THE COMMERCIAL BANK OF QATAR

Transcription

1 THE COMMERCIAL BANK OF QATAR Lackluster 2010 but Undervalued key data Highlights Fair Value per Share (QR) Closing Price (QR) * week High / Low (QR) / YTD / 12-month Return 9% / 6% Trailing P/B 1.4 Market Cap (QR Millions) 15,265 Shares Outstanding (Millions) Free Float 80% Reuters / Bloomberg COMB.QA / CBQK QD *As of. Sources: Reuters and NBK Capital key metrics 2009A 2010F 2011F 2012F EPS (QR) EPS Growth -19% -8% 21% 16% P/B Dividend Yield 8.9% 8.2% 8.2% 8.6% RoAA 2.6% 2.5% 2.9% 3.1% RoAE 13.9% 12.1% 14.2% 15.7% Op. Income (QR millions) 2,931 2,671 2,942 3,242 Op. Income Growth -1.5% -8.9% 10.2% 10.2% Net Profit (QR millions) 1,524 1,463 1,774 2,064 Net Profit Growth -11% -4% 21% 16% Net Interest Margin 3.3% 3.3% 3.3% 3.2% Sources: Company financial statements and NBK Capital QUARTERLY forecasts QR Millions 2Q2009A 1Q2010A 2Q2010F 3Q2010F Operating Income Income before Provisions Source: NBK Capital Rebased Performance Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 CBQ MSCI Qatar Banking and Financial Index Sources: MSCI, Reuters, and NBK Capital Analysts Fair Value: QR Recommendation: Buy Risk Level**: 3 Reason for Report: Initiation of Coverage We initiate coverage of the Commercial Bank of Qatar (CBQ) with a Buy recommendation and a fair value per share of QR 92.80, representing a 38% upside potential. CBQ is trading at a price-to-book (P/B) ratio of 1.4x versus the peers average of 2.3x. CBQ is the second-largest bank in Qatar, with an 11% market share of assets, and is a privatesector-focused bank. Following the capital injections in 2009, the Qatari government now holds a 9.1% stake in the bank. The two key advantages for Qatari banks are very high economic growth going forward and the firm, proactive support of a wealthy government. The challenge remains whether the private sector in Qatar benefits more from this expected increase in the overall gross domestic product (GDP). CBQ will increase its focus on the public sector, which is experiencing faster growth than the private sector. The branch network is being expanded, and CBQ will continue to focus on the retail segment, especially the high-net-worth local population. The balance sheet will continue to be tightly managed to safeguard interest margins, and a close eye will be kept on cost efficiency. Regarding CBQ s associates in Oman and the United Arab Emirates (UAE), there will be a strict domestic focus for each bank and an ongoing focus on reaping synergies from across the three banks. CBQ witnessed a 33% drop in net profit in 1Q2010 after the bottom line declined by 11% in FY2009. The main reason for that decrease was declining non-interest earnings. Net interest income, however, expanded by 29% in FY2009 and 5% in 1Q2010 on higher interest margins and despite a 7% drop in the loan book between December 2008 and March Going forward, we see net profit dropping by 4% in 2010 before rebounding in 2011 to increase by 21% on lower provisioning charges. We expect a further weakening in asset quality indicators but not to the extent that will pose a serious threat to profitability or solvency. We see loan growth at 6% in FY2010 before picking up to 10% in FY2011. We believe the main risks facing CBQ are a further loss of market share in terms of loans and additional weakening in asset quality. Raja Ghoussoub, CFA T E. raja.ghoussoub@nbkcapital.com Munira Mukadam T E. munira.mukadam@nbkcapital.com **Please refer to page 22 for recommendations and risk ratings. nbkcapital. com

2 contents Executive Summary... 3 Valuation... 4 Discounted Equity Cash Flow... 4 Dividend Discount Model... 5 Peer-based Valuation... 5 Risks and Challenges... 6 bank overview... 8 Bank Background... 8 Strategy... 8 Financial overview and forecasts... 9 Lending... 9 Deposit Accumulation and Liquidity Profitability Asset Quality Financial Statements... 21

3 Executive Summary CBQ is the second-largest bank in Qatar, with an 11% market share of assets as of March CBQ is a private-sector-focused bank. Following the capital injections in 2009, the Qatari government now holds a 9.1% stake in the bank. A strong advantage for Qatari banks is the fact that economic growth in Qatar is expected to be very strong in the coming three years with the real GDP forecasted to grow by 18%, 14%, and 9% in 2010, 2011, and 2012, respectively. More importantly, the key challenge is for the private sector in Qatar to benefit more from this expected increase in overall GDP. Another key advantage for Qatari banks is the firm and proactive support of the government, which we expect will remain the case going forward. CBQ, although private-sector focused, will increase its focus on the public sector in Qatar, which is experiencing faster growth than the private sector. The branch network is being expanded, and CBQ will continue to focus on the retail segment, especially the high-net-worth local population. As in 2009, the balance sheet will be tightly managed to safeguard interest margins, and a very close eye will be kept on cost efficiency. Regarding CBQ s associates in Oman and the UAE, the strategy will be a strict domestic focus for each bank and ongoing attempts to reap cost and revenue synergies from across the three banks. Overall, the strategy outside Qatar remains partnering with existing players in the GCC rather than having a direct branch presence. CBQ witnessed a 33% drop in net profit in 1Q2010 after the bottom line declined by 11% in FY2009, underperforming the bank s Qatari peers. The main reason for the decrease was declining non-interest earnings, especially income from fees and commissions and investment earnings. Net interest income, however, expanded by 29% in FY2009 and 5% in 1Q2010 on higher interest margins and despite a 7% drop in the loan book between December 2008 and March Going forward, we see CBQ s operating income decreasing by 9% in FY2010 to later expand by 10% in FY2011. We see net profit dropping by 4% in 2010 before rebounding in 2011 to increase by 21% on lower provisioning charges. We expect a further weakening in asset quality indicators but not to the extent that will pose a serious threat to profitability or solvency. We see loans growing by 6% in FY2010 before picking up to 10% in FY2011. We expect a drop in the return on equity to 12% in 2010 before it gradually improves toward 17% by the end of our forecast horizon. Our estimate of CBQ s fair value per share stands at QR 92.80, 38% above the share s closing price on, hence, our Buy recommendation. CBQ is trading at a P/B of 1.4x versus the peers average of 2.3x. We believe CBQ will continue to pay rich dividends with our 2010 dividend yield forecast standing at 8.2%. We have assigned CBQ a risk rating of 3 (on a scale of 1 to 5). We believe the main risks facing CBQ are a further loss of market share in terms of loans and additional weakening in asset quality. nbkcapital. com 3

