JCR-VIS Credit Rating Company Limited Affiliate of Japan Credit Rating Agency, Ltd.

Rating Report

July 3, 2007
Analysts: Sobia Maqbool Faryal Ahmad Latest AA+/A-1+
Jun 28, 07

United Bank Limited

Chairman: HH Shaikh Nahayan Mabarak Al Nahayan President & CEO: Mr. Atif R. Bokhari

Rating Rationale
Category Entity TFC 1
Rs. 2.0b

Previous AA/A-1+
Jun 23, 06

AA
Jun 28, 07

AAJun 23, 06

TFC 2
Rs. 2.0b

AA
Jun 28, 07 Jun 28, 07

AAJun 23, 06 Sept 6, 06

United Bank Limited (UBL) was privatized in 2002 with Abu Dhabi Group (UAE) and Bestway Group (UK) each acquiring 25.5% shares and management control in the bank. The Government of Pakistan (GoP) held 44.7% shares at year-end 2006, having divested approximately 4.2% to the public when the bank was listed on the exchanges in 2005. Another 20-25% is being divested by the GoP to international investors through a GDR offering. Paid-up capital of UBL was increased by way of bonus issue during FY06. Along with healthy reserves and retained earnings, UBLs total net worth, adjusted for final cash dividend, increased to Rs. 27.9b (FY05: Rs. 20.4b). Despite rapid business growth and the resultant increase in risk assets, capital adequacy ratio (adjusted for dividend payout) improved to 10.5% (FY05: 8.7%) at year end FY06. At 7.3% tier-1 capital adequacy is also considerably above the minimum required 4%. Deposit base of the bank increased by approximately 16% to Rs. 335.1b (FY05: Rs. 289.3b) as at December 31, 2006, with significant increase coming through the fixed deposit schemes. As UBL has a growing international presence, almost 19% of the total deposit base is mobilized from the overseas branches and contributed almost 52% to the growth during FY06. This growth is mostly manifested in relatively higher cost deposits. Non-remunerative current accounts and low cost saving accounts together still constitute 63% of the total deposit base. Overall deposit base remains diversified with the top 100 depositors accounting for 18.8%. Liquid assets as a proportion of total borrowings and total assets increased to 41% (FY05: 39.5%) and 36.8% (FY05: 35.8%) respectively by year-end FY06. Liquidity indicators have remained consistent over the last two years. Net advances increased to Rs. 247.3b (FY05: Rs. 204.8b) during 2006. Both corporate and consumer lending have contributed to the growth achieved during FY06. The banks consumer portfolio is one of the largest in the sector at Rs. 44.5b (FY05: Rs. 28.3b), where the auto product has acquired a significant market share. Overseas operations have also contributed to this growth. While increase in overseas operations has a risk benefit in terms of increased geographical diversification, the bank has taken some fairly large exposures. Although there has been growth in NPLs, overall portfolio quality indicators have improved with net infection reducing to 1.1% (FY05: 1.2%) and 10.2% (FY05: 14.1%) as a proportion of tier-1 capital. Increasing markup rates on the banking book, resulted in a substantial widening of spreads (FY06: 5.4%; FY05: 4.5%) and drove interest based earnings to new highs. Profitability was also supported by increased fee and commission based income. Though administrative expenses increased in absolute terms, efficiency indicators improved to 39% compared to 41% in the preceding year. Basic ROAE and ROAA also improved to 63% (FY05: 54%) and 4.2% (FY05: 3.4%) respectively with an increased overall revenue base for the year. Though funding cost may rise given the increased competition in the market; assuming steady growth, profitability indicators are likely to remain strong.

TFC 3
Rs. 2.0b

AA

AA-

Outlook Stable Stable Key Financial Trends

Key Financial Trends

80 60 40 20 0 2004 2005 2006

*Basic ROAE%

ROAE%

Efficiency%

* based on recurring profit before provision and taxation

400.00 300.00 200.00 100.00 0.00 2004 2005 2006

Rs. Billion

Earning Assets
100

Loans

Deposits

10

1 2004
CAR (%) Net Infection (%)

2005

2006

Net NPL%Tier 1 Capital

Overview of the Institution

UBL operates with a network of 1,059 branches (including 15 overseas branches) and employed 9,738 staff members as at December 31, 2006. Apart from its overseas branches, the bank has presence in Switzerland and UK through its subsidiaries, United Bank AG Zurich and United National Bank Limited, and in Oman through an associate - Oman United Exchange Company in which UBL has 25% shareholding, with management control J C R -V IS
Information herein was obtained from sources believed to be accurate and reliable; however, JCR-VIS does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. JCR-VIS Credit Rating Company Limited is paid a fee for most rating assignments. This rating is an opinion on credit quality only and is not a recommendation to buy or sell any securities. Copyright 2007 JCR-VIS Credit Rating Company Limited. All rights reserved. Contents may be used by news media with credit to JCR-VIS Credit Rating Company Limited.

