Current Price as of Nov 16th, 2015

Commercial Banks

November 19, 2015

BUY36.7 29.8 23.3

Shares (mn) 1,590 45.0

455

3M 6M 12M2.2 0.2 5.70.8 1.2 2.1

29.2 29.2 32.524.9 23.9 23.9

Source: Bloomberg

E: shiraz.zaidi@arifhabibltd.com

UAN: +92 21 111 245 111, Ex t: 248

47,307

– Abu Dhabi Group

Relative Performance

Major Shareholders

Price Performance

Avg. Volume (mn)High Price - PKRLow Price - PKR

Return %

Market Cap. (PKR mn)

Shiraz H. Zaidi

F:+92 21 3242 0742

D:+92 21 3246 2589

BAFL PA

Free float (% )

Upside (% )Current PriceTarget Price (Dec'16)

Analyst:

Recommendation

www.arifhabibltd.com

Market Cap. (USD mn)

80%

90%

100%

110%

120%

130%No

v-14

Dec-1

4Ja

n-15

Feb-

15Ma

r-15

Apr-1

5Ma

y-15

Jun-

15Ju

l-15

Aug-1

5Se

p-15

Oct-1

5No

v-15

BAFL KSE100

We reinitiate our coverage on BAFL - BUY!

Our Dec’16 Target Price of PKR 36.7 offers a hefty 23% upside potential. The stock currently trades at 0.80x book value (CY15E), which compares well to an average of 1.26x for peers (BAHL, AKBL) and 1.63x for larger banks (HBL, UBL, MCB). Our Dec’16 Target Price implies a comfortable CY16F P/Bx of 0.92x, P/E of 7.6x, with a DY of 10%, and an EPS CAGR of 12% - CY16-19F (Total Return of 33.3%).

Deposit Base Re-profiling and On-going Cost Cutting to Control Future NIMs Re-profiling deposit base has been an industry wide phenomenon recently; amidst subdued return on advances and fresh investments suffering the likes, along with Banking Spreads at an 11 year low. In line with this norm, Bank Alfalah (BAFL) has managed to successfully shrink its cost of deposits from 5.7% CY11 to 4.8% CY14. The Bank is diligently working to reduce the cost of deposits further through retirement of its costly Fixed Deposits, already down by 12% in 9MCY15; to provide support to otherwise attiring Net Interest Income and to maintain Net Interest Margins (NIMs) at an expected average of 3.7% from CY16-19F.

Strong Base of High Yielding Investments to Provide Tailwinds in Near Future Following the industry norm, Bank Alfalah grew investments at a staggering +27% CAGR during CY09-14, reaching PKR 324bn or ~54% Investments to Deposit Ratio (IDR) and that too dominated by government securities, with Pakistan Investment Bonds (PIB) at 57% and Market Treasury Bills (MTB) at 9% of its total investments. Looking forward, we project the investments to grow at an annual average of 9% in CY16-19, with PIB and MTB making up 80% of total investments, at 10.0% and 7.5% average yields respectively. This uptick in IDR, we believe, should provide a substantial cushion to the subdued growth in loan book.

Cautious Lending Supported By Growth in Other Streams of Income Due to recent challenging economic environment and uncertainties, Bank Alfalah has been taking a cautious approach in lending. To curtail its exposure to industry wide increments in Non-Performing Loans (NPL), the Bank had implemented a segment wise strategy allowing exposure only in selected segments with a proven history, successfully cutting down its Infection ratio (NPL/Gross Loans) from 6.4% CY14 to 5.8% in 9MCY15. Going forward, we estimate advances growth to stay modest around ~6.9% during CY15-19, however, with a better performance. In addition, we expect Bank Alfalah to maintain a healthy YoY growth in cross-sell products such as Bancassurance, Credit Cards, and other Investment products.

Exhibit: Key Financial Highlights Year-End (Dec) PKRbn CY13 CY14 CY15E CY16F CY17F Net Income 4.7 5.6 8.3 7.7 8.2 Earnings growth (%) 2.6 20.8 47.6 -7.6 6.6 EPS diluted (PKR) 2.9 3.6 5.2 4.9 5.2 Mkt. Cap / PPOP 5.9 4.6 3.0 3.4 3.2 BVPS (Tier I+II) 20.1 28.2 37.4 39.9 43.9 P/B (x) 1.2 1.2 0.8 0.7 0.7 P/E (x) 8.0 9.1 5.7 6.1 5.8 DPS (PKR) 2.0 2.0 3.0 3.0 3.0 Dividend Yield (%) 8.5 6.2 10.1 10.1 10.1 CAR (%) 12.1 12.8 14.5 14.8 14.5 Source: Company Financials, AHL Research

Bank Alfalah Limited

Bank on Strong Business Agility and 23% Upside

Bank Alfalah Limited Page 2

Commercial Banks

Exhibit: International Branch NetworkTotal

Bangladesh 7Dhaka 4Chittagong 1Sy lhet 1Dhanmondi 1

Afghanistan 3Kabul 2Herat 1

Bahrain (WBU) 1Manama 1

Total 11Source: Company Financials, AHL Research

Exhibit: Shareholding Pattern

Source: Company Financials, AHL Research

Directors & CEO

15%

Related Parties

4%GP -Local8%

GP -Foreign29%

Foreign Compa

nies27%

Others17%

Exhibit: Domestic Branch NetworkConventional Islamic Total

Karachi 81 36 117Lahore 62 31 93Rawalpindi 26 8 34Islamabad 23 9 32Faisalabad 17 11 28Quetta 14 4 18Peshawar 11 4 15Multan 9 6 15Gujranwala 7 2 9Hyderabad 6 2 8Gujrat 3 2 5Others 221 43 264Total 480 158 638Source: Company Financials, AHL Research

Business and Network Overview Headquartered in Karachi, Pakistan, Bank Alfalah Ltd is the sixth largest bank in Pakistan that provides a full range of financial solutions to individuals, corporations, institutions, and governments through a broad spectrum of products and services, including corporate and investment banking, consumer banking and credit, securities brokerage, commercial, small and medium sized enterprises, agri-finance, Islamic and asset financing. Bank Alfalah has an efficient network of 649 branches and 580 ATMs across the country including 158 Islamic branches, with a noticeable presence in other frontier markets; Afghanistan, Bangladesh, and a representative office in Bahrain. Owned by the Abu Dhabi Group, the bank maintains more than PKR 790bn in assets, PKR 302bn in advances, and PKR 586bn in deposits.