4 Valuation The purpose of this valuation exercise is to estimate CBQ s fair value per share 12 months from now. Although the estimate reached is our best guess of the share s value one year from now, this does not mean we believe the price will actually migrate toward this fair value. Ultimately, investor behavior determines the price of any share. This behavior is a function of a wide array of factors, including sentiment, risk tolerance, objectives, and technical analysis, as well as analyst recommendations. Our estimate of CBQ s fair value per share stands at QR 92.80, 38% above the share s closing price on. The value is a weighted average of three estimates reached via three valuation models: discounted equity cash flow (DECF), the dividend discount model (DDM), and a peer-based multiples valuation model (Figure 1). CBQ is trading at a P/B of 1.4 versus the peers average of 2.3x, although that is largely attributed to CBQ s higher equity-to-assets ratio. In terms of P/E, CBQ is trading in line with its peers at around 11.5x. CBQ has traditionally paid rich dividends with the dividend payout amounting to 85% in both 2008 and 2009, while the dividend yield for 2009 was a generous 9%. Despite the recent rally CBQ s share price is still 15% below its recent high on April 13, The banking index on the Qatar Exchange (QE) and the overall market index are still 9% and 8%, respectively, below the respective highs of April 13, Figure 1 Weighted Average Fair Value per Share Valuation Method Value (QR) Weight (%) Our fair value for CBQ is QR per share Discounted Equity Cash Flow (DECF) Dividend Discount Model (DDM) Peer-based Valuation % 40% 20% Weighted Average Fair Value % Source: NBK Capital Discounted Equity Cash Flow For the DECF, we assume a 15% target capital adequacy ratio (CAR) as indicated by CBQ s management. We add back depreciation to net profit and deduct 15% of the change in risk weighted assets to reach equity cash flows. We use a perpetual growth rate of 5% and a cost of equity of 11.5% for CBQ. The DECF model (Figure 2) results in a QR 25.2 billion value to shareholders. Dividing this value by the current number of shares outstanding (226.8 million) yields a fair value of QR per share. Figure 2 DECF Valuation The DECF valuation resulted in a fair value of QR per share QR Thousands Forecast Net Attributable Income 1,773,824 2,064,193 2,385,276 2,630,460 2,990,879 Equity Cash Flows 1,186,275 1,321,875 1,566,692 1,745,937 1,979,563 Terminal Value 31,977,559 Total Value of Equity in 12 Months 25,208,939 Number of Shares Outstanding ('000) 226,826 Fair Value per Share (QR) Source: NBK Capital nbkcapital. com 4

5 One major drawback of discounted cash flow valuations is that they are highly sensitive to the inputs. This issue is more acute in the case of banks because they are more heavily leveraged than most other companies. To assess the impact of input changes on the valuation output, we performed a sensitivity analysis on two primary inputs of the DECF model: the cost of equity and the perpetual growth rate (Figure 3). Figure 3 DECF Sensitivity The fair value is highly sensitive to two primary inputs Cost of Equity Source: NBK Capital Perpetual Growth Rate % 4.5% 5.0% 5.5% 6.0% 10.5% % % % % Dividend Discount Model The DDM can be used when the dividend stream can be reasonably forecasted, a situation that generally applies to banks. We have assumed that CBQ will continue to pay rich dividends with an average payout of 61% in our forecast horizon compared with an average of 72% in the past three years. While CBQ s dividend payout has varied a lot in the past four years, the yearly dividend per share payment has been more stable with the bank paying between QR 4 per share and QR 7 per share in the past five years, and averaging around QR 5.5 per share. Going forward, we have assumed that CBQ will pay QR 5.5 per share as yearly cash dividends during our forecast horizon. Our 2010 dividend yield forecast stands at 8.4% using the June 03, 2010, closing price for CBQ. The DDM yields a total value for shareholders of QR 20.1 billion. Dividing by million shares outstanding, we arrived at a fair value of QR per share (Figure 4). Figure 4 Dividend Discount Model QR Thousands Forecast The DDM resulted in a fair value of QR per share Dividend Payout 70.3% 63.5% 57.7% 54.9% 50.7% Dividends 1,247,542 1,309,919 1,375,415 1,444,186 1,516,395 Terminal Value 24,495,611 Total Value of Equity in 12 Months 20,083,511 Number of Shares Outstanding ('000) 226,826 Fair Value per Share (QR) Source: NBK Capital Peer-based Valuation We used a peer-based multiples valuation model that is a variant of the warranted equity valuation (WEV) model. We employed this model by comparing the adjusted P/B multiples of some similarly rated commercial banks operating in countries comparable to Qatar in terms of gross domestic product (GDP) per capita. In fact, since Qatar has one of the highest GDPs per capita in the world, most of the countries we chose have a lower GDP per capita than Qatar. In this peer-based valuation, we adjust the P/B ratio by correcting for two variables that significantly affect the P/B level, namely, expectations of future earnings growth and future return on equity levels. The peer-based valuation resulted in a value of QR per share for CBQ (Figure 5). nbkcapital. com 5