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Corporate Profile United Bank Limited (UBL) was privatized in 2002 with Abu Dhabi Group (UAE) and Bestway Group (UK) each acquiring 25.5% shares and management control in the bank. The Government of Pakistan (GoP) held 44.7% at year-end 2006, having divested approximately 4.2% to the public when the bank was listed on the exchanges in 2005. Another 20-25% is being divested by the GoP to international investors through a GDR offering, which will enable listing on the London Stock Exchange. The Board of Directors of UBL is chaired by H. H. Shaikh Nahayan Mubarak Al Nahayan who is a prominent member of Abu Dhabis royal family. Deputy Chairman of the bank, Sir Mohammed Anwar Pervez, is currently chairing the Bestway Group which is one of the largest wholesalers in the UK market. There are 5 other board members, including 3 nominees of the GoP. Mr. Atif Bukhari, President & CEO, has been associated with the bank since 2004 and has extensive prior banking experience as does the senior management team of the bank. The team has largely remained stable except for the position of Group Head Treasury, that has been vacant far the past 10 months. As at December 31, 2006, the organization had a total staff strength of 15,369 (FY05: 13,479) employees, of which 9,738 were the banks own staff, while the remaining were out sourced resources. Turnover for the year was about 10%, while approximately 1,300 new employees had been hired during the year. UBL has a growing presence in the international market through 15 branches in various foreign countries, with significant activity in Middle Eastern markets, particularly in United Arab Emirates and the Kingdom of Bahrain. Additional branches in the Arabian region will be established during the ongoing year. Profit before tax from international operations increased by 31% to Rs. 2.48b during FY06. International business has increased considerably with increased mobilization of deposits, which rose by 61% to Rs. 63.5b while advances increased by 46% to Rs. 38.8b.

Two major strategic initiatives during the out-going year included the formation of an insurance company, UBL Insurers Limited and launch of UBL Ameen, the Islamic division of the bank. UBL Ameen will target customers through dedicated Islamic banking branches. UBL was also one of the first few banks to set up an asset management company. Information Technology & Control Infrastructure Operations of UBL have been significantly streamlined post-privatization, however further plans for improving operational efficiency are under-way. Currently the bank is using an internally developed distributed database software called UNIBANK. This software is utilizing Oracle Financials at the back end. As all daily banking transactions are stored at the respective branches, consolidation at the head office takes place at day end. UBL has a total of 1,059 branches (including 15 over seas branches) of which 640 branches have on-line connectivity (FY05: 496) with the head-office through an ISDN or satellite connection while the remaining are still to be brought on-line. Out of the total off-line branches there are at least 211 branches in the far-flung areas of the country (FATA, parts of Kashmir) which are not automated. Critical information from these offices is physically delivered to a nearby located main branch. The bank has specialized software to support its various functions and the focus for some time has now been on enterprise application integration (middleware). The management launched a transformation program in 2006 which aims to accomplish bank-wide business and technology reengineering. The business aspect of this program is expected to improve performance through implementation of uniform business processes and training is ongoing in this respect. With a large branch network that is geographically spread out over the entire country, it is imperative to have an effective control infrastructure. Purchase of an off-the-shelf core banking application has been finalized. It has been estimated that a minimum period of 2 years will be required to fully migrate all operations onto the new system. It is also expected

