Research

3Q09

4Q09

1Q10

2Q10

NBAD's asset quality the least

affected

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.

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INITIATION OF COVERAGE

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

Client base mainly comprises

government/public and corporate sectors

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

100%

80%

60%

40%

20%

0%

-20%

2006

2007

2008

2009

1H10

NBAD

ADCB

Source: Bank financials, Naeem Research

FGB

ENBD

MASQ

UNB

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.

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NATIONAL BANK OF ABU DHABI (NBAD)

Exposure to over 10 NBAD's loan book is also well-diversified across sectors, thereby mitigating sectors default risk.

Fig. 9: Breakdown of loans by customer type

Fig. 10: Breakdown of loans by economic sector

Retail 17%

Government 13%

Public Sector 12%

Corporate 58%

Note: Breakdown of loans is as of June 2010 Source: Company data, Naeem Research

Retail Others 6%

Retail Consumption

11%

Others 1% Agriculture 0%

Energy 12%

Manuf acturing 6%

Government 12%

Services 8%

Banks and f inancial

institutions 13%

Construction 6%

Real Estate 17%

Transport 4%

Trading 4%

High exposure to the real estate and

construction sectors

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.

NBAD's NPL ratio was improving until

the financial crisis

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.

Building up provisions

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.

NBAD maintained the lowest NPL

ratio among peers

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.

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INITIATION OF COVERAGE

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

9%

180%

8%

7%

160.6%

158.4%

8.2%

160% 140%

6%

120%

5%

117.0%

4%

3%

2%

1%

1.3%

0%

NBAD

1.5% UNB

2.0% FGB

106.1% 2.6% ENBD

5.2% 67.8%

ADCB

54.9% MASQ

100% 80% 60% 40% 20% 0%

NPLs

Coverage Ratio (RHS)

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.

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

Bank

ADCB ENBD FGB MASQ NBAD UNB

Saudi Group

exp (AEDm)

2,238 1,280

202 771 32 222

Dubai World

exp (AEDm)

9,909 11,010 1,695

na 826 300

% of Loans

9.8% 5.8% 1.9% 1.9% 0.6% 1.0%

NPLs %

5.4% 2.9% 2.5% 4.8% 1.5% 1.4%

Prov. Cover

%

77% 117% 128% 134% 146% 132%

Provision excess

(shortage) (AEDm)

(1,531) 1,059

681 665 968 239

NPLs after adding DW exp

15.2% 8.7% 4.4% 6.6% 2.1% 2.3%

Additional Provision needed after adding exp * (AEDm) (11,440)

(9,951)

(1,014)

na

-

(61)

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

Source: Media and banks' announcements, Naeem Research

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

Easing back on provision building

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.

Asset quality to get worse, before it gets better

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%.

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