Symbol: NCBJ Shares Outstanding: 2,466,762,828 units Market Value Of Shares Outstanding: $51,728,016, Sector: Financial Services

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1 Fundamental Value: $27.52 Market Price: $ Week Range: $ $ Recommendation: BUY 3 Symbol: NCBJ Shares Outstanding: 2,466,762,828 units Market Value Of Shares Outstanding: $51,728,016, Sector: Financial Services Executive Summary NCBJ, a subsidiary of AIC (Barbados), is incorporated in Jamaica and is listed on the Jamaica Stock Exchange (JSE) and the Trinidad and Tobago Stock Exchange (TTSE). Currently, NCBJ maintains the largest market share in loans and deposits in the commercial banking industry and is the largest commercial bank in Jamaica when measured by assets, capital base or branch network. The company has maintained a profitable position for several years, even in the challenging periods, which indicates its ability to withstand challenging economic climates. Company Overview NCBJ started in 1837 as The Colonial Bank of London, England. Through a series of mergers and acquisitions, the bank s name was changed in 1977 to National Commercial Bank Jamaica Ltd. NCBJ, a subsidiary of AIC (Barbados) Ltd, currently operates 42 branches island-wide and offers a range of financial products and services including retail, corporate, treasury and correspondent banking, wealth management and health insurance. NCBJ is also recognized locally for its corporate social responsibility, through the work of the NCB Foundation. The stock trades on both the JSE and TTSE and the management has announced plans to list in the US. In August 2011, NCBJ acquired a 27% stake in Jamaica Money Market Brokers (JMMB) through its subsidiary company, NCB Capital Markets. Earlier this year the company also acquired Advantage General Insurance Company. Financial Performance Snapshot Outlook 9 MONTHS ENDED JUNE 30 With a dim outlook both globally and locally, financial institutions could be faced with heightened challenges. Globally, the crisis in the Eurozone continues, posing a threat to other markets. Uncertainty continues to plague the United States market as investors anticipate the results of the November Presidential Election and an impending Fiscal Cliff 6. Locally, the outstanding International Monetary Fund (IMF) agreement has put the country in a wait-and-see mode, with investors adopting a cautious approach to investing. Regulators have put in place measures to prepare the economy for this IMF agreement. These measures include the recent asset tax imposed on financial institutions accounting for 0.2% of assets. However, volatility in the foreign exchange rate, coupled with negative growth projections, continue to plague the Jamaican economy. Local financial institutions are now required to comply with the US Foreign Account Tax Compliance Act (FATCA) that will enable US regulators to gain access to, and tax accounts belonging to their residents and citizens and held in institutions outside the US. Projections and Valuation: % 5 Assets (J$B) Operating Income (J$B) Net Income (J$B) EPS (J$) P/E (x) ROE (%) The Dividend Discount Model yields a fundamental value of $27.52, which signals that the stock is currently undervalued. This valuation model is suitable for NCBJ as it is a regular dividend paying stock. Dividends are projected to contract at a rate of 0.5% over the next year given the ongoing challenges both locally and globally. However, over the longer term (>3 years), dividends are expected to grow as the economy picks up. We estimate medium to longterm sustainable dividend growth rate to be approximately 5% p.a. The company s pending IPO could be realized, which could start reaping benefits. Additionally, the global economy could be revitalized, thereby providing some buffer for the local economy. 1 As at October 23, As at October 23, Shares offer attractive long-term appreciation potential from current prices. Stock is expected to outperform the market over a longer-term horizon. 4 As at October 23, Percentage Change 6 The Fiscal Cliff represents the expiration of temporary tax breaks and the introduction of tax increases and spending cuts that are expected to take effect in the US when the new Government comes into office. Page 1 of 8