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that some of the current applications will become redundant once the new system has been installed. The Board Audit Committee (BAC) comprising three members meets every quarter and is responsible, among other things, for ensuring the effectiveness of the internal audit function and systems for monitoring compliance. Internal audit procedures include routine branch and business function audit as well as special surprise audits. There is also a dedicated compliance division mainly to follow up on the recommendations advised by the audit team. The deliberations of BAC however reflect concern regarding the overall control environment. The audit and inspection department has been highlighting issues with regard to operational control weaknesses at the branch level. While most of these are routine in nature, further emphasis on HR training may help in improving the control environment. Some of the issues raised by the external auditors pertain to the capacity of the existing software applications, which the management expects to address over the near term. FINANCIAL PERFORMANCE Credit Risk Total asset size of UBL increased by approximately 22% to Rs. 423.3b as at December 31, 2006 from Rs. 347.1b at the end of the previous year. The gross advances of the countrys entire banking sector saw a sizable increase to over Rs. 2.4trillion by the end of FY06 (FY05: Rs. 2.0trillion), translating into a growth of 20% in the overall market size. Growth in UBLs local advances was slightly below the market, though increased lending from overseas operations resulted in aggregate growth of 20% for the year 2006. Net advances amounted to Rs. 247.3b (FY05: Rs. 204.8b) as at December 31, 2006. With UBLs ability to lend at competitive rates along with the continued growth in the credit appetite of the market, UBLs gross advances increased by about 18% to Rs. 260.9b at the end of FY06 from Rs. 219.3b at the end of the previous year. Though the bank witnessed healthy growth on the deposit side, the loan to deposit ratio (LDR) saw an increase to 73.8% (FY05: 70.8%) by the end of FY06.

Growth in UBLs advances portfolio is attributable to both the corporate and the consumer portfolio, as reflected in the table below:
Categories Corporate Banking Commercial Banking Consumer Banking Others International Net Performing Advances FY06 FY05 Growth% (Rs. in billions)

103.5 52.6 44.5 3.8 38.8 243.2

94.1 49.2 28.3 3.1 26.5 201.2

9.9 6.9 57.2 25.7 46.4 20.9

Over the last two years, the composition of banking book has experienced steady diversification with consumer lending now representing almost 18% of the total, where the risk is largely spread out, as against FY04 when it constituted a meager 5%. Along with this, the corporate and commercial loan book also continued to expand. During FY06, the corporate loan portfolio grew by approximately 10% to Rs. 103.5b and commercial banking constituted approximately 22% of the total portfolio at Rs. 52.6b at the end of the year. Lending from the overseas operations amounted to Rs. 38.8b (FY05: Rs. 26.6b) at the end of FY06, also contributing to the above mentioned growth. The overseas loan book is mostly concentrated in the Middle Eastern markets. Though some lending has been in the form of personal loans, majority of the lending has been to the corporate sector. Particularly, exposures taken in UAE are in the construction and real estate sectors. There has been a boom in the construction industry as a result of heavy infrastructure development throughout the Middle Eastern region. Growth in the private sector has over the years diluted the banking sectors exposure towards public sector concerns. Also, new sectors have opened up for credit in recent years with considerable new funding directed to the so far unconventional sectors like telecom, energy transmission and the hospitality industry. Banks have increased exposures to cement, food industries and other non-financial service sectors. As a result, overall exposure to the textile sector has diluted. UBLs exposure to the textile industry has also reduced, both in absolute terms to

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Rs. 53.75b (FY05: Rs. 55.31b) and also in relation to its total portfolio, though it still remains its largest sector-wise exposure. Exposures have been reduced in the construction and transportation sectors. Significant portion of fresh lending at UBL has been channeled towards the energy production and transmission sector and also the infrastructure development sector. The management also remains positive on the telecommunication sector, though it represents a small proportion of the total outstanding portfolio. With continuing increase in the trade finance business, outstanding unfunded exposure at year-end 2006 was higher at Rs. 142.4b (FY05: Rs. 98.1b). However, almost 61% (FY05: 18%) of this exposure has been taken against the government, including both local and overseas sovereigns. Client wise concentration for domestic operations has shown improvement over that in 2005 with funded exposure against the top 10 clients amounting to about 14.6% of the portfolio as compared to 16.7% at the end of FY05. On an aggregate basis, funded exposure against the 10 largest clients (including domestic and overseas operations) amounted to 13.5% at the end of FY06. Given the banks single exposure taking capacity, individual lending transactions are generally not very large although the largest funded exposure amounts to nearly 32% of tier 1 capital of the bank. This exposure has however been taken against a semi-government organization and as such represents manageable credit risk. Some large size exposures have also been taken by the banks overseas branches, with the largest unfunded exposure as at December 31, 2006 taken against a construction company exceeding Rs. 10b, though this is guaranteed by the UAE government. While the local UAE laws specify limits on funded exposures, no restriction has been placed on unfunded exposures. All such decisions are however routed through a centralized risk management system at the head office of the bank to ensure controls. All credit proposals of over Rs. 1b are required to be approved by the Board of Directors. Delegation to the management for credit approval seems adequate as