Bank Alfalah (BAFL) was incorporated as a public company on 21st June, 1992 and commenced banking operations in November 1997. A major shift in BAFL’s ownership came through an acquisition of 15% of its stake by International Finance Corporation (IFC) in 2014, a subsidiary of the World Bank, as part of IFC’s long term strategic collaboration. We believe IFC’s investment of USD 67mn in BAFL will not only boost Bank’s capital and reserve base but prove to strengthen BAFL’s ability to offer a wider range of services in the local and international markets.

In addition, BAFL also tied knots with Asian Development Bank’s (ADB) Trade Finance Program, Department of International Development UK (DFID), and USAID, while it was already a part of IFC Global Trade Finance Program.

Bank Alfalah has been steered by a highly accomplished Central Management Committee, providing a high standard of competence from top down. Mr. Atif Bajwa chairs the position of Director and Chief Executive Officer of the Bank since his appointment in 2011. Mr. Bajwa has a diversified and rich experience in Banking and has held various key positions including President of the Abu Dhabi Group (Pakistan), as well as Chief Executive Officer position for MCB.

Furthermore, Bank Alfalah conducts diligent hiring of highly talented staff and invests in extensive training to ensure outstanding performance in all practices. Bank Alfalah also hires special teams to address Bank’s specific objectives from branch level upwards.

Shareholders’ Pattern Exhibit: Shareholder’s Pattern

No of Shares No of Shr Holders % of Shrs

Directors & CEO 230,381 7 15% Related Parties 70,072 7 4% NIT & ICP 6,998 3 0% Other FIs 56,652 25 4% Insurance Companies 11,421 15 1% Modarabas & MFs 68,348 36 4% Public Companies 61,323 6 4% GP - Local 129,416 13,631 8% GP - Foreign 459,265 23 29% Foreign Companies 429,809 44 27% Others 63,558 172 4% 1,587,243 13,969 100% Source: Company Financials, AHL Research

Bank Alfalah Limited Page 3

Commercial Banks

Exhibit: Growth in Remittances Amidst Oil Crisis

Source: SBP, AHL Research

40 50 60 70 80 90 100 110 120

1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8

1QCY

14

2QCY

14

3QCY

14

4QCY

14

1QCY

15

2QCY

15

3QCY

15

Home Remittances

Crude Oil Prices (RHS)(USD bn) (USD/bbl)

Macro-economic Synopsis Pakistan’s economy has started showing signs of gradually strengthening with the FY16 GDP projected to grow at ~4.3% and FY17 at ~4.6%, compared to FY15 GDP growth of 4.2%. The uptick in growth is supported by planned improvements in supply of gas and electricity, and investment related to China Pakistan Economic Corridor (CPEC). The current account is expected to strengthen on the back of lower international oil prices, along with largest federal reserves and strong remittances. Foreign investments are also expected to pick up as the Pakistani Stock Market offers an attractive PE at 8.94x, P/B at 1.65x, and a DY of 5.90%, along with an improved law and order situation. On the contrary, limiting factors to GDP growth can be receding private sector credit growth and declining exports industry.

Overall in FY15 (2HCY14-1HCY15), the Banking sector registered a strong growth in profitability and improved asset quality due to stringent regulation of capital adequacy requirement (CAR) which increased to 17.2% FY15 from 15.0% FY14. Looking forward, we expect the international oil prices to remain stabilized in 2HFY16 at USD 50bbl.

A few key developments in the economy impacting Banking Sector are as follows:

Interest rates at record low coupled with lowest inflation in decades will keep Real Interest rates at sky high of > 5%. Our outlook on interest rates is to remain status quo during 4QCY15.

Although, improvement in mortgage foreclosure and corporate recovery was registered during the year, a significant growth in industry-wide provisioning was noticed in the 1HCY15 due to old NPL aging. We expect the provisions to gradually decline for the short term (4QCY15 – 1HCY16) but register a possible uptick in the long term (CY16-18).

PIB yields are lowest they have been in over a decade (since 2004). The Banking industry is of the view, as are we, that these yields have bottomed out and should show but a slow uptick in coming quarters. We have taken a conservative approach towards interest rates and the spread offered by the government sovereign bonds, with an annual average SBP Reverse Repurchase Rate of 7.3% for CY15-17, and an annual average of 9.8% yield offered by 5Yr PIBs.

Banking Spreads hit an 11 year low during 9MCY15 which, though conditional that there is no further MP rate cut, we believe, should show gradual pickup going forward. Whereas, in case of another 50bps cut in Policy Rate, spreads may remain under pressure and drop another 5-10bps.

SECP legislation on SBP’s extended autonomy which should bolster future MP credibility and governance.