6 Figure 5 Peer-based Valuation Country Bank P/B* (2010 f) ROE EPS Growth WEV FSR Moody's CBQ appeared fairly valued compared to its peers Australia Bendigo and Adelaide Bank % 11.8% 82.2 C Australia Bank of Queensland % 7.6% C Austria Erste Group Bank % 13.4% 66.4 C- Denmark Sydbank A/S % 5.7% C+ Denmark Danske Bank A/S % 11.8% 71.5 C Denmark Spar Nord Bank % 11.7% 65.8 C- Finland Pohjola Bank % 14.4% 77.1 C- France Natixis % 9.5% 88.8 D+ France Credit Industriel et Commercial % 12.3% 35.8 C- Germany Commerzbank AG % 65.6% 14.0 C- Germany Deutsche Postbank AG % 24.7% 42.3 D+ Ireland Allied Irish Banks % 73.5% 21.4 D Norway SpareBank 1 SR-Bank % 10.6% 70.7 C- Sweden Skandinaviska Enskilda Banken % 28.6% 37.7 C- Switzerland Banque Cantonale Vaudoise % 4.9% C- Qatar Qatar National Bank % 10.5% C- Qatar Doha Bank % 6.2% D+ Average** 80.5 Qatar CBQ % 8.8% 80.5 C- Fair Value (QR) * Prices as of ** Excluding outliers. Sources: Reuters Knowledge, Moody s, and NBK Capital Risks and Challenges Risk of further weakening in asset quality. Non-performing loans (NPLs) have increased in absolute terms and as a share of the total loan book. Although the NPL ratio is still at manageable levels (2.4% as of March 2010), we believe it will increase further going forward. While we are not expecting a drastic increase in that ratio, if that scenario does in fact materialize, asset quality will become the key concern for CBQ. Risk of loss of market share. CBQ has lost market share in terms of loans and deposits in the overall Qatari banking sector in the past few years although the bank has remained the secondlargest in Qatar. One reason for the loss of market share is increased competition, especially from new entrants to the banking sector that have a much smaller base from which to grow. CBQ has traditionally focused on the private sector, not on the public sector. The demand for loans from the public sector is currently growing faster than the private sector. This will result in a further drop in CBQ s market share if the bank does not focus on growing its public sector business. CBQ s management, however, has indicated that focusing more on the public sector is high on the bank s agenda. The growth of Islamic banking in Qatar has been faster than the growth of conventional banking and is expected to remain so in the next few years. The growth of CBQ s Islamic business, however, has lagged behind the overall growth of Islamic banking in Qatar. Hence, CBQ may face further loss of market share if the bank does not focus more on growing its Islamic business. nbkcapital. com 6

7 CBQ is interested in regional expansion. While meaningful expansion beyond the Qatari borders will help diversify the earning stream, it still has its own risks. There is implementation risk in expanding into countries whose banking sectors are less understood by CBQ s management than the Qatari banking sector. In addition, there is the risk of overpaying when acquiring a stake in another bank, thereby penalizing CBQ s shareholders. For example, CBQ has a 35% stake in the National Bank of Oman (NBO), where the carrying value of that investment is 28% above its current market value, raising concerns of possible impairment that might need to be taken. CBQ is still a domestic Qatari player, despite the regional expansion. Hence, the bank is overexposed to the health of the Qatari economy, which is very much tied to one factor: the gas and oil sector. A significant drop in oil prices or a disruption of gas supplies will have a major effect on capital inflows to Qatar and overall economic growth. Geopolitical risk: This risk is especially related to the proximity of Qatar s giant North Field gas reservoir to Iran. nbkcapital. com 7

8 Bank Overview Bank Background CBQ is the second-largest bank in Qatar, with an 11% market share of total assets as of March The Qatar Investment Authority (QIA) holds a 9.1% stake in CBQ through Qatar Holding following two capital injections that took place in The bank is listed on the QE, and global repository receipts (GDRs) are listed on the London Stock Exchange. CBQ has traditionally focused on the private sector business. The bank offers conventional and Shari a-compliant products and services. The bank s operations can be broadly broken down into three segments, corporate banking, retail banking, and Islamic banking. CBQ has 32 branches in Qatar, eight of which are dedicated to Islamic banking, and more than 140 ATMs. Abroad, CBQ has a 34.9% stake NBO, the country s second-largest bank, and a 40% stake in United Arab Bank (UAB), a small commercial bank based in the UAE, which has assets of USD 1.7 billion as of March CBQ is rated by the main international rating agencies, Standard and Poor s, Moody s, and Fitch as A-, A1, and A, respectively. Strategy The private sector has been the main focus area for CBQ as the bank has deliberately kept its exposure to the public sector low. However, CBQ s management has indicated that, going forward, the bank will focus more on the public sector (especially the infrastructure projects) in Qatar, which is experiencing faster growth than the private sector. CBQ will continue to focus on the retail segment, especially the high-net-worth (HNW) local population rather than the expatriate population. The branch network is being expanded, with a total of six branches set to open during CBQ will continue to focus on credit cards, an area in which the bank is the leader in Qatar, and on mortgages, which the bank already aggressively pushes. As Qatari banks are again permitted to conduct brokerage activities on the QE subject to approval upon submitting official applications, CBQ will focus on that business line. CBQ s management believes that the bank has an advantage over its peers in that respect as CBQ s brokerage business was not completely disbanded a few years ago when Qatari banks were banned from conducting direct brokerage activities on the QE. CBQ already submitted an application and is hoping to have a brokerage capability on the QE soon. Going forward, CBQ s management indicated that they will continue to tightly manage the balance sheet (just as in 2009) to support interest margins and keep a very close eye on cost efficiency. Regarding CBQ s associates in Oman and the UAE, the strategy will be a strict domestic focus for each bank to grow local market share. The strategy will be to continue to focus on reaping cost and revenue synergies from across the three banks by aligning product offerings and sharing common platforms. Overall, the strategy outside Qatar remains partnering with existing players in the GCC rather than having a direct branch presence. nbkcapital. com 8