only a limited number of banking relationships exceed this amount. The bank previously had Corporate Centers only in Karachi and Lahore, providing corporate and individual customers with all banking facilities under one roof. UBL has been able to set-up 3 more such centers in major cities of the country including Multan, Faisalabad and Islamabad while a sub-centre in Rawalpindi is under construction. This has been able to provide flexibility and one-stop banking arcades to clients in nearly all business hubs of the country. The bank has also managed to develop a sizeable portfolio of consumer finance assets offering a range of secured and unsecured products. The portfolio has recorded substantial growth since inception, and is continuing to grow at a steady pace. UBL has one of the largest consumer portfolio in the banking sector and represents 13.7% of the total outstanding consumer lending at the end of FY06. UBL has been able to benefit from its outreach and continuous product innovation, with each product offering customer friendly features. UBL offers three secured financing products which include car financing, house financing and business financing, while three unsecured products include credit cards, personal finance and running finance lines. The following table shows product wise break-up of the consumer portfolio as at December 31, 2006. Products
Auto Loans House loan Cards Cash Line Business Line Personal Loan Net Performing FY06 FY05 (Rs. in bn) 20.8 14.6 5.2 3.6 5.3 3.3 4.7 3.2 5.0 2.4 3.6 1.3

44.5

28.3

UBL operates its consumer financing division through a centralized structure and is currently offering these products in 38 cities. The consumer banking division employs a total of approximately 2000 personnel all over the country; including over 40 employees for business development, with the remaining deployed for credit management, sales and

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recovery. Approximately 90% of the sales force is outsourced. Target set for consumer lending is over Rs. 64b by the end of FY07. Along with significant growth in the consumer portfolio, gross infection in the portfolio has also increased from less than 0.3% to over 1.6%. However, provisions set aside against the consumer portfolio of Rs. 1.2b, which is in line with regulations, are in excess of the NPLs at year-end 2006. While the bank managed to reduce its delinquent portfolio of overseas branches by almost Rs. 1.92b, fresh classification in domestic operations had an offsetting effect and total non-performing loans at yearend 2006 were only lower by Rs. 705m at Rs. 16.3b (FY05: Rs. 16.96b). Incremental infection during the year was about 1.8% in the domestic portfolio. Almost 30% of the NPLs represent exposures in the textile sector where the largest proportion of the portfolio had been deployed. Overall gross infection decreased to 6.2% from 7.6% at the end of the previous year on account of writeoffs during the year to the tune of Rs. 2.9b (against provisions). After accounting for the additional charge of Rs. 2.63b created for the year, total provisions held against the infected portfolio amounted to Rs. 13.6b (FY05: Rs. 14.5b), translating into provisioning coverage against NPLs of 83% (FY05: 85.3%). Net infection was lower at year end at 1.1% (FY05: 1.2%) while as a proportion of tier-1 capital net infected portfolio amounted to 10.2% (FY05: 14.1%). During 1QFY07, net infection has however increased to 1.4%. UBL also has a sizeable fixed income portfolio of Rs. 61.0b (FY05: Rs. 58.1b), of which almost 66% has been deployed in local government securities. The UAE office acts as a central treasury to the banks foreign operations. From that platform, the bank has also invested in bonds issued by other sovereigns, whereby the credit ratings on foreign currency scale range from speculative grade in case of Government of Indonesia USD Bonds to A+ rated USD bonds issued by the Government of Qatar. The portfolio of term finance certificates amounted to Rs. 8.8b at the end of 2006, having reduced from Rs.

9.4b at the end of FY05. Unlisted TFCs form a majority of this portfolio at Rs. 7.6b (FY05: Rs. 8.3b). Market Risk Gross investments increased to Rs. 67.5b from Rs. 63.4b, with the increase coming about largely in the fixed income portfolio of Rs. 61.0b (FY05: Rs. 58.1b) while the remaining has been deployed in equities & mutual funds. Of the total fixed income portfolio, almost two-third is either invested in short-term instruments or carries market linked returns. The portfolio of long term government securities amounting to Rs. 7.8b (FY05: Rs. 7.2b) has a weighted average duration of 3.23, implying a 2.96% erosion in value for a single 100bps parallel shift in yield curve. Loss in value arising from this portfolio is mostly accounted for in the banks books, except for that on the PIBs portfolio of Rs. 4.69b which is classified in the held to maturity category. The equities portfolio amounted to Rs. 4.7b (FY05: Rs. 3.4b) including mutual funds of Rs. 1.7b (FY05: Rs. 0.8b) and is well within the limit prescribed by prudential regulations. The portfolio is fairly diversified across sectors and scrip-wise exposures have been kept prudently on the lower side. The bank also has investments in subsidiaries and associates to the tