bahrain-banking-06-2007.pdf

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GlobalResearch

June 2007

Banking

Bahrain Banking Sector ReportBah

rain

Competitive banking environment


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Global Investment House KSCC

Banking Research

Souk Al-Safat Bldg., 2nd FloorP.O. Box 28807 Safat

13149 Kuwait

Tel: (965) 240 0551

Fax: (965) 240 0661

Email: [email protected]

http://www.globalinv.net

Global Investment House stock market indices can be accessed

from the Bloomberg page GLOH

and from Reuters Page GLOB

Omar M. El-Quqa, CFAExecutive Vice [email protected] No:(965) 2400551 Ext.104

Faisal Hasan, CFAHead of [email protected] No:(965) 2400551 Ext.304

Burhan AliFinancial [email protected] No:(965) 2400551 Ext.229

Mihir J. MarfatiaFinancial [email protected] No:(965) 2400551 Ext.421


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Bahrain Banking Sector Report

Global Research - Bahrain Global Investment House

June 2007

Investment Summary

Bahrains banking sector has remained to be a cornerstone for growth of the domestic

economy. After the oil and gas sector, the financial institution sector remains the highest

contributor to the countrys GDP. Central Bank of Bahrain (CBB) replaced the Bahrain

Monetary Agency (BMA) on 7 September 2006. The introduction of new central bank in

the country, with the objective to monitor and enhance the banking sector regulations.

Bahrains financial services industry continued to develop and expand during 2005 and

2006, with 7 new licenses issued in 2005 and 9 new licenses issued at the end of 3Q-06.

The total number of banks and financial institutions at the of end of 3Q-06 was 371.This comprises 150 banking institutions, 151 insurance firms, 36 capital market brokers

and 34 others. The country has continued to attract a good mix of locally incorporated,

regional and international institutions.

In July-2006, the Bahrain Monetary Agency (BMA) announced details of a comprehensive

package of regulatory reforms to modernize and strengthen the licensing framework for

banks operating in the Kingdom. This is line with BMAs effort to create a clearer, more

modern bank licensing regime, whilst strengthening Bahrains position as the leading

international finance centre in the Gulf. Similar licensing reforms have already been

implemented for the insurance and investment business sectors, in April 2005 and April

2006 respectively.

The total assets of the banking system grew at a CAGR of 22.9% during the period 2003-

2006. The total assets of the banking system (Retail and Wholesale) at the end of 2006

stood at BD70.43bn (US$187.35bn), a substantial increase of 33.5% as compared to the

previous year. The growth of the asset size is comparatively higher when compared to the

growth attained during the last two years, which was 17.8% in 2004 and 18.1% in 2005.

Wholesale banks dominates the banking system in Bahrain and contributes 87.7% of the

total Bahrain banking assets. The contribution of the wholesale banks have remained in

the range of 88.2% - 87.7% during the period 2003-2006. Market share of retail banks in

terms of total assets was 12.3% at the end of 2006.

The total assets of the Islamic banks grew at a CAGR of 43.2% during the period 2003-

2006, which has exceeded the growth of the entire banking system of Bahrain. The total

assets of Islamic banks operating in Bahrain stood at BD4.59bn (US$12.21bn) at the end

of 2006, which was an increase of 52.4% over its 2005-year end level.

The importance of Islamic banking can be further substantiated with the increasing

contribution of Islamic banking assets to the total banking system. The total assets of the

Islamic banks have grown at a much faster rate than the Bahrain banking system assets.

As a result, the contribution of Islamic banking to total assets increased from 4.1% in

2003 to 6.5% in 2006. Going forward, we believe that Islamic banks will continue to

grow at a faster pace than the conventional banking assets, as many investors are migratedfrom conventional banking to Islamic banking.

BAHRAIN BANKING SECTOR REPORT

Outlook: Positive


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2 June 2007

The total loans and advances of the banking system grew at a CAGR of 19.0% from

BD1.79bn (US$4.79bn) in 2003 to BD3.03bn (US$8.07bn) in 2006. In the year 2006,

it increased by 15.6% and stood at BD3.03bn (US$8.07bn) as compared to BD2.62bn

(US$6.98bn) at the end of December 2005. The lending to business sector accounted for

53.4% of the total credit, while personal and government sector accounted for 41.3% and

5.3% respectively.

The peer group comparison is done on five banks, namely Ahli United Bank (AUB),

Bank of Bahrain and Kuwait (BBK), National Bank of Bahrain (NBB), Bahrain Islamic

Bank (BIsB) and Bahraini Saudi Bank (BSB). Al Salam Bank was not included in the

peer group comparison.

The size of the banks under our coverage increased from BD5.3bn in 2003 to BD11.8bn

in 2006, registering a CAGR of 30.9%. In the year 2006, the size of banks under coverage

increased by 35.9% as compared to the previous year. Over the next four years (2006-

2010), we expect the banking assets for the banks under review to register a CAGR of11.3% to reach BD18.14bn in 2010.

Deposits for banks under review grew at a CAGR of 26.3% for the period 2003-06

from BD2.8bn in 2003 to BD5.7bn in 2006. The top three banks (NBB, BBK and AUB)

deposits grew at a CAGR of 10.2%, 7.7% and 47.7% respectively for the period under

review. Over the next four years (2006-2010), deposits are likely to grow at a CAGR of

15.7% for the banks under review to reach BD10.24bn in 2010

On the lending side, gross loans and advances grew at a CAGR of 29.3% for the period

2003-06. Gross loans increased from BD2.6bn in 2003 to BD5.5bn in 2006. Net loans for

the banks under review grew at a CAGR of 31.5% for the period 2003-06, from BD2.4bnin 2003 to BD5.4bn in 2006. Over the next four years (2006-2010), gross loans are likely

to record a CAGR of 15.3% for the period 2006-2010 to reach BD9.79bn in 2010.

Profits of the banks under review, increased from BD82.5mn in 2003 to BD182.9mn

in 2006, growing at a CAGR of 30.4% for the period under review. In 2006, profit of

the banks under review witnessed a growth of 29.8% from BD141.03mn in 2005 to

BD182.9mn in 2006Over the next four years (2006-2010), net profits of the bank under

review are likely to record a CAGR of 16.8% to reach BD340.29mn in 2010.

The return on average equity (ROAE) improved from 12.8% in 2003 to 15.2% in 2006.

The return on average assets improved from 1.50% in 2003 to 1.78% in 2006. BBK

had the highest ROAE of 18.2% in 2006, followed by BIsB with 17.8%. In terms ofaverage ROAA, BIsB was leading the way with RoAA of 3.4% followed by NBB at 2.3%

respectively in 2006.

Table 1: Global Valuation Matrix

Price Target Reco.Change

%BV EPS P/BV P/E

AUB 1.30 1.26 HOLD -2.8% 0.53 0.09 2.5 13.8

BBK 670 811 BUY 21.1% 294.4 58.0 2.3 11.6

BIsB 448 539 BUY 20.4% 248.9 69.8 1.8 6.4

Note: * Based on 2007E

Source: Global Research, Market prices as on May 31, 2007

All in fils except for AUB, which is US$


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June 2007

Bahrain Economy

Bahrains nominal Gross Domestic Product (GDP) increased to BD5.03bn in 2005 from

BD4.21bn reported in the previous year, recording a growth of 19.7% on the back of improvedperformance seen in financial, real estate and construction sector. It is worth noting that this

was the highest nominal growth reported in the last five years by the country. In terms of real

GDP, the country witnessed a growth of 7.8% in 2005.

Table 1: Gross Domestic Product

2002 2003 2004 2005*

GDP at current market prices (BD bn) 3.18 3.65 4.21 5.03

- (% change) 6.6 14.8 15.3 19.7

GDP at constant market prices (BD bn) 2.87 3.07 3.24 3.50

- (% change) 5.2 7.2 5.6 7.8

Crude oil production (US Barrels 000) 86,500 87,481 76,337 68,096

GDP Per Capita (BD) 4,726.0 5,290.0 5,945.7 6,943.0

Source: Ministry of Finance & National Economy, *Provisional Data

The total revenue for the year 2005 registered an yearly increase of 28.5% and stood at

BD1.67bn as compared to BD1.30bn reported for 2004. This is attributed mainly to better-

than-expected oil revenues, which was projected at around US$28 per barrel, and ended up at

an average of US$55 per barrel. Oil revenue, which was projected at BD895.7mn for the year

2005, actually contributed BD1.27bn to the total revenue of the government. The contribution

of oil and gas to the total revenue of the government in 2005 was higher than the year 2004,

which had seen an increase due to higher high oil prices in the year 2005. Oil revenue for

the year 2006 would also continue to be higher due to higher oil prices through out the year

2006. The government projected a deficit of BD208.6mn for 2005, but the country recorded

a surplus of BD257.3mn or 5.1% of GDP. This surplus is one of the highest recorded by the

country in the past five years.

The total exports of Bahrain in 2006 stood at BD4.35bn and oil exports contributed BD3.46bn

of the total exports during the period. The total exports in 2006 were up by 15.3%, on account

of higher oil prices in the year 2006. The total non-oil exports stood at BD0.88bn or around

20.3% of the total exports in 2006. The non-oil exports reported an increase of 4.7% in 2006

and hence the contribution to the total exports has been the lowest since 2002. The total

imports increased by 12.6% in 2006 to reach BD3.36bn. The total oil imports during 2006

stood at BD1.84bn, witnessing an increase of 17.6%, while non-oil imports witnessed an

increase of 7.0% and stood at BD1.52bn as compared to BD1.42bn recorded in 2005. As

a result, the non-oil imports contribution to the total imports declined from 66.6% in 2002

to 45.2% in 2006. The resultant trade balance in 2006 stood at BD984.80mn, registering an

increase of 26.0%. Thus on an external front, higher oil prices allowed maintaining a healthy

balance of trade. In our opinion, 2007 is likely to have a higher trade surplus as oil prices

have remained at high level, although not at the same levels seen in 2006.

The broad money supply as measured by M2 has grown at a high rate, which is primarily

attributed to the increase in private sector time and savings (Quasi Money) as well as demand

deposits. Keeping in-line with the rising demand deposits, the money (M1) increased by

21.4% at the end of 2006 to reach BD1.06bn. At the end of 2006, quasi money witnessed an


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June 2007

increase of 12.2% to reach BD2.75bn, whereas it increased by 21.4% in 2005 as compared

to 2004. The broad money supply (M2) had increased from BD3.51bn at the end of 2005 to

BD4.04bn at the end of 2006, an increase of 14.9%. There has also been a consistent rise in

the money supply as measured by M3, which was primarily due to a substantial rise witnessedin deposits from the government in the year 2006. At the end of 2006, M3 witnessed an

increase of 17.4% to reach BD4.89bn as compared with BD4.17bn in 2005. The growth in

money supply as measured by M3 in the year 2006 has been in line with the growth of 17.6%

witnessed at the of 2005.

Interest on interbank deposits increased from 2.8% (3-6 month offered rate) in 2004 to 4.7%

in 2006, which is in line with the increasing interest rate environment in the US (currency

peg). Following the same trend the deposit rates for the 3-12 months period also inched up

sharply from 2.62% in the first quarter of 2005 to reach 3.70% by the end of fourth quarter

of 2005, which was further increased up to 4.40% by the end of forth quarter of 2006. The

interest rates for construction and real estate sector lending jumped from 5.47% in the fourth

quarter 2004 to 8.82% at the end of fourth quarter of 2006. The highest rate was seen in the

second quarter of 2006, where it reached 9.14%, the highest rate seen in the last couple of

years. These trends suggests that gradually domestic interest rates are moving northwards,

however, the rise in rates will be a measured one rather than any drastic surge.

Bahrain has been the hub for foreign banks to operate from to tap the Middle Eastern markets.


2006. The total assets of the banking system (Retail and Wholesale) at the end of 2006 stood

at BD70.43bn (US$187.35bn), a substantial increase of 33.5% as compared to the end of

2005. The growth of the asset size is comparatively higher when compared to the growth

attained during the last two years, which was 17.8% in 2004 and 18.1% in 2005. At end of

2006, net foreign assets of the banking system were at BD2.41bn (US$6.41bn) at the end of

2006 as compared to BD2.21bn (US$5.87bn) at the end of 2005, an increase of 9.2%. The

total domestic assets amounted to BD10.40bn (US$27.67bn) at the end of 2006, an increase

of 29.5% over Dec 2005. It is worth noting that foreign assets accounted for 85.2% of the

total banking assets, indicating its significance for the Bahrain banking system.

Bahrains economy has been one of the most diversified economies in the region, particularly

its financial sector, which has developed strongly, and increased its contribution to GDP and

employment in the country. Bahrains economy is supported by prudent fiscal discipline

characterized by restraint on current expenditure and improved budget balances along with

an effective system of resource allocation for health, education and infrastructure projects. It

is worth mentioning that Bahrain is comparatively less dependent on oil compared to other

GCC countries. So, in other words, Bahrain will be the less vulnerable if the oil prices start

dropping in near future.


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June 2007

Bahrain Banking Sector

Bahrains banking sector has remained to be a cornerstone for economic growth. After the oiland gas sector, the financial institution sector remains the highest contributor to the countrys

GDP. Central Bank of Bahrain (CBB) replaced the Bahrain Monetary Agency (BMA) on 7

September 2006. The introduction of new central bank in the country, with the objective to

monitor and enhance the banking sector regulations. Now, CBB is responsible for licensing,

supervision and regulation of the financial sector and its new supervisory and regulatory

framework has played a significant role in liberalizing the sector to international banks.

The banking system in the region and in Bahrain is witnessing the entry of new players

and some consolidation among the existing players. Bahrains financial services industry

continued to develop and expand during 2005 and 2006, with 7 new licenses issued in 2005

and 9 new licenses issued till the end of 3Q-06. The total number of banks and financialinstitutions at the of end of 3Q-06 was 371. This comprises 150 banking institutions, 151

insurance firms, 36 capital market brokers and 34 others. The country continued to attract a

good mix of locally incorporated, regional and international institutions.

In July-2006, the Bahrain Monetary Agency (BMA) announced details of a comprehensive

package of regulatory reforms to modernize and strengthen the licensing framework for banks

operating in the Kingdom. This is in-line with BMAs effort to create a clearer, more modern

bank licensing regime, whilst strengthening Bahrains position as the leading international

finance centre in the Gulf. Similar licensing reforms have already been implemented for the

insurance and investment business sectors, in April 2005 and April 2006 respectively. A

key feature of the revised framework for banks is the simplification of existing categoriesof onshore and offshore banking licenses, enabling offshore banks to undertake onshore

business in a controlled manner. The existing bank license sub-category of Full Commercial

Bank is replaced by Retail Bank. Meanwhile, the two-existing offshore sub-categories of

Offshore Banking Unit and Investment Banking License are to be merged and replaced with

one unified Wholesale Bank license sub-category.

Recently, BMA has granted three new licenses to international banks that will offer a diverse

range of banking activities. CBB granted a license to the Royal Bank of Scotland (RBS) for

establishing a Representative Office in Bahrain. CBB also granted a license, separately, to

Coutts & Co, the private banking arm of The RBS Group. RBS & Coutts & Co will focus

on mainly two lines of business, wholesale banking and private banking from Bahrain. TheBahrain office will also support RBS activities in the area of project finance and explore

opportunities in Islamic banking. This will be RBSs first on-ground representation in the

Middle East and North Africa (MENA) region. Another license was granted to the leading

international private bank, EFG Bank to establish a Representative Office in Bahrain. EFG

Bank is a wholly-owned subsidiary of EFG International, a global private banking group

headquartered in Zurich, Switzerland. The bank will provide wealth management solutions to

their clients, both institutional and individual in the region through their Bahrain office. The

bank believes that surge in liquidity and increase in wealth levels in recent years is providing

a new growth momentum for private banking services and Bahrain would be the ideal place

to do business in the region. The entry of such diverse financial institutions from across the

world demonstrates the excellent reputation the Kingdom enjoys as an international financialcenter.


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June 2007

Banking sector assets growing at a faster pace.


2006. The total assets of the banking system (Retail and Wholesale) at the end of 2006 stood

at BD70.43bn (US$187.35bn), a substantial increase of 33.5% as compared to the end of

2005. The growth of the asset size is comparatively higher when compared to the growth

attained during the last two years, which was 17.8% in 2004 and 18.1% in 2005. At end of

2006, net foreign assets of the banking system were at BD2.41bn (US$6.41bn) at the end

of 2006 as compared to BD2.21bn (US$5.87bn) recorded at the end of 2005, an increase of

9.2%. The total domestic assets amounted to BD10.40bn (US$27.67bn) at the end of 2006,

an increase of 29.5% over 2005. It is worth noting that foreign assets accounted for 85.2% of

the total banking assets, indicating its significance for the Bahrain banking system.

Table 2: Consolidated Balance Sheet: Retail and Wholesale Banks

US$ mn 2003 2004 2005 2006

Banks 6,965.8 8,681.0 10,099.8 13,784.9

Private Non-Banks 5,505.5 7,032.9 8,403.5 10,417.7

General Government 1,382.0 1,786.7 1,872.1 1,883.7

Other Assets 693.4 730.5 984.1 1,584.3

Foreign Assets 86,388.1 100,682.0 119,022.2 159,684.3

Total Assets 100,934.8 118,913.1 140,381.7 187,354.9

Banks 6,055.4 7,622.1 9,175.4 12,892.2


General Government 2,084.0 2,694.0 2,703.5 3,065.6

Other Liabilities 2,888.3 4,107.5 5,413.6 6,484.3

Foreign Liabilities 82,387.2 96,692.2 113,149.3 153,274.0

Total Liabilities 100,934.8 118,913.1 140,381.7 187,354.9

Source: Central Bank of Bahrain

Banks in Bahrain is categorized by wholesale retails banks. Wholesale banks dominates the

banking system in Bahrain. Wholesale banks contributes 87.7% of the total Bahrain banking

assets. The contribution of the wholesale banks have remained in the range of 88.2% - 87.7%

during the period 2003-2006. Market share of retail banks in terms of total assets was 12.3%

at the end of 2006. During the period 2003-2006, the market share of retail banks remained

in the range of 11.8% 12.3%. This indicates that the growth in the banking assets has been

across the board, which means that wholesale and retails banks are exhibiting more or less

the same growth over the last few years.


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June 2007 7

Chart 1 : Wholesale and retails banking assets


Liability mix all about foreign liabilities

Liabilities grew at a CAGR of 22.9% for the period 2003-06 from BD37.94bn (US$100.93bn)

in 2003 to BD70.43bn (US$187.35bn) in 2006. In the year 2006, total liabilities grew by

33.5% as compared to end of 2005. Foreign liabilities accounted for about 81.8% of the total

liabilities. From 2003 to 2006, foreign liabilities have remained in the rage of 80%-82%.

Private non-banks contribution declined during 2006 to 6.2% from 7.1% at the end of 2005.

Banks contribution to the total liabilities increased from 6.5% in 2005 to reach 6.9% at the

end of 2006.

Chart 2: Liability Mix

Source: Central Bank of Bahrain, Global Research

Wholesale banks dominates the banking sector.

In the latest regulatory reform by the BMA, Offshore Banking Unit and Investment Banks

are merged and replaced as Wholesale Banks. The total assets of the wholesale banks grew

at a CAGR of 22.8% during the period 2003-2006. The total assets of the wholesale banks

stood at BD61.74bn (US$164.26bn) at the end of 2006, which represents 32.6% increase as

compared to BD46.55bn (US$123.85bn) at end of 2005. The total assets of the wholesale bank

witnessed substantial rise in the year 2006, mainly from the foreign assets, which contributes

100.0%

95.0%

90.0%

85.0%

80.0%

2003 2004 2005 2006

Wholesale Banks Retail Banks

87.9%

12.1% 12.3%

87.7% 88.2%

11.8% 12.3%

87.7%

100%

90%

80%

70%

2003 2004 2005 2006

Foreign Liabilities Banks Private Non-Banks General Government Other Liabilities

81.6%

6.0%

7.5%

2.1%

2.9% 3.5%

2.3%

6.6%

6.4%

81.3%

80.6%

6.5%

7.1%

1.9%

3.9% 3.5%

1.6%

6.2%

6.9%

81.8%


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June 2007

about 92.0% of the total assets of the wholesale banks. This indicates the important role

played by foreign banks in the overall economy of Bahrain, which is also the back-bone of

the entire banking sector of Bahrain.

Table 3: Consolidated Balance Sheet of Wholesale Banks

In US$ mn 2003 2004 2005 2006

Assets

Banks 4,552.8 5,813.8 7,089.0 9,802.8

Private Non-Banks 840.1 1,254.3 1,427.6 2,113.2

General Government 284.4 409.0 426.1 347.5

Other Assets 349.1 369.7 535.9 853.5

Foreign Assets 82,669.0 96,443.3 114,366.8 151,146.2

Total Assets 88,695.4 104,290.1 123,845.4 164,263.2

Liabilities

Banks 5,193.8 6,271.3 7,798.9 9,942.2

Private Non-Banks 696.6 710.1 1,228.4 1,460.5General Government 715.9 884.8 945.5 1,013.3

Other Liabilities 1,651.1 2,588.3 3,533.8 3,878.3




The system remains a net external creditor, with net foreign assets of wholesale banks

amounting to BD1.19bn (US$3.18bn) at end of 2006, however it declined by 21.1% when

compared to 2005 level. Domestic assets of the wholesale banks amounted to BD4.93bn

(US$13.18bn) at the end of 2006 as compared to BD3.56bn (US$9.48bn) reported at the

end of Dec-2005, while the domestic liabilities amounted to BD6.13bn (US$16.29bn) as

compared to BD5.08bn (US$13.51bn) recorded at the end of 2005.

Retail banks growing in-line with the system assets.

In the latest regulatory reform by the BMA, Full Commercial Banks are replaced as Retail

Banks. The total assets of the retail banks grew at a CAGR of 23.6% during the period

2003-2006. Retail banks in Bahrain continued to show outstanding growth in 2006, as the

total assets of retail banks stood at BD8.68bn (US$23.09bn) as compared to BD6.22bn

(US$16.54bn) at the end of Dec-2005, an increase of 39.6%. The strong performance by

retail banks was a reflection of the positive business and economic conditions prevalent in

Bahrain and the quality of assets held by those banks. As a result, most of the local listed

banks showed higher earnings growth during the year 2006. This was due to low cost offunds prevailing in the market coupled with an upbeat lending market, further supported the

banks earnings for the year 2006.


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June 2007

Table 4: Consolidated Balance Sheet of the Retail Banks

In BD mn 2003 2004 2005 2006

Cash 40.3 39.6 41.8 52.0

Banks 603.5 782.1 745.3 1,091.7


Bahrain Monetary Agency 263.5 256.4 344.9 353.6


Other Assets 129.4 135.7 168.5 274.8

Foreign Assets 1,398.4 1,593.8 1,750.4 3,210.3

Total Assets 4,602.0 5,498.3 6,217.6 8,682.5

Capital & Reserves 387.9 463.5 565.4 797.5

Banks 257.6 445.9 420.3 1,071.7


Bahrain Monetary Agency 66.4 62.0 97.3 37.5

General Government 514.4 680.3 661.0 771.7Other Liabilities 77.2 107.7 141.4 182.4

Foreign Liabilities 732.9 1,074.1 1,056.7 1,994.7



The net foreign assets of the retail banks were BD1.22bn (US$3.23bn) at the end of 2006,

recording a whopping increase of 75.2% as compared to 2005-end level. Domestic assets

of the retail banks amounted to BD5.47bn (US$14.56bn) at the end of 2006 as compared to

BD4.47bn (US$11.88bn) at the end of Dec-2005 while the domestic liabilities amounted to

BD6.69bn (US$17.79bn) as compared to BD5.16bn (US$13.73bn) at the end of 2005.

Islamic banking increasing its penetration..

Liquidity in the GCC region has fuelled growth for both Islamic and conventional banking,

but Islamic banking has grown at a much faster pace when compared to conventional banking

over the last couple of years. The Islamic banking industry in Bahrain has witnessed growing

desire of customers to transact their financial activities in accordance with the Islamic Sharia

principles. Bahrain, which has spearheaded the Islamic banking activities in the region, has

become the natural and convenient location for Islamic finance in the Middle East region

with 27 Islamic financial institutions.

The strong growth of Islamic banking and its impact on financial markets has prompted anumber of traditional local and international banks to seek stronger relationships and joint

project financing arrangements with their Islamic counterparts. The Islamic banking industry

in Bahrain is becoming highly competitive and more multinational banks are entering in the

Islamic banking arena, thus changing the competitive setting of the commercial banking

sector in Bahrain.

According to the latest regulations, Islamic retail banks in Bahrain have been granted a key

exemption, which will considerably facilitate the Islamic mortgage business in the Kingdom.

The move will eliminate the payment of stamp duty twice on mortgages extended in

accordance with Islamic principles. The strengthening and development of Islamic banking


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0 June 2007

has been, and remains, an important aspect in the governments policy in maintaining and

enhancing Bahrains status as the regions pre-eminent international centre. As a result of

the various initiatives undertaken by the Bahraini government to develop the country as an

Islamic banking hub, the size of Bahrains Islamic banking and finance industry rose sharplyin 2005 and has continued to grow in 2006.

Table 5: Consolidated Balance Sheet of Islamic Banks

In US$ mn 2003 2004 2005 2006

Cash 10.1 12.6 14.8 21.2

Banks 1,092.3 1,147.5 1,737.2 3,065.6

Private Non-Banks 678.8 1,022.5 1,585.3 1,986.5


Other Assets 189.8 231.8 392.8 651.7

Foreign Assets 2,080.3 2,899.0 4,116.5 6,401.4

Total Assets 4,156.9 5,434.2 8,009.4 12,208.3

Capital & Reserves 678.4 1,056.6 1,286.4 2,238.5

Banks 429.8 817.5 1,212.9 2,253.5



Other Liabilities 48.1 61.8 231.5 258.4




The total assets of the Islamic banks grew at a CAGR of 43.2% during the period 2003-2006,

which has exceeded the growth of the entire banking system of Bahrain. The total assets ofIslamic banks operating in Bahrain stood at BD4.59bn (US$12.21bn) at the end of 2006,

which was an increase of 52.4% over its 2005-year end level. The growth in assets was

mainly fuelled by 55.5% rise in foreign assets of the banks, which also contributes more than

half of the total assets of Islamic banks. At the end of 2006, the net foreign assets of the banks

jumped from BD291.2bn (US$774.6mn) in 2005 to BD387.5bn (US$1.03bn), an increase of

33.1%. The growth in the Islamic banks during the last three years augurs well for Bahrain,

as Bahrain expects to become the preferred destination of Islamic banking in the region.

Chart 3: Consolidated Balance Sheet of Islamic Banks


5.2

4.2

3.2

2.2

1.2

2003 2004 2005 2006

7.0%

6.0%

5.0%

4.0%

4.1%

4.6%

5.7%

6.5%

Islamic Banking Islamic Banking % of Banking sys tem

BDbn

CAGR - 43.2% (2003-06)


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June 2007

The importance of Islamic banking can be further substantiated with the increasing

contribution of Islamic banking assets to the total banking system. The total assets of the

Islamic banks have grown at a much faster rate than the Bahrain banking system assets. As

a result, the contribution of Islamic banking to total assets increased from 4.1% in 2003 to6.5% in 2006. Going forward, we believe that Islamic banks will continue to grow at a faster

pace than the conventional banking assets, as many investors are migrated from conventional

banking to Islamic banking.