9 Financial Overview and Forecasts Lending CBQ s loan growth dropped sharply in 1Q2010 and 2009 after witnessing high growth rates in the previous years. CBQ s net loans decreased by 6% and 1% in FY2009 and 1Q2010, respectively, underperforming the sector s 11% and 7% growth rates, respectively (Figure 6). In fact, CBQ has been losing market share in terms of loans since 2007 as the bank s loans grew slower than the sector s. In FY2009, CBQ sold QR 3 billion of loans to the government (as part of the latter s initiatives to support the banking sector). Adjusting for that, CBQ s loan growth would have stood at around 3% in FY2009. The drop in CBQ s loans in 1Q2010 occurred despite the bank giving out around QR 3.3 billion in new loans during that quarter. Hence, it was significant maturities and repayments as well as an early settlement of a QR 500 million loan that counterbalanced the new loans given, resulting in a slight drop in net loans in 1Q2010. In fact, CBQ was faced with QR 6.9 billion (22% of the December 31, 2009 loan book) of loan maturities in 1Q2010. Figure 6 Loan Growth: CBQ versus Sector 70% 60% 59% 57% 50% 47% 44% 51% CBQ s loan growth dropped sharply in 2009 and 1Q2010 after averaging 46% in the three years before 40% 30% 35% 20% 10% 11% 7% 0% -10% Q2010-6% -1% CBQ Sector Sources: CBQ s financial statements, Qatar Central Bank, and NBK Capital We believe a major reason for CBQ s loss of market share is a lack of focus on public sector business, which has been growing faster than the private sector business in Qatar. For example, CBQ s public sector loans (comprising government, government agencies, and semi-government agencies) dropped by 12% in the two years ending in 2009 to represent 9% of CBQ s total loans at the end of 2009 compared with 13% at the end of 2007 (Figure 7). On the other hand, at the sector level, public sector loans expanded by 107% in the two years ending in 2009 compared with 57% for private sector loans. The faster growth in public sector loans has continued so far in 2010 with an estimated 20% year-to-date (YTD) growth by April, while private sector loans dropped in the same period. Hence, at the sector level, the share of public sector loans increased from 22% at the end of 2007 to 33% by the end of April nbkcapital. com 9

10 Figure 7 Breakdown of CBQ s Lending Book 100% 90% 16% 16% 16% 15% 14% Others Real estate loans represent a bigger share of CBQ s loans while the shares of consumer and public sector loans are decreasing 80% 70% 60% 50% 40% 9% 9% 16% 13% 11% 11% 11% 6% 10% 10% 9% 7% 10% 13% 14% 11% 16% 14% 13% 13% Public Contracting Services Commercial 30% 20% 29% 22% 19% 19% 26% Consumer 10% 13% 13% 17% 19% 20% Real Estate 0% Mar-2010 Sources: CBQ s financial statements and NBK Capital Real estate loans continue to represent a bigger share of CBQ s total loans, standing at 20% by March 2010 compared to 13% in In 2009, real estate loans managed to grow by 7% despite the sale of QR 3 billion of real estate loans to the government. The sector as a whole saw strong growth in real estate loans in 2009, which increased by 21% (QR 7.15 billion) despite the government buying QR 15 billion of such loans from Qatari banks during On the other hand, the share of consumer loans out of CBQ s total loans dropped from 29% in 2006 to 19% in March Another reason for the loss of market share for CBQ is weak growth in the bank s Islamic business compared to very high growth at the sector level. For example, CBQ s net financing activities (Shari a-compliant business) dropped by 5% in 2009 while growth was around 33% in the overall Islamic sector in Qatar. CBQ s management indicated that a re-focus of the bank s Islamic business has occurred and believes that CBQ is in a better position to capture some of the growth that is being witnessed in the Islamic business. A final reason for the loss of CBQ s market share is simply tougher competition in the Qatari banking sector, especially with the entrance of new players with smaller loans and deposits bases to grow in the first place. On a more positive note, economic activity in Qatar is expected to be very robust, leading to significant potential for the banking sector. Real GDP in Qatar is forecasted to surge by 19% and 14% in 2010 and 2011, respectively (Figure 8), driven by liquified natural gas (LNG) production expansion, which the International Monetary Fund (IMF) estimates will increase from 39 million tons in 2009 to 58 million tons in Even higher growth rates will be witnessed when it comes to the nominal GDP, which is forecasted to jump by 32% and 19%, in 2010 and 2011, respectively. The 2010/2011 budget, the largest ever in Qatar, had a 25% increase in expenditures (QR billion) compared with the previous budget. Revenues are forecasted to increase by 44% to reach QR billion, resulting in a budget surplus of QR 9.6 billion. Moreover, the budget is based on a conservative oil price assumption of USD 55 per barrel. nbkcapital. com 10

11 Figure 8 GDP Growth Rates in Qatar 50% 40% 41% 32% 30% 25% The real GDP is expected to surge by 19% in 2010 and 14% in % 10% 14% 16% 9% 19% 14% 19% 12% 9% 0% -10% -20% -16% F 2011F 2012F Real GDP Nominal GDP Sources: IMF and Qatar Statistics Authority We believe the sizable expansion in the economy will result in increased demand for loans, even though the effect on the private sector has yet to be felt. Hence, we still see the public sector growing faster than the private sector in Qatar. We also still see a drop in CBQ s market share of loans as the bank remains, predominantly, private sector oriented. Nevertheless, we expect CBQ to increase its focus on getting a share of the public sector business in Qatar, awaiting a pickup in private sector loan demand. CBQ is faced with large maturities in its loan book in As much as QR 8.9 billion of loans (28% of the December 2009 loan book) will be maturing in FY2010. Hence, a decent amount of new loans will need to materialize before an increase in the loan balance happens in Overall, we see CBQ net loans growing by 6% in FY2010, and by a CAGR of 10% between 2010 and nbkcapital. com 11

