Commercial Bank of Ceylon Ltd (COMB)

Rs. 146.00 180 160 140 120 100 80 60 40 Price Volume Sri Lanka Equities Corporate Update Commercial Bank of Ceylon Ltd (COMB) COMB PRICE - VOLUME GRAPH Price 01-Apr-03 09-May-03 17-Jun-03 18-Jul-03 21-Aug-03 24-Sep-03 31-Oct-03 04-Dec-03 12-Jan-04 19-Feb-04 24-Mar-04 03-May-04 10-Jun-04 20-Jul-04 23-Aug-04 01-Oct-04 04-Nov-04 16-Dec-04 27-Jan-05 09-Mar-05 19-Apr-05 27-May-05 01-Jul-05 09-Aug-05 13-Sep-05 14-Oct-05 23-Nov-05 28-Dec-05 02-Feb-06 21-Mar-06 08-May-06 16-Jun-06 Volume 8,000,000 7,000,000 6,000,000 5,000,000 4,000,000 3,000,000 2,000,000 1,000,000 COMB Issued Share Capital (Shares) *Voting *Non Voting 12 mth High/Low (Rs.) Average Daily Volume (Shares) Market Capitalisation (Voting) Rs. mn 132,778,324 9,300,460 178.00/120.00 112,651 19,917 Price Performance (%) 1 mth 6 mth 12 mth ASPI (4.71) 3.97 9.88 COMB (5.50) 0.00 13.62 0 REGIONAL PLAYER BUY Financial Net NPAT PAT, MI & EPS EPS PER (x) Dividend Year Income (Rs.mn) Pref Divid (Rs.) Growth Rs. Yield % DPS Rs. 2002 4,465 1,313 1,193 8.40 8.61 17.39 3% 5.00 2003 5,870 1,467 1,235 8.69 3.55 16.79 3% 5.00 2004 7,397 1,727 1,495 10.52 21.04 13.87 4% 6.00 2005 8,769 2,360 2,128 14.98 42.32 9.75 4% 6.00 2006E 11,244 2,943 2,710 19.07 27.35 7.65 4% 6.00 2007E 14,423 3,728 3,612 25.42 33.29 5.74 4% 6.00 *Excluding exceptional items Commercial Bank has consistently outperformed its peers in the local banking industry recording above average loan growth, low cost to income ratio and an impressive ROAA of 1.48%, making it a benchmark amonst the local banks in the country. Its effective adoption of technology together with efficient risk management seen in a well balanced lending portfolio and funding base provides a sturdy foundation to further its regional plans. Its aim to replicate its strategy of growing a predominately corporate bank into a nationwide bank in Bangladesh promises healthy returns in addition to its already impressive performance in Sri Lanka. LOAN GROWTH AND NPL s Continuous branch expansion and a customer oriented product portfolio together with a focus on the SME segment would drive loan growth by 31% for FY06 and 30% in FY07. Effective credit selection and monitoring enabled absolute NPL s to decline in FY05 despite recording a loan growth of 31.9%. We expect COMB s gross NPL s to to decline to 3.7% in FY06 from 4.18 in FY05. A JKSB Research Publication Yolan Seimon yolan@jkstock.keells.com John Keells Stock Brokers (Pvt) Ltd. 130, Glennie Street, Colombo 2, Sri Lanka. Tel: 941 2421 101-9 (Gen.), 941 2326 003, 941 2439 047/8 Fax: 941 2326 863, 941 2342 068 June 2006 INCOME AND EXPENSES Net Interest Margins are expected to pick up with a upward pressure on interest rates and a significant surplus in low cost retail deposits that continues to help fund the bank s corporate lending portfolio. Further, steady spreads and impressive loan growth coupled with enhanced fees and commission income is expected to result in net income growing by 26.1% in FY06, excluding the recognition of mark to market gains on equity investments. In addition a heavy focus on streamling and automation of internal prcoesses is expected to see a decline in cost to income ratio from 54.4% in FY05 to 53.2% in FY06. VALUATIONS Continued branch expansion feeding COMB s loan growth coupled with increased earnings from fee based activities and its over seas expansion should translate into earnings growth of 27.35% and 33.29% in FY06 and FY07 respectively excluding exceptional items. At a PER of 7.65x FY06 earnnigs, the counter is at a 10.63% discount to the market. We believe that consolidation of its position in the local banking industry together with prospects of regional expansion warrant a significant premium on the counter. We recommend BUY. Page 1 of 5

PROFILE Commercial bank (COMB) continues to out perform other local rivals in the banking industry registering healthy bottom line growth driven by above average loan growth and a low cost/income ratio. Efficient credit risk management and healthy capital adequacy has reinforced the banks strength enabling its to acquire a market share of over 9% of domestic banking assets. COMB s long-established focus on corporate banking and trade finance via its international links acquired during its association with The Eastern Bank Ltd, has given rise to relationships with large conglomerates and reputed trading establishments. Its decision to become a bank with a nationwide presence in the mid 80 s resulted in an expansion of