Credit portfolio - getting bigger

The total loans and advances of the banking system grew at a CAGR of 19.0% from BD1.79bn

(US$4.79bn) in 2003 to BD3.03bn (US$8.07bn) in 2006. In the year 2006, it increased by

15.6% and stood at BD3.03bn (US$8.07bn) as compared to BD2.62bn (US$6.98bn) at the

end of December 2005. The lending to business sector accounted for 53.4% of the total

credit, while personal and government sector accounted for 41.3% and 5.3% respectively.

The contribution of business lending has increased from 46.8% in 2005 to 53.4% in 2006,

which plays an important role in driving the credit growth especially in favorable macro-

economic conditions. On the other hand, contribution of credit to government sector has

declined from 7.7% in 2005 to 5.3% in 2006. The credit to personal segment accounted for

41.3% in 2006 as compared to 45.5% at the end of 2005. Going forward, we believe that the

new regulation will smoothen the unprecedented growth seen in the consumer lending in the

last couple of years.

Chart 4: Credit Portfolio Break up


The personal segment witnessed an increase in lending by 4.9% at the end of 2006. The

lending to the personal segment has witnessed healthy growth in the last three years, but the

growth in the personal lending slowed down in the year 2006. Lending to personal segment

plays a significant role in the growth of commercial bank earnings as the interest rates

charged on the personal segment is much higher compared to the business segment during

the year 2005. The slower growth in personal lending during 2006 can be attributed to the

new regulation on consumer lending by the CBB.

100%

80%

60%

40%

20%

2003 2004 2005 2006

Business Personal General Government

46.5%

44.9%

8.6% 9.3%

45.5%

45.2%46.8%

45.5%

7.7% 5.3%

41.3%

53.4%


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2 June 2007

Lending from government witnessed a decline from BD202.6mn (US$539.0mn) in 2005 to

BD161.5mn (US$429.6mn) in 2006, recording a drop of 20.3%. In lending to government

segment, there has been a declining trend since 2004, which continued in the year 2006 as

well.

Table 6: Commercial Banks Credit to Various Sectors

BD mn 2002 2003 2004 2005 2006

Business 842.7 837.1 1,008.6 1,226.9 1,619.1

Manufacturing 255.7 251.1 298.2 282.6 312.3

Mining & Quarrying 0.6 1.0 2.3 2.3 1.8

Agriculture, Fishing & Dairy 5.9 6.3 8.5 9.0 6.5

Construction & Real Estate 176.9 165.8 187.1 302.1 484.2

Trade 299.6 286.2 341.3 436.2 551.6

Non-Banking Financial Institutions 27.9 41.1 71.0 67.7 75.1

Transportation & Communication 13.2 85.6 41.5 44.4 49.0

Hotels & Restaurants 24.4 15.1 27.5 27.0 22.0Other Sectors 38.5 26.7 31.2 55.6 116.6

General Government 108.4 154.3 207.4 202.6 161.5

Personal 678.7 807.5 1,014.7 1,194.0 1,252.9

Total 1,629.8 1,798.8 2,230.7 2,623.5 3,033.5


Business segment registered a CAGR of 24.6% from BD837.1mn (US$2.2bn) in 2003 to

BD1.62bn (US$4.3bn) in 2006. In the year 2006, the business segment continued to be the

main source of growth for bank credit portfolio. The business segment has registered an

increase of 32.0% in 2006 as compared to the previous year. The growth in business sector is

mainly driven by trade, manufacturing and construction and real estate sector, as collectively

they account for almost 83.3% of the total business segment lending at the end of 2006.

The trade sector accounted for the largest pie among the three sectors of the commercial banks

credit to the private sector. It accounted for almost 34.1% of the total credit to the business

segment and followed by the manufacturing and construction and real estate sector, which

accounted for another 19.3% and 29.9% respectively during the same period. In absolute

terms, lending to trade sector grew at a CAGR of 24.4% from BD286.2mn (US$761.4mn) in

2003 to BD551.6mn (US$1,467.4mn) in 2006. As a result, the contribution of trade sector to

the overall credit has been increasing since 2003, from 15.9% in 2003 to 16.6% in 2005, and

further increased to 18.2% at the end of 2006.

Lending to real estate and construction grew at a CAGR of 42.9% to BD165.8mn

(US$441.1mn) in 2003 to BD484.2mn (US$1.3bn) in 2006. In the year 2006, it increased by

60.3% from BD302.1mn (US$803.7mn) reported in 2005 to BD484.2mn (US$1.3bn). It is

worth noting that the lending to the construction and real estate sector has more than doubled

since the end of 2004. In our opinion, several large-scale construction projects are expected

to further bolster growth and lending from the construction and real estate sector, which will

also be the driving force for the growth in business segment.

Lending to manufacturing sector grew at a CAGR of 7.5% from BD251.1mn (US$668.0mn)

in 2003 to BD312.3mn (US$830.8mn) in 2006. In the year 2006, the lending to manufacturing

sector increased by 10.5% as compared to the previous year. It is worth noting that the


15/96



June 2007

contribution of manufacturing sector to total credit of the banking system declined from

14.0% in 2003 to 10.3% in 2006.

In our opinion, the lending market is expected to remain buoyant in near term due to increasedgovernment spending in various sectors, which will further bolster the lending portfolio of

the banking system.

Banks in Bahrain are expected to shore up their retail businesses by expanding their operations

in other parts of the region. Banks are also expected to refocus on their target market through a

process of re-engineering its retail capabilities, upgrading human resources, improve product

range delivery and enhanced client segmentation. Consequently, prospects for Bahrains

commercial banks are challenging given their relative size and lending opportunities. As

banks in Bahrain have shown their intentions to grow, banks needs to look aggressively

for opportunities elsewhere in the region. Since the banking sector in the region is still in a

consolidating phase Bahraini banks would have an early mover advantage.


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June 2007

Peer Group Comparison

The peer group comparison is done on five banks, namely Ahli United Bank (AUB), Bank of

Bahrain and Kuwait (BBK), National Bank of Bahrain (NBB), Bahrain Islamic Bank (BIsB)and Bahraini Saudi Bank (BSB). Al Salam Bank was incorporated on 19th January 2006 in

the Kingdom of Bahrain with a paid-up capital of BD120mn (US$318mn), and commenced

commercial operations on 17th April 2006, which we have not included in the peer group

comparison. The size of the banks under coverage increased from BD5.3bn in 2003 to

BD11.8bn in 2006, registering a CAGR of 30.9%. In the year 2006, the size of banks under

coverage increased by 35.9% as compared to the previous year.

Chart 5: Balance Sheet Size

Source: Company Reports

The top three banks namely NBB, BBK and AUB assets grew at a CAGR of 10.6%, 8.8% and

49.1% respectively for the period 2003-2006. AUB increased its presence in various regions

by acquiring stakes in banks, which helped the bank in increasing its total asset size. In 2005,

the bank increased its stake in the Bank of Kuwait and the Middle East to 75%. Although,

Bahrain has the maximum number of foreign banks in the region, the top three local banks

have been able to maintain their market share through increasing branch networks and strong

relationship network with the local Bahrainis.

Going forward, we believe that the growth in Bahraini economy augurs well for the banking

industry as it will be flushed with liquidity. The opportunities for lending will continue due tothe strong growth in the corporate sector coupled with changing demographics in the country.

Banks have also started concentrating on Small and Medium Enterprises (SMEs), which will

be the trend going forward.

12,500

11,500

9,500

8,000

6,500

5,000

3,500

5,272.3

6,226.2

8,710.6

11,837.1

2006200520042003

BDmn

CAGR - 30.9% (2003-06)


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June 2007

Chart 6: Deposits growth Banks Under Review


Deposits of banks under review grew at a CAGR of 26.3% for the period 2003-06 from

BD2.8bn in 2003 to BD5.7bn in 2006. The top three banks (NBB, BBK and AUB) deposits

grew at a CAGR of 10.2%, 7.7% and 47.7% respectively for the period under review. The

other two banks under review, namely BIsB and BSB deposits grew at a CAGR of 21.2% and

4.4% respectively. In 2006, customer deposits of the banks under review reached BD5.7bn

as compared to BD4.5bn in 2005, registering an increase of 26.6%. AUB, NBB and BBK,

deposits registered an increase of 35.7%, 18.3% and 11.6% respectively in 2006 as compared

to the previous year.

In order to support strong loan growth in the banking sector, resource mobilization is the key.

Due to the strong network and improved relationships with corporate and retail customer,

banks have been able to increase their deposits. In addition, banks have also increased their

branch and ATM network throughout the Kingdom. This will further help banks to shore up

their loan book.

Chart 7: Gross Loans and Advances Banks Under Review


On the lending side, gross loans and advances grew at a CAGR of 29.3% for the period

2003-06. Gross loans increased from BD2.6bn in 2003 to BD5.5bn in 2006. In 2006, gross

loans grew by 34.5% as compared to 2005. Net loans for the banks under review grew at

6,000.0

5,000.0

4,000.0

3,000.0

2,000.0

36.0%

32.0%

28.0%

24.0%

20.0%

2003 2004 2005 2006

Deposits Growth in deposits

20.7%

31.9%

26.6%BDmn

6,000

5,500

5,000

4,500

4,000

3,500

3,000

2,500

2,000

1,500

2003 2004 2005 2006

2,557.1

2,906.2

4,111.2

5,531.1

InBD

mn


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June 2007

a CAGR of 31.5% for the period 2003-06, from BD2.4bn in 2003 to BD5.4bn in 2006. In

2006, the net loans increased by 35.8% as compared to 2005. However, in 2006 the regulator

issued guidelines on lending to the consumer segment. It was issued with the objective of

limiting the rapid expansion of consumer loans. Banks that followed prudent lending normsfor consumer loans did not witness any slow down in the consumer loans.

We believe banks will continue to witness strong lending requirements from the service

and real estate sectors, especially the services sector. Governments efforts to diversify the

economy and improve the investment climate through regulatory and structural measures in

various sectors will also augur well for the banking sector going forward.

Chart 8: Credit Deposits Ratio


The growth in loans and advances has been in line with the growth in deposits. Gross loans as

a percentage of deposits increased from 90.0% in 2003 to 96.8% in 2006. However, there is

still room for the banks to expand their loan portfolio. Growth in loan book will be facilitated

by the banks provided banks are able to maintain their deposit growth.

Total non-performing loans of the banks under review amounted to BD203.1mn in 2004

as compared to BD173.2mn in 2006, which represented 3.1% of the banks aggregate loan

portfolio at the end of year 2006 as compared with 7.0% in 2004. BBK had the highest non-

performing loans (NPLs) amongst the peer group, representing 39.44% of the sectors total

NPLs and 6.9% of the banks gross loans, which is well above the average in the sector. It is

worth noting that BBK had done a commendable job in reducing its NPLs from BD100.6mn

in 2003 to BD68.3mn at the end of 2006. This is further expected to drop as the bank has

taken major initiatives to reduce the NPLs. Even BSB has done commendable job in reducing

its NPLs to Gross Loans ratio from 68.4% reported in 2004 to 48.9% at the end of 2006. BSB

NPLs to gross loans is very high as compared to peers. It is worth noting that the NPLs to

gross loans would have been 2.2% at the end of 2006, excluding BSB.

6,500

5,500

4,500

3,500

2,500

1,500

100.0%

96.0%

92.0%

88.0%

84.0%

80.0%

2003 2004 2005 2006

90.0%

84.8%

91.2%

96.8%

Customer Deposits Gross Loans & advances Gross Loans % of Customer deposits

BDmn


19/96



June 2007 7

Chart 9: Asset Quality


NBB has the lowest ratio compared to the banks under review. NPLs as a percentage of gross

loans for NBB declined from 2.2% in 2003 to 1.1% in 2006. Despite the growth in the loan

book, the conservative credit risk policies and the success of recovery efforts has helped the

bank improve its credit risk during the last three year. AUB and BIsB are not far away from

NBB in improving asset quality over the last three years. At end of 2006, AUB and BIsB

were at 1.2% and 1.1% respectively. The average NPL/Gross Loans ratio in the Bahraini

banking sector is 3.1%, which is higher than most of the largest banking sector in the GCC,

such as UAE and Saudi Arabia.

Bahraini banks coverage ratio was 91.5% in 2006 as compared to 85.5% at the end of 2005.

Except NBB and AUB, the other three banks had coverage ratios of less than 100%. NBB

had the highest coverage ratio of 173.5% followed by AUB with 122.8% coverage. BBK had

the lowest coverage ratio of 69.4%, followed by BIsB (71.6%) and BSB (83.5%).

Net profits growing by double digits in 2006

Profits of the banks under review, grew from BD82.5mn in 2003 to BD182.9mn in 2006,

growing at a CAGR of 30.4% for the period under review. In 2006, profit of the banks under

review witnessed a growth of 29.8% from BD141.0mn in 2005 to BD182.9mn in 2006. It

is worth noting that all the banks under review reported a double digit growth in net profit

during the year 2006. The profit margins of the banks under review improved from 48.1% in

2003 to 54.7% in 2006.

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

94.0%

92.0%

90.0%

88.0%

86.0%

84.0%

82.0%

80.0%

78.0%

76.0%

2003 2004 2005 2006

6.9%7.0% 4.4%

3.1%

91.5%

85.5%

82.5%

87.3%

NPL/Gross Loans Coverage


20/96



June 2007

Chart 10: Profit Margin


Net interest income grew from BD102.0mn in 2003 to BD203.4mn in 2006, increasing at a

CAGR of 25.9%. In the year 2006, the net interest income increased by 36.6% as compared

to the previous year. In our opinion, banks will continue to witness growth in the core banking

activities.

Chart 11: Margins


Yield on average interest earnings assets for the banks under review increased from 4.04%

in 2003 to 6.21% in 2006. At the same time, the cost of average bearing liabilities increased

from 1.84% in 2003 to 4.30% in 2006. However, with the general increase in interest rates,

cost of funds for the bank has gone up in the past few years. In addition, the banks have been

attracting deposits by paying higher interest rates. As a result of this, the net spread for the

banks under coverage declined from 2.20% in 2003 to 1.99% in 2005 and further dropped to

1.91% in 2006.

In 2006, net interest margin (commission margin in case of BIsB) of the banks under review

ranged between 1.7% and 6.9%. The range for these banks in 2003 were 2.1% and 3.9%. The net

interest margin (commission margins in case of BIsB) of the banks under review dropped from

2.33% in 2003 to 2.16% in 2006. AUB and BSB witnessed a drop in net interest margin during

this period, whereas NBB, BBK and BIsB witnessed an increase during the same period.

200.0

180.0

160.0

140.0

120.0

100.0

80.0

60.0

40.0

57.0%

55.0%

53.0%

51.0%

49.0%

47.0%

45.0%

2003 2004 2005 2006

54.7%54.7%

49.7%

48.1%

Net Profit Profit margin

BDmn

7.00%

5.00%

3.00%

1.00%

2.30%

2.15%

2.00%

0.85%

2003 2004 2005 2006

Interest on average earnings assets Cost on interest bearing liabilities Net Spread

2.20%

2.04%

1.99%

1.91%


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June 2007

Non-interest income of banks under review grew at a CAGR of 23.5% from BD70.5mn in

2003 to BD132.7mn in 2006. In the year 2006, the non-interest income increased by 19.6%

as compared to the previous year. Fees and commission income from banking services was

main determinant for the growth in non-interest income.

Chart 12: Fees and Commission Income (2006)


Fees and commission income grew at a CAGR of 27.0% from BD33.3mn in 2003 to

BD68.12mn in 2006. In 2006, fees and commission income increased by 47.5% as compared

to the previous year. Contribution of fee based income of total non-interest income for the

banks under review increased from 47.9% in 2003 to 51.2% in 2006. During the year 2006,

most of the bank increased participation in syndicated facilities and IPO financing, which

helped the banks to increase its fees and commission income.

Operating expenses (Opex) of the banks under review increased from BD74.2mn in 2003 to

BD133.3mn in 2006, grew at a CAGR of 21.6%. In the year 2006, the operating cost increased

by 32.3% as compared to the previous year. The increase in operating expenses was mainly

due to the increase in manpower along with other expenses on business development.

Chart 13: Operating Efficiency for Banks Under Review

Source: Global Research

100.0

80.0

60.0

40.0

20.0

-

80.5%

60.5%

40.5%

20.5%

0.5%

NBB BBK AUB BIsB BSB

Non-Interest income Fee income % of Non-Interest income

47.2%

59.6%

54.3%

60.0%

13.5%

45.00%

43.00%

41.00%

39.00%

37.00%

35.00%

1.57%

1.36%

1.15%

2003 2004 2005 2006

Cost to Income Opex. to Average Assets

43.30%

1.35%

1.48%

42.50%

1.35%

39.02% 39.80%

1.30%


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20 June 2007

Cost to income ratio of the banks under review declined from 43.3% in 2003 to 39.8% in

2006. Cost to income ratio increased on the back of increasing business development costs.

In 2006, the lowest cost to income ratio was for NBB at 36.0%, which is below the average

of the banks under review. The highest was for BSB at 61.9%, which witnessed an increasein manpower costs as well as expenses on developing IT platforms for business segments.

Opex as a percentage of average assets (AA) ratio declined from 1.35% in 2003 to 1.30% in

2006. The lowest ratio was for AUB at 1.1% and highest was for BSB at 2.4% at the end of

2006.

Chart 14: Return Ratios Banks Under Review


The year 2006 has been a good year for Bahraini banks, as all the banks under review

witnessed a double digit growth in net profit. As a result, the return ratios for the banks under

review improved during the year 2006. The return on average equity (ROAE) improved from

12.8% in 2003 to 15.2% in 2006. The return on average assets improved from 1.50% in 2003

to 1.78% in 2006. BBK had the highest ROAE of 18.2% in 2006, followed by BIsB with

17.8%. In terms of average ROAA, BIsB was leading the way with RoAA of 3.4% followed

by NBB at 2.3% respectively in 2006.

2.0%

1.8%

1.6%

1.4%

1.2%

1.0%

16.0%

15.0%

14.0%

13.0%

12.0%

11.0%

10.0%

2003 2004 2005 2006

15.2%

14.4%

13.2%12.8%

ROAA ROAE


23/96



June 2007 2

Bahraini Banking Sector Outlook

Banks in Bahrain have benefited from strong economic growth witnessed during the last

three years on the back of high oil prices. During the last three years, the credit deploymentto consumer, construction & real estate and manufacturing segments was particularly strong.

A number of real estate friendly regulations were initiated which further complemented the

real estate sector in Bahrain.