12 Figure 9 CBQ s Net Loans CAGR = 10% 40 CAGR = 23% 35 We forecast CBQ s loans to grow by 6% in FY2010 and by a CAGR of 10% in the following three years QR Billions F 2011F 2012F 2013F Sources: CBQ s financial statements and NBK Capital Deposit Accumulation and Liquidity CBQ s deposits surged by 10% in 1Q2010 after dropping by 18% in FY2009 (Figure 10). The drop in deposits in FY2009 occurred mostly in 4Q2009 (a drop of 14%) as CBQ shed high-cost deposits while it tapped the international capital markets and raised USD 1.6 billion in senior and subordinated debt in November The increase in deposits in 1Q2010 was primarily through the relatively expensive time deposits (not in demand deposits) just like the shedding of deposits in FY2009, which was entirely driven by time deposits. Similar to the loan breakdown, public sector deposits represent a smaller share of CBQ deposits than is the case at the sector level. As of March 2010, public sector deposits represented 16% of CBQ s total deposits while that share stood at 27% in the overall sector. Figure 10 Deposit Growth: CBQ versus Sector 60% 50% 40% 41% 50% 39% 30% 30% 27% 25% The 10% surge in deposits for CBQ in 1Q2010 followed a 18% drop in 4Q % 10% 16% 10% 10% 0% -10% -20% -30% -18% Q2010 CBQ Sector Sources: CBQ s financial statements, Qatar Central Bank, and NBK Capital nbkcapital. com 12

13 The increase in deposits in 1Q2010 brought down CBQ s simple loans-to-deposits ratio (LDR) from 122% in December 2009 to 110% in March In fact, CBQ s LDR has been in excess of 100% since June 2008, similar to the case at the sector level. However, the Qatar Central Bank (QCB) includes borrowings with deposits in its calculation of the LDR and caps that at 90%. With USD 1.6 billion of new borrowings in November 2009, CBQ s total borrowings stood at QR 9.9 billion at the end of March 2010, representing 22% of total liabilities and 18% of total assets. The earliest maturity of CBQ s borrowings is in October 2011 when USD 500 million of floating rate notes (under the bank s EMTN program) will mature. We estimate CBQ s regulatory LDR to have been close to 82% at the end of March 2010, giving the bank room to grow the loan book without raising additional deposits. Going forward, we expect CBQ to keep its regulatory LDR below the 90% cap. Overall, we see deposits growing by 21% in FY2010 and by a CAGR of 12.5% in the following three years, slightly ahead of our loan growth forecast. Figure 11 CBQ s Deposits CAGR = 12.5% 40 CAGR = 15% 35 We forecast CBQ s deposits to grow by 21% in FY2010 and by a CAGR of 12.5% in the following three years QR Billions F 2011F 2012F 2013F Sources: CBQ s financial statements and NBK Capital Profitability CBQ witnessed a 33% drop in net profit in 1Q2010 after the bottom line declined by 11% in FY2009. The main reason for the drop in 1Q2010 net profit was a QR 165 million one-off gain from the sale of real estate in 1Q2009. If that one-off gain were excluded, net profit would have still declined by 8% in 1Q2010 because of the lower level of non-interest earnings. Specifically, income from fees and commissions declined by 16% year on year (YoY) driven by lower loan-related fee income. Income from fees and commissions in 1Q2010, at QR 163 million (26% of operating income), was lower than the quarterly average for FY2009 (QR 170 million) but represented a 26% increase over the weak QR 129 million achieved in 4Q2009. Another reason for the drop in operating income, and hence net profit, was the almost total disappearance of dividend income in 1Q2010, which stood at QR 4 million compared with QR 47 million in 1Q2009, as CBQ sold its entire QE equity investments to the government in A third reason was lower earnings from associates, which declined from QR 39 million in 1Q2009 to QR 21 million in 1Q2010. This does not really reflect weaker results from CBQ s associates but an adjustment to the provisioning level of NBO in FY2009 (QR 47 million) as required by the Central Bank of Oman, which CBQ accounted for its share (QR 17 million) in its 1Q2010 results. nbkcapital. com 13

14 On a more positive note, net interest income increased by 4.5% YoY, although it dropped by 1% quarter on quarter (QoQ), reflecting an improvement in interest margins compared to 1Q2009 and FY2009 driven by a dropping cost of funds as customer deposit rates in Qatar have softened recently. Costs were up by 9% YoY, resulting in a 30.6% cost-to-income ratio (CIR) compared with 20.6% in 1Q2009 and 26% in FY2009. Loan provisioning charges, on the other hand, dropped to a low of QR 12 million in 1Q2010, compared to QR 57 million in 1Q2009 and an average quarterly figure of QR 115 million in FY2009. It is important to mention that this provisioning level is the lowest for CBQ since 3Q2008. Figure 12 Net Profit Growth: CBQ versus Peers 80% 60% 61% CBQ saw its net profit drop by 11% in FY2009 and 33% in 1Q % 20% 0% 15% 26% 26% 31% 22% 2% 10% -20% -11% -40% -33% Q2010 CBQ Peers Sources: Banks financial statements and NBK Capital The 1Q2010 results followed an 11% drop in the bottom line in FY2009. Again, it was lower non-interest earnings (which decreased by 25%), combined with a 24% increase in total provisioning (for loans and investments), which led to the decrease in the bottom line. All non-interest income components decreased, with fees falling by 28% on much lower loan-related fees and investment earnings plummeting by 68% on the back of a drop in profit from availablefor-sale (AFS) investments from QR 278 million in 2008 (9.3% of operating income) to QR 37 million in 2009 (1.3% of operating income). Net interest income, however, expanded by 29% in FY2009 to result in nearly flat operating income in that year. The increase in net interest income was driven by an improvement in interest margins on the back of a drop in the cost of funds. Costs were very much under control, inching up by 1% in FY2009, resulting in a slight increase in the CIR from 25% in FY2008 to 26% in FY2009. Provisioning took its toll on the bottom line as the increase in loan provisioning charges (from QR 59 million in 2008 to QR 461 million in 2009) outweighed the decrease in provisioning on investments (from QR 465 million in 2008 to QR 182 million in 2009), resulting in a net increase of QR 119 million in total provisioning. Total provisioning charges stood at QR 648 million in 2009, representing 30% of income before provisions, compared with QR 524 million in 2008, which represented 24% of income before provisions. In Figure 13, we plot the components of CBQ s operating income. It is important to note that non-interest income averaged more than 50% of total operating income in the years before 2009, which, at first glance, is a positive indicator reflecting a diversified income stream. However, the main reason for that was the high contribution from the relatively low-quality investment earnings, which was in excess of 10% of operating income in the years before This high contribution nbkcapital. com 14