its branch network which was accelerated in the mid 90 s. This led to COMB acquiring significant exposure into retail banking and small and medium sized enterprises. As at end 2004 Corporate lending accouted for 57% of the banks lending portfolio with Consumer lending and increased exposure to loans to Small and Medium Enterprises accounting for as much as 43% of its loans. The Bank has expressed its intent of advancing its regional presence while continuing to consolidate its position in Sri Lanka. FINANCIAL PERFORMANCE INTEREST INCOME Earnings grew 38% yoy for FY05, augmented by earnings from its venture in Bangladesh with loan growth of 31.9% boosting interest income by 35.9% for the year. We forecast a 31% growth in COMB s loan book for FY06 and a 30.0% growth for FY07, assisted by an expected increase in exposure into small and medium sized enterprises (SME s) as well as an anticipated 12-14 new branches to be opened locally in the next two years. COMB continues to maintain fairly consistent and healthy spreads, which are expected to increase marginally in FY06 and FY07 with upward pressure on interest rates. Net interest margins declined slightly to 3.87% in FY05 from 3.95% in FY04 largely due to increased exposure toward low yielding government securities. However with upward pressure on interest rates and higher yields from an increased exposure into SME s, Net interest Margins are expected to pick up to 3.96% in FY06 and increase further in FY07. A surplus in low cost retail deposits over retail lending continues to help fund the Banks corporate lending portfolio having a direct positive impact on net interest margins. COMB s ROAA increased to 1.48% last year from 1.35% in FY04 on the back of healthy growth from all key revenue streams. The increase in financial VAT from 15% to 20% and the increase in corporate tax to 35% proposed under the last budget would see ROAA remaining largely unchanged in FY06 and increasing marginally in FY07. Higher taxes including restrictions on tax allowances for advertising, entertainment and head office expenses has increased the banks effective tax rate. We expect the effective tax rate for COMB for FY06 to be 45% up from 35.7% in FY05; still lower than most other banks due to COMBs exposure in Bangladesh. Page 2 of 5

INTEREST INCOME The banks non interest income has grown steadily recording a CAGR of 23.78% over the last four years, with over 50% of non interest income, coming by way of Fees and Commission income which has grown at a CAGR of 28.98% over the last 4 years. A majority of fee-based income is derived from trade finance services and increasingly from income generated via COMB s payment infrastructure. Ever-increasing usage of online and phone banking services and facilities streamlining utility bill payments together with other value added services in the pipe line should see contribution from fee and commission based income continuing to grow. We expect fees and commission income to grow by 23.3% and 24.4% in FY06 and FY07 respectively. With the modest depreciation of the rupee likely to continue we forecast foreign exchange income of Rs.820mn for FY06 increasing to Rs. 975mn in FY07 arising from profits retained in the Off Shore Banking Centre and a conversion of acconunts of the Bangladesh operations to SL Rupees. OPERATING EXPENSES COMB s cost/income ratio of 54.6% for FY05 continues to rank as the lowest amongst competing banks. Expenses continue to curtailed by an emphasis on the widespread adoption of technology in providing value added services, automating its back office process and streamlining internal processes. Despite personnel costs having increased at a CAGR of 24.13% over the last 3 years, the rationalizing of internal processes has enabled the Bank to maintain the lowest employee to bank branch ratio amongst its peers. As a result we see the banks cost/income ratio continuing to decline going forward. Provisions for staff retirement benefits had increased by a CAGR of 49.7% over the last four years upto FY04 in a bid to bridge the funding gap of the employee s defined benefit pension scheme. The funding gap currently stands at approximately Rs. 0.65bn. The company however has discontinued the pension scheme for new recruits and has been taking steps to allay the banks pension liabilities which include an increase in employment of outsourced personnel. This has resulted in provision for staff retirement benefits decling by 27% in FY05. CREDIT RISK COMB s lending portfolio is fairly