First Gulf Bank - GulfBase.com · First Gulf Bank has a network of 15 branches in addition to 20...

First Gulf Bank “A room to grow”

January 2008

First Gulf Bank 2

Key Data ValuationCurrent Price (AED)* 22.8 22.80 Country UAE52 Week High - Low (AED) 25.77 Sector BankingNumber of Shares (Million) 1,250 13% Exchange ADSM

RecommendationReuters Code FGB.ADBloomberg Code FGB DH Bank Financials (AED Mn)Market Cap (AED bn) 28,500 Assets 2006 2007E 2008E 2009EFree Float 26% Cash & Interbank 16,383 9,799 11,759 14,111 P/E Trailing 16.8 Investments 5,511 7,221 8,665 10,398 P/B Trailing 3.3 Loans & Advances (Net) 25,161 45,756 52,062 62,475

Fixed Assets 334 705 727 747 Others Assets 370 389 408 428

Fact Sheet 2006 2007E 2008E 2009E Total Assets 47,759 63,869 73,621 88,158 Total Assets Growth 82% 34% 15% 20%Net Loans Growth 85% 82% 14% 20% Liabilities & Equity 2006 2007E 2008E 2009ETotal Deposit Growth 98% 47% 19% 24% Deposits 34,384 48,138 57,765 69,318

Interbank Liabilities 297 2,833 2,883 5,716 Liquid Assets / Total Assets 46% 27% 28% 28% Other Liabilities 1,569 2,330 2,788 3,358 Net Loans / Total Depsoits 73% 90% 86% 83% Medium / Long Term Loans 3,398 1,845 913 - Cust. Deposits / Total Deposits 99% 94% 95% 92% Provisions - - - -

Total Equity 8,111 8,724 9,271 9,766 Total Equity/Total Assets 17% 14% 13% 11% Total Liabilities & Equity 47,759 63,869 73,621 88,158 Total Equity/Net Loans 32% 19% 18% 16%CAR 21% 0% 0% 0% Income Statement (AED Mn) 2006 2007E 2008E 2009E

Interest Income 2,884 3,964 5,462 6,395 LLP/Gross Loans 1.8% 1.5% 1.5% 1.5% Interest Expense (1,676) (2,563) (3,321) (4,051) NPLs / Gross Loans 1.8% 1.5% 1.5% 1.5% Net Interest Income 1,208 1,401 2,141 2,345 NPLs Coverage Ratio 102% 120% 120% 120%Gross Loans/Cust. Deposits 75% 97% 92% 92% Fees & Commissions 282 440 556 667Earning Assets/Total Assets 98% 98% 98% 98% Investment Income 38 509 477 572

Other Income 541 316 115 138Net Interest Margin 3.3% 2.6% 3.2% 2.9% Total Non-Interest Income 860 1,265 1,147 1,377 Net Non-interest Margin 1.3% 1.3% 0.6% 0.6%Cost/Income 19% 21% 23% 24% General & Admin Expenses (380) (533) (723) (856) Interest Income/Interest Expense 172% 155% 164% 158% Depreciation (20) (26) (28) (30) Interest on Average Earning Assets 7.9% 7.2% 8.1% 8.0% Other Expenses 0 0 0 0Funding Cost 6.0% 5.6% 5.8% 5.9% Total Non-Interest Expense (400) (559) (752) (886) Interest Spread 2.0% 1.6% 2.3% 2.1%Net Profit Margin 74% 64% 63% 61% Provisions & Taxes (132) (406) (462) (555) RoAA 4.1% 3.0% 3.0% 2.8% Minority Interest - (17) (21) (23) RoAE 19.6% 20.2% 23.1% 24.0%

Net Attributable Income 1,536 1,683 2,054 2,258 Performance of the stock Vs the ADSMI

Shareholding Structure

AS per the report first figure

* As of 3.1.2008

Upside Potential Buy

22.85 / 11.10

First Gulf Bank (FGB)Market PriceFair Value

Abu Dhabi Ruling Family

60%

UAE Funds 4%

Free Float 26%

Other Major shareholders 10%

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-20%

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FGB

ADSM

First Gulf Bank 1

• As per 2006 figures, First Gulf Bank is the fourth largest bank in the UAE in terms of total assetswith 7% market share. In terms of deposits and loans, respectively, the bank is ranked third and fifth with a market share of 9.6% and 6.7%.

• FGB has a network of 15 branches in the UAE in addition to 20 ATMs and 15 EDMs. Although the bank has focused on corporate business, recently it has increased its retail banking activity. The bank also has diversified into new sectors including real estate development and management.The bank is setting up a commercial bank in Libya and is seeking a banking license in Algeria.

• The ruling family in Abu Dhabi Emirate owns 60% of the outstanding shares of FGB, which gives the bank a rare opportunity to develop lucrative relationships with government-related clients.

• Fitch upgraded its credit rating for FGB from BBB+ Positive to A+ Stable. The upgrade reflectsFitch’s strong belief that FGB is very likely to garner the support of UAE authorities should the need arise.

• Since 2003, the bank’s total assets have grown by a CAGR of 60% from AED 7 billion to AED 47 billion. The bank grew rapidly partly because initially it was smaller than other banks in the UAE. However the major reason for its rapid growth was the large capital raise in 2005 which gave the bank a large, interest-insensitive source of funding of AED 5 billion. Going forward, we conservatively expect to see assets grow by a CAGR of 18% until the end of our forecast period in 2011.

• Most of the assets of FGB consisted of Loans & Advances and Due from banks. The ratio of loans to total assets has declined from 71% in 2003 to only 51% in 2006. In fact, the bank was not able to grow its customer loans in line with deposits and other sources of funds. From 2003 to 2006, loans grew by a CAGR of 68% while deposits grew by 80%. This explains why the bank has a relatively low utilization ratio and why it has increased its lending to other banks. Going forward, we expect the bank to grow its loans and deposits by 26% and 23%, respectively, during the forecast period. We also expect its utilization rate to improve from 73% in 2006 to reach 92% in 2011.

• FGB’s net income grew at an amazing CAGR of 133% from AED 181 million in 2003 to AED 1.5 billion in 2006. During this period, the contribution of non-interest income to total operating income increased to reach 58% in 2006 at the expense of net interest income. Most of the increase came in 2006 as the bank was granted a plot of land by the government of Abu Dhabi. Additional gains resulted from a re-evaluation of real estate assets. Conservatively, we expected net income to grow by CAGR of 12% to reach AED 2.65 billion by 2011.

• As of 2006, FGB was well-capitalized with a Capital Adequacy Ratio (CAR) of 21%. This affected the bank’s Return on Equity (18.3%) although the bank reported the highest Return on Assets (4.1%) among its peers according to Bloomberg. We expect the bank to reduce its CAR in the future through the exploration of investment opportunities.

• We valued the bank using a combination of Discounted Cash Flow to Equity and Multiples Methods. We assigned a weight of 80% to the cash flow and 20% to book value method, whichgenerated a fair market value of AED 25.77 per share with an upside potential of 13% compared to the current market’s price.

• Hence, we initiate our coverage on FGB with positive outlook and Buy recommendation as the bank gives investors a good opportunity to have an exposure to the UAE fast growing sector through one of the aggressive and well capitalized banks, with an upside potential of 13%.

Executive Summary

SECTOR ANALYST

HANY SEIF

[email protected]

VP - HEAD OF RESEARCH

HANY HUSSEIN, CFA

[email protected]

First Gulf Bank 2

• Bank Overview 3

• Lines of Business 5

• Financials 7

• Valuation 14

Contents

First Gulf Bank 3

2007 is another outstanding year forthe bank

In 2006, the management doubled the bank’s assets, loans, and despots

Lower quality of assets triggered a restructure in the1990s

Bank Overview

First Gulf Bank (FGB) was established in 1979 and headquartered in Abu Dhabi. Since October 1996, a majority of the shares have been owned by the Al-Nahyan family, the ruling family of Abu Dhabi. The bank, which has focused on corporate banking, has benefited from lucrative contractswith state-owned, corporate clients. Recently, it has become more active in retail business where funds are cheaper. The management also is focusing on new lines of business such as treasury and investment services in an attempt to augment its non-interest revenues and to diversify its income.

First Gulf Bank has a network of 15 branches in addition to 20 ATMs and 15 EDMs concentrated in Abu Dhabi, Dubai, and Sharjah. The bank has strengthened its position in the retail market by adding 3 branches to its network by end of 2007. The bank employs 780 people in addition to 1,200 outsourced sales agents for retail products.

During the 1990s, FGB experienced a number of financial problems caused by the poor quality ofits assets. These problems encouraged the largest shareholder to restructure the management which brought a former Citi Bank management team on board.

To stimulate further growth, FGB introduced investment banking services in 2001 and retail banking in 2002. In 2005, the strong performance of the secondary market as well as investors’ appetite for IPOs encouraged all UAE companies to raise capital regardless of the need for it. FGB raised equity of almost AED 5 billion – more than any other UAE bank – through bond conversion and rights issue. Almost AED 800 million was converted from debt to 93 million shares. In addition, 502 million new shares were introduced, which increased the total number of outstanding shares to 1,250 million. This conversion gave the ruling family 60% of the bank’s ownership and signaled the confidence of the shareholders in plans for expansion.

In 2006, FGB grew more quickly than any UAE bank. Its assets, loans, and deposits grew by 82, 83, and 99%, respectively, and its net income grew by 46%. Although FGB has reported a strong Return on Average Assets of 4.1%, this failed to fuel an increase in Return on Investment due to its high capital adequacy ratio and relative low equity multiplier compared to other banks.

For two successive years, FGB has been nominated as the fastest growing bank in the world. Among UAE banks, FGB is sixth largest in terms of equity and reported profits and seventh largestin terms of assets.

It seems that 2007 has been another outstanding year for FGB. On a year over year basis, total assets grew by 71%, during the first nine months of the year, to reach AED 62 billion. Loans andadvances grew by 80% to reach AED 40 billion and deposits grew by 94% to reach AED 45 billion. On the profitability side, the bank has reported a net income for the same period of AED 1.11billion, which represented growth of 22% on a year over year basis.

First Gulf Bank 4

The ruling family in Abu Dhabi owns 60% of the bank, which helps the bank gain the lucrative contracts with most of state-owned companies. The free float stands at approximately 26%, whilethe remainder represents ownership by other shareholders. It is worth mentioning here that due to the fact that the ruling family owns a majority of shares ensures that FGB is highly rated by rating agencies. Fitch recently has affirmed the rating of the bank at ‘A’ with an outlook of “stable”.

Figure1: Ownership Structure - 2007

Fitch upgraded its rating for FGB from BBB+ Positive to A+Stable. The Upgrade reflects Fitch’sbelief that FGB would like to get any support from UAE authorities should the need arises

Abu Dhabi Ruling

Family 60%

UAE Funds 4%

Free Float 26%

Other Major shareholders

10%

Source: Damac & FGB

Qualitatively, Fitch upgraded its credit rating for FGB from “BBB+ with Positive outlook” to “A+ with Stable outlook”. The upgrade reflects Fitch’s strong belief that FGB is almost certain to garnerthe support of the UAE authorities should the need arise. This belief is affirmed by the long historyof the UAE authorities’ support of its banks and by the stake in the bank of the ruling family of Abu Dhabi. Quantitatively, the “Stable outlook” reflects the bank’s improved performance in 2006and H1 2007. During that period, year over year growth of net income was 22%. In addition, the quality of assets was high. Non-performing loans were as low as 1.5% and the coverage ratio was greater than 100%. The rating also reflects the bank’s strong capitalization. As of 2006, its CapitalAsset Ratio was 21%.

FGB’s increased tolerance of market risk can be deduced from its investments in the real estate sector as well as its increased investment in securities. Furthermore, the current turmoil in the international financial markets has had little effect on the bank. Large deposits from state-ownedcompanies and other government-related customers remain the vast majority of FGB’s funding resources, which also contributed to Fitch’s “Stable outlook” rating.

The Ruling family of Abu Dhabi owns 60% of the bank’s outstanding shares

First Gulf Bank 5

Corporate banking group offers financial services for medium to large corporations. The groupfocuses on oil & gas, manufacturing, energy and real estate. It has in its fold the following units:

• Institutional Banking: main focus is on financial institutions, international and region syndications,structured deals, Initial Public Offerings (IPOs) • Private Banking Group: offers customized and diversified range of products in Real Estate,Funds, and Equities.• Islamic Banking: offers all types of Islamic financing and investment products including Murabaha,Ijara, and Mudaraba.

The corporate banking group in FGB is involved increasingly in financing the numerous powerand construction projects in the UAE, particularly in Abu Dhabi. In addition to the usual corporate activities, FGB maintains a division responsible for lending to small and medium enterprises (SME). Going forward, corporate banking activities are expected to be the largest contributor to FGB operating income.

Under the umbrella of Corporate Banking, FGB established its real estate department. The department’s main areas of activities include real estate management, leasing, accounting, maintenance and advisory services. It also slated to design, develop, and sell real estate projects in Abu Dhabi and Dubai. After establishing a track record in the real estate sector, FGB established some companies that focus on business development and property management. We believe that the bank will spin off its real estate business as a separate vehicle. The move will follow the decision of the UAE central bank to permit the banks to take up real estate subsidiaries. Among the FGB’s announced projects are Burj Al Noujoum which consists of 30 floors and 395 units and theWestbury Square with total investments of AED 600 million comprising commercial and residential units at the Business Bay in Dubai.

The Treasury and Investment banking group provides the following products: • Foreign exchange & money markets • Derivatives and structured products • Local and international equity brokerage • Selling international funds and private equity • Bonds/fixed income instruments • Proprietary local & international portfolio • Portfolio management

FGB is seeking to increase its treasury fee income through providing new products and services to its corporate customers. In 2006, FGB sold a stake of 35% in First Gulf Financial Services with a substantial gain of AED 98 million to a number of the ruling family members, signaling a decrease in the contribution of brokerage income to the operating income of the bank.

Retail banking focuses on offering mortgages and personal loans to UAE nationals. Recently, loans have been extended to expatriates and women. Current and savings accounts are also offered to penetrate the funding base of the retail sector.

Figure 2: Contribution of different business segments 9M07

Retail Banking

Treasury & Investment BankingGroup

FGB is getting more exposed to the Real estate sector

Corporate Banking

Lines of Buisness (LOBs)

Assets Operating Income Net Profit

60%

50%

40%

30%

20%

10%

0%

Corporate Banking

Treasury

Retail Banking

Subsidiaries

Source: Damac & FGB Financials

First Gulf Bank 6

In addition to its main groups, FGB’s investments in associates include the following subsidiaries: • First Gulf Financial Services Company (45%)• Green Emirates for property management and brokerage (40%). Other shareholders include Al Dar properties, Sorouh properties, and Reem Investments• Aseel Finance for Islamic Mortgage Finance (40%)• First Merchant International (100%)• Mismak Property Development Company (100%)

A major financial goal of First Gulf Bank is to achieve carefully planned, consistentgrowth. To do that, the bank will continue to serve corporate clients as well as individuals of high net-worth while simultaneously opening additional branches to expand its retail banking network. The bank will continue to capitalize on inexpensive sources of funds as well as lucrative investment opportunities with government-related clients through its relationships with the Al-Nahyan family.

The management of the bank is aware that the banks’ Capital Adequacy Ratio, which is somewhat high, has the potential to affect the bank’s performance. However, the bank has access to governmental support if the need arises. Maintaining a high Capital Adequacy Ratio and a concomitantly low Equity Multiplier reduced the bank’s Return on Equity in 2006, although its Return on Assets was the highest among its peers. In the future, we expect to see additional growth in balance sheet items and hopefully without an increase in capital.

FGB is being re-structured to become a full fledged financial group. The bank’sdiversification strategy focuses on establishing several subsidiaries covering differentlines of business such as property management, real estate development, Islamic financing, and merchant banking. Diversification will continue to be an underlying ethosof the bank and will extend not only to products and services but also to its geographic footprint as the bank will expand regionally as well as internationally.

FGB’s Strategy

Bank subsidiaries

First Gulf Bank 7

FGB is considered the first bank in the world in terms of growth. Since 2003, the bank’s assets havegrown at a cumulative annual growth rate of 60%, increasing from AED 7 billion to AED 47 billion. In 2006 alone, the bank’s assets almost doubled. The rapid growth of the bank can be explained partly by its small base relative to its peers. However the main driver underlying its growth has been the large capital raise in 2005, which had given the bank a large, interest-insensitive source of funding of AED 5 billion.

Figure 3: Growth in Assets vs. Total Assets

When capital is raised, the performance of a bank’s management team can suffer because time and energy is diverted into assuring that the new resources are used efficiently. Consequently, thedecision to raise capital can be of concern to shareholders. This happened to FGB in 2005 when management raised AED 5 million of new capital. Total loans and advances (the main interest-earning asset) increased from AED 14 billion in 2005 to AED 26 billion. However, the rate of growth in loans declined from 128% (2004) and 104% (2005) to only 84% in 2006. Loans and advances declined to only 51% of total assets in 2006 compared with 71% in 2003.

Figure 4 (Right): Asset Allocation in %Figure 5 (Left): Loans Vs. Growth in Loans.

How did FGB invest its assets?

Bank’s total assets was almost doubled in 2006 to reach AED 48 billion

Financials

76%

106%

45%

82%

7.2

12.7

26.2

47.7

2003 2004 2005 2006

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Loans & Advances Growth



2003 2004 2005 2006

CashMarketable SecuritiesOther Assets

Due From BanksLoans & Advances

80%

70%

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0%

2003 2004 2005 2006

AED bn

AED bn

First Gulf Bank 8

FGB’s lending to the real estate and construction sector almost tripled from 2005 to 2006, increasing from AED 2 billion to AED 5.7 billion. The sector represented 22% of total loans in 2006 compared with only 14% the year before. This increase came partially at the expense of the personal loan segment which declined from 30% to 23% of total loans. The bank also reduced its lending to the share financing segment during the same period due to unfavorable conditions in local markets.

Figure 6: Loans to Deposits ratio

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Loans

Deposits

Loans/Deposits

2003 2004 2005 2006

74%81%

69%

92%


Figure 7 (Right): Loans breakdown 2005Figure 8 (Left): Loans breakdown 2006

Services 14%

Personal

(Retail & Others) 30%

Real Estate & Construction

22%

Share Financing

12%

To utilize the capital it had raised, FGB lent to other banks aggressively, taking dues from banks to 25% of total assets

From 2003 to 2006, FGB increased its lending to other banks from 7% to 25%, although the interest rate on loans to commercial banks is lower than the rates on customer loans. This raises a question as to whether it was necessary for FGB to raise capital in 2005 or whether the bank was simply following a trend fueled by the heated stock market of 2005. In 2006, the bank’s utilization rate (the ratio of loans to customer deposits) was only 74%, which is significantly lower than itshistorical levels and lower than that of other banks.

Loans Portfolio breakdown

Share Financing 8%

Others

41%

Real Estate &

Construction

14%

Personal(Retail &

Others) 23%

Services

14%


AED bn

Others

22%

First Gulf Bank 9

In 2003, time deposits represented more than 90% of the total deposits (Fig. 12, left). The remaining 10% consisted of savings deposits and demand deposits. The charts below also indicate that each of the three types of deposits almost had the same share to total deposits from 2003 to 2006.

Figure 11 (Right): Deposits breakdown 2006Figure 12 (Left): Deposits breakdown 2003

Customer deposits contributed 72% of the bottom line in 2006 compared with 66% in 2005. In general the bank did extremely well in growing its customer deposits, which increased from AED 6 billion in 2003 to reach AED 34 billion in 2006 (a CAGR of 54%). Money Market deposits or dues from banks represented less than 1% of total assets. In fact, FGB is a new lender to other banks rather than a borrower.

Figure 9 (Right): Deposits Vs Growth in DepositsFigure 10 (Left): Liability allocation in %

How did FGB Finance its Assets?

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99%

74%72%

45%

Customer Deposits Growth Rate

AED bn

2003 2004 2005 2006

Deposits

Owners Equity

Loans & MTLs

Due to other banks


Demand

Deposits 7%

Savings

Deposits 1%

Time Deposits

90%

Demand

Deposits 9%

Time Deposits

92%

Savings Deposits

1%


2003 2004 2005 2006

First Gulf Bank 10

As of 2006, FGB had two loans worth AED 4 billion. Loans as a funding source for assets increased from just 2% to 9%. In 2004, the first loan (USD 175 million), which was made to a syndicatecomprising several foreign banks, is repayable in full in November 2007. The loan accrues interest at the rate of LIBOR plus a margin of 0.4% per annum, which is payable semiannually. In 2006, a second loan (USD 750 million) was made to syndicate comprising several foreign and local banks. It is repayable in full in March 2009. The loan accrues interest at the rate of LIBOR, plus a margin of 0.3%, plus mandatory costs calculated by the Facility Agent as a weighted average of the lender’s additional cost rates, which are payable semiannually.

Owners’ equity, which is the second largest source of funding after customer deposits, stood at 17% of total assets as of 2006. Before the capital raise of 2005, owners’ equity comprised 29% of total assets. From 2003 to 2006, the Capital Adequacy Ratio also declined from 37% to 21%. It seems that the bank remains overcapitalized and will need more time to fully utilize its capital. FGB is setting a commercial bank in Libya, and is also seeking a commercial banking license in Algeria.

Having much larger pool of capital than the minimum required by the regulatory body allows the bank to have a lower effective funding cost. In 2006, the funding cost (excluding equity) was 6%. If we include equity, which is not an interest-bearing source, the effective cost would decline to 4.7%.

For a bank, liquidity means the ability to meet its financial obligations as they come due. Lendingallows a bank to invest in relatively illiquid assets but a bank funds its loans mainly with short-term liabilities. Thus, one of the main challenges to a bank is to ensure its own liquidity under all reasonable conditions. In case of FGB, the bank enjoys considerable liquidity. The proportion of assets that are liquid has improved from 28 to 46% during the period from 2003 to 2006. Also, the ratio of total liquid assets to total deposits has increased from 34% to 64% during the same period. Bank liquidity risk can be increased by market disruptions or by a credit downgrade, which may immediately reduce the availability of funds. FGB mitigates such risk as its management diversified funding sources and maintained a healthy balance of cash, cash equivalents, and readilymarketable securities. In the case of FGB, liquidity risk is only a minor concern because the ruling family of Abu Dhabi controls 60% of the bank’s outstanding shares. This makes us quiet sure that they will certainly intervene if any need arises.

Figure 13: Liquid Assets to total Assets & Deposits

80%

70%

60%

50%

40%

30%

20%

10%

0%2003 2004 2005 2006

28%34%

46%

59%

47%

71%

46%

64%

Liquid assets/Total assets Liquid assets/Customer Deposits


By 2009, FGB will have paid its loans

Owners equity is the second source of funding for assets which reduces the overall cost of funding

FGB has sufficientliquid assets to ensure that all financial obligationswill be met when they are due

First Gulf Bank 11

With low NPLs and more than 100% coverage, FGB’s assets enjoy high degree of quality

Liquidity risk may be affected as well by the mismatch of due assets and liabilities. The contractual maturities of assets and liabilities is being determined on the basis of the remaining period at the balance sheet date to the contractual maturity date and do not take account of the effective maturities as indicated by the Bank’s deposit retention history and the availability of liquid funds. FGB short term deposits, less than a year, amounted to 99.9% of total deposits in 2005 while loans of the same maturity reached 54.1% for the same year. In 2006, deposits due in less than a year amounted to 85.4% of total deposits, while corresponding loans of same maturity reached 55.6%. The maturity gap between loans and deposits are supported by a strong liquid position as illustrated above.

Figure 14: Maturity of Loans & Deposits

120%

100%

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< 1 >1 <1 >1

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54%43%

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Deposits

Loans

Non Performing Loans (NPLs) as a percentage of gross loans have improved from 6.14% as of 2003 to 1.8% as of 2006. The management of FGB made sure to create enough provision for the non performing loans which stood at 100% as of 2006.

Figure 15: NPLs/ Gross Loans Vs. provisions for NPLs

LLP/Gross Loans

NPLs/Gross Loans

Coverage Ratio

7%

6%

5%

4%

3%

2%

1%

0%

140%

120%

100%

80%

60%

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0% 2003 2004 2005 2006


91% 110%

120%

102%

First Gulf Bank 12

FGB cost of funding witnessed steady increases from 0.74% in 2003 to 2.05% in 2004 and 6.98% in 2005 before it declined back in 2006 to reach 5.96%. IPO funding related expenses represented 62% and 21% of the total interest expense in 2005 and 2006. On the other side, IPO funding related interest income represented 52% and 21% of the total interest income during the same period. Figure 16 and 17 show the impact of IPO funding business on the bank’s spread. It is illustrated that IPO funding helped the bank to achieve higher spread of 2.93% rather than 2.10% only in 2005 and 1.96% rather than 1.84% in 2006. Going forward, we expect that the bank will be able to sustain its spread at 2%.

Figure 16 (Right): Spread (Excluding IPO related interest expenses and income)Figure 17 (Left): Spread (Including IPO related interest expense and income)

8%

7%

6%

5%

4%

3%

2%

1%

0%2003 2004 2005 2006

Interest On Average Earning AssetsFunding CostSpread

3.5%

3%

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2%

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1%

0.5%

0%

12%

10%

8%

6%

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0%2003 2004 2005 2006

Interest On Average Earning AssetsFunding CostSpread


IPO funding had a positive impact on the spread during 2005 and 2006

From 2003 to 2006, FGB’s interest income increased at a CAGR of 90%, from AED 223 million to AED 2.9 billion. Net interest income increased at a CAGR of 62% from AED 176 million to reach AED 1.2 billion. Most of the income derived from IPO funding activity was classified under interestincome as IPO funding related interest income. In 2005, more than half of the total interest income came from IPO funding. From 2004 to 2006, interest income increased almost 4 fold, but in 2006, the year over year increase in total interest income was only 52%, as the contribution from IPO funding interest income declined to 21%. With the recovery in the local stock exchanges, we expect more IPO activity in 2008 and 2009 which will have a positive impact on the income stream of the bank.

Figure 18: Interest income 2003-2006

2003 2004 2005 2006

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1,000

500

0

Net Interest

Income

Interest

Expense

Total Interest

Income

AED mn


The cumulative annual growth rate of Net Interest Income was 62%

3.5%

3%

2.5%

2%

1.5%

1%

0.5%

0%

2.43%

2.93%

1.96%

2.93%

2.43%

2.95%

2.1% 1.84%

First Gulf Bank 13

In 2006, 58% of the bank income came from non core business. Since 2003, the contribution of non core business - as percentage of total operating income - has been growing steadily at the expense of the core banking from 21% to 58%. We expect this trend to continue as the bank is diversifying its business lines into other business segments such as real estate development and management.

In 2006, other income increased from AED 58 million to AED 541 million representing 26% of the bank total operating income. Other income increased tremendously due to three main effects; firsta plot of land was granted by the Government of Abu Dhabi and stated at fair value of AED 165 million based on an independent professional valuation. Second; A amount of AED 177 million as a gain on revaluation of investment properties, and finally; an amount of AED 98 million as a gainon a partial sale of its brokerage arm, First Gulf Financial Services LLC, in which FGB sold 43.75% of its 80% shareholding.

Figure 19 (Left): Core Vs. Non Core income (2003 -2006)Figure 20 (Right): Breakdown of Non Core income in 2006

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

2003 2004 2005 2006

78%

58%

42%

21%

Net Interest Income Non Interest Income

600

500

400

300

200

100

02003 2004 2005 2006

Fees & commissionsInvestment IncomeOther IncomeSource: Damac & FGB Financials

The bank’s ratio of cost to income declined from 42.3% and 28.3% in 2003 and 2004, to 16.4% and 19.3% in 2005 and 2006 respectively. The improvement can be explained by two factors. First, economies of scale were achieved as the bank has grown over the last few years, making fixedexpenses less visible compared to the income generated from a bigger balance sheet. Second, the bank started to book new kinds of revenues such as revaluation of land bank and investment property, grants, and the sale of subsidiaries.Significant income from IPO-related business helped the bank to become more efficient. In thefuture, we may see some deterioration in efficiency as income from non-recurring items and non-core business is not sustainable over the long term.

Figure 21: Cost to Income Ratio

2003 2004 2005 2006

45%

40%

35%

30%

25%

20%

15%

10%

5%

0%

42%

28%

16%

19%


Due to significantincome from IPO activity, investmentincome, and non recurringiterm, FGB looks more efficient

Since 2003, Non interest income grew by CAGR of 109%. reaching 58% of total operating income

AED mn

First Gulf Bank 14

FGB has achieved strong return on average assets of 4.1% in 2006. However, Return on average Equity was 19.3% as the bank holds a large capital position which led to a smaller equity multiplier. Going forward, we expect Return on Equity to get improved as size of balance sheet will continue to grow which will result in a higher equity multiplier and greater return on capital.