15 from investments came to an end in 2009 and 1Q2010, and hence, the share of non-interest income in total operating income decreased to 43% in FY2009 and 36% in 1Q2010. Figure 13 Components of CBQ s Operating Income The contribution of noninterest income dropped starting in FY2009 QR Billions % % % % 45% % 50% % Q2010 Other Earnings Earnings from Associates Investment Earnings Fees & Commissions Net Interest Income % % % 64% Sources: CBQ s financial statements and NBK Capital Going forward, we expect net interest income to remain the major income component where we see its contribution to operating income peaking in FY2010 at 62% before a gradual decrease in that contribution occurs in our forecast horizon. However, we believe the large drop in investment earnings, which are expected to remain subdued for the near future, will put pressure on the contribution of non-interest earnings to operating income. We see income from fees and commissions in FY2010 similar to the level in FY2009 before an improvement happens in FY2011. The brokerage business can serve as a driver for income from fees and commissions after CBQ commences that business on the QE, and in fact, CBQ s management is bullish on that point. We believe that the brokerage business will support fee income growth going forward, but unless there is a marked pickup in trading activity on the QE (which averaged QR 292 million a day in the first five months of 2010), the brokerage business will not have a large impact on the bottom line. As for interest margins, CBQ was able to increase its net interest margin (NIM) in FY2009 and 1Q2010, as mentioned previously. For the remainder of 2010, we believe the NIM will decrease slightly compared to the high reached in 1Q2010. CBQ s management has indicated that margin management will remain a top priority for the bank where asset yields will be defended and the balance sheet will remain tightly managed. On the other hand, we believe there will be pressure on the NIM as CBQ increases its exposure to public sector loans, which are generally lower yielding compared to private sector ones. Overall, we believe the NIM in FY2010 and FY2011 will be broadly in line with the level in FY2009 (Figure 14). nbkcapital. com 15

16 Figure 14 Net Interest Margin 4.0% 3.5% 3.0% We expect the NIM in FY2010 and FY2011 to be similar to that seen in FY % 2.0% 1.5% 1.0% 0.5% 0.0% F 2011F Sources: CBQ s financial statements and NBK Capital Cost efficiency has been fairly stable in the past three years with the CIR at around 25% to 26%. This changed in 1Q2010 when the CIR increased to 30.6% as costs expanded by 9% while operating income fell by 27%. CBQ s management has indicated that tight cost control will remain the case in 2010 (as it was in 2009). Figure 15 Cost-to-Income Ratio 40% 35% 30% 31% 30% 30% 25% 26% 25% 26% We expect an increase in the CIR to around 30% in FY2010 and for that to average around 29% over our forecast horizon 20% 15% 10% 5% 0% Q F 2011F Sources: CBQ s financial statements and NBK Capital nbkcapital. com 16

17 Despite CBQ s ongoing expansion with the opening of a total of six branches in 2010, we see costs expanding by a moderate 5% in FY2010, which will drive up the CIR from 26% in FY2009 to around 30% in FY2010, slightly lower than the 30.6% level prevailing in 1Q2010. As for CBQ s associates, NBO and UAB, they have contributed around 10% to 12% of CBQ s bottom line in the past three years. Going forward, we do not see a drastic change in that and we forecast their contribution to be around 12% of net profit in our forecast horizon. As mentioned before, the drop in investment earnings will be hard to compensate. As the QE equity investments have been entirely sold to the government and CBQ is pursuing exit strategy when it comes to international investments, we forecast only a marginal contribution from investment earnings to the bottom line in our forecast horizon. This is one of the reasons we are expecting an increase in the CIR compared to its level prevailing in the past three years. All in all, we forecast operating income and net profit to drop by 9% and 4%, respectively, in FY2010 before they grow by a CAGR of 11% and 18%, respectively, in the following three years. Figure 16 CBQ s Total Operating Income and Net Profit We see operating income and net profit decreasing by 9% and 4%, respectively, in FY2010 to later increase by 10% and 21%, respectively, in FY2011 QR Billions F 2011F 2012F 2013F Total Operating Income Net Profit Sources: CBQ s financial statements and NBK Capital CBQ has tended to have a lower RoAE compared to the bank s Qatari peers as can be seen in Figure 17. One reason for that is the fact that CBQ generally had a higher equity-to-assets ratio. As of December 2009, for example, CBQ s equity-to-assets measure stood at 21% versus the peers average of 13.5%. nbkcapital. com 17

