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Global Investment House KSCC

Sharq, Global Tower

P.O. Box 28807 Safat

13149 KuwaitTel: (965) 295 1000

Fax: (965) 295 1005

E-mail: [email protected]

http://www.globalinv.net

Global Investment House stock market indices can be accessed

from the Bloomberg page GLOH

and from Reuters Page GLOB

Omar M. El-Quqa, CFAExecutive Vice [email protected] No: (965) 295 1110

Faisal Hasan, CFAHead of [email protected] No: (965) 295 1270

Mahmoud SoheimManager-Egypt [email protected]

Phone No:(202) 37609526

Cherine Fayez Farkouh, CFAFinancial AnalystSenior [email protected] No: (202) 37609526

Naveed AhmedFinancial [email protected]

Phone No: (965) 295 1280


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Table of Contents

Investment Summary .......................................................................................................... 1

Economic Overview ............................................................................................................ 4

Background on the Banking Sector ................................................................................... 8

Financial Performance of the Banking Sector ............................................................... 15

Peer Group Comparison .................................................................................................. 28

Banking Sector Outlook ................................................................................................... 33

Valuation & Recommendation ........................................................................................ 34

Players Profile

Commercial International Bank .................................................................................. 37

National Societe Generale Bank ................................................................................. 58

Credit Agricole-Egypt ............................................................................................... 78

The Egyptian Gulf Bank ............................................................................................ 98

Export Development Bank of Egypt ......................................................................... 115


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GlobalResearch - Egypt Global Investment House

September 2008 Egypt Banking Sector 1

Investment Summary

The Egyptian banking sector has gone through major reforms in the last few years. The main

reasons triggering such reforms were to eliminate disturbed banks and to enhance the assets

quality and capital adequacy of the banking sector.

The problem rose when the large four public banks, constituting approximately 50% of the

sectors total assets in 2003, had a huge amount of Non Performing Loans NPLs, resulting

mainly from extending large portions of loans to distressed public enterprises, in addition to

having a lack of adequate risk management practices.

Therefore, the government decided to restructure the banking system through several

methods. One of which was to sell stakes of public banks in other joint ventures in order to

solve the NPLs problem. Another form was to amend regulations concerning the minimum

required paid-in capital and the capital adequacy ratio.

A consolidation trend prevailed in the banking sector, during the last few years. Small banks

and poor performers were easy acquisition targets, as they couldnt abide by the regulations

modified by the Central Bank of Egypt CBE, while foreign banks were involved in such

actions, in an attempt to enter the Egyptian banking sector, especially after the governments

announcement that no banking licenses will be granted for the time being.

This foreign interest in the Egyptian banking sector reflects how the sector is perceived as

having a promising growth potential, given the fact that there is a low banking penetration rate

and many of the Egyptians do not have banking accounts. Besides, a large proportion of the

population is in the youth age, lying between 20 and 45 years old, implying a potential growth

of demand from this group. Another factor drawing the foreign interest is the continuing

growth of the economy, which was reflected on many sectors. This growth, in turn, provided

an improved business climate and encouraged investments by Egyptians and foreigners as

well. The result was greater lending opportunities necessary to finance emerging projects,

boosting the performance of the banking sector and implying promising aspects.

Foreign interest was illustrated by the participation of foreign players, whether international

or regional banks in the bids that took place to acquire stakes in the Egyptian banks. These

banks include BNP Paribas, Barclays, Piraeus, Credit Agricole, Societe Generale, BLOM and

Audi. Foreign banks expressed their desire to enter the Egyptian banking sector by offering

higher premiums in bids over local banks. The latest acquisitions that took place in 2007

were the acquisition of a 51.3% stake in the National bank for Development by Abu Dhabi

Islamic Bank, as well as the acquisition of a 98.1% stake in Al Watany Bank of Egypt by the

National Bank of Kuwait.

Another attempt by the Egyptian government to enhance the performance of the banking

system was the privatization of Bank of Alexandria in 2006, where the Italian Intesa San

Paolo Bank acquired an 80% stake in the Bank, reflecting again the attractiveness of the

banking sector in Egypt.

Banque du Caire was about to be privatized, but the deal was cancelled in June 2008, as

the presented bids did not match the value set by the government for the Bank. It is worth


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2 Egypt Banking Sector September 2008

mentioning that there were 5 International and regional banks competing to acquire a stake

in the Bank, which was set to be a maximum of 67% of the Banks shares. These banks were

the Saudi Samba Bank, the National Bank of Greece, the British Standard Chartered Bank,

a consortium composed of the Jordanian Arab Bank group and the Saudi Arab NationalBank, and another consortium led by Mashreq Bank. The Saudi Samba Bank and the British

Standard Chartered Bank did not participate in the auction, as they did not present bids. On

the other hand, the three remaining banks presented their bids, with the highest price being

that presented by the National Bank of Greece, amounting to US$1.4bn. Surprisingly, the

government declined to sell the Banks stake at that price, revealing that the Banks intrinsic

value is much higher.

As for the regulatory intervention in the banking system, the CBE has moved towards

targeting inflation through employing a tight monetary policy and assigning the Monetary

Policy Committee MPC, which main responsibility was to set each six weeks the deposit

and lending rates at the CBE. This is done in accordance to the prevailing rate of inflation.

Given the economic growth that the country is witnessing, along with skyrocketing food

and energy prices internationally and in the local market, inflation reached 23.6% in August

2008, forcing the CBE to raise its rates to reach 11.5% and 13.5% in September 2008,

respectively.

Our outlook for the Egyptian banking sector is positive, on the back of the promising prospects

of the Egyptian economy and the resulting attractive investment climate. This climate

is expected to spur projects in various sectors along with attracting foreign investments,

representing enormous lending opportunities for banks in Egypt.

Additionally, there are still plenty of hidden opportunities in the sector. These are represented

by many segments that do not participate extensively in the banking activity. The most apparent

opportunities rely in the retail segment, which is almost unexploited. Large percentage of the

population has no banking accounts. This represents a great potential for Egyptian banks, as

they can capitalize on growth opportunities in this segment, given the growing demographics

and the fact that more than half of the population is in the working age. Hence, demand from

this segment is huge and is expected to increase furthermore. This is one of the reasons that

triggered almost all private banks to announce the expansion of their branches in 2007 to

satisfy larger client base.

Other untapped segments are the mortgage lending and lending to the Small and Medium

Enterprises (SMEs). These segments constitute a minor fraction of the banks loans due to

the high risks associated with them. However, the latest government regulations concerning

the registration of the housing units and the SMEs, along with the establishment of the credit

bureau are expected to boost lending to such segments.

Another key driver for potential growth is the fierce competition existing among local

players. Though the number of banks was reduced from 62 banks in 2000 to 41 banks now,

local lenders compete harshly to gain more market shares, through introducing new products

and services, as well as investing in their infrastructural system.

The growth of the banking activity over the last few years supports our positive vision for the

banking sector. This is expressed by the development of the total deposits and loans in the


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sector. Total deposits (including government deposits) grew at a CAGR of 14.6% over the

period from 2002/03 to 2006/07, reaching LE658.2bn, while total loans increased at a CAGR

of 5.6% during the same period, reaching LE352.4bn in 2006/07.

Table 01: Global Valuation Matrix

Price (LE) Target (LE) Reco.Upside

PotentialBVPS* (LE) EPS* (LE) P/BV* (x) P/E* (x)

CIB 46.9 49.0 Hold 4.5 14.6 5.0 3.2 9.5

NSGB 30.0 34.3 Buy 14.4 13.2 4.0 2.3 7.5

CAE 15.2 17.0 Buy 11.8 5.8 1.7 2.6 8.7

EGBE (US$) 2.6 2.0 Sell -22.5 0.9 0.1 2.8 23.0

EDBE 21.1 20.6 Hold -2.2 12.8 2.9 1.6 7.2

Source: GlobalResearch, market prices as of September 7th, 2008.* Based on 2008E for all banks and 2008/09E for EDBE, adjusted for goodwill and extraordinary items, if any.


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Economic Overview

The Economy is Still Gaining Momentum

Following the sound performance of the Egyptian cabinet led by Prime Minister Ahmed Nazifsince 2004, the Egyptian economy has strengthened and showed positive signs. Effective

means were carried out resulting in a buoyant GDP growth and major improvements in various

sectors. The government implemented several economic reforms including privatization,

cutting tax rates, attracting foreign investments, financial sector reforms, as well as public

and private sector reforms. These reforms were reflected by a better investment climate.