broad based, diversifying its credit risk across growth sectors in the country s economy. Absolute NPL s declined by 4.07% last year with better economic conditions assisting in recoveries of bad debts. The bank has consistently focused on improving the quality of its lending portfolio with steps taken to improve its internal customer-rating scheme that would further facilitate thorough credit selection and monitoring. As a result of these measures COMB s Gross NPL ratio declined to 4.18% for FY05 down from 5.34% in FY04, which is the lowest gross NPL ratio amongst competing banks. The bank is expected to see absolute NPLs increasing marginally over the next two years. This is largely a consequence of COMB s increased exposure to relatively untried markets in Bangladesh as well as with expanding portfolios in consumer lending and the SME segment. Nevertheless despite possible increases in absolute NPL s our forecasts indicate that COMB s gross NPL ratio should continue to decline to 3.9% and 3.7% in FY06 and FY07 on the back of strong loan growth. Page 3 of 5

FUNDING AND CAPITAL COMB continues to be funded for most part by customer deposits largely built up by savings deposits and current account balances accounting for 53% of the deposit base in FY05. The large exposure to low cost savings deposits and current account balances will continue to contribute toward healthy spreads maintained by the bank. The expansion of the banks network of branches will help the bank increase its retail deposit base giving it access to further new low cost savings deposits. The considerable loan growth the bank has exhibited in recent years has led to the banks relative capital adequacy declining over the last few years. A capital infusion in 2003 helped boost the banks Equity to Asset ratio in 2003 along with the raising of subordinate debt and a revaluation surplus enabling the bank to manage its capital strength despite its loan growth. COMB s Tier 1 and Total capital adequacy ratios for FY05 as reported by the bank stood at 9.68% and 12.08%, comfortably above central bank requirements of 5% and 10% respectively. FOREIGN OPERATIONS COMB s acquisition of the Bangladesh operations of Credit Agricole Indosuez in late 2003 has given rise to new avenues of growth with the firm committed to expand its presence in the region. The acquired bank with 2 existing branches and 2 booths accounted for approximately 8% of COMB s assets as at end 2004. The acquired entity is predominantly a corporate bank, much like COMB in its formative years. COMB intends to enhance the ventures corporate banking activities whilst progressively building a retail-banking segment. The opening of a new branch in Dhanmondi in just over a year since its entry into the country as well as COMB being awarded the best foreign bank award for 2005 by Industry Business Awards 2005 in Bangladesh for the second successive year reflects a successful entry into the market. The banks operations in Bangladesh contributed pre tax profits of Rs. 452mn in FY05 accounting for 12.3% of group pre tax earnings.the bank intends to gradually open more branches, but the pace at which the branch network would expand is still unclear and is subsequent to gaining relevant approvals from regulatory authorities. The overseas operation has a varied income base with significant earnings arising from fee-based activities with Non Performing Loans being nil. The roll out of retail operations via a variety of products would diversify its lending portfolio and source of funds helping in part to over come its heavy credit concentration risks in certain sectors including apparel. With the banking industry in Bangladesh still largely underdeveloped, new innovative products and enhanced service levels would make the Bangladesh Operations a major contributor to COMB s future growth prospects. VALUATIONS COMB s sound management and strong fundamentals have been translated into consistently strong performances over the years. earnings growth of 27.35% and 33.29% in FY06 and FY07 respectively excluding exceptional items provide a corresponding forecast PER of 7.65x and 5.74x at a market price of Rs.146/-. The counter is currenlty trading at a 10.63% discount to the market on FY06 earnings. Earnings including recognition of mark to market gains on a transfer of equity investments from a long term fund to a trading fund would amount to Rs. 3.3 bn forfy06 with a corresponding PER of 6.72x FY06 earnings. Given the continued consolidation of its market position in Sri Lanka it is our view that COMB ought to be trading at a significant premium to the market. We recommend BUY. Page 4 of 5