2 Dividends- Payment and Policy NCBJ has indicated that dividends will be subject to a maximum of 50% of the ordinary realized profit earned annually and will be applied after taking account of all transfers. In the event that the payout is less than 50% in any one year, the Board reserves the right to increase future distributions proportionately. 7 In FY 2011 NCBJ paid out approximately 26% of profits as dividends. Dividend yield for 2011 was 4.95%. YTD the company has a dividend yield of 3.5% 8 with lower dividend payments overall this year when compared to last year. Dividend Timetable Payment date Feb 24 May 27 Aug 26 Dec 1 Feb 24 May 25 Aug 27 Dividend Per Share (J$) Management/Corporate Governance NCBJ is headed by Group Managing Director, Patrick Hylton, who is supported by a recognizable team of managers including General Manager, Treasury and Correspondent Banking Division, Septimus (Bob) Blake, Group CFO, Yvonne Clarke, and General Manager, Credit and Risk Management, Allison Wynter. The directors bring a blend of professional experience and youth and a good mix of independence and oversight to the Board. The Board has established 3 committees, the Credit Committee, the Audit Committee and the Corporate Governance Committee. Although the company has established a remuneration policy it appears to be in breach of the PSOJ s Corporate Governance Code which states that companies should have a Nominations Committee and a Compensations Committee in addition to an Audit Committee. Directors Experience Michael Lee- Chin (Chairman) Chairman- Portland Holdings Inc 9 Wayne Chen Sandra Glasgow Patrick Hylton (M.D.) Dennis Cohen (Deputy M.D.) Robert Almeida Sanya Goffe Noel Hylton Thalia Lyn Alvin G. Wint CEO- Super Plus Food Stores; Former President- Jamaica Employers Federation (JEF); Director- AIC (Barbados); Director- NCB Cayman; Chairman-Urban Development Corporation (UDC), Chairman- National Land Agency (NLA) CEO- Private Sector Organization of Jamaica (PSOJ); Director- Export Import Bank of Jamaica (EX-IM Bank); Director- Director- Planning Institute of Jamaica (PIOJ); Director- Grace Kennedy Foundation (GK Foundation) Chairman- Harmonisation Ltd; Director- Caribbean Information & Credit Rating Services Ltd. (CariCRIS); Past President- Jamaica Bankers Association (JBA) CEO- NCB Capital Markets; Former Head- Citibank Relationship Management Group; Former Senior Accountant- PricewaterhouseCoopers Executive Director- AIC Global Holdings Inc; Managing Partner- AIC Caribbean Fund; Former Executive- Canadian Imperial Bank of Commerce (CIBC) Attorney-at-Law; Director- Pension Funds Association; Former Commissioner- Fair Trading Commission (FTC) Chairman & CEO- The Port Authority of Jamaica (PAJ) CEO- Island Grill; Director- Jamaica Macaroni Factory Ltd; Director- Jamaica Promotions Corporation (JAMPRO) Professor and Pro Vice Chancellor- University of the West Indies (UWI); Director- Jamaica Producers Group (JP) 7 Source: NCBJ Annual Report As at October 23, Parent Company for AIC Holdings & AIC Barbados and NCBJ s ultimate parent company. Page 2 of 8

3 Top 10 Shareholders Number of Units Held Percentage Held AIC Barbados Ltd 1,308,040, % LOJ PIF Equity Fund 110,795, % Harprop Ltd 110,521, % AIC Global Holdings Inc 49,565, % NCB Insurance Co Ltd WT ,874, % Advantage General Insurance Ltd 44,430, % Ideal Portfolio Services Company Ltd 41,867, % Portland (Barbados) Ltd 38,045, % Beta SPV Ltd 20,000, % SJIML A/C ,574, % Total 1,788,714, % NCB s Operational Structure Subsidiaries NCB Capital Markets Ltd NCB Insurance Company Ltd NCB Jamaica (Nominees) Ltd West Indies Trust Company Ltd NCB Cayman Ltd Nature of Business Wealth and Asset Management Insurance Registrar and special issues services for corporations and employee share schemes Trust Services including the making of wills and administration of estates of deceased persons Offshore banking SWOT ANALYSIS Strengths Largest financial institution in Jamaica in 2012 when measured by assets, capital base, branch network Strong brand recognition Profitable company S&P rating (B-); rated best in region CariCRIS rating (BBB); rated based on strong market position as well as its asset quality Opportunities IPO on US stock exchange to raise additional capital, thereby facilitating further expansion Low interest rate environment is conducive to growing the loan book High barriers to entry into the local banking sector Weaknesses Heavy exposure to Jamaican government debt Large bad debt portfolio. Non-performing loans as at June 2012 accounted for 7.1% of gross loans. Heavy reliance on trading income relative to core savings/loans business Heavy taxation of the financial sector in excess of taxes levied on other, less profitable, sectors Threats Regulatory changes, specifically the new asset tax could challenge the bottom line Active competition in fee-related services Domestic economy struggling to emerge from recession Central bank running out of options and could resort to interest rate increases to maintain economic stability Page 3 of 8