Bahrain is in the midst of a diversification stage, which indicates that the banking sector

will continue to see more demand from the corporate as well as the consumer segment.

Manufacturing and construction sectors are likely to be the key growth drivers for the entire

banking system. Real Estate and construction sector, one of the main sectors in Bahrain

is likely to attract attention as there are lot of projects in the pipeline. Bahrain has been

promoting its tourism sector over the year, which will further encourage more hotels and

resorts in the country. Even changing demographics and the increasing expatriate populationis likely to boost the consumer lending segment.

On the funding side, deposit franchise of Bahraini banks registered a CAGR of 26.3% during

the last three years. Banks in Bahrain are able to raise sufficient funds through paying higher

interest rates, which the banks will be able to support the loan growth with a longer duration.

The above mentioned big-ticket projects are long-term in nature and hence in order to avoid

asset-liability mismatches, banks are raising funds either through fixed deposits or long term

debt.

On the profitability, during the last three years, profits grew at a CAGR of 30.4% on the back

of core income growth of 25.9% and non-interest income growth of 23.8%. Core incomewill continue to be the driving force for earnings growth. However, most of the banks have

also started participated in syndication facilities and IPO financing, which boosted their non-

interest income. In order to increase fees from banking activities, banks will continue to

participate in syndication facilities as well as IPO financing. In our opinion, core banking

operations are likely to be the key focus areas in the years to come.

Core income registered a strong growth of 36.6% in 2006 as compared to the previous year.

Non-interest income also increased by 20.4% in 2006 as compared to the previous year.

Banks are taking appropriate initiatives in order to increase its non-interest income, either

through the introduction of new products such as trading online or through credits cards

fees.

Going forward, government thrust towards providing further impetus to economic growth is

likely to benefit the banking sector. However, the banks will continue to face competition

in the market with international banks, but the domestic banks will continue to leverage

its brand as well as strong customer relationship to continue the growth trajectory. In our

opinion, the outlook for the banking sector is positive on the back of buoyant core banking

activities.


24/96



22 June 2007

Valuation & Recommendation

For arriving at the fair value of the banks under review, we have used two valuation

methods:

1. Cash flow approach represented by the Dividend Discounting Model

2. Market approach represented by Peer Group valuation.

Dividend Discounting Model - DDM

The DDM model constructed is based on a 4-year forecast of dividends as cash flows (2007-

10). The dividends for the forecasted period and the terminal value are then discounted back

at the cost of equity to arrive at the total net present value (NPV) of the company. In our

calculations, we have made the following assumptions in order to arrive at the equity valueof individual banks:

1. Cost of Equity of 11.62% derived using Capital Asset Pricing Model.

2. Risk free rate of 6.62%.

3. Equity risk premium of 5.0%.

4. Beta of 1. The actual beta of the banks is less than 1, but to more appropriately reflect the

market risk we have taken it as 1.

5. Terminal growth rate of 3.0%. (4.0% for BIsB being an Islamic Bank)

Table 7: Value as per DDM Approach

DDM Value

AUB (US$) 1.25

BBK (Fils) 831.5

BIsB (Fils) 519.6



25/96



June 2007 2

Peer Group Valuation

The peer group valuation is done by comparing the price to book value (P/BV) multiples

enjoyed by similar companies.

Table 8: Companies average P/BV ratios in the banking sector

Equity

2007

Shares O/S BV/Sh. Price Market

Cap.

P/BV

(BD mn) (mn) (BD) (BD) (BD mn) (x)

AUB 581.7 2,860.0 0.203 0.490 1,401.7 2.41

BBK 187.7 672.2 0.279 0.670 450.4 2.40

BIsB 66.7 602.1 0.111 0.448 269.8 4.05

NBB 203.9 648.0 0.315 0.800 518.4 2.54

BSB 53.1 500.0 0.106 0.150 75.0 1.41

Total/Average 1,093.0 5,282.3 0.207 2,715.2 2.48

Source: Global Research,Market prices as on May 31, 2007

As indicated in the table 2, the average P/BV multiple for the banks in Bahrain is around

2.48x. Therefore, on the basis on industry average P/BV of 2.48x, the value of the banks

under review is given in the table below.

Table 9: Value as per Market Approach

P/B value

AUB (US$) 1.31

BBK (Fils) 731.3

BIsB (Fils) 618.2


As the book value multiples vary with time and are dependent on several factors such as

market sentiment and other qualitative factors, we have provided 20% weightage to the P/BV

multiple and 80% to the DDM method.

Table 10: Valuation

DDM Value P/B Value Weighted Price

AUB (US$) 1.25 1.31 1.26

BBK (Fils) 831.5 731.3 811.5

BIsB (Fils) 519.6 618.2 539.3


Table 11: Global Valuation Matrix

Price Target Reco.%

ChangeBVPS EPS P/BV P/E

AUB 1.30 1.26 HOLD -2.8% 0.53 0.09 2.5 13.8

BBK 670 811 BUY 21.1% 294.4 58.0 2.3 11.6

BIsB 448 539 BUY 20.4% 248.9 69.8 1.8 6.4

Note: * Based on 2007E

Source: Global Research, Market prices as on May 31, 2007

All in fils except for AUB, which is US$


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2 June 2007

Players Profle


27/96



June 2007 2

Key Data

EPS (US cents)* 9.39 Avg. daily vol.(000) 700,537

BVPS (US cents)* 473.1 52 week Lo / Hi 0.79/1.36

P / E (x) 13.8 Market Cap (US$ mn) 3,718P / BV (x) 2.7 Target Price (US$) 1.26


* Projected (2007)

Company Background

Ahli United Bank (AUB) is a Bahrain based bank operating under a retail banking license

and is regulated by the Central Bank of Bahrain. The bank provides retail, commercial and

investment banking business, global fund management and private banking services. AUB

is among the top three local banks in the Kingdom. Banks growth strategy encompasses

a merger and acquisition model which entails assessing and pursuing strategy fit banksin the region.

AUBs businesses consist of the operations in Bahrain, subsidiaries in the UK and Kuwait

and associates in Bahrain, Qatar, Iraq and Egypt. AUB holds 75 percent stake in the Bank

of Kuwait and the Middle East (BKME). The banks also has a 40 percent stake in Ahli

Bank Q.S.C. a commercial bank in Qatar. AUB has a 10-year management contract with

Ahli Bank Q.S.C.

Apart from the banks, AUB has now an enhanced nominal stake of 73% in Kuwait and

Middle East Financial Investment Company (KMEFIC) a brokerage, asset management

and corporate finance company based in Kuwait with operations around the Arabian Gulf.The AUB Group, through its subsidiaries and associates, operates through a network of

78 branch offices and employs over 2,800 people.

This development has helped accelerate progress in the delivery of financial services and

penetration into targeted geographical markets. The business area strategies are geared

to achieve stable and sustainable income growth, operational competitiveness, a higher

quality of service, maximum cost efficiencies and greater risk assessment capabilities.

It is worth noting that the bank is actively traded stock on the Bahrain Stock Exchange

(BSE). At the end of March 2007, AUB is one of the largest in terms of market capitalization

as it accounted for 15.74% of the total market capitalization of the Bahraini index.

Reuters Code:

AUB.BH

Listing:

Bahrain Stock Exchange

Current Price

US$1.30 (May 31st, 2007)

Recommendation

HOLD

Ahli United Bank


28/96



2 June 2007

The banks new headquarters in Al-Seef district of Bahrain, includes a full service branch

facility and the Group support functions of audit, compliance, IT & operations, finance

and human resources. In addition, it also provides the private banking as well as wealth

management business across the Gulf, as well as the treasury, commercial banking andretail banking departments.

Recent Developments

In March 2007, AUB was awarded Best Bank in the Middle East 2007 by Global

Finance for the second year in a row. This demonstrates the continuing success of business

strategies and the soundness of management principles to be the leader in this industry.

In December 2006, AUB was named Best Bank of the Year in the Middle East for

2006 by The Banker magazine ahead of all other regional banks besides being the Best

Bank in Bahrain 2006 and the Best Local Private Bank Middle East for 2006 under

a private banking survey by Euromoney. The Bank also earned accolades as the best

Foreign Exchange Bank Middle East for 2006 by Global Finance.

AUB also earned Her Highness Shaikha Sabeeka bint Ibrahim Al Khalifas Award for

Empowering Bahraini Women.

In November 2006, Fitch upgraded AUB and its subsidiaries to A- rating. Fitch also

upgraded the Issuer Default Rating (IDR) of AUB from BBB+ to A- with a Stable

outlook. Similarly, AUBs subsidiary in the UK, Ahli United Bank (UK) PLC, and in

Kuwait, Bank of Kuwait and the Middle East (BKME) were both upgraded to A- from

BBB+.

In November 2006, AUB signed a US$200mn loan agreement with the International

Finance Corporation (IFC), the private sector arm of the World Bank Group. This will be

IFCs single largest investment in the MENA region. This has been fully drawn down in

December 2006.

In October 2006, AUB announced a US$1.2bn 3-year syndicated deposit facility, the

largest ever syndicated financing deal by any financial institution in the Middle East. 51

banks participated in the syndicated deposit facility, which was arranged by ABN Amro,

BNP Paribas, Commerzbank, Lloyds TSB Bank and Mizuho Corporate Bank.