Bank Alfalah Limited Page 4

Commercial Banks

Investment Positives Re-profiled Deposit Base and Improved Operations’ Efficiency Bank Alfalah increased its deposit base faster than the banking sector at a CAGR of 13.3% versus the industry average of 10.2% during CY09-14. On the other hand, BAFL had an annual Cost of Deposits of 4.8% compared to mid-tier banking sector of AHL Universe with an average of 5.2% in CY14. We believe as the Bank continues its focus on cost cutting and deposits re-profiling, the upward trend in CASA mix will most likely continue. So far BAFL has successfully managed to grow its vault by 4%YoY in 9MCY15 compared to SPLY, even with an 8% reduction in fixed deposits during the same period, bringing its CASA to 76%. However; for the 9MCY15, overall deposits declined by 3% compared to Dec’14, due to heavy deposit re-profiling coupled with seasonal retirements.

Bank Alfalah has been aggressively strategizing to increase its share of industry deposits, currently at 7.3%. Recently, BAFL implemented a smart neighborhood branch model to ensure the right mix of residential and semi commercial areas, catering to the needs of both market segments. In addition, the Bank has introduced multiple innovative mediums to reach out to the unbanked masses such as the Business Development Officers Project (branch placement of dedicated sales force with an extensive training and performance monitoring to focus on CASA deposits growth).

Exhibit: Bank Alfalah Comparative Deposit Growth

Source: Company Financials, AHL Research * Averages of HBL, UBL, MCB, ABL, BAHL, AKBL & FABL

Exhibit: Bank Alfalah CASA Mix with Declining Cost of Deposits

Source: Company Financials, AHL Research

11.1%

8.0% 9.2%

6.0%

17.9%

11.5% 11.4%

-3.3%-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

CY12 CY13 CY14 9MCY15

Average* BAFL

77% 76% 75% 80% 83%

23% 24% 25% 20% 17%

5.3% 4.5% 4.8%

4.2%3.7%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

0%

20%

40%

60%

80%

100%

120%

CY12 CY13 CY14 CY15E CY16F

Fixed Deposits CASA Cost of Deposit (RHS)

Bank Alfalah Limited Page 5

Commercial Banks

Bank Alfalah also participated in different Government to Person (G2P) payment initiatives over the years such as the Benazir Income Support Program (BISP) launched in 2011. Through the BISP program, BAFL has already issued over 873 thousand debit cards and disbursed over PKR 27.5bn of funds, including quarterly installments.

Through such initiatives, BAFL successfully managed to focus on low cost deposits (CASA growth), increasing CASA to 76% in 9MCY15 from 73% in 9MCY14. In queue of this, we project that the Bank should achieve a stable CASA mix of ~82% from CY16-19. Additionally, in order to raise its CASA deposits, Bank Alfalah has been striving to provide competitive complementary products/services to its customers such as free checkbooks, online banking across Pakistan, SMS Alerts, issuance of POs/ DDs, etcetera.

Locked in High Yield PIBs Coupled with Liquid MTBs Historically, Bank Alfalah has had a small portfolio of investments, as its average Investments to Deposit Ratio (IDR) has hovered around mid-30s% during CY09-13. In 1HCY14, however, BAFL management made a stout decision to park a hefty PKR 111bn in Pakistan Investments Bonds at generous rates of above 11%, and another PKR 79bn during 1HCY15 at modest rates.

Compared to majority of the banking sector, at present, BAFL has one of the lowest IDRs (9MCY15: 63%), however, it has one of the highest concentration of Pakistan Investment Bonds (PIB) at 59% (9MCY15) as a percentage of its total investments (UBL 61%, MCB 47.52%, HBL 33%) which has supported the declining Net Interest Income with a profitable spread, along with Non-Interest Income with modest capital gains. Consequently, Net Interest Margins (NIMs) climbed up to 3.8% in CY14 from 3.4% in CY13, backed by interest income from investments, which we expect the Bank to maintain at an annual average of ~3.8% from CY15-19F.

Exhibit: PIB Concentration (% of Total Investments)

Source: Company Financials, AHL Research

0%10%20%30%40%50%60%70%

CY10

CY11

CY12

CY13

CY14

CY15

E

CY16

F

CY17

F

CY18

F

CY19

F

IDR PIB % of Total Investments

Bank Alfalah Limited Page 6

Commercial Banks

Further dissecting the CY14 & 1HCY15 investments, reveal that a big chunk of PKR 106bn of their total investments (PKR 324bn) will be maturing by end of CY15, and another PKR 108bn maturing in CY16. Upon retirement of these investments, we assume, the Bank will keep reinvesting in sovereign securities with a growing proportion in MTBs until PIB yields pick up.

With these facts in place, we believe the Bank may not book any significant swing in capital gains from sale of its bonds portfolio in the coming quarters, though, nominal gains may be noticed. Whereas, the net interest income will notice a downturn of ~3%YoY in CY16, with a meagre pickup expected in CY17. However, a sizeable growth is anticipated in advances in CY18-19, along with an increase in yield on secured investments.

Another important item to include in the discussion is the substantial increase in overnight borrowing through SBP Overnight Market Operations (OMO), noticed throughout the sector during 1HCY15, (predominantly by large banks with an average increase in borrowings of over 85% compared to Dec’14). Third quarter CY15 registered the highest borrowing hitting the highs of PKR 1.3tr, as per Markets and Monetary Management Division at SBP. With the recent decline in interest rates and borrowing costs, Banks find a profitable spread of ~20-180bps with borrowing overnight and investing it in MTBs, PIBs, or lending to other financial institutions at KIBOR +

Exhibit: Upward Trend in Interest Income from Investments and NIMs

Interest Earned by Investments has been a major contributor to maintaining attractive NIMs for BAFL.