Nominal GDP went up at a CAGR of 14.1% during the 5-year period from 2001/02 to

2006/07, whereas real GDP witnessed a 5.1% CAGR over the same period. Considering y-

o-y growth, nominal GDP grew by 18.4% in 2006/07, reaching LE731.2bn, while real GDP

increased by 7.1%, reaching LE486.5bn.

Moreover, nominal GDP grew by 21.0% y-o-y, over the 9M period ending March 2008, as

it reached LE652.7bn, compared to LE539.4bn, realized in the same period of the previous

year.

The development in the general economy was transmitted to a better standard of living for

Egyptians, as the per capita GDP rose at a CAGR of 6.3% in the last five years and at 16.8%

y-o-y, from US$1,460 in 2005/06 to US$1,706 in 2006/07.

Contributing Sectors

The sectors that showed major contribution to the GDP in 2006/07 were the agriculture

sector with 13.8% of GDP, the extractive industry (compromising petroleum and naturalgas), contributing to 15.2%, whilst the manufacturing industry alone constituted 16.8% of

GDP. Finally, the wholesale and retail trade portion of GDP was 11.4%.

The extensive efforts of the Egyptian government resulted in better than planned figures, as

the actual fiscal deficit in 2006/07 amounted to LE54.7bn, compared to an estimated figure

of LE62.2bn. Such decline was a result of the 9.9% increase in the actual revenues over the

budgeted figure, reaching LE180.2bn instead of LE163.9bn, which was a consequence of an

8.2% rise in tax revenues. The actual fiscal deficit realized in 2006/07 represented 7.5% of

GDP, compared to 8.2% in 2005/06, showing evidence of the significant efforts implemented

by the government.

Current Account

Egypt has proven competitiveness in the export market illustrated by the increase of the

exports by 19.3% y-o-y in 2006/07, reaching US$22.0bn and a 25.3% CAGR from 2001/02

to 2006/07.

It is worth mentioning that the major component of exports in 2006/07 included fuels, mineral

oil and products, constituting 46.6% of total exports. Finished goods, in turn, attributed to

34.2% of total exports in the same year.

The major export market for Egypt in 2006/07 was the European Union, with a share of

33.8%. The second highest market was the USA with a 31.1% share, followed by Asia, with


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13.5%. Exports to the USA, growing by 21.4% from 2005/06 to 2006/07, have significant

importance in the external trade market for Egypt. One of the main reasons that led to

increasing exports to the USA was the Qualified Industrial Zones (QIZ) Protocol that Egypt

entered in 2004, which helped boost exports to the USA, given the fact that Egypt couldexport goods to the USA without quota or duties. Exports to the Arab countries were 12.4%

in the same year, while the remaining 9.2% of total exports were distributed among Europe,

Africa and other countries.

On the other hand, imports grew by 24.3% y-o-y in 2006/07, realizing US$37.8bn. The major

portion of imports was directed to the intermediate goods, which constituted 27.6% of the

total Egyptian imports, then came the investment goods with 26.0%, while consumer goods

reached 14.0%. It is worthy to note that the major export markets were the same main import

markets, the European Union, the USA and Asia, with 34.4%, 21.8% and 15.9% of total

imports, respectively.

The fact that imports reached US$37.8bn in 2006/07, while exports reached only US$22.0bn,

resulted in a preliminary trade deficit of US$15.8bn. Fortunately, this deficit was compensated

by a 39.8% increase in the services account, which was mainly attributed to receipts from

transportation, especially from the Suez Canal, as well as growth in investment income.

Such improvements in the services account along with the 27.3% y-o-y increase of net

transfers, contributed to a rise in the current account surplus by 53.9% y-o-y in 2006/07,

reaching US$2.7bn, compared to US$1.8bn recorded the previous year.

In March 2008, exports proceeds surged by 31.1% y-o-y, reaching US$20.8bn. This incline

was pushed by the 35.4% increase in oil exports and the 27.4% rise in other exports. As for

imports, they amounted to US$37.6bn, realizing a y-o-y growth of 43.1%. This was attributed

to the significant surge in oil imports, growing by 138.1% y-o-y, reaching US$6.8bn, along

with the 31.5% rise in other imports, amounting to US$30.8bn. The fact that growth in

imports surpassed that of exports resulted in an increase in the trade deficit balance, reaching

US$16.8bn, compared to US$10.4bn, over the same period a year before.

It is worth mentioning that this deficit was compensated by a surplus in the service and

transfers accounts by US$10.9bn and US$6.4bn, respectively. This led to a surplus in the

current account, amounting to US$488.4mn.


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Accelerated Infation

After the floatation of the Egyptian pound in 2003 and the enhanced confidence in the

Egyptian economy, as a result of the economic reforms adopted by the government, thedemand for investing in Egypt increased, causing an appreciation of the local currency

against the US$ starting from 2005. The exchange rate reached LE5.5:US$1 in Nov 2007,

compared to LE5.8:US$1 in 2005. Fortunately, the appreciation of the Egyptian pound did

not negatively affect the Egyptian exports, as shown earlier.

In 2005, the Central Bank of Egypt moved towards inflation targeting. For this purpose, it

established the Monetary Policy Committee, which was scheduled to meet every six weeks to

identify the corridor range, representing the overnight deposit and lending rates at the CBE,

which were set initially at 9.5% and 12.5%, respectively. In June 2006, rates were reset at

8.0% and 10.0%. Since then, these rates have been moving according to the development of

the inflation rate. In April 2008, the inflation reached 16.4%, while deposit and lending ratesreached 10.0% and 12.0% in May 2008, respectively.

In May 2008, the government announced the removal of tax exemption on treasury bills,

private schools and universities, as well as extensive energy consuming industries, operating

under the free-zones system, mainly fertilizers, cement, steel and petrochemicals. In addition,

energy subsidies have been reduced for all energy intensive industries. Moreover, new fees

were imposed on car licensing, with different categories according to the engines types. Later

on, the tax exemption on newly issued treasury bonds was also removed.

These decisions were reflected on higher inflation, reaching 23.6% in August 2008, pushing

the MPC to further raise the corridor range, which reached 11.5% and 13.5% in September2008, respectively.

Hikes in inflation during the last few years were also a result of the increased money supply

in the Egyptian economy, which was illustrated by the jump of the Domestic Liquidity (M2)

by 18.3% in 2006/07, reaching LE662.7bn. This could be attributed to the 20.1% growth in

Narrow Money Supply (M1) and the 17.8% rise in Quasi Money. These rises were a result

of the growth realized in the economy, which triggered the development of many investment

projects, leading to the current increase in liquidity witnessed in the banking system.

On the other side, interest rates reflected a slight decrease over the period from 2003/04

to 2006/0 7, where deposit rate for less than one year declined to 6.9% in June 2007 from7.77%. Also, the lending rate for less than one year went down from 13.27% to 12.60%.


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Outlook for the Egyptian Economy

Our outlook for the Egyptian economy is positive given the strong growth realized since the

appointment of the current cabinet in 2004. The achievements made in various sectors of theeconomy and the thriving investment climate are all signs of continuing development in the

years to come.

The continuous efforts of the government towards improving the economys growth support

our positive vision for the Egyptian economy, as the government announced many objectives

to be achieved within the 5-year governmental plan ending mid 2012. Such objectives are

represented by shifting the annual GDP growth to 8%, decreasing inflation to 6%, reducing

unemployment to 5.5% down from 9% along with other objectives, which if achieved should

bring fruitful benefits to the Egyptian economy. We believe such objectives could be realized

relying on the fact that the Egyptian cabinet has proven to be successful in reaching planned

goals.

Currently, the main challenges facing the Egyptian economy are the rising inflation rate and

the weakening US Dollar. Up till now, the government has been successful in dealing with

both problems, which are more external than internal.


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Background on the Egyptian Banking Sector

Banking Structure Development

The first Egyptian bank was the National Bank of Egypt NBE, which was established in

1898, with a capital of GB1mn. It used to perform the duties of a central bank in the 1950s.

Banque Misr BM was then established in 1920 followed by Banque du Caire BdC in 1952

and Bank of Alexandria BoA in 1957. The Central Bank of Egypt CBE was established

in 1961. During the 1960s, banks were nationalized and NBE acted as a commercial bank,

while still carrying out some of the duties that were not covered by the CBE at that time.

The open door policy adopted in Egypt in the 1970s to attract foreign investments resulted

in an expansion of the banking system, which was composed at that time of 4 public banks,

3 investment banks and 19 specialized banks. Meanwhile, the banking law was established,

identifying the three types of banks, along with the functions of each type.

The banking structure swelled significantly since then and until the 1990s, as the numberof banks soared from 26 to 63 banks in 1999. The branch network also expanded from 527

to 2,434 branches. As a result of the consolidation movement that took place in the sector

during the last few years, represented by mergers and acquisitions actions, and the fact that

7 branches of foreign banks ended their business in Egypt, the number of banks shrank to 41

by 2007 and the branch network expanded to compromise currently 3,252 branches in order

to cover larger client base.

Table 02: Banking Structure Development

End of JuneCommercial

BanksInvestment Banks Specialized Banks Total # of Banks

1970 5 0 20 25

1975 4 3 19 26

1980 19 29 4 52

1985 43 33 4 80

1990 44 33 4 81

1995 28 32 4 64

2000 28 31 3 62

2005 27 22 3 52

2006 23 17 3 43

Source: CBE, GlobalResearch

Chart 01: Banking Structure in 2006/07It is worthy to note that the private and

joint venture banks constituted 68.3%

of the total number of banks in 2006/07,

whereas off-shore banks and public

banks shares were 17.1 and 14.6%,

respectively.

Public Sector

14.6%

Off-Shore Banks

17.1%

Private and Joint

Ventures 68.3%



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Poor Performance Triggered Reforms

The Egyptian banking sector was dominated by the four large public banks NBE, BM, BdC

and BoA. As a result of long existence in the Egyptian market and accordingly, having huge

number of branches serving greater share of the population compared to the private banks,

the public banks constituted approximately half of the sectors assets in 2003. This being

the case along with the fact that these banks provided large portion of their loans to public

enterprises had negatively impacted the performance of the four banks and resulted in a

combined non-performing loans/ total assets ratio of approximately 12% in 2002.

That said, the Egyptian government was urged to alleviate the banking systems turmoil,

realizing its importance in the development of the economy. Therefore it devoted significant

efforts to make major reforms in the sector, including amendments in some regulations,

accompanied by privatization and consolidation actions. The main objective behind these

reforms was to improve the sectors efficiency, in terms of asset quality as well as capital

adequacy.

Public Banks Being the Primary Concern

The Government adopting several reforms tools, began with selling stakes of public banks in

joint venture banks to curb the problem of hefty bad debts. The following table summarizes

the public stakes sold over the period from 2004 to 2007.

Table 03: Sale of Public Banks Stakes in Joint Ventures

Divested Public Bank Acquirer Acquired Shares in Joint Ventures

Ripplewood Consortium Commercial International Bank

National Bank of Egypt Arab Banking Corporation International Suez Canal Bank

Societe Generale National Societe Generale Bank Banque Misr National Societe Generale Bank Misr International Bank

BLOM Bank Egypt Romania Bank

Arab African International Bank Misr America International Bank

Banque du Caire Audi Cairo Far East

Union National Bank Alexandria Commercial and Maritime

Bank of Alexandria Barclays Cairo Barclays

Piraeus Egypt Commercial Bank

Credit Agricole Egypt American Bank

Shareholders in Delta International Bank Delta International Bank

National Investment Bank Misr Iran Development Bank

Source: Ministry of Finance, GlobalResearch

In 2005, Non-performing Loans NPLs owed by public enterprises to public banks amounted

to LE 26bn. The government paid as fractional settlements for these loans LE6.9bn in January

2006 and LE9.1bn in December 2006, with the remaining amount to be finalized by 2009,

according to the governments plan.

Moreover, the government has appointed skilled management and staff, along with improving

internal processes of state-owned banks, in order to raise their competitiveness.


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Notable Reforms to the Whole System

Aiming at enhancing the banking systems competitiveness in terms of adequate capital

together with improving the capabilities of banks to meet default on their loans, the government

has set regulations for increasing the minimum required paid-in capital and capital adequacy

ratio. Additionally, the government enhanced the role of the CBE in regulating the sector and

assigned it more responsibilities.

As an additional attempt to control NPLs for the whole banking system, the CBE issued a

decree in September 2004 to establish a unit in the CBE to monitor the banks NPLs books and

asked banks to establish a similar internal unit. The role of the CBE would be to continuously

monitor these units to make sure that they are well implemented and well performing to deal

with NPLs. The efforts performed by this unit resulted in the settlement of 67% of NPLs in

private banks over the period from 2004 to March 2007.

Recently, a credit bureau, under the supervision of the CBE, has been established with the aim

of providing information to banks regarding personal and financial information on borrowers,

as well as their financial history, including loans defaults, bankruptcies, court judgments and

late payments. Other positive information such as timely settlements is also included. The

objective of establishing this bureau was to facilitate time saving procedures. According to

this process, borrowers will not have to wait for a long time until the bank investigates their

financial position and approves loans requests. Furthermore the risk of default will diminish

by providing banks with accurate information that will help them in their decision making.

Moreover, the government motivated the consolidation of the sector through privatization,

mergers and acquisitions to get rid of disturbed banks.

Consolidation Dominated the Sector

The Government aimed at consolidating the banking sector in order to increase the players

competitiveness and eliminate lowly performers. An important factor contributing to the

consolidation of the banking sector was the amendments of regulations by the CBE.

According to the Unified Banking Law of 2003, the minimum required paid-in capital was

raised to LE500mn from LE100mn. In addition, the capital adequacy ratio was raised from

8% to 10% of the risk-weighted assets. It is worthy to note that this law gave the CBE

more responsibilities as a regulatory organization, where the governor directly reports to the

countrys President.

Meanwhile, these amended regulations spurred local banks, especially small ones and poor

performers to opt for mergers and acquisitions in order to conform to the new laws.


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Table 04: Banks Mergers during the Period from 2004 to 2007

First Bank Second Bank New Entity Date

American Express Bank (Branches in

Egypt)Egyptian American Bank Egyptian American Bank Sep-04

Misr Exterior Bank Banque Misr Banque Misr Sep-04

Credit Lyonnais Branch Credit Agricole Indosuez Calyon Mar-05

Misr America International Bank Arab African International Bank Arab African International Bank Sep-05

Mohandes Bank National Bank of Egypt National Bank of Egypt Oct-05

Bank of Commerce and Development National Bank of Egypt National Bank of Egypt Dec-05

Nile Bank with Islamic International

Bank for Investment and DevelopmentUnited Bank of Egypt United Bank of Egypt Jun-06

Egyptian American Bank Calyon Credit Agricole Egypt Sep-06

Misr International Bank National Societe Generale Bank National Societe Generale Bank Nov-06

Banque du Caire Banque Misr Banque Misr Feb-07

Source: Ministry of Finance, GlobalResearch

Foreigners Chasing Opportunities in the Sector

Foreign banks have shown continuous interest in the booming banking sector in Egypt

in the last few years. This was due to a number of reasons, the majority of which were a

pure result of the economic reforms, as well as the banking reforms that Egypt is currently

witnessing. Such reforms helped boost the banks profitability over the last few years, along

with decreasing NPLs gradually and entailing good lending prospects.

The major inducement for the foreign interest was the escalating demographics in Egypt and

its resulting potential for the retail segment, as the population rose at a CAGR of 2% over

the last 5 years, reaching 75mn in 2006/07, with a high percentage of youth, almost in theworking age group. We believe that a wide range of the population in Egypt has a low or

even zero banking penetration. This could be attributed to the low income levels, the lack of

awareness of the importance of participation in banking activities, in addition to the informal

job market. Foreign attention was thus stimulated by the short of saturation of the retail

segment in an attempt to capitalize on the huge unfulfilled demand.

In addition, foreign players were enticed to participate in mergers and acquisitions, especially

after the Governments announcement regarding not granting any new banking licenses.

The foreign interest was divulged by the flow of international foreign and Arab banks

acquisitions of local lenders since the banking sector reforms were initiated in 2004. It beganwhen the British bank Barclays acquired from banque du Caire its 40% remaining stake in

Cairo Barclays. Other foreign banks that acquired stakes in the sector over the last few years

were Credit Agricole, Societe Generale, Piraeus, BLOM Bank, Abu Dhabi Islamic Bank and

National Bank of Kuwait. Yet there was a larger range of foreign banks that revealed their

interest in the Egyptian banking sector and strived to obtain stakes in it, but they did not reach

their target to win the related bids.


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Table 05: Most important Acquisitions over the Period from 2005 to 2007

Acquired Bank AcquirerAcquisition

Date

%Acquisition

Price (LE)

Deal

Value

(LEmn)

BV per

share

BV

Weights

P/BV

*

Misr America

International Bank

Arab African

InternationalMay-05 100.0 239.5 239.5 146.0 18.2% 1.6

Egyptian Commercial

Bank**Piraeus Jun-05 88.0 20.0 169.0 18.0 2.2% 1.1

Suez Canal BankArab International

BankAug-05 16.8 10.0 48.2 29.4 3.7% 0.3

Misr International

BankNSGB Sep-05 90.7 43.2 2,204.0 21.4 2.7% 2.0

Misr Romania *** BLOM Bank Dec-05 99.4 11.8 590.0 13.7 1.7% 0.9

Egyptian American

BankCredit Agricole Feb-06 74.6 45.0 2,176.6 11.8 1.5% 3.8

CIB****

A consortium led by

Ripplewood Holdings Feb-06 18.7 53.5 1,302.5 16.3 2.0% 3.3

Cairo Far East Audi Bank Mar-06 99.7 205.3 540.1 70.6 8.8% 2.9

Misr Iran

Development Bank

National Investment

BankApr-06 29.9 223.4 107.7 411.8 51.4% 0.5

Delta International

Bank

A consortium led by

Ahli United BankAug-06 89.3 37.0 1,652.0 11.5 1.4% 3.2

Alexandria

Commercial MaritimeUnion National Bank Aug-06 94.8 23.0 244.5 15.3 1.9% 1.5

Bank of Alexandria San Paolo Dec-06 80.0 72.0 9,215.0 10.4 1.3% 6.2

National Development

Bank

Abu Dabi Islamic

BankJul-07 51.3 11.0 159.1 11.2 1.4% 1.0

Al Watany Bank of

Egypt

A consortium led

by National Bank ofKuwait

Dec-07 98.1 77.0 5,660.2 13.8 1.7% 5.6

Total 801.3 100%

Average P/BV (Simple) 2.3

Average P/BV (Weighted) 1.3

Source: News Announcements, GlobalResearch

* P/BV Calculation (Equity less net profit of the year /outstanding number of shares).

**In June 2005, Piraeus acquired around 69% of the Egyptian Commercial Bank, bringing its total stake to

88.0%.

***In December 2005, Blom Bank acquired around 84% of Misr Romania Bank, in which it originally owned

12.5%, bringing its total stake to 96.7%.Later on, it raised its stake to 99.4%.

****Currently, the Consortiums stake in CIB is 5.6%

Two Major Acquisition Bids in 2007

The year 2007 witnessed two acquisitions of local lenders by Arab banks mainly from the

GCC countries, attracted by the positive sentiment on the Egyptian banking sector. In June

2007, the CBE announced its approval for three foreign banks to conduct due diligence on Al

Watany Bank of Egypt. The three banks were National Bank of Kuwait NBK, Commercial

Bank of Kuwait and the Greek EFG Eurobank. NBK won the bid and acquired 70.3mn shares

of Al Watany Bank of Egypt at LE77.0 per share in November 2007, implying a P/BV of

5.6x. In addition, NBK acquired a 2.1% additional stake in the Bank in December 2007,

where its total stake reached 98.1%.


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In July 2007, a consortium led by Abu Dhabi Islamic Bank acquired 51.3% of the National

Development Bank at LE11 per share, which was close to the shares book value. The

National Development Bank had NPLs of LE2bn, exceeding 50% of the Banks total loans,

which- according to the acquirer- will be covered over a 5-year period, during which no cashdividends will be distributed.

It is worth mentioning that the Egyptian Gulf Bank and the Arab Investment Bank are

potential acquisition targets, due to their relatively low market shares, low capital base and

modest performance, compared to large peers in the market.

One of the Big Four Privatized

The foreign appetite in the Egyptian banking sector was again revealed in the privatization

deal of BoA. In February 2006, the government announced its intention to privatize BoA, the

smallest bank of the large four public banks, through selling a stake of 75-80% of the Banks

shares to a strategic investor, 15-20% to the general public through an IPO and 5% to be

allocated to the Banks employees. There were 13 banks that submitted requests to purchase

the announced stake, comprising international, regional and local banks, of which 8 banks

presented preliminary offers. The CBE allowed 6 of these banks to perform due diligence

on BoA, among which were Mashreq Bank, Intesa San Paolo Bank, Arab Bank, CIB and

BNP Paribas. The final purchase offers presented were from 4 European and Arab banks

not including any local bank. Finally, in October 2006, the Italian Bank Intesa San Paolo

won the bid and acquired after 2 months, 80% of the Banks shares at a total of LE9.2bn

(US$1.6bn), representing US$12.6 per share, which was more than 5.5 times the shares

book value. The second highest premium was presented by the Arab Bank, which offered

LE7.9bn (US$1.4bn).

The government is currently awaiting the right time to offer the remaining 15% of BoA

shares through an IPO.

The privatization of BoA revealed the foreign players will to acquire a local bank at a high

premium, just to ensure a seat in an under-banked country with robust growth potential.

Privatization of BdC Postponed Surprisingly

Still attracting foreign lenders, the government was about to privatize the third largest public

bank BdC. The story began in May 2007 when the government announced the merge

of BdC with BM. Three months later, it was announced that BdC, which captures a 6%

market share in terms of total deposits and also of total assets of the banking sector, would

be privatized. The privatization would have occurred through selling a maximum stake of67% to a strategic investor, offering a 28% stake through an IPO in the stock exchange, with

the 5% remaining stake to be distributed among the Banks employees. Among 14 financial

advisory institutions, JP Morgan was assigned responsible for the sale. The preliminary offers

presented, amounting to 12 offers illustrated the flow of foreign interest to gain presence in

the market. These offers were represented by the Arab Bank Consortium, Deutsch Bank,

Mashreq Bank, Kuwaits Noor Financial Investment Company, Commercial Bank of

Kuwait and other foreign and Arab banks. In March 2008, the CBE announced the short-list

consisting of 5 banks that were allowed to make the due diligence on BdC, these banks were

the Saudi Samba Bank, the National Bank of Greece, the British Standard Chartered Bank, a

consortium composed of the Jordanian Arab Bank group and the Saudi Arab National Bank,

and another consortium led by Mashreq Bank.


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Surprisingly, the deal was cancelled in June 2008 and it was announced that the privatization

of the Bank would be postponed, as the bids presented were below the minimum price set

for acquisition.

Two of the competing banks, Saudi Samba Bank and the British Standard Chartered Bank,

were disqualified and did not participate in the bid. National Bank of Greece presented

the highest bid, at US$1.4bn, followed by Mashreq Bank and the consortium composed of

the Jordanian Arab Bank group and the Saudi Arab National Bank, presenting a price of

US$0.9bn and US$0.8bn, respectively.

Though the cancellation of the deal was surprising and raised questions regarding the reasons

for not undergoing the privatization procedures, this event ensures the existence of inherent

opportunities in the Banking sector, as the government viewed that the presented bids did not

meet the real value of the Bank.

Furthermore, the government announced that it was not planning to privatize the two

remaining public banks (NBE and BM) in the coming five years to let the banks strengthen

their institutional performance.


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Financial Performance of the Banking Sector

Performance Positively Affected by Reforms

The reforms taking place in the Egyptian banking sector since 2004 had positively influencedthe performance of the banks in terms of improved consolidated assets and liabilities and

resulting performance ratios. The period under analysis in our report is from 2002/03 to

2006/07 to show how the adopted reforms positively affected the banks performance. We

will analyze the development of the consolidated assets, liabilities, deposits, loans of the

banking sector, along with some performance indicators.

Increased Money Supply

The acceleration of the Egyptian economy, accompanied by the banking sector reform

program, stimulated investments in various business sectors leading to an increase in the

money supply in the market, which was translated into the incline of the consolidated assets

and liabilities of the banking system.

Domestic Liquidity (M2) increased by 18.3% y-o-y in 2006/07, reaching LE662.7bn,

compared to LE560.4bn in 2005/06. Narrow Money Supply (M1), represented by currency

in circulation and demand deposits in local currency, rose by 20.1%, reaching LE131.3bn,

while Quasi Money, which consisted of time and saving accounts in local currency along

with demand, time and saving deposits in foreign currency, moved up by 17.8% reaching

LE531.4bn in the same year.

Chart 02: Domestic Liquidity Development

-

100,000

200,000

300,000

400,000

500,000

600,000

700,000

2002/03 2003/04 2004/05 2005/06 2006/07

LEmn

M1 Quasi Money


Vast Funding Base

The increased money supply in the banking system was reflected in rising figures of the

aggregate assets and liabilities. The funding base, representing the key driver for the banks

good performance has ameliorated in 2006/07 by 23.2% y-o-y, reaching LE937.9bn,

compared to LE761.6bn in 2006.


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Table 06: Aggregate Systems Liabilities

In LEmn 2002/03 2003/04 2004/05 2005/06 2006/07

Capital 18,155 20,346 22,949 27,112 33,037

Reserves 11,805 11,454 12,419 13,418 12,552Provisions 40,099 44,584 49,541 54,950 53,469

Long-term loans and bonds 14,866 15,012 14,254 17,526 26,351

Obligations to banks in Egypt 35,579 29,933 22,671 21,488 82,619

Obligations to banks abroad 16,247 10,332 12,262 8,770 10,006

Total deposits 403,144 461,697 519,649 568,841 649,953

Other liabilities 38,043 40,078 49,883 49,457 69,936

Total Liabilities 577,938 633,436 703,628 761,562 937,923


Since 2002/03, total deposits have been the major component of the banking system liabilities,

reaching around LE650bn in 2006/07 and representing 69.3% of total liabilities.

Chart 03: Composition of Aggregate Liabilities-2006/07

Capital 3.5%Other liabilities 7.5% Reserves 1.3%

Total deposits 69.3%

Provisions 5.7%

Long-term loans and bonds 2.8%

Obligations to banks abroad 1.1%

Obligations to banks in Egypt 8.8%


Deposits Moving Up

The aggregate deposits balance of the banking system, including government deposits,

grew at a 15.2% y-o-y in 2006/07. The main driver behind the increase in total deposits wasthe escalating non-government deposits, which grew by 18.8% y-o-y in 2006/07, reaching

approximately LE581.3bn and representing 88.3% of the total deposits.


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Chart 04: Government and Non-Government Deposits Growth

0

100

200

300

400

500

600

700

2002/03 2003/04 2004/05 2005/06 2006/07

LEbn

Total Government Deposits Total Non-Government Deposits


It is worth mentioning that deposits in local currency represented 71.6% of total deposits in

the banking system in 2006/07, while deposits in foreign currency represented 28.4% in the

same year. The household sector contributes to 75.5% of total non-government deposits in

local currency and 62.9% in foreign currency. The private sector comes second with 18.2%

in local currency and 31.4% in foreign currency.

Chart 05: Non-Government Deposits in Local

Currency in 2006/2007 (Including cheques and

drafts)

Chart 06: Non-Government Deposits in Foreign

Currency in 2006/2007 (Including cheques and

drafts)

Public Sector5.5%

Private

Sector

18.2%

Household

Sector

75.5%

Non-Residents0.8%

Public Sector

4.3%

Private

Sector

31.4%

Household

Sector

62.9%

Non-Residents

1.4%


Rise in Deposits Reflected on Total Assets

The aggregate banking system figures in 2006/07 illustrate remarkable growth in total assets

on the back of the realized incline in the sources of funds, namely deposits. Total assets grew

by 23.2% y-o-y, reaching LE937.9bn. Looking at the components of assets, we realize that

the securities and investments in treasury bills declined by 9.2% in 2006/07 and the loans and

discount balances went up by the same percentage, which can be explained by the decrease in

treasury bills yields, which was compensated by the increase in lending rates.


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Table 07: Aggregate Systems Assets

In LEmn 2002/03 2003/04 2004/05 2005/06 2006/07

Cash 5,557 5,412 6,594 6,813 7,705

Securities and investments in treasury bills 111,337 137,431 170,659 193,965 176,098

Balances with banks in Egypt 110,874 116,290 124,986 121,695 217,363

Balances with banks abroad 29,798 43,290 51,204 72,554 124,366

Loans and discount balances 284,722 296,199 308,195 324,041 353,746

Other assets 35,650 34,814 41,990 42,494 58,645

Total Assets 577,938 633,436 703,628 761,562 937,923


Loans and advances have always captured the lions share of the banking systems total assets.

The growth in total assets in 2006/07 was mainly driven by the acceleration of the loans and

discount balances, constituting 37.7% of the total aggregate asset base of the sector.

Chart 07: Composition of Aggregate Assets-2006/07

Cash 0.8%Other assets 6.3%Securities and investments in

treasury bills 18.8%

Balances with banks

in Egypt 23.2%

Balances with banks

abroad 13.3%

Loans and discount

balances 37.7%


Growing Loans Books

Egyptian banks benefited strongly from the large available funding base to expand their

lending capabilities in 2006/07. Loans books witnessed a y-o-y growth of 9.1%, which was

stimulated by the reforms that have been occurring in Egypt over the past few years, impacting

various sectors, where the need rose for loans to fund necessary investments. Alternatively,

the reforms that took place in the banking system positively affected the banks performance

and enhanced their ability to fulfill required loans.


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Chart 08: Loans Growth

280

290

300

310

320

330

340

350

360

2002/03 2003/04 2004/05 2005/06 2006/07

LEbn


Government loans in 2006/07 accounted for a minor fraction of the total loans in the banking

system, representing only 7.6% and amounting to LE26.7bn, while the major component,

consisting of 92.4% of total loans consisted of non-government loans reaching LE325.8bn.

On the other hand, loans denominated in local currency represented 70.3% of the total loans

in the same year.

Most of the non-government loans in 2006/07 went to the industrial sector, as this sector

contributed to 31.3% of the non-government loans in local currency and 41.1% in foreign

currency. Then comes the services sector with 26.3% of loans in local currency and 36.7%

in foreign currency. It is worthy to note that the retail lending represented only 17.0% of the

total loans in 2006/07, which could be explained by the huge risk associated with lending

to individuals compared to institutions, as probability of default is much higher. Besides,

information on the financial position of borrowers was not yet available, but should be

accessible shortly, as the credit bureau that will be responsible for gathering data on the

financial position of the banks clients has been recently established. When such information

will be available, retail lending is expected to ameliorate, especially with the huge unfulfilled

demand for loans in the household sector.

Chart 09: Non-Government Loans in Local Currency-

2006/07

Chart 10: Non-Government Loans in Foreign Currency-

2006/07

Agriculture Sector

2.9%

Industry Sector

31.3%

Trade Sector

15.8%

Services Sector

26.3%

Household &

External Sector

23.7%

Agriculture Sector

1.0%

Industry Sector

41.1%

Trade Sector 13.2%

Services Sector

36.7%

Household & External

Sector 8.1%



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Projected Banking Figures

We assumed future figures of the Egyptian banking system based on the forecasted figures

of GDP by the International Monetary Fund. We took the average of the annual M2 as a %

of GDP to project future balances of M2. We also projected future deposits balances based

on the annual average of deposits/M2. It is worth mentioning that we have added a slight

premium to this ratio to take into account the expected increase in deposits balances, as a

result of the amendments on the corridor range. In addition, we projected future loans based

on the average of the annual loans/deposits ratio, with a minor incline to reflect the increase

that is expected to occur in loans balances as well.

Table 08: Projected Figures of the Banking System

In LEmn Jun-05 Jun-06 Jun-07 Jun-08 E Jun-09 E Jun-10 E Jun-11 E

GDP 538,528.0 617,676.4 731,201.6 857,633.0 1,005,339.0 1,161,365.0 1,337,537.0

M2 493,884.0 560,356.0 662,688.0 780,617.6 915,059.6 1,057,074.4 1,217,426.2

% of GDP 91.7% 90.7% 90.6% 91.0% 91.0% 91.0% 91.0%% change y-o-y 13.5% 18.3% 17.8% 17.2% 15.5% 15.2%

Deposits (including

government deposits)521,745.0 571,461.0 658,215.0 819,648.4 960,812.5 1,109,928.1 1,278,297.5

% of M2 105.6% 102.0% 99.3% 105.0% 105.0% 105.0% 105.0%

% change y-o-y 9.5% 15.2% 24.5% 17.2% 15.5% 15.2%

Loans 308,195.0 324,041.0 353,746.0 463,148.4 576,487.5 665,956.9 766,978.5

Loans/Deposits 59.1% 56.7% 53.7% 56.5% 60.0% 60.0% 60.0%

% change y-o-y 5.1% 9.2% 30.9% 24.5% 15.5% 15.2%

Source: International Monetary Fund, CBE and GlobalResearch

Performance IndicatorsAs illustrated in the previous section, the banking reforms have positively influenced the

performance of the banking sector, which was shown by the acceleration of the aggregate

banking system figures over the period from 2002/03 to 2006/07. To highlight the effect of

these reforms, we will present some performance indicators, including interest rate spread, a

couple of profitability ratios and loans/deposits ratio.