18 Figure 17 RoAE: CBQ versus Peers 30% 25% 26% 23% 25% 24% CBQ has generally underperformed in terms of RoAE; we see CBQ s RoAE dropping to around 12% in FY % 15% 10% 15% 21% 14% 20% 5% 0% CBQ Peers Sources: Banks financial statements and NBK Capital The decrease in CBQ s RoAE in 2008 and 2009 was partly due to the capital increases conducted during these two years. In 2008, QR 3.2 billion (51% of December 2007 shareholders equity) was raised, and in 2009 QR 1.6 billion (16% of December 2008 shareholders equity) was injected by the QIA as part of the government s efforts to support the banking sector. Going forward, we see the RoAE dropping to around 12% in FY2010 before it increases gradually to around 17% to 18% by the end of our forecast horizon. Asset Quality Asset quality has been the major concern in Qatar just like the rest of the GCC since the outbreak of the global financial crisis. The NPLs-to-gross loans ratio increased for most Qatari banks in CBQ s ratio increased from 0.8% in December 2008 to 2.2% in December 2009 and up to 2.4% by March In fact, the bank s NPL ratio and the absolute level of NPLs have steadily increased in each quarter since September NPLs (including interest in suspense) have increased from QR 290 million in December 2008 to QR 725 million in December 2009 and up to QR 788 million in March A single default of QR 170 million accounted for around 40% of the total increase in NPLs in According to management, this default is already fully provisioned, and there is a high chance for it to be recovered. As for NPL coverage (defined here as specific provisions-to-npls), CBQ tended to maintain a ratio that is in the high 90s in the past few years. Specifically, CBQ s measure was flat at around 99% to 100% in 2009, but dropped slightly to 96% by March It is important to mention that Qatari banks are required to hold risk reserves (taken directly in shareholders equity and not a charge to the income statement) at a minimum of 1.5% of total credit facilities granted to the private sector. nbkcapital. com 18

19 Figure 18 CBQ s Asset Quality Indicators 4.0% 3.5% 97% 99% 100% 96% 3.4% 3.6% 100% 3.0% 89% 91% 80% We see CBQ s NPLs-to-gross loans ratio reaching 3.4% by the end of 2010 while we expect the NPL coverage ratio to drop slightly to around 89% 2.5% 2.0% 1.5% 2.2% 2.4% 60% 40% 1.0% 0.5% 0.8% 0.8% 20% 0.0% Mar F 2011F 0% NPLs-to-Gross Loans (Left) NPL Coverage Ratio (Right) Sources: CBQ s financial statements and NBK Capital Going forward, an important change for CBQ will be the move to a 90-day overdue NPL definition instead of the current 180-day overdue NPL definition. According to the bank s management, CBQ is in the process of updating the systems to enable that move. As of March 2010, and following a 90-day NPL definition, CBQ s NPL ratio stood at 2.9% as opposed to the 2.4% 180-day definition. We have assumed that the move to the 90-day definition will occur in FY2010, and accordingly, our forecasts reflect that. We see continued NPL formation for CBQ in 2010 and expect the NPL ratio to increase to around 3.4% by December 2010 and up to 3.6% by December As for provisioning, we expect it to remain high for CBQ during the remainder of 2010 to safeguard NPL coverage at high levels, which we expect will be maintained at between 85% and 90% in our forecast horizon even with the move to a 90-day NPL definition. CBQ provisioned the most of the Qatari banks in FY2009 (both in absolute terms and relative to the size of the loan book), with the bank s ratio of net provisioning charges-to-average gross loans (risk cost) standing at 1.4%, a higher level than those of its peers (Figure 19). nbkcapital. com 19

20 Figure 19 CBQ s Net Provisioning Charges-to-Average Gross Loans 1.6% 1.4% 1.4% 1.2% We expect provisioning to remain high in FY2010 but lower than the FY2009 level 1.0% 0.8% 0.9% 0.6% 0.6% 0.4% 0.4% 0.2% 0.2% 0.2% 0.0% F 2011F 2012F Sources: CBQ s financial statements and NBK Capital Although we believe provisioning will remain high in FY2010, we expect it to be lower than it was in FY2009 before a further drop in provisioning occurs in This expected reduction in provisioning charges will be a major driver of the increase in the bottom line for CBQ, in our view. CBQ has also incurred impairment provisions on its investment portfolio in the past few years but especially in 2008 and 2009, when investment provisions stood at QR 465 million and QR 182 million, respectively, amounting to 16% and 6%, respectively, of operating income in those years. Investment provisions continued to impact the bottom line in 1Q2010, standing at QR 21.6 million, compared to an average quarterly figure of QR 45 million in FY2009. The ongoing investment provisions are related to the bank s international investments. According to CBQ s management, the bank is implementing an exit strategy when it comes to international investments, and although management expects additional investment provisions going forward, it will not be to the extent witnessed previously. In fact, CBQ s current strategy when it comes to the bank s investments is to focus on low-risk investments, primarily fixed-income ones. The breakdown of CBQ s investment portfolio as of March 2010 supports that with Qatar government bonds and QCB CDs representing 82% of the total QR 9.8 billion portfolio. Another 8% is in other fixed-income securities while the remaining 10% is in equities and investment funds. Hence, equities and investment funds represent a relatively low 1.8% of assets and 8.8% of shareholders equity as of March One issue for CBQ is the fact that the carrying value of NBO (QR 1.48 billion) as of March 2010 is 28% above the latest market value of that investment, giving rise to the possibility of incurring an impairment going forward. It is important to mention that as much as QR 574 million (39% of NBO s carrying value) relates to goodwill. Goodwill was assessed for impairment at the end of 2009 and none was required at that time. As for capital adequacy, CBQ has one of the highest CARs in the Qatari banking sector, standing at 19.1% as of March, much higher than QCB s 10% minimum requirement. This level for the CAR is also much higher than the target level of CBQ s management, which is 15%, leaving the bank with much room to grow without being constrained by capitalization issues. nbkcapital. com 20