Source: Company Financials, AHL Research

Exhibit: Bank Alfalah - PIB and MTB mix (% of Total Investments at cost)

Source: Company Financials, AHL Research

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

0%

10%

20%

30%

40%

50%

60%CY

08

CY09

CY10

CY11

CY12

CY13

CY14

CY15

E

CY16

F

CY17

F

CY18

F

CY19

F

NIMs (RHS) Income Earned by Investments (% of total)

11% 16% 17% 14%

56%67% 66% 65% 58% 54%39%

41% 45% 49%

14%10% 13% 15%

21% 25%

0%10%20%30%40%50%60%70%80%90%

CY10

CY11

CY12

CY13

CY14

CY15

E

CY16

F

CY17

F

CY18

F

CY19

F

MTB PIB

Bank Alfalah Limited Page 7

Commercial Banks

premium. Similar to other banks, BAFL borrowed substantially in 9MCY15 up to PKR 113bn compared to PKR 55bn in CY14, up 105%. We expect the borrowings to gradually decline during the next few quarters to come down to PKR 105bn in CY16.

Accretion in Quality Loan sheet Amidst depressed outlook on advances for the next few quarters, similar to the industry, Bank Alfalah has been taking measures to improve upon the quality of fresh loans and to cut back on exposure to viral Non-Performing Loan book. The Bank successfully increased its loan book to PKR 304bn with a CAGR of 8.8% during CY10 -14 compared to industry CAGR of 6.7%. In 9MCY15, the Bank managed to capture additional 4.0% of its Dec’14 loan book, while the industry grew only 2.4%.

The Bank strives to implement a segment wise strategy allowing exposure only in selected segments with a proven history, successfully cutting down its Infection ratio (NPL/Gross Loans) from 6.4% CY14 to 5.8% in 9MCY15. In CY14 the six sectors that comprised 76% of total advances were as follows; Textile with an 18% weightage, Oil and Gas 15%, Individuals 6%, Retail Trade 5%, Fertilizers 4%, and Others 30%.

Going forward, based on discussions with the Management, BAFL is focused to capture potential opportunities directly driven by China Pakistan Economic Corridor (CPEC), mostly in the Energy/Power and Infrastructure sectors, as well as consequent opportunities in other sectors. Our assumptions incorporate this growth, projecting a rise in advances by 9%YoY in CY18 (from an average of 6%YoY CY15-17).

Exhibit: Spread between SBP OMO Rate, MTB, and PIB

Source: SBP, AHL Research

Exhibit: Advances growth CY08-19F

Source: Company Financials, AHL Research

8.4%

7.1%6.4%

6.0%6.5% 6.3%

0

50

100

150

200

250

5.0%5.5%6.0%6.5%7.0%7.5%8.0%8.5%9.0%

1QCY15 2QCY15 3QCY15 4QCY15F 1QCY16F 2QCY16F

SBP OMO PIB Spread (RHS)MTB Spread (RHS)

(bps)

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

CY08

CY09

CY10

CY11

CY12

CY13

CY14

CY15

E

CY16

F

CY17

F

CY18

F

CY19

F

Bank Alfalah Limited Page 8

Commercial Banks

Furthermore, as part of its strategy to capture a bigger share of growing sectors, BAFL has taken a keen interest in the Small and Medium Enterprise (SME) market, along with an active support provided to agri-based businesses; particularly the cotton and wheat sectors. BAFL successfully took simple SME lending to providing a complete SME banking solutions by introducing innovative products and providing end-to-end solutions, which focuses on meeting financial, non-financial, transactional, investments, and advisory needs of SME clientele. In CY14, Bank Alfalah became the first Bank in Pakistan to have launched an SME Toolkit through which the Bank will provide client specific development tools and financial knowledge, capturing significant unbanked masses going forward.

Improved Asset quality and Increased Coverage of Declining NPLs Bank Alfalah has been working towards a noticeable improvement in its asset quality and a better coverage for its existing infected loan book. BAFL reported a CAR of 14.1%, along with a Coverage Ratio of 80.0% in 9MCY15 (UBL: 82.4%, HBL: 86.9%, MCB: 82.0%, NBP: 87.1%, ABL: 88.4%), much improved from Dec’14 with a CAR of 12.9% and a Coverage of 70.1%. However, it would need further improvement, considering the lending opportunities expected to arise in CY18-19, and to catch up with the industry norm (Industry 9MCY15 CAR - HBL 15.7%, UBL 15.1%, MCB 20.1%).

With that being said, Bank Alfalah is resilient in maintaining its asset quality with its NPL Coverage expected to stabilize at a higher-to-mid-80%. In addition, the Bank enjoys a strong parental support from the Abu Dhabi Group along with a significant IFC holding, which provides it the buffer to raise its capital if required. Based on Management guidance, Bank Alfalah would pursue a CAR target of ~12% from CY16-19.

Concomitantly, Bank Alfalah has aggressively taken upon controlling its infection rate through both, cutting down the current non-performing loans and by implementing stringent qualification requirements for fresh loans. At present, Bank Alfalah has one of the lowest infection ratios in the industry with only 5.8% 9MCY15 (MCB 6.4%, ABL 6.9%, HBL 12.0%, UBL 10.1%), while the Bank noticed a 5% decline in its NPLs during 9MCY15, compared to CY14.

Exhibit: Capital Adequacy Ratio (CAR) Industry Average

Source: Company Financials, AHL Research * Average of HBL, UBL, MCB, ABL, BAHL, AKBL & FABL

14.0%14.8% 15.3% 15.0%

15.8%

10.5%11.6%

12.6%12.1%

12.8%

9.5%10.5%11.5%12.5%13.5%14.5%15.5%16.5%

CY10 CY11 CY12 CY13 CY14

Average* BAFL

Bank Alfalah Limited Page 9

Commercial Banks

As discussed earlier, 76% of the Bank’s total advances lie in Textile, Oil and Gas, Individuals, Retail Trade, Fertilizers, and Others based on CY14 data, with infection ratios of 28%, N/A, 12%, 16%, 12%,and 10%, respectively. For the most risky sector that of Textile, as indicated by its infection rate of 28%, Bank Alfalah has up to 85% coverage. We believe a meagre uptick in NPLs of ~3%YoY for CY16-19 may be the trend for the Bank, hence the Management may raise its provisioning accordingly, during CY16-19 to weather the storm.