Interest Rate Spread

The interest rate spread is the best indicator to show banks performance, as it illustrates the

income generated from core banking activities.

This income is generated through realizing a spread between the lending rate and the cost of

funds, represented by interest rates on different deposits. The spread has been relatively stable

over the last 4 years, as the rates are more or less moving together in the same direction.

Banks generate additional income through other sources, one of which is reaping fees and

commissions from lending activities and contingent liabilities offered to clients, in addition

to fees from investment banking activities. Banks have other sources of income, but these are

volatile. These sources encompass dividend income, gains on sale of financial investments,

profits realized from foreign exchange operations, financial investments valuation differences

and other items.


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Chart 11: Interest Rate Spread

5

6

7

8

9

10

1112

13

14

2003/04 2004/05 2005/06 2006/07

%

Less than three-months deposits Less than six-months depositsLess than one year deposits Loans of one year or less


ROAA and ROAE Moving Positively

Profitability of the banking sector, measured by Return on Average Equity (ROAE) and

Return on Average Assets (ROAA), have been positively affected by the reforms in the

sector and the economy as a whole. ROAE and ROAA moved in an upward trend since

2003/04, reaching 14.3% and 0.8% in 2006/07, up from 9.8% and 0.5%, respectively.

Chart 12: Profitability Indicators (2003/04-2006/07)

8.0

9.0

10.0

11.0

12.0

13.0

14.0

15.0

2003/04 2004/05 2005/06 2006/07

%

0

0.1

0.2

0.3

0.4

0.50.6

0.7

0.8

0.9%

ROAE ROAA (right scale)


A Significantly Unleveraged Sector

Total loans witnessed a modest CAGR of 5.6% over the period from 2003/04 to 2006/07,compared to a CAGR of 14.6% in total deposits. As a result, the loans/deposits ratio declined

from 64.2% to 54.4%. This implies that banks are still reluctant to use great portions of

deposits in providing loans and having to bear the risk of default. Alternatively, banks prefer

to invest more of their funds in less risky assets like treasury bills and other investments,

while they have to abide by the minimum required liquidity ratio. They have to keep a

minimum of 20% in liquid assets denominated in local currency and 25% in foreign currency.

Meanwhile, the tax exemption previously exerted on treasury bills pushed banks to augment

their investments in these instruments and put a break on their lending activity. This was

another reason leading to the decline of the loans/deposits ratio.


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As these practices were far away from the core banking activities, the government decided in

May 2008 to remove the tax exemption shield on treasury bills gains, in an attempt to push

banks to expand their lending facilities and restrain from investing their funds in a way that

deviates from their core business. The tax exemption on treasury bonds was also cancelledafterwards.

In the meantime, the relatively low loans/deposits ratio indicates that banks have enough

room if they decide to direct more of their funds to lending opportunities.

Chart 13: Loans/Deposits Ratio Development

52.0

54.0

56.0

58.0

60.0

62.0

64.0

66.0

2003/04 2004/05 2005/06 2006/07

%


CBE and Regulatory Intervention

Inflation on the Rise

As described earlier, the growth in the Egyptian economy since 2004 led to an enhanced

investment climate and increased money supply. This in turn led to a rise in aggregate

demand and consumption, uncoupled with local production, resulting in soaring commodity

prices. Simultaneously, the improvements achieved in many sectors resulted in increased

raw material prices. Meanwhile, economic growth decreased the rate of unemployment

and raised demand for labor, shifting wages upward. In addition, the increase in food and

energy prices internationally was reflected on domestic prices. All these factors combined

attributed to hiking prices and inflation reaching 23.6% in August 2008, compared to 6.9%

in December 2007.

Tight Monetary Policy Targeting Inflation

The Unified Banking Law of 2003, which identified the various functions of the CBE, gave ita free-hand to implement the appropriate monetary policy. The policy adopted by the CBE is

a tight one aiming at decreasing inflation, which if not adjusted would harm the economy.

Counteracting Inflation through the Corridor Range

In 2005, the CBE decided that its main tool to adjust inflation would be the overnight deposit

and lending rates at the CBE, which is the corridor range that is adjusted every six weeks

according to the MPC meeting. In 2005, deposit and lending rates at the CBE were set at

9.5% and 11.5%, respectively. In June 2006, rates were readjusted to be 8% and 10%. The

MPC continuously amended the corridor range, in response to the accelerating inflation. Of

late, precisely in September 2008, the deposit and lending rates stood at 11.5% and 13.5%,

respectively, as the inflation reached 23.6% in August 2008.


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Chart 14: Development of the Inflation and Corridor Range

7.2

8.6

6.9

14.4

16.4

19.7 20.2

10.5

12.1

4.7

22.1

23.6

4

9

14

19

24

29

June-05

June-06

June-07

December-07

January-08

February-08

March-08

April-08

May-08

June-08

July-08

August-08

September-08

%

Deposit Rate at the CBE Lending Rate at the CBE Inflation Rate


Will the Tight Monetary Policy Succeed in Targeting Inflation?

It is not certain whether the restrictive monetary policy will succeed to decrease the inflation

rate, especially in the short run, as the government plans to expand the growth of the economy

could alternatively lead to higher levels of inflation. Besides, the fiscal policy is contradicting

with the monetary policy, where the governments plan to decrease its expenditures through

cutting subsidies, especially those concerning the energy intensive industries, in addition to

removing some tax exemptions, could have a significant impact on rising prices and thus

increasing inflation. Nevertheless, if inflation continues to rise, which will mostly be the

case, the CBE is expected to further raise interest rates gradually.

Combined Effect on Interest Rate Spread

Not surprisingly, many banks have raised the interest rates on their deposits, following the

consecutive climbs of the corridor range. This is expected to be followed by a similar or

greater increase in rates posed on the banks loans. Albeit the banks will be able to widen

their spread in 2008 and 2009, as a result of these practices, it is plausible that spreads will

contract thereafter, as a result of the intensifying competition in the sector. This competition

will push banks to decrease the rates on loans, while posing higher rates on deposits to be

able to maintain their market shares, which will be negatively reflected on the banks interest

rate spread.

The same goes for treasury bills yields, as they are expected to grow higher till 2009,compensating for the removed tax shield, then to decline afterwards, as banks will probably

be less relying on these instruments in their investment portfolios.


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Chart 15: Lending Rates vs. Treasury Bills Rates

12.5 12.7

13.413.1

12.512.0

6.9

9.09.4

8.7 8.5 8.5

6

7

8

9

10

11

12

13

14

2007 2008 E 2009 E 2010 E 2011 E 2012 E

%

Commercial banks lending rate (average) 3-month Treasury-bill rate (year-end)

Source: Economic Intelligence Unit, GlobalResearch

Other CBE Tools of Regulatory Intervention

The most important regulations of the CBE governing the banking sector are those related to

liquidity, reserves, extended credit, capital adequacy and provisions. These are presented in

more details below.

Capital Adequacy

The Unified Banking Law of 2003 requires banks in Egypt to raise the ratio of capital

adequacy from 8% to 10%.

Minimum Paid-In Capital

The Unified Banking Law of 2003 also obligated banks to raise their minimum paid-incapital from LE100mn to LE500mn, which was the main motive for small local banks and

poor performers to opt for the mergers and acquisitions in the last few years.

Reserve Requirement

Banks are required to keep 14% of their deposits denominated in local currency as reserves

with the CBE to provide enough liquidity in case deposits are withdrawn by customers. It is

worthy to note that these reserves are not interest earning.

This explains why banks seek to invest their excess liquidity in interest earning instruments

like treasury bills and other government securities to decrease their cost of unused funds.

Though banks should focus on exerting more lending activity and orienting fewer funds to

investments in treasury bills, this has not been the case for several years, due to the banks

unwillingness to get exposed to the risk of default.

It is worth mentioning that banks should also keep 10% of their deposits denominated

in foreign currency as reserves with the CBE, but these reserves earn interest related to

LIBOR.

Liquidity Ratio

Banks must keep at least 20% liquid assets denominated in local currency and 25% of assets

denominated in foreign currency.


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Extending Credit

Banks must not extend credit to a single borrower in excess of 20% of the banks book

value. In addition, banks are not allowed to extend credit to one particular borrower and his

affiliates in excess of 25% of the banks total equity.

Provisions

Banks are required to keep provisions according to the credit risk level associated with each

loan. Loans are classified into two categories related to regular and irregular settlements. For

regular settlements, loans are categorized under many risk levels ranging from low to watch

list risk, where each level has a corresponding provision required rate ranging from 0% to

5%. For irregular loans, they are classified into three types, substandard debt, for which a

20% provision must be kept, doubtful debt, with a required 50% provision. Finally, loss debt

must have a 100% provision. More conservative banks usually keep higher provision rates

than required.

Untapped Segments as Key Prospects

Retail Segment

The retail banking activities in Egypt are considered an unexploited segment, promising high

potentials for the banking sector. There is a great unfulfilled demand for banking activities in

this sector. This comes from the fact that large percent of the population, which amounted to

75mn in 2006/07, after a 2% y-o-y increase, still does not participate in banking activities or

even have a slight participation, which could be a result of low income levels or not enough

understanding of the importance of banking activities. Moreover, 61.1% of the population

is in the working age, which implies further increase of demand of the retail segment in the

future. From the banks side, they have always been reluctant to direct great portions of

their loans to individuals fearing of the risk of default, but this is expected to change in thefuture, especially after the establishment of the credit bureau that should facilitate the flow of

necessary information to banks concerning clients history and would therefore minimize the

risk of default. Lending to individuals is only provided according to salaries and usually not

exceeding 20% of the monthly salary.

Currently, a large number of banks are expanding their branch networks to fulfill unsatisfied

needs from the retail segment. As of March 2008, there were 3,252 branches in Egypt with

each branch serving an average of 23.1 thousand people.

As for branch network, it is important to note that around 65% of the existing branches

in Egypt are owned by the public banks. Some of the private banks that announced their

intention to expand their branches were Commercial International Bank, National Societe

Generale Bank, BoA, Audi, HSBC, Piraeus, Blom, Barclays, Export Development Bank of

Egypt, BNP Paribas and Credit Agricole.

SMEs Segment

Small and Medium Enterprises SMEs are defined as companies whose revenues do not

exceed LE1mn. Banks are usually hesitant to lend to SMEs due to the high risk associated

with these companies, in terms of lack of adequate capital and assets, in addition to the fact

that they are usually not registered. As for the SMEs, interest rates could be high, making

the cost of finance through banks higher. These factors explain the low banking penetration

of this segment.


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Recently, the government encouraged the registration of SMEs, which could reduce the

reluctance of banks to SMEs lending, through the provision of collateral. If this happens,

along with the presence of the credit bureau and its role in minimizing default risk, growth

potential in this segment is expected to be high, as banks will be able to expand their bankingactivities for this sector and hence increase their client base, enabling them to realize higher

margins.

Mortgage Segment

The Mortgage Financing Law was launched in Egypt in 2001. Mortgage loans represent

a small fraction of banks loans due to many factors. The fact that most properties were

not registered due to high registration fees, made banks hesitant to extend mortgage loans,

fearing of loans default, especially that unregistered properties could not be used as collateral.

Another factor can be attributed to the high rates on mortgage loans reaching 14%, coupled

with low purchasing power and low wages.

In 2005, the government reduced the registration fees on properties to 3% down from 12% of

the propertys price or a maximum fee of LE2,000. Also, property taxes were cut from 46%

to 10% of the annual rental value. Such regulations should facilitate property registration

and thereby would give more confidence to banks or mortgage finance companies to extend

mortgage loans now that they can rely on registered properties as collateral. Moreover,

developers are now targeting middle and upper-middle class level, which may facilitate

mortgage lending in the coming few years.

Mortgage lending opportunities are expected to boost, after the establishment of the

governmental institution the Egyptian Company for Mortgage Refinancing, along with the

emergence of new lending mortgage companies, in addition to the newly established credit

bureau.

The potential growth expected in the mortgage segment induced the CBE to allow banks

increasing the share of loans allocated to the real estate sector from 5% to 15% of their total

loan books, to be equally distributed among real estate developers, mortgage borrowers and

touristic development companies.

An Additional Key Prospect

The restructuring that occurred following the banking sector reform program, resulted in a

reduction of the number of banks from 61 banks in 2004 to 41 banks in 2007 and raising the

number of branches from 2,783 branches to a current number of 3,252 branches.

The major influence on the sector was the heating competition among lenders, which

accelerated substantially in the last few years, especially with the emergence of foreign

expertise. To boost competency, most banks currently provide a wide range of products and

services including house and car loans, credit and ATM cards services, automated machines

and 24-hour services, capital markets and investment banking activities, along with the

traditional banking activities. This intense competition is expected to enhance the banks

profitability by attracting greater client base through providing better quality of products and

services to the public.


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Issues to be Considered

As the Egyptian banking sector was ruled by the public sector banks for decades, the service

was never an issue. These banks were serving the government in financing mainly public

enterprises. Now that most of the banks became private, ameliorating the service became a

must in order to boost, or at least maintain their market shares.

Another important issue is the dissemination of information to the public. As most of the

banks are publicly traded now, there is a need for a minimum of disclosure for shareholders

about the banks operations and performance in any given period. Still the fear of fierce

competition stops banks from operating liberally.

The sector is shaping and these issues will improve with competition, which pours at the end

in the clients interests.


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Peer Group Comparison

Banks Current Market Shares of The Total Branching Network

As of March 2008. The banking system branch network encompassed 3,252 branches. Itis worthy to note that public banks and other private banks outside our coverage universe,

account for 90% of the branching network, approximately.

As for our covered banks, Commercial International Bank CIB captures the highest market

share, represented by 4.2%, which is explained by the long presence of the Bank in the

market, relative to the other banks. National Societe Generale Bank NSGB followed, with

a market share of 3.6%.

Chart 16: Banks Branches Market Shares

CIB 4.2%

NSGB 3.6%

CAE 1.6%

EGBE 0.3%

EDBE 0.3%

Public & other Private

Banks 89.9%

Source: GlobalResearch

Balance Sheet Performance

Major Source of Funds

In terms of deposits market share, also CIB was able to make the highest contribution to the

total deposits of the banking system, 6.0%, followed by NSGB, contributing to 4.8% of total

deposits.

On the other hand, the highest growth realized in deposits over 2007, was performed by

Credit Agricole Egypt CAE, which witnessed a 36.5% increase. This stems from the banks

intention to increase its market share, as it stood at 2.6% in H1 2008, lagging far behind the

two major players, CIB and NSGB.


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Chart 17: Deposits market shares-H1 2008 Chart 18: Deposits Growth (2006-2007)

CIB 6.0%

NSGB 4.8%

CAE 2.6%

EGBE 1.1%EDBE 0.5%


Banks 85.0%

25.1%

18.0%

36.5%

21.4%

13.0%

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

CIB NSGB CAE EDBE EGBE

LEmn

0%

5%

10%

15%

20%

25%

30%

35%

40%

Deposits-2006 Deposits-2007 % change y-o-y (right scale)

Source: Banks financials, GlobalResearch

Comparative Growth in Balance Sheet

Not surprisingly, the major contribution to total assets came from the two largest banks,

CIB and NSGB, contributing to 5.2% and 4.1% of the total assets of the banking system,

respectively. This was attributed to the large funding base of these banks, which was founded

on the relatively immense deposits balances.

In the mean time, the highest y-o-y growth in deposits that CAE was able to realize in 2007,

was translated into the highest growth realized in total assets in the same year, as well. That

said, total assets of CAE swelled by the same growth of deposits realized in 2007.

Chart 19: Total Assets Market Shares-H1 2008 Chart 20: Total Assets Growth (2006-2007)

CIB 5.2%

NSGB 4.1%

CAE 2.1%

EGBE 0.5%

EDBE 1.2%


Banks 87.0%

27.2%

19.8%

36.5%

19.7%

11.9%

-

10,000

20,000

30,000

40,000

50,000

60,000


LEmn

0%

5%

10%

15%

20%

25%

30%

35%

40%

Total assets-2006 Total assets-2007 % change y-o-y (right scale)

`


Resulting Acceleration in Lending Activity

As for loans, major share went to the two large players, as well. CIB and NSGB contributed

to 6.4% and 6.1% of the total loans in the banking system, respectively.

The major growth in loans over the year was realized by NSGB and CAE, realizing 22.8%

and 22.5%, respectively. This illustrates the two banks target of expanding their market

shares, relative to their peers.