Income Statement 2002 2003 2004 2005 2006E 2007E For the Year Ended 31st December Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Income 8,900 9,749 12,437 16,226 21,738 27,419 Interest Income 7,456 7,630 9,778 13,293 17,996 22,974 Less: Interest Expense 4,435 3,879 5,039 7,456 10,494 12,996 Net Interest Income 3,021 3,751 4,738 5,837 7,502 9,978 Foreign exchange profit 464 397 874 587 820 975 Fee and commisison income 824 1,051 1,377 1,760 2,170 2,700 Other Income 232 671 409 586 752 770 4,541 5,870 7,397 8,769 11,244 14,423 N.S.L 76 - - - - - Net Income 4,465 5,870 7,397 8,769 11,244 14,423 Less Operating Expenses Personnel Costs 1,121 1,398 1,820 2,144 2,600 3,120 Premises and Equipment expenses 684 833 1,019 1,146 1,355 1,600 Provision for staff retirement benefits 196 311 326 236 275 285 Loan losses and Provisions 413 623 699 415 514 590 Other Overhead expenses 375 708 1,015 1,258 1,550 2,050 Total Expenses (2,790) (3,874) (4,879) (5,199) (6,294) (7,645) Profit from Operations 1,675 1,996 2,518 3,570 4,950 6,778 Add: Share of PBT of Assoc. 28 43 76 100 - - Profit before Tax 1,704 2,039 2,594 3,670 4,950 6,778 Less: Provision for Taxation 391 572 867 1,311 2,007 3,050 Profit after taxation 1,313 1,467 1,727 2,360 2,943 3,728 Less: Minority Interest 2 2 2 2 3 4 Net profit for the year 1,311 1,465 1,725 2,358 2,940 3,724 Cum. Red. Pref. Shares 13% 118 118 118 118 118 Cum. Red. Pref. Shares 11.25% 113 113 113 113 113 NPAT, MI & Pref. Dividend 1,193 1,235 1,495 2,128 2,710 3,612 COMB PER BAND Price Rs. 350 Price 5 7 10 14 Balance Sheet 2002 2003 2004 2005 2006E 2007E As at 31st December Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn ASSETS Cash and short-term funds 1,837 9,002 12,136 18,657 19,850 20,850 Balances with Central Banks 3,244 5,233 6,320 9,045 9,250 9,950 Government Treasury Bills and Bonds 16,778 20,748 6,647 19,160 20,501 21,936 Commercial paper 1,080 547 560 408 560 620 Sec. purchased under re-sale agreements 1,449 3,971 2,087 808 2,824 2,900 Dealing Securities 200-110 182 279 298 Investment securities 705 2,606 2,940 3,691 3,150 3,270 Treasury Bonds Maturing after one year 148-14,379 1,714 2,743 3,428 Bills of Exchange 2,552 2,495 2,799 2,790 3,202 3,674 Loans and Advances 47,350 60,585 82,605 108,917 142,682 185,486 Lease rec. within one year 698 1,277 2,004 2,676 3,559 4,627 Lease rec. from one to five years 1,197 2,050 3,243 4,295 5,670 7,371 77,238 108,513 135,828 172,345 214,270 264,411 300 250 200 150 100 50 0 2003 2004 2005 2006 Investment in Assoc. 141 171 243 283 58 58 Interest and Fees receivables 295 390 1,143 1,199 953 1,256 Other Assets 1,958 1,872 1,445 2,944 2,191 2,950 Property, Plant and Equipment 1,753 1,877 3,134 3,365 3,423 3,455 TOTAL ASSETS 81,385 112,823 141,792 180,135 220,895 272,130 Financed By : - - - - - - Deposits form customers 54,480 75,097 98,622 127,491 164,285 209,725 Dividends Payable 121 190 232 230 230 112 Borrowings 4,200 5,406 9,090 13,453 15,874 18,335 Sec. sold under repurchase agreements 9,922 12,951 12,261 11,386 10,247 9,428 Other Liabilties 3,912 4,596 3,491 6,070 6,014 6,194 Tax Payable 64 231 484 773 1,311 2,007 Deferred Taxation 253 259 251 239 250 255 Debentures 500 2,244 3,244 4,553 4,189 3,854 73,453 100,973 127,676 164,168 202,401 249,911 Minority Interest 13 13 12 13 12 12 SHAREHOLDERS FUNDS Ordinary Shares - Voting 390 650 650 1,328 1,328 1,328 Ordinary Shares - Non Voting - 47 47 93 93 93 13% Cum. Pref. shares - 907 907 907 907 907 11.25% Cum. Red. Pref. Shares - 1,000 1,000 1,000 1,000 1,000 Share Capital 1,324 2,603 2,603 3,327 3,327 3,327 Statutory Reserve Fund 1,009 1,009 1,010 1,422 1,010 1,010 Reserves 5,586 8,224 10,491 11,205 14,145 17,869 Shareholders Funds 7,919 11,836 14,105 15,954 18,482 22,207 81,385 112,822 141,792 180,135 220,895 272,130 This document is published by John Keells Stockbrokers (Pvt.) Limited for the exclusive use of their clients. All information has been compiled from available documentation and JKSB s own research material. Whilst all reasonable care has been taken to ensure the accuracy of the contents of this issue, neither JKSB nor its employees can accept responsibility for any decisions made by investors based on information contained herein. John Keells Stockbrokers (Pvt) Ltd. 130, Glennie Street, Colombo 2, Sri Lanka. Tel: 941 2421 101-9 (Gen.), 941 1446 694/5, 941 1342 066/7 Page 5 of 5