Exhibit: Major Sectors of Loan Book with Respective Coverage and Infection Ratio (PKR mn) Advances % of Advances Coverage Infection Ratio* Oil and Gas 2,815 15% 43% N/A Textile 3,536 18% 85% 28% Retail Trade 924 5% 71% 16% Individuals 1,203 6% 56% 12% Fertilizers 791 4% 85% 12% Others 5,851 30% 69% 10% Source: Company Financials, *SBP Quarterly Compendium, AHL Research

Other Significant Items Fee & Commission Income Bank Alfalah has enjoyed a healthy growth in Fee & Commission income with a CAGR of 12% from CY09-14. In 9MCY15, BAFL registered a staggering growth of 31%YoY in its Fee Income, part of which was due to reclassification of its Other Income (declined by 51% 9MCY15) coupled with an estimated effective growth of over 15%. In the longer term, we expect Fee & Commission income to stay stable from CY16-17 with a reasonable growth of 10%YoY.

Capital Gains on Sale of Investments Another great source of supporting total income has been capital gains on sale of securities. Historically speaking, during CY08-11 BAFL posted gains of PKR 286mn on an annual average, however; from CY12 to CY14 the average climbed up to PKR 1.4bn. Similar to the industry, BAFL realized higher than usual gains in 9MCY15 with a growth of over 139%YoY at PKR 1.35bn, compared to PKR 563mn during 9MCY14. Going forward, with substantial investment maturity due by CY16 coupled with a stretch of declining yields on fresh investments, we don’t expect any significant swings in realized capital gains of the likes of 1QCY15 to be witnessed during CY16-17.

Exhibit: Bank Alfalah – One of the lowest Infection ratios in the Industry

Source: Company Financials, AHL Research * Average of HBL, UBL, MCB, ABL, BAHL, AKBL & FABL

10.2%10.9% 10.6% 10.4%

10.0% 9.6%

8.4%9.0% 8.9%

6.6% 6.4%5.8%

5.0%6.0%7.0%8.0%9.0%

10.0%11.0%12.0%

CY10 CY11 CY12 CY13 CY14 9MCY15

Average* BAFL

Bank Alfalah Limited Page 10

Commercial Banks

Expenses Historically, as part of Bank’s CY14 branch expansion plans, 74 new branches were added to the network bringing the total branch network to 648 – equal coverage of rural and urban areas. In addition, introducing innovative products/services such as SME Toolkit, Mobile Paisa, Branchless Banking, and strengthening its ATM network increased BAFL’s OpEx by 21%YoY in CY14. In CY15TD, Bank Alfalah has only added one more Islamic branch to their network, expanding it to 649.

Bank Alfalah’s Operating Expenses have maintained a subtle growth YoY with a CAGR of 13% from CY09-14. Whereas, due to the on-going cost cutting initiatives discussed earlier, BAFL managed to mute down the OpEx to 9%YoY during 9MCY15, with a 1%QoQ stall in 3QCY15. Going forward, we expect a cost-income improvement to be underway. Based on management guidance, Bank will strive to bring down its cost to income ratio from mid-60% to the industry norm of mid 50% as part of its long term plans. We estimate BAFL’s OpEx to grow at an average rate of ~5% CY15-19 supported by freeze on branch expansion during 2HCY15, lower inflation, and other cost efficiency initiatives. Nevertheless, Bank Alfalah plans to add another 35 branches during CY16.

Exhibit: Improved Cost to Income with Freeze in Branch Expansion

Source: Company Financials, AHL Research

Exhibit: Bank Alfalah Expected to Post Record High Capital Gains in CY15

Source: Company Financials, AHL Research

243 692

81 129

1,328 1,589

1,058

1,988

- 500

1,000 1,500 2,000 2,500

CY08

CY09

CY10

CY11

CY12

CY13

CY14

CY15

E

(PKR mn)

1,056

969 1,017

1,068 1,121

69%

66%

57%61%

62%

50%52%54%56%58%60%62%64%66%68%70%

900

950

1,000

1,050

1,100

1,150

1,200

CY13 CY14 CY15E CY16F CY17F

Deposit Per Branch Cost to Income (%)(PKRbn)

Bank Alfalah Limited Page 11

Commercial Banks

Taxes Pakistan’s banking industry experienced a major shift in taxes through introduction of tax reforms during 1HCY15/FY15. Two of the major reforms were i) a onetime 4% Super Tax on CY14 earnings, and ii) Uniform Tax of 35% to be charged on all sources of income. Similar to the industry, BAFL booked the Super Tax of PKR 341mn during the 2QCY15 dragging down the earnings for the quarter by PKR 0.27/share. In addition, the Uniform Tax hauled down the earnings further by an increased tax expense of PKR 430mn.

Overall, the Bank shed an additional ~27% of earnings in taxes during 2QCY15, which based on our estimates will increase the tax charge for CY15 to ~40%. Looking forward into CY16-19, however; we expect the annual tax charges to normalize to ~37%.