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Chart 21: Loans Market Shares-H1 2008 Chart 22: Loans Growth (2006-2007)

CIB 6.4%

NSGB 6.1%

CAE 1.8%

EGBE 0.7%

EDBE 1.9%


Banks 83.1%

16.7%

22.8% 22.5%20.8%

39.3%

-

5,000

10,000

15,000

20,000

25,000


LEmn

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Loans-2006 Loans-2007 % change y -o -y ( righ t sca le )


Most Conservative While Having Lowest NPLs RatioAlthough CIB has the lowest NPLs ratio, 3%, it adopts the most conservative provisioning

policy, as its coverage ratio stood at 166% in 2007. It is worth mentioning that the NPLs

ratios of NSGB and CAE are magnified, as they inherited bad debts from the acquisitions of

MIBank and EAB, respectively. Nevertheless, they are performing well, as their coverage

ratios are close to 100%.

Chart 23: Provisioning Policies Adopted-2007

19.6%24.2%

9.0%9.6%

3.0%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%


Coverge Ratio NPLs/Gross Loans


Income Statement Performance

Spreads were suppressed over the year

Net spread, representing the core income of banking activity, has narrowed for almost all

banks under coverage in 2007, except for CAE and Export Development Bank of Egypt

(EDBE), as it inclined from 2.7% to 2.8% and from 1.5% to 1.6%, respectively. The decline

in spreads could be a result of the intensifying competition. Nevertheless, we expect spreads

to rise until 2009, as a response to the successive jumps in the corridor range. Beyond 2009,

the spreads are projected to decline, as a result of the foreseen competition.


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As a consequence, net interest margin decelerated over the year for almost all banks, except

for EDBE, which was able to raise its margin from 2.2% in 2006 to 2.5% in 2007.

Table 09: Net Interest Margin and Net Spread

Net Interest Margin Net Spread

2006 2007 2006 2007

CIB 3.5% 3.5% 3.9% 3.9%

NSGB 4.1% 3.3% 4.3% 3.3%

CAE 3.0% 3.0% 2.7% 2.8%

EDBE* 2.2% 2.5% 1.5% 1.6%

EGBE 3.3% 2.8% 2.8% 2.3%

Source: Banks Financials, GlobalResearch

* EDBEs fiscal year ends in June.

Growing Profits

Looking at net profit, we realize that all banks witnessed increases in their net income, except

for EGBE, as its income grew at lower pace than the previous year, as a result of higher added

provisions. On the other hand, the highest growth was realized by EDBE, which income rose

by 104.6% in 2007. This growth was amplified, as the Bank realized losses the previous

year. These losses were due to the large amount of provisions added that year, as required by

the CBE. It is worth mentioning that growth in net income is calculated after adjusting for

extraordinary items and goodwill amortization.

Chart 24: Net Profit Growth (2006-2007)

36.6%

2.8%

60.7%

104.6%

-17.3%

-400

-200

0

200

400

600

800

1000

1200

1400


LEmn

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

2006 2007 % change y-o-y (right scale)

`


Profitability Ratios

Regarding profitability ratios, the best performers were the two largest banks along with

CAE. In terms of ROAA, CAE was the best performer followed by CIB then NSGB, where

each one realized a ratio of 3%, 2.7% and 2.5% respectively.

Concerning ROAE, NSGB realized the highest ratio, which stood at 40.5%, followed by

CAE and CIB, with 38.1% and 30%, respectively. It is worthy to note that these ratios are

adjusted for extraordinary items and goodwill amortization.


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Chart 25: Profitability Ratios-2007

2.7% 2.5% 3.0%

0.1% 1.4%

30.0%

40.5%

38.1%

1.0%

10.7%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%


ROAA ROAE


Capital Adequacy Ratios

The Egyptian Gulf Bank EGBE was able to realize the highest equity/total assets ratio in

2007, as it stood at 13.4%. This could be explained by the fact that the Bank has the lowest

market share of total assets, compared to its peers, reaching 0.5%.

In the mean time, equity/gross loans ratio was the highest in CAE, as it reached 30.4%. This

in turn can be explained by the relatively low market share of the Bank, in terms of the loans

of the total banking system relative to other players, as it ranked fourth in 2007, with a market

share of 1.5%.

Chart 26: Capital Adequacy Ratios-2007

9.2% 9.1%7.3%

9.8%

13.4%

0%

5%

10%

15%

20%

25%

30%

35%


Equity/Gross Loans Equity/Total Assets


Banks Performance in H1 2008

The following table summarizes the performance of the banks under coverage during H1

2008, in terms of growth in assets and in net profit.


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Table 10: H1 2008 Performance

Assets (LEmn) Net Profit (LEmn)

2007 H1 2008 q-o-q change H1 2007 H1 2008 y-o-y change

CIB 47,763.2 56,342.7 18.0% 663.4 961.7 45.0%NSGB 47,256.7 44,233.3 -6.4% 339.3 549.4 61.9%

CAE 21,521.1 22,253.2 3.4% 211.5 215.5 1.9%

EDBE* 8,782.9 13,376.1 52.3% 7.5 310.7 4026.9%

EGBE 5,135.0 4,917.2 -4.2% 65.2 67.0 2.7%


* EDBE results are for the FYE June 2008, compared to the FYE June 2007.

Banking Sector Outlook

With the banking sector being primarily influenced by the economic status of the country,

we maintain a positive outlook for the sector in Egypt. As GDP is expected to reach 7.4%in 2008, compared to 7.1% in June 2007, we believe the banking industry in Egypt will

be significantly enhanced. An accelerated growth of GDP will tempt investors to explore

investment prospects, which represent potential lending opportunities to the banking sector.

Moreover, improvements in several business sectors including tourism, real estate,

telecommunication and financial services, will be translated into better investments in the

country, as projects will expand in such sectors and financing needs will grow and thus better

lending opportunities will be available for the banking sector, especially with the current

extremely low loans/deposits ratio.

Meanwhile, these developments will attract foreigners to invest in the country, which willresult in better Foreign Direct Investment (FDI). The latest figures support our opinion, as

the FDI increased by more than 100% y-o-y from 2004/05 to 2005/06, then rose by 44%,

amounting to US$13.1bn in 2006/07. This improvement came on the back of the growth

experienced in the economy and the various sectors mentioned previously.

Alternatively, demographics outlook support the sectors potential. With a population CAGR

of 2% over the 5-year period from 2001/02 to 2006/07 and the fact that large percentage of

the population is not engaged in the banking activity, the huge unfulfilled demand in the

retail segment is expected to increase and sequentially be absorbed by the sector in the form

of retail lending and mortgage financing. Banks will be encouraged to explore such fields

together with lending to SMEs, as risk of default will be diminished, especially after theestablishment of the credit bureau.

In addition, most of the banks are currently updating their IT systems and expanding their

branch networks to improve their competency. This is expected to have a positive impact on

the quality of products and services provided to the public, which will increase the client base

coverage and will therefore enhance the banks profitability.

Though we believe the sector in Egypt has a promising growth, resulting from the inherent

opportunities in the unexploited segments, there is a prevalent discomfited sentiment for the

sector, stemming from the cancellation of the sale of Banque du Caire, in addition to the fail

of the merge between CIB and AAIB.


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The rising inflation rate in Egypt has been reflected in higher costs of equities for Egyptian

banks valuations.

Valuation & RecommendationFor arriving at the fair value of the banks under review, we have used two valuation

methods:

1. Cash flow approach represented by the Dividend Discounting Model.

2. P/BV target multiple approach using an adaptation of the Gordon Growth Model.

Dividend Discounting Model - DDM

The DDM is based on a 4-year forecast of dividends as cash flows (2008-11), except for EDBE

Bank, as the Banks fiscal year ends in June 2008. That is why we have made a projection

period for the Bank from 2008/09 to 2011/12. The dividends for the forecast period and the

terminal value are then discounted back at the cost of equity to arrive at the total net present

value (NPV) of the company. In our calculations, we have made the following assumptions

in order to arrive at the equity value of individual banks:

1. Cost of Equity (COE) derived using Capital Asset Pricing Model.

a. Risk free rate of 8.4% (YTM of 2011 government bonds), except for EGBE, as we

used a risk free rate of 4.7% (YTM of 2011 sovereign Eurobond) and EDBE, as we

used the rate of 8.8% (YTM of 2012 government bonds)

b. Market risk premium of 7.8% for all banks and 6.5% for EGBE, taking into

consideration that the Banks stock is traded in US

egypt banking sector 2008 gih

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