Financial Performance - 2006

AUBs financial statements comprise of financial statements of the bank as well as its

subsidiaries namely AUB United Kingdom (100%), Bank of Kuwait and Middle East

(75%) and Kuwait and Middle East Financial Investment Company (48%). The bank

started consolidation of financial statements from the date of control, where the bank has

the power to govern the financial and operating policies of respective entities.

AUBs asset size increased from BD2.36bn (US$6.27bn) in 2003 to BD7.84bn

(US$20.79bn) in 2006, registering a CAGR of 49.1%. The banks total deposit (includes

customer deposits and certificate of deposits) increased from BD1.10bn (US$2.92bn) in

2003 to BD3.56bn (US$9.45bn) in 2006, registering a CAGR of 47.9%. The banks loan


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June 2007 27

book increased from BD0.99bn (US$2.65bn) in 2003 to BD3.39bn (US$9.01bn) in 2006,

registering a CAGR of 50.3%.

In 2006, the total assets stood at BD7.84bn (US$20.79bn) as compared to BD5.23bn(US$13.87bn) in the previous year, registering an increase of 49.9%. The growth in

total assets was mainly driven by the growth in the loan book, increasing investment

in securities and investment in associates (acquiring stake in banks, which is part of the

banks strategy).

The total funding of the bank grew at a CAGR of 53.4% for the period 2003-06, from

BD1.94bn (US$5.14bn) in 2003 to BD6.92bn (US$18.53bn) in 2006. On a yearly basis,

the total funding of the bank increased by 55.6% in 2006, from BD4.45bn (US$11.81bn)

in 2005 to BD6.99bn (US$18.53bn) at the end of 2006.

The banks total deposit (includes customer deposits and certificate of deposits) increased

from BD1.10bn (US$2.92bn) in 2003 to BD3.56bn (US$9.45bn) in 2006, registering a

CAGR of 47.9%. The banks customer deposit increased from BD1.06bn (US$2.81bn)

in 2003 to BD3.41bn (US$9.04bn) in 2006, registering a CAGR of 47.7%, whereas

certificate of deposits grew at a CAGR of 53.8% from BD42.21mn (US$111.95mn) in

2003 to BD153.44mn (US$406.99mn) in 2006. Mobilizing deposits is the main source

of funding for the bank, as it accounted for about 50% of the total funding at the end of

2006.

In 2006, customer deposits increased by 35.7% from BD2.51bn (US$6.66bn) in 2005 to

BD3.41bn (US$9.04bn) in 2006. Certificate of deposits registered a whopping increase

of 845.8% to BD153.44mn (US$406.99mn) in 2006 as compared to BD16.22mn

(US$43.04mn) in 2005. Total deposits accounted for about 50.98% of total funding of

the bank at the end of 2006.

Customer deposits accounted for 48.78% in 2006, whereas certificate of deposits

accounted for 2.20% in 2006. Due from banks and other financial institutions accounted

for 37.34% in 2006. Term debt contribution to the total funding declined from 11.76% in

2004 to 8.32% in 2006.

Chart 1: Total Funding Break up


100.00%

80.00%

60.00%

40.00%

2003 2004 2005 2006

Customer deposits Due to banks Certificate of deposits Term Debt Subordinated Liabilities

2.52%

8.06%

2.18%

32.59%

54.65% 58.09%

26.51%

1.69%

11.76%

1.95% 3.69%

8.12%

0.36%

31.88%

55.95%

48.78%

37.34%

8.32%

3.36%


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2 June 2007

On the lending side, the banks loan book increased from BD0.99bn (US$2.65bn) in 2003

to BD3.39bn (US$9.01bn) in 2006, registering a CAGR of 50.3%. Favorable economic

conditions resulted in strong demand for credit, both from the corporate as well as from

the consumer segment. Net loans and advances grew at a CAGR of 52.4% from BD0.95bn(US$2.51bn) in 2003 to BD3.35bn (US$8.87bn) in 2006. The banks gross loan and

advances to total customer deposits increased from 91.0% in 2005 to 95.4% in 2006, but

the contribution declined from 51.2% in 2005 to 48.6% in terms of total funding of the

bank.

Chart 2: Gross Loans and Advances as a percentage of Total deposits


Lending to personal/consumer, trading and manufacturing and construction and real estate

sector accounted 80.38% of the total loan portfolio in 2006, which declined as compared

to 82.50% recorded in the previous year. The lending to personal/consumer witnessed a

drop in 2006, from 41.8% in 2005 to 32.1% in 2006, which can be attributed to the new

regulation by CBB on consumer lending.

Chart 3: Gross Loans and Advances Break up


3,600

3,200

2,800

2,400

2,000

1,600

1,200

800

100.0%

95.0%

90.0%

85.0%

80.0%

75.0%

70.0%2003 2004 2005 2006

Total deposits Gross loans and advances As a % of total deposits

90.8%

73.6%

91.2%

95.4%

BDmn

100%

75%

50%

25%

2004 2005 2006

Consumer/Personal

Banks & other financial insitutions

Others

Trading and manufacturing

Construction

Real Estate

Government/Public Sector

12.79%

6.83%

14.84%

22.83%

42.55%41.85%

20.57%

13.06%

8.51%

7.58% 8.41%

3.92%

7.56%

20.89%

23.52%

32.06%


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June 2007 2

The contribution of real estate and construction sector to total loan book increased from

20.0% in 2005 to 24.8% in 2006. In our opinion, looking at the real estate projects in the

pipeline in the region, the demand for real estate financing will continue to buoyant in

the mid term. Contribution of trading and manufacturing sector to total loan book alsoincreased from 20.6% in 2005 to 23.5% in 2006.

Chart 4: Asset Quality


During the last four years, the banks asset quality has improved significantly. Gross Non-

Performing Loans (NPLs) as a percentage of gross loans declined from a high of 6.08%

in 2003 to 1.22% in 2006, which is also one of the lowest among its peers. This indicates

that the growth in the loan book was not at the cost of quality. In absolute terms, NPLs

have declined from BD60.78mn (US$161.23mn) in 2003 to BD41.29mn (US$109.53mn)

in 2006. The conservative credit risk policies and recovery efforts has helped the bank in

improving its credit risk during the last three year.

Chart 5: Coverage ratio


3,500

2,500

1,500

500

7.0%

5.0%

3.0%

1.0%

2003 2004 2005 2006

6.08%

4.33%

1.99%

1.22%

Gross loans and advances NPLs to Gross loans

BD

mn

65.0

60.0

55.0

50.0

45.0

40.0

35.0

130%

120%

110%

100%

90%

80%

2003 2004 2005 2006

122.8%

95.5%

102.2%

89.8%

BD

mn

NPLs Coverage ratio


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0 June 2007

NPL coverage ratio of the bank was above the 100% at the end of 2006. The coverage

ratio of the bank increased from 89.8% in 2003 to 122.8% in 2006. It is worth nothing that

AUBs coverage is higher than the average for the peers, which was 91.5% at the end of

2006.

The banks non-trading investment securities increased by a CAGR of 24.7%, from

BD0.65bn (US$1.72bn) in 2003 to BD1.26bn (US$3.34bn) in 2006. In 2006, non-

trading investment securities increased by 31.5% from BD0.96bn (US$2.53bn) in 2005

to BD1.26bn (US$3.34bn). Non-trading investment securities comprised of 56.7% of

floating rate notes and certificate of deposits, 22.7% in GCC and US government bonds,

12.9% in equities and the remaining 7.7% in funds and other investments.

During the period (2003-2006), the banks net profit grew at a CAGR of 33.6% from

BD32.83 (US$87.08mn) in 2003 to BD78.22mn (US$207.48mn) in 2006. During the

same period, operating income of the bank registered a CAGR of 38.8%, where as total

expense registered a CAGR of 36.7%.

Chart 6: Net Profit


In the year 2006, the net profit of the bank increased by 25.8% to BD78.22mn

(US$207.48mn) as compared to BD62.15mn (US$164.87mn) reported in the previous

year. As a result of consolidated financial statements, the performance of subsidiaries

is also reflected in the groups income statement. Due to increase in operating expenses

during the year 2006, profit margin dropped from 50.4% in 2005 to 45.4% in 2006.

The bank continued to show healthy growth in the core banking activities in the last three

years, as it grew at a CAGR of 35.5%. The net interest income of the bank increased

by 59.5% to BD104.98mn (US$278.46mn) in 2006 as compared to BD65.81mn

(US$174.56mn) in the previous year, which was supported by the strong growth in

business volume of the group (includes subsidiaries).

90.0

80.0

70.0

60.0

50.0

40.0

30.0

20.0

10.0

-

54.0%

52.0%

50.0%

48.0%

46.0%

44.0%

42.0%

40.0%

2003 2004 2005 2006

Net Profit Profit margin

50.9%

52.8%

50.4%

45.4%BD

mn


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June 2007

Chart 7: Margins

Source: Company Report, Global Research

The banks yield on interest earnings assets increased from 4.85% in 2005 to 6.05% in

2006. Similarly, the cost of interest bearing liabilities increased from 3.25% in 2005 to

4.52% in 2006. As a result of this, the net spread for the bank declined from 1.61% in

2005 to 1.53% in 2006. Going forward, we expect that the net spread to be under pressure

due to the increased competition in the market.