Islamic Banking Bank Alfalah operates one of the largest Islamic Banking window in the country, with a network of 157 dedicated branches, offering products such as Falah Forward Cover, Falah Currency Salam, and Falah Tijarah. As of 9MCY15, Islamic Banking consisted of 11% of total loan book, at PKR 33.2bn. Historically speaking, Islamic Banking business has contributed to overall banking business tenfold. With an earning CAGR of over 40% from CY10-14, it has added ~15% of total earnings/share year over year. In CY14, Islamic Banking business posted an earnings growth of 25%YoY at PKR 8,513mn. We expect Bank Alfalah Islamic Banking to maintain its strong growth and improve its share capital going forward.

Rating Based on the financial statements for the quarter ended June 30, 2015, PACRA, a premier rating agency of the country, has rated Bank Alfalah ‘AA’ (double A) for the Long Term and a A1+ (A one plus) for the Short Term, with an improved outlook on the Bank as Positive from Stable previously. These improved ratings denote a much lower expectation of credit risk, and a well-managed liquidity and solvency outlook. Furthermore, the unsecured subordinated debt (Term Finance Certificates) of the Bank has been awarded rating of AA- (double A minus).

Entity Rating CY15 Long Term AA Positive Short Term A1+ Positive

Source: Company Accounts

Bank Alfalah Limited Page 12

Commercial Banks

Profitability Profitability to show a +12% CAGR over CY16-19F We estimate Bank Alfalah to achieve an earning CAGR of 12% over CY16-19F based on a) an ongoing deposit re-profiling to keep NIMs in check at an annual average of ~3.7%, amidst bottomed out interest rates, b) stronger PIB holdings to churn high yields supporting the top line income, c) growth in cross-sell products, and d) stringent controls over operational expenses.

Based on an estimated annual pay-out of 60%, we estimate BAFL to maintain its ROE at an average of 13.8% from CY16-19F, with a slight decline during CY16 and CY17, however; expect a rise in CY18. Along with an earnings growth of 12%YoY in CY16, BAFL offers an attractive 10% dividend yield, providing a robust 33% Total Return.

Recommendation & Valuation We value Bank Alfalah using a Justified Price to Book ratio with our estimated average ROE of 13.8% for the five year period CY15-19 (risk-free rate 7.0%, equity risk premium 6.0%, and beta factor 1.2x). We estimate a sustainable growth in earnings through a retention rate kept at 39.7% (pay-out ratio of 60.3%) and ROE-g and COE-g kept at 8.3% and 9.0%, respectively.

With the stated, our justified P/B multiple comes out to be 0.92x. In addition, we use our CY16 estimated book value per share of PKR 39.9 (Tier1 + Tier2). Our Target Price implies a CY16F P/Bx of 0.92x and P/E of 7.57x, as well as a healthy dividend yield of 10% (providing a potential Total Return of 33%). This compares favorably in the context of trailing P/E 9.14x and P/B 1.15x. Hence we rate the stock as Buy!

Exhibit: P/E Band Exhibit: P/B Band

Source: Source: Company Financials, Bloomberg, AHL Research Exhibit: EPS & PE Exhibit: PAT & RoE

Source: Source: Company Financials, AHL Research

- 5

10 15 20 25 30 35 40 45

Dec-1

0Ap

r-11

Aug-

11De

c-11

Apr-1

2Au

g-12

Dec-1

2Ap

r-13

Aug-

13De

c-13

Apr-1

4Au

g-14

Dec-1

4Ap

r-15

Aug-

15

Price 3-Multiple 4-Multiple

6-Multiple 7-Multiple 8-Multiple

(PKR)

- 5

10 15 20 25 30 35 40 45 50

Dec-1

0

Apr-1

1

Aug-

11

Dec-1

1

Apr-1

2

Aug-

12

Dec-1

2

Apr-1

3

Aug-

13

Dec-1

3

Apr-1

4

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14

Dec-1

4

Apr-1

5

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15

Price 0.25-Multiple0.50-Multiple 0.75-Multiple1.00-Multiple 1.25-Multiple

3.6

5.2 4.9 5.2

6.5 6.8

9.1

5.5 6.0 5.6 4.5 4.3

3.0

4.0

5.0

6.0

7.0

3.0 4.0 5.0 6.0 7.0 8.0 9.0

10.0

CY14 CY15E CY16F CY17F CY18F CY19F

EPS (RHS) PE (LHS)(X) (PKR)

5.6

8.3 7.7 8.2

10.3 10.7

14.7 16.0

12.6 12.3

14.3

13.6 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0

12.0

13.0

14.0

15.0

16.0

17.0

CY14 CY15E CY16F CY17F CY18F CY19F

PAT (RHS) RoE (LHS)(%) (PKR bn)

(PKR)

Bank Alfalah Limited Page 13

Commercial Banks

Risk Factors Based on empirical evidence, banking industry is exposed to two major risks while performing its intermediary function in the economy; a) Credit Risk, and b) Interest Rate Risk. While Credit Risk arguably remains the most obvious risk to banking sector in general, Bank Alfalah has adequately estimated the price and created sufficient provisioning for possible credit losses, as was discussed earlier in this report. Moreover, our view is that the Bank will be more prudent in issuing fresh loans going forward.

Secondly, in our view, interest rates going forward should stay relatively stable at current levels. Considering which, we believe, meagre Interest Rate changes should not have a drastic impact on Bank Alfalah’s business model or on its earnings. With that being said, our performed analysis yielded the following results:

Exhibit 1 below, illustrates the changes in NIMs, EPS, and our CY16 Target Price with +/- 50bps change in Policy Rate throughout CY16-19. Our originally estimated Policy Rates for CY16-19, come out to 6.9%, 7.7%, 8.0%, and 8.1%.

Exhibit: Changes in Policy Rate* (CY16E) Scenarios - 50bps 6.90% + 50bps NIMs 3.7% 3.7% 3.6% EPS 4.9 4.9 4.9 EPS %Δ 0% 0% TP 36.5 37.0 37.5 TP %Δ -1% 1% ROE 12.6 12.6 12.6 ROE %Δ 0% 0%

Source: AHL Research. * With changes only in CY16.