4 Financial Analysis NCBJ financial year ends September 30. Revenues: NCBJ s Operating Income for the 9M period ended June 2012 amounting to $26.3 billion, a marginal increase year on year. Net Interest Income increased by 3% stemming from growth in the loan portfolio as well as growth in repurchase agreements in the wealth management segment. Meanwhile Non-Interest Income (Fee Income & Other Operating Income) decreased by 3% mainly as a result of a 47% decline in insurance premium income as gains on foreign currency and investment activities increased by 11% and fee income increased by 12%. Expenses: The company s Operating Expenses increased 18% year on year mainly due to higher provision for credit losses, likely due to a deterioration in the quality of the loan portfolio. Despite the challenging economic environment, NCBJ s staff costs increased significantly by 16% year on year reflecting increases in salaries and staff benefits. Given this large increase, we do not expect to see similarly high increases in the short term. In addition, the company through its wealth management subsidiary recorded impairment charges on investment securities amounting to $314 million (approximately 2% of expenses). Balance Sheet: 9M results showed a 9% increase in asset base to $379.4 billion compared to the previous year stemming from growth in the loan portfolio (which accounted for 29% of assets) as well as growth in investment securities (which accounted for 55% of assets). Total Liabilities also increased 9% to $315.2 billion due to increases in deposits (which accounted for 54% of liabilities) and repurchase agreements (which accounted for 31% of liabilities). Hence, total equity at the end of the 9M period stood at $64 billion representing a 10% increase over the prior year. Cash Flow: Net cash provided by operating activities rose 93% year on year largely due to positive changes in net working capital. Net cash used in financing activities was 88% higher influenced mainly by higher repayments under securitization agreements. Net cash used in investing activities increased more mutedly by 9% mainly due to acquisitions. These activities resulted in a 6% decrease in cash and cash equivalents at the end of the period amounting to $26.5 billion. Given the uncertainty in the economy, this situation could reverse going forward as NCBJ, like other major global banks, could begin increasing its stock of cash as a defensive strategy. Ratio Analysis Financial Health: The company s debt to equity position (a measure of the degree of financial leverage) has declined year over year. Going forward, if the IPO is successful, the proportion of shareholders debt to equity could continue on the declining trajectory, as a result of the capital injection. Of note is that there has been an increase in repurchase agreements (repos) on the liabilities side of the balance sheet. Although this is contrary to the Financial Services Commission s (FSC) directive of reducing the amount of transactions involving repos, it provides a buffer against the uncertainty that exists regarding the future direction of short term interest rates Debt/Equity (times) Q3-2011Q Page 4 of 8

5 VMWM Research Department, November 2, 2012 Liquidity: The company maintains a liquid position with current assets sufficient to meet short-term obligations. Additionally, liquidity ratios have remained stable, which is a good sign, indicating management has a good grasp ofn the company s liquidity needs. Given the increasing uncertainty both locally and internationally, financial institutions have been shoring up their stocks of cash in a defensive move and NCBJ could do the same going forward Current Ratio Cash ratio (x) Profitability: NCBJ has maintained a profitable position for several years. The company recorded a decrease in Net Profit Margin (NPM) and Operating Profit Margin (OPM) for the 9M period ended June This represents a year over year decline in both Operating Profit and Net Profit. The decline in Operating Profit stems from a decline in Premium Income while the decline in Net Profits stems from the increased tax bill which was passed earlier this year. Also, there was an increase in expenses for the 9M period. Prior to this NCBJ s NPM and OPM both improved year over year, even in the challenging period, indicating the company s ability to withstand challenging economic climates. However, the company is expected to record a decline in Net Profit for year end 2012 as its top line slips % 40.00% 30.00% 20.00% 10.00% 0.00% Operating profit margin Net Profit Margin ROE and ROA have remained relatively stable over the period However, annualized 2012 figures reveal a reduction in both ROE and ROA to 21.54% and 2.58% respectively. This is supported by an expected decline in Net Income. ROE 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% ROA ROE ROA Prior to 2011, and even in the 2008/2010 recessionary period, Net Interest Margin (NIM) had been increasing, influenced mainly by increases in Net Interest Income. However, in 2011 NIM fell marginally influenced moreso by a slight increase in earnings asset. For year end 2012, net interest income is expected to decreasee reflective of the declining interest rate environment coupled with an increase in the asset base, thereby resulting in reduced NIM. Already, PIOJ has reported a real decline in net interest income for Q2 for sector overall, thus contributing to the contraction in the finance and insurance sectors. 4.50% 4.00% 3.50% 3.00% Net Interest Margin Annualized 2012 Page 5 of 8