Chart 8: Total Income Break Up


The non-interest income of bank registered a CAGR of 36.9% from BD31.47mn

(US$83.48mn) in 2003 to BD80.83mn (US$214.40mn) in 2006. In the 2006, the non-

interest income reported a growth of 16.3% from BD69.48mn (US$184.29mn) in 2005 to

BD80.83mn (US$214.40mn) in 2006. Non-interest income contribution to total income

was 43.5% in 2006 as compared to 42.7% in 2003. However, the contribution declined

from 51.4% in 2005 to 43.5% in 2006, which can be attributed to performance of groups

subsidiary, which showed a decline in its non-interest income for the year 2006.

7.00%

6.00%

5.00%

4.00%

3.00%

2.00%

1.00%

0.00%

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

2003 2004 2005 2006

3.02%

2.25%

1.61% 1.53%

Interest income/Avg interest earning assets

Interest expense/Avg interest bearning liabilities

Net spread

Spread

100%

80%

60%

40%

20%

0%

2003 2004 2005 2006

Net interest Income Non-interest Income

42.7%

57.3%

51.4%

48.6% 51.4%

48.6%

56.5%

43.5%


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2 June 2007

Fees and commission income increased by a CAGR of 51.4% from BD12.63mn

(US$33.51mnl) in 2003 to BD43.88mn (US$116.38mn) in 2006. In the year 2006, fees

and commission income increased by 53.9% from BD28.50mn (US$75.60mn) in 2005 to

BD43.88mn (US$116.38mn) in 2006. The contribution of fees and commission incometo total non-interest income was 54.3% in 2006 as compared to 40.1% in 2003.

Income from associates, which is one of the main determinants of the non-interest income,

as the banks strategy is to acquire and merge with banks to increase its presence in

the region. As a result, the income from associates increased at a CAGR of 7.3% from

BD8.63mn (US$22.89mn) in 2003 to BD10.67mn (US$28.29mn) in 2006. On a yearly

basis, the income from associates declined from BD22.71mn (US$60.24mn) in 2005 to

BD10.67mn (US$28.29mn) in 2006. This can be attributed to the fact that in August

2005, the bank increased its minority stake to a controlling 75% stake in BKME, which

then became a subsidiary and was accounted in the consolidated financial statements of

the group in accordance with International Financial Reporting Standards.

Chart 9: Operating Efficiency

Source: Company Report

Operating expenses (Opex) grew at a CAGR of 36.7% from BD28.99mn (US$76.90mn)

in 2003 to BD74.00mn (US$196.29mn) in 2006. In the year 2006, opex increased by

48.8% from BD49.73mn (US$131.91mn) in 2005 to BD74.00mn (US$196.29mn) in

2006. As a result, cost to income ratio of the bank increased from 36.8% in 2005 to 39.8%

in 2006, whereas the opex to average assets declined from 1.20% in 2005 to 1.13% in

2006.

53.0%

50.0%

47.0%

44.0%

41.0%

38.0%

35.0%2003 2004 2005 2006

1.6%

1.4%

1.2%

1.0%

0.8%

1.13%

1.20%

1.39%

1.35%

Cost to income ratio Opex to average assets


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June 2007

Chart 10: Return Ratios


During the period (2003-2006), the banks net profit grew at a CAGR of 33.6% from

BD32.83 (US$87.08mn) in 2003 to BD78.22mn (US$207.48mn) in 2006. Due to this,

the banks return ratios (return on average equity (ROAE) and Return on average assets

(ROAA)) have improved during the period under consideration. ROAA declined from

2.1% in 2005 to 1.70% in 2006 essentially due to the BKME consolidation effect, whereas

ROAE increased from 13.5% in 2005 to 15.1% in 2006. On a proforma consolidation basis

for full year of 2005, the adjusted proforma ROAA of c.1.7% for 2005 was comparable

to 2006.

Chart 11: Capital Adequacy Ratio


As at end 2006, the banks Capital Adequacy Ratio (CAR) stood at 14.8% as compared

to that of 16.4% in 2005. The banks capital adequacy ratio is well above the Basel

requirement of 8% and also above the minimum required rate of 12% by the Central Bank

of Bahrain (CBB).

1.6%

1.5%

1.4%

1.3%

1.2%

1.1%

1.0%

15.0%

14.0%

13.0%

12.0%

11.0%

10.0%

9.0%

2006200520042003

10.60%

11.00%

13.92%

14.26%

Return on Average Asse ts Return on Average Eguity

ROAA

ROAE

24.0%

22.0%

20.0%

18.0%

16.0%

14.0%

12.0%

10.0%

8.0%

2003 2004 2005 2006

14.8%

16.4%

23.7%

20.6%

Minimum requirement by CBB-12%

Capital Adequacy Ratio (CAR)


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June 2007

Financial Performance First Quarter of 2007

AUBs asset size increased by 4.2% to reach BD8.17bn (US$21.68mn) at the end of 1Q-

07 as compared to BD7.84bn (US$20.79mn) report ed at the end of 2006. Total funding

base of the bank increased by 3.9% to BD7.02bn (US$18.61mn) in 1Q-07 as compared to

BD6.75bn (US$17.91mn) in 2006.

Total deposits of the bank increased by 8.0% to BD3.85bn (US$10.20bn) at end of 1Q-

07 as compared with BD3.56bn (US$9.45bn) at the end of year 2006. As a result, the

contribution of total Despite to total assets increased from 45.4% at the end of 2006 to

47.1% at the end of 1Q-07.

Customer deposits increased by 11.1% from BD3.41bn (US$9.04bn) in 2006 to

BD3.79bn (US$10.04bn), whereas the certificate of deposits dropped from BD153.44mn

(US$406.99mn) in 2006 to BD61.24mn (US$162.43mn) at the end of 1Q-07.

On the lending side, the net loans and advances increased by 5.4% to BD3.52bn

(US$9.35bn) at the end of 1Q-07 as compared with BD3.35bn (US$8.87bn) reported

at the end of 2006. As a result of this marginal growth compared to the total deposits,

the contribution of loans and advances to total deposits declined from 93.9% in 2006 to

91.6% at the end of 1Q-07.

The non-trading investment securities of the bank declined by 7.1% to BD1.17bn

(US$3.10bn) in 1Q-07 as compared to BD1.26mn (US$3.34bn) at the end of 2006. Trading

securities, on the other hand, increased by 15.9% to BD33.14mn (US$87.89mn) in 1Q-

07 as compared to BD28.58mn (US$75.83mn) in 2006. Treasury bills also increased

during the 1Q-07 by 10.6% to BD400.07mn (US$1.06bn) as compared to BD361.81mn

(US$0.96bn) at end of 2006.

On the earnings side, net interest income of the bank increased by 19.7% to BD27.28mn

(US$72.35mn) in 1Q-07 as compared BD22.79mn (US$60.47mn) reported in the

corresponding period of the previous year. On other hand, the non-interest income of the

bank increased by 15.0% to BD24.53mn (US$65.06mn) for the period under review. As

a result, the total income of the bank increased by 17.4% to BD51.80mn (US$137.41mn)

as compared to BD44.12mn (US$117.04mn) reported in the corresponding period of the

previous year on the back of income from core banking activities.


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June 2007

Table 1 : First Quarter of 2007

1Q 1Q %

Amount in BD000 2006 2007 Change

Interest Income 67,989 113,708 67.2%

Interest Expense (45,192) (86,432) 91.3%

Net Interest income 22,796 27,276 19.7%

- Fees & Commission (net) 9,297 10,619 14.2%

- Trading Income 885 1,808 104.3%

- Gain on sale of non-trading investments 3,920 2,371 -39.5%

- Dividend income 3,738 3,164 -15.3%

- Income from associates 2,620 5,818 122.0%

- Other operating income 868 747 -14.0%

Total non interest income 21,328 24,526 15.0%

- Provisions for loan losses, impairment of non-trading invt 310 (1,136)

Total operating income 44,434 50,667 14.0%

- Staff costs (9,593) (11,320) 18.0%

- Depreciation (1,005) (1,084) 7.8%- Other Operating Expenses (5,398) (5,850) 8.4%

Total operating expenses (15,996) (18,254) 14.1%

- Tax (653) (938) 43.6%

Net profit for the perid 27,785 31,476 13.3%

Minority interest (4,966) (5,482) 10.4%

Net Profit to equity shareholders 22,819 25,993 13.9%


The total operating expenses have also grown by 14.1% to BD18.25mn (US$48.42mn) in

1Q-07 as compared to BD15.99mn (US$42.43mn) recorded in the corresponding period

of the previous year. The resultant net profit of the bank to equity shareholders registered

a growth of 13.9% to BD25.99mn (US$68.95mn) at the end of 1Q-07 as compared to

BD22.82mn (US$60.53mn) during the corresponding period of the previous year.

Earnings per share of the bank increased to 70fils at the end of 1Q-07 as compared to

61fils reported at the end of 1Q-06.

Outlook

AUB has emerged itself as one of the best banks in Bahrain. In addition, AUB has

increased its presence in Qatar, Kuwait, Iraq, Egypt and UK. The bank is looking at good

opportunities and the next target for the bank is to enter Saudi Arabia, UAE, Oman, and

Switzerland. The banks has and will continue to explore new opportunities in these region

either by acquiring or merging with the local banks in these respective countries. The

bank will also continue to focus on its core areas of business in the kingdom.

One of the banks strategy is to maintain a profitable UK presence and establish its

presence in the Swiss market as a non-regional banking arm, which will also profitably

complement regional expansion and support the commercial and private banking activities

of the bank.


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