In addition to Interest Rate Risk, we believe, a further slowdown in advances growth could hurt BAFL earnings. Exhibit 2 illustrates the changes in NIMs, EPS, and our CY16 Target Price with +/- 100bps change in Policy Rate only for CY16. Our original estimate for growth in Advances for BAFL during CY16 stands at 6.21%.

Exhibit: Changes in Loan Growth* (CY16E) Scenarios - 100bps 6.21% + 100bps NIMs 3.6% 3.7% 3.7% EPS 4.8 4.9 4.9 EPS %Δ -1% 1% TP 36.8 37.0 37.2 TP %Δ -1% 1% ROE 12.4 12.6 12.7 ROE %Δ -1% 1% Source: AHL Research. * With changes only in CY16.

Bank Alfalah Limited Page 14

Commercial Banks

Financial Highlights Profit & Loss (PKR mn) 2013A 2014A 2015E 2016F 2017F CAGR & Avg* Net interest income 16,895 21,873 28,884 28,074 28,700 14% Non-Interest Income 8,279 9,036 9,129 9,178 9,460 3% Fee and Commission 2,800 3,120 3,852 4,229 4,685 14% Capital Gains 1,597 1,218 1,988 1,608 1,208 -7% Income from FX Contracts 1,536 2,043 1,622 1,745 1,942 6% Other Income 1,862 2,163 913 940 959 -15% Operating expenses 17,313 20,863 22,595 23,437 23,854 8% Pre-provisioning earnings 7,861 10,047 15,418 13,815 14,307 16% Provisions 1,054 1,534 1,517 1,575 1,260 5% Pre-tax income 6,807 8,513 13,901 12,239 13,047 18% Taxes 2,131 2,873 5,560 4,529 4,827 23% Net income 4,676 5,641 8,341 7,711 8,220 15% EPS (PKR) 2.9 3.6 5.2 4.9 5.2 4.4* DPS (PKR) 2.0 2.0 3.0 3.0 3.0 2.6* Dividends 2,698 3,174 4,762 4,762 4,762 15% Key Balance Sheet Items (PKR mn) & Capital Ratios CAGR & Avg* Total assets 611,428 743,128 842,658 872,172 930,925 11% Interest Earning Assets 549,648 656,065 757,944 788,027 847,036 11% Interest Bearing Liabilities 558,632 671,183 750,726 772,767 822,011 10% Non-performing loans 17,947 19,412 18,312 19,512 19,270 2% Allowance for loan losses 12,441 13,601 14,513 15,509 16,117 7% Loans 260,780 290,597 308,571 327,706 349,254 8% Deposits 525,526 605,963 627,745 657,397 699,673 7% NIMs 3.4 3.8 4.2 3.7 3.5 3.7% * Tier-1 Ratio (CAR) 12.1 12.8 14.9 14.5 14.5 13.8% * Shareholders' equity 31,902 44,819 59,380 63,379 69,843 22% Valuation Ratios & Profitability Measures Average P/E x 8.0 9.1 5.7 6.1 5.8 6.9 P/B x 1.2 1.2 0.8 0.7 0.7 1.0 Dividend yield % 8.5 6.2 10.1 10.1 10.1 9.0 Dividend Cover x 1.7 1.8 1.8 1.6 1.7 1.7 ROE % 15.1 14.7 16.0 12.6 12.3 14.1 ROA % 0.8 0.8 1.1 0.9 0.9 0.9 Payout Ratio % 57.7 56.3 57.1 61.8 58.0 58.2 Shares Outstanding # 1587 1587 1587 1587 1587 1,587.2 Deposits/Branch 916 935 967 961 1,000 955.7

Net Interest Income expected to be under pressure in CY16 on the back of slowdown in private credit off-take and heavy investment maturity.

Fee Commission to post solid growth from CY16-17. It is also pertinent to mention that BAFL has recently reclassified part of its Other Income to Fee Income, translating into a negative CAGR for CY13-17.

Capital Gains expected to decline due to maturing investments. However, nominal gains may be backed by heavy PIB portfolio and a surplus backlog.

We have taken a conservative approach in booking NPLs and respective provisions for Bank Alfalah. Based on Management guidance, we maintain Coverage Ratio close to 82%, whereas, considering the recent decline in BAFL NPLs, we assume only a meager uptick for CY16 (along with reasonable payments), translating into lower provisioning in CY17.

Dividends expected to maintain at current levels with Payout ratio averaging at 59% (CY15-17).

BAFL offers attractive P/E and P/B multiples, along with a lucrative DY.

Bank Alfalah Limited Page 15

Commercial Banks

Credit quality ratio 2013A 2014A 2015E 2016F 2017F Average Infection ratio % 6.6 6.4 5.7 5.7 5.3 5.9 Coverage ratio % 69.3 70.1 79.3 79.5 83.6 76.4 Loss/Gross NPL % 90.5 86.2 86.6 85.9 85.9 87.0 Reserves /NPLs % 40.5 63.6 86.1 99.2 118.6 81.6 Growth Rates and Key Ratios Average Net Interest Income % (9.1) 29.5 32.1 (2.8) 2.2 10.4 Fee & Commission % 10.4 11.4 23.5 9.8 10.8 13.2 Non-Interest Income % 13.7 9.1 1.0 0.5 3.1 5.5 Total Revenues % (2.7) 22.8 23.0 (2.0) 2.4 8.7 Operational Expenses % 11.6 20.5 8.3 3.7 1.8 9.2 Provisions % (70.4) 45.6 (1.1) 3.8 (20.0) (8.4) Advances % 11.5 11.4 6.2 6.2 6.6 8.4 Investments % 15.9 47.6 19.1 7.6 11.3 20.3 Other Assets % 23.8 90.6 (25.0) (10.0) (8.0) 14.3 Deposits % 15.0 15.3 3.6 4.7 6.4 9.0 Borrowings % 8.9 138.9 104.6 (6.9) 6.4 50.4 Other Liabilities % (18.5) 27.9 15.0 10.0 8.0 8.5 Non-financial information Employee # 7,253 7,785 7,788 8,208 7,910 Branches # 574 648 649 684 700