21 FINANCIAL STATEMENTS Balance Sheet (QR Thousands ) Fiscal Year Ends December ASSETS Cash and Balances with Central Banks 3,015,283 4,374,423 4,942,277 5,318,427 6,053,549 6,268,518 6,536,027 Due from Banks 14,315,648 5,643,561 4,111,524 4,317,640 4,569,597 4,793,142 5,030,657 Net Investments 8,416,449 13,507,233 14,425,370 15,402,591 16,485,742 17,553,658 18,711,373 Net Loans and Advances 33,897,513 31,929,268 33,935,612 37,190,230 41,029,881 45,402,856 50,067,984 Net Fixed Assets 1,136,073 1,029,632 1,059,604 1,094,089 1,132,023 1,173,751 1,219,651 Other Assets 703, , ,569 1,095,094 1,183,863 1,273,360 1,369,288 Total Assets 61,484,671 57,317,359 59,473,957 64,418,071 70,454,656 76,465,284 82,934,979 LIABILITIES & EQUITY Historical Due to Banks 10,922,869 7,391,335 3,782,603 3,885,876 3,884,158 4,170,033 4,527,592 Customer Deposits 32,185,874 26,271,548 31,806,140 35,888,988 40,887,481 45,316,503 50,023,693 Other Purchased Funds 6,096,091 9,924,358 9,927,896 9,927,896 9,927,896 9,927,896 9,927,896 Other Liabilities 2,301,392 1,719,935 1,709,909 1,941,621 2,164,780 2,385,154 2,535,056 Total Liabilities 51,506,226 45,307,176 47,226,548 51,644,381 56,864,314 61,799,586 67,014,236 Total Shareholders' Equity 9,978,445 12,010,183 12,247,408 12,773,690 13,590,342 14,665,698 15,920,743 TOTAL LIABILITIES & EQUITY 61,484,671 57,317,359 59,473,957 64,418,071 70,454,656 76,465,284 82,934,979 Forecast Income Statement (QR Thousands ) Historical Fiscal Year Ends December Net Interest Income 1,292,091 1,660,791 1,668,051 1,737,152 1,851,662 2,031,001 2,198,362 Income from Fees and Commissions 943, , , , , ,486 1,089,919 Other Operating Income 740, , , , , , ,175 Total Operating Income 2,976,214 2,930,561 2,670,560 2,942,028 3,241,543 3,608,837 3,948,455 Provisions for Credit Losses (58,812) (461,050) (302,257) (216,777) (163,582) (166,048) (166,546) Salaries and Employee Related Expenses (468,591) (465,886) (479,863) (528,642) (577,174) (636,801) (690,360) General and Administrative Expenses (213,546) (200,825) (212,875) (234,514) (258,388) (287,666) (314,738) Depreciation (67,973) (92,742) (101,339) (109,956) (120,952) (133,047) (146,352) Other Provisions and Operating Expenses (464,850) (186,464) (111,331) (78,315) (57,253) - - Total Operating Expenses (1,273,772) (1,406,967) (1,207,664) (1,168,204) (1,177,350) (1,223,562) (1,317,996) Net Operating Profit 1,702,442 1,523,594 1,462,896 1,773,824 2,064,193 2,385,276 2,630,460 Other Income / (Expenses) Income Taxes Minority Interest Net Profit 1,702,442 1,523,594 1,462,896 1,773,824 2,064,193 2,385,276 2,630,460 Forecast EPS (QR) Key Ratios Fiscal Year Ends December Growth in Loans 35.5% -5.8% 6.3% 9.6% 10.3% 10.7% 10.3% Growth in Deposits 24.9% -18.4% 21.1% 12.8% 13.9% 10.8% 10.4% Growth in Net Profit 22.4% -10.5% -4.0% 21.3% 16.4% 15.6% 10.3% Growth in Operating Income 43.4% -1.5% -8.9% 10.2% 10.2% 11.3% 9.4% Loans-to-Assets 55.1% 55.7% 57.1% 57.7% 58.2% 59.4% 60.4% Loans-to-Deposits 105.3% 121.5% 106.7% 103.6% 100.3% 100.2% 100.1% NPLs-to-Gross Loans 0.8% 2.2% 3.4% 3.6% 3.7% 3.8% 3.9% NPL Coverage 98.9% 99.6% 88.6% 90.6% 89.6% 88.6% 87.6% Capital Adequacy 15.7% 18.9% 18.5% 17.7% 17.0% 16.7% 16.5% Growth in Costs 38.8% 1.2% 4.6% 10.0% 9.6% 10.6% 8.9% Non-Interest Expense-to-Average Assets 2.4% 2.4% 2.1% 1.9% 1.7% 1.7% 1.7% Cost-to-Income 25.2% 25.9% 29.7% 29.7% 29.5% 29.3% 29.2% Non-Interest Income-to-Operating Income 56.6% 43.3% 37.5% 41.0% 42.9% 43.7% 44.3% Dividend Payout 84.8% 85.3% 85.3% 70.3% 63.5% 57.7% 54.9% Net Interest Margin 2.9% 3.3% 3.3% 3.3% 3.2% 3.2% 3.2% RoAE 21.0% 13.9% 12.1% 14.2% 15.7% 16.9% 17.2% RoAA 3.2% 2.6% 2.5% 2.9% 3.1% 3.2% 3.3% Sources: Bank s financial statements and NBK Capital Historical Forecast nbkcapital. com 21

22 RISK AND RECOMMENDATION GUIDE RECOMMENDATION UPSIDE (DOWNSIDE) POTENTIAL BUY MORE THAN 20% ACCUMULATE BETWEEN 5% AND 20% HOLD BETWEEN -10% AND 5% REDUCE BETWEEN -25% AND -10% SELL LESS THAN -25% RISK LEVEL LOW RISK HIGH RISK Disclaimer The information, opinions, tools, and materials contained in this report (the Content ) are not addressed to, or intended for publication, distribution to, or use by, any individual or legal entity who is a citizen or resident of or domiciled in any jurisdiction where such distribution, publication, availability, or use would constitute a breach of the laws or regulations of such jurisdiction or that would require Watani Investment Company KSCC ( NBK Capital ) or its subsidiaries or its affiliates to obtain licenses, approvals, or permissions from the regulatory bodies or authorities of such jurisdiction. The Content, unless expressly mentioned otherwise, is under copyright to NBK Capital. 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