6 VMWM Research Department, November 2, 2012 Price Movement Year to date the Main JSE Index declined 6% while NCBJ s stock price declined 31%. Obviously, stock prices generally have been constrained. As the market awaits the IMF agreement, investor confidence remains low with persons investing less in the stock market. More specifically related to NCBJ, the failure of the Palmyra resort to honour debt obligations that resulted in a dramatic increase in bad debts may have added to low investor confidence in the stock. In 2007 NCBJ structured financing for the Palmyra Resort, which later failed to service the US$88 million loan. Also, the 2011 announcement of the IPO on the US Stock Exchange, which to date has not been materialized, may have contributed to disillusionment of investors to NCBJ. However, these events have not caused a significant decline in the company s profitability, whichh indicates that the current price may not reflect the stock s true potential value. NCBJ traded at a 52-week high of $33 in November 2011, a time when the market had rebounded from a recession and the level of optimism was high. Also, during that period, the company had just revealed its plans to list on the New York Stock Exchange and had just acquired a stake in JMMB. This, at the time, resulted in increased demand for the stock, hence, a spike in the price, perhaps even overshooting its true fundamental value. The stock traded at a 52-week low of $20.55 on October 25, 2012, following the declaration made by STATIN that the economy is back in recession. Due to this, it is expected that wages and salaries in general across the sector will remain stable rather than increase. In addition, the PIOJ has affirmed a 0.5% contraction in the financial sector for Q reflecting declines in Net Interest Income. In spite of all this, NCBJ remains a liquid stock with trading taking place almost daily. Page 6 of 8

7 Outlook In the midst of a weak economic environment both locally and globally, an unfriendly tax environment and increasing regulatory obligations imposed by overseas countries, the company is likely to face challenges over the short to medium term. Globally, the crisis in the Eurozone continues, posing a threat to other markets. Uncertainty continues to plague the United States market as investors anticipate the results of the November Presidential Election and an impending Fiscal Cliff. On the local scene, as the country seeks an agreement from the IMF, new tax measures, which are particularly prejudicial to the financial sector, have been put in place by the Government. Among these measures is a 0.2% asset tax as well as retention of the 33 1/3% corporate income tax rate 10. In addition, the company will be required to comply with FATCA, which will see increased operational compliance procedures and associated costs. The 9M decline in Net Income could indicate that growth for the financial year ended Sept 2012 has slowed. As low interest rates, in the absence of economic growth, continue to plague the economy, Net Interest Income is expected to decline, forcing financial institutions to rely more on core interest generating activities like loans. Also, Year-end Operating Expenses are expected to increase as the company increased its provision for credit losses. NCBJ, in 2011, announced its intention to pursue listing on a US stock exchange but, to date, this has not materialized. The IPO is aimed at raising capital for further expansion. This initiative, if realized, could prove beneficial to NCBJ in the medium- to long-term. Projections & Valuations The Dividend Discount Model yields a fundamental value of $27.52 which signals that the stock is currently undervalued. This valuation model is suitable for NCBJ as it is a dividend paying stock. In the short-term NCBJ s profit is expected to shrink, given the ongoing challenges both locally and globally. Locally, the government s fiscal consolidation measures have resulted in negative growth of 0.2% 11 for Q For the 9M period ended June 2012, NCBJ s financials reveal a 25% year over year reduction in profits and a 17% reduction in dividend payments. This signals a downturn in profits at year end. In light of this, we have assumed a short-term contraction rate for NCBJ of 0.5%, with growth of 5% in the years following. The company s cost of equity is calculated using the CAPM model. CAPM is adjusted to include the country risk premium and the equity risk premium. Conclusion & Recommendation: We believe this stock is undervalued, currently trading below its book value and at a low P/E relative to the industry. We recommend investors buy at current prices as there is potential for price appreciation. In addition, the stock provides regular dividend income. The pending listing on a US stock exchange, if materialized, should also give management increased incentives to deliver improved value to both local and international shareholders. Prepared by: VMWM Research Department, November 2, Non-financial institutions benefited from a reduction in the corporate income tax to a rate of 25%. 11 Source: Statistical Institute of Jamaica (STATIN) Page 7 of 8

8 Disclaimer: This Research Paper is for information purposes only. The information stated herein may reflect the opinion and views of VM Wealth Management in relation to market conditions and does not constitute any representation or warranties in relation to investment returns and the credibility of the sources of information relied upon in the preparation of this report, without further research and verification. Before making any investment decision, please consult a VM Wealth Management Advisor. Page 8 of 8