Bank Alfalah Limited Page 16

Commercial Banks

Analyst Certification: The research analyst(s), is (are) principally responsible for preparation of this report. The views expressed in this research

report accurately reflect the personal views of the analyst(s) about the subject security (ies) or sector (or economy), and no part of the

compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations and views expressed by

research analyst(s) in this report. In addition, we currently do not have any interest (financial or otherwise) in the subject security (ies). Furthermore,

compensation of the Analyst(s) is not determined nor based on any other service(s) that AHL is offering. Analyst(s) are not subject to the supervision

or control of any employee of AHL’s non-research departments, and no personal engaged in providing non-research services have any influence or

control over the compensatory evaluation of the Analyst(s).

Equity Research Ratings Arif Habib Limited (AHL) uses three rating categories, depending upon return form current market price, with Target period as December 2015 for Target Price. In addition, return excludes all type of taxes. For more details kindly refer the following table;

Rating Description BUY Total return of subject security(ies) is more than +10% from last closing of market price(s) HOLD Total return of subject security(ies) is between -10% and +10% from last closing of market price(s) SELL Total return of subject security(ies) is less than -10% from last closing of market price(s)

Equity Valuation Methodology Following valuation technique is used to arrive at the target price of subject security (ies);

Justified Price to Book Value (JPBV)

Risks The following risks may potentially impact our valuations of subject security (ies);

Market risk Interest Rate Risk Exchange Rate (Currency) Risk

Disclaimer: This document has been prepared by Research analysts at Arif Habib Limited (AHL). This document does not constitute an offer or solicitation for the

purchase or sale of any security. This publication is intended only for distribution to the clients of the Company who are assumed to be reasonably sophisticated

investors that understand the risks involved in investing in equity securities. The information contained herein is based upon publicly available data and sources

believed to be reliable. While every care was taken to ensure accuracy and objectivity, AHL does not represent that it is accurate or complete and it should not be

relied on as such. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors. The information given in

this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information is

subject to change without any prior notice. AHL reserves the right to make modifications and alterations to this statement as may be required from time to time.

However, AHL is under no obligation to update or keep the information current. AHL is committed to providing independent and transparent recommendation to its

client and would be happy to provide any information in response to specific client queries. Past performance is not necessarily a guide to future performance. This

document is provided for assistance only and is not intended to be and must not alone be taken as the basis for any investment decision. The user assumes the entire

risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent evaluation

of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult his or her own advisors to

determine the merits and risks of such investment. AHL or any of its affiliates shall not be in any way responsible for any loss or damage that may be arise to any

person from any inadvertent error in the information contained in this report.

© 2015 Arif Habib Limited: Corporate Member of the Karachi, Lahore and Islamabad Stock Exchanges. No part of this publication may be copied, reproduced, stored or

disseminated in any form or by any means without the prior written consent of Arif Habib Limited.

Bank Alfalah Limited Page 17

Commercial Banks

Contact Information

Shahid Ali Habib Chief Executive Officer shahid.habib@arifhabibltd.com +92 -21-3240-1930

Research Team Shahbaz Ashraf, CFA Head of Research shahbaz.ashraf@arifhabibltd.com +92-21-3246-0742 Tahir Abbas AVP- Senior Investment Analyst tahir.abbas@arifhabibltd.com +92-21-3246-2589 Syed Fawad Basir AVP- Investment Analyst fawad.basir@arifhabibltd.com +92-21-3246-2589 Ahmed Lakhani Investment Analyst ahmed.lakhani@arifhabibltd.com +92-21-3246-1106 Rao Aamir Ali Investment Analyst amir.rao@arifhabibltd.com +92-21-3246-0742 Syed Shiraz Zaidi Investment Analyst shiraz.zaidi@arifhabibltd.com +92-21-3246-1106 Waleed Rehmani Investment Analyst mt.research@arifhabibltd.com +92-21-3246-1106 Misha Zahid Investment Analyst mt.research@arifhabibltd.com +92-21-3246-1106 Ovais Shakir Officer- Database ovais.shakir@arifhabibltd.com +92-21-3246-1106

Equities Sales Team Khurram Schehzad EVP- Head of Sales k.shehzad@arifhabibltd.com +92-21-3246-8285 Azhar Javaid VP- International Sales azhar.javaid@arifhabibltd.com +92-21-3246-8312 Usman Taufiq Ahmed AVP- International Sales usman.ta@arifhabibltd.com +92-21-3246-8285 M. Yousuf Ahmed SVP- Equity Sales yousuf.ahmed@arifhabibltd.com +92-21-3242-7050 Syed Farhan Karim VP- Equity Sales farhan.karim@arifhabibltd.com +92-21-3244-6255 Farhan Mansoori VP- Equity Sales farhanmansoori@arifhabibltd.com +92-21-3242-9644 Afshan Aamir VP- Equity Sales afshan.aamir@arifhabibltd.com +92-21-3244-6256 Atif Raza VP- Equity Sales atif.raza@arifhabibltd.com +92-21-3246-2596 Furqan Aslam AVP- Equity Sales furqan.aslam@arifhabibltd.com +92-21-3240-1932