Figure 22: Return on Average Assets & Average Equity

In 2006, FGB reported astrong ROA of 4.1%, howeverkeeping to much capital hurtthe Return on Equity

2004 2005 2006

25%

20%

15%

10%

5%

0%

RoAA


20.1%

2.4%

5.5%

23%

4.1%

19.6%

RoAE

First Gulf Bank 15

We initiate coverage on FGB with a target value of AED 25.77 per share with an upside potential of 13% to the current market price of AED 22.8 per share (as of January 3rd, 2008), with a BUY recommendation. We valued the bank using a combination of two approaches - free cash flow toequity holders and multiple valuations.

Discounted Cash Flow to Equity (DCFE) valuationThe model gave us a fair value of AED 27.62 per share based on a risk-free rate of 4.1%, a beta of 0.7 and a market risk premium of 8% applied for a forecasted time span of five years from 2007to 2011. Going forward, we applied a perpetual growth rate of 4%.

Multiples ValuationBased on the current market price of AED 22.8 (as per Jan 3rd 2007), the stock is trading at three times the 2007 estimated book value, along with an adjusted book value per share of 6.5 as of 2006. The stock value as per the average P/BV in Abu Dhabi (2.825 as of 2006) is AED 18.36.

Our value to FGB is based on both methods with an 80% weight to discounted cash flow to equityand 20% to multiples valuation, yielding an estimate of AED 25.77.

Despite the spectacular performance of FGB stock over the last 12 months, we believe that there is still a room to grow

Valuation

Figure 23: UAE banks valuation summary

ROE ROA PBV PERatio

NBAD 25.79% 2.27% 3.54 16.49

ADIB 23.84% 1.95% 1.88 16.64

ADCB 21.61% 3.00% 2.38 12.05

Mashreqbank 21.46% 3.04% 3.94 18.15

FGB 18.27% 4.15% 2.99 16.08

UNB 18.00% 2.64% 2.37 14.73

CBI 16.10% 2.35% 2.80 16.17

Investment Bank 11.68% 2.74% 2.31 17.62

National bank of Umm Al Quwain 1.05% 0.15% 3.44 17.12

Source: Bloomberg, December 2007

First Gulf Bank 16

DisclaimerThis research report has been compiled and prepared by the research team of DAMAC Capital International. Although the information in this report has been obtained from sources DAMAC Capital International believes to be reliable, we do not represent nor warrant its accuracy nor an independent verification nor the possibility of being condensed or incomplete.DAMAC Capital International accepts no liability whatsoever for any loss arising from the use of this document or its content or otherwise arising in connection therewith. All opinions expressed herein reflect the opinion(s) of the analyst (s) which mayor may not coincide with those of the company, and these opinion are subject to change without notice based on exogenous variation of the inputs to the decision making process. This document is not to be used or considered as an offer to sell or a solicitation of an offer to buy any properties mentioned herein. This document may not be reproduced or circulated without the prior written consent of DAMAC Capital International. Past performance is not necessarily indicative of future performance. Potential investors or readers of this report must understand that projections and estimates regarding future prospects may not be realized and they must make their own assessment of the information mentioned herein, of their suitability as an investment and of the risk involved. This research is a gratis research that it is not tailored to any specificinvestment objective(s), financial situation or needs of any specific individual/institution that may receive this report. Westrongly advise potential investors to seek financial guidance when determining whether an investment is appropriate totheir needs. Foreign currency rates of exchange may also affect the value, price or income of any investment referred to in this report.

DisclosureWe, Hany Hussein and Hany Seif hereby certify that the views expressed in this document accurately reflect our personalviews about the banking sector and banks that are the subject of this report. We also certify that neither we nor our spouses or dependants (if relevant) hold a beneficial interest in the securities of the banks mentioned in this report.

Contacts

Head OfficeAl Moosa Tower 2Sheikh Zayed RoadP.O.Box: 2195Dubai – UAE Tel: +971 4 331 3663Fax: +971 4 331 1651Email: [email protected]

VP-Head of ResearchHany Hussein, CFAEmail: [email protected]

Investment AnalystsHany SeifEmail: [email protected]

Pamela Chikhani, MSc.Email: [email protected]

Technical AnalystTaimur Saadat, CMTEmail: [email protected]

EditorJim Duthie

Customer ServiceTel: 800-STOCKEmail: [email protected]

Retail and Institutional SalesAkil SharmaTel: +971 50 551 1812Email: [email protected]

Mazen SalhabTel: +971 50 559 4603Email: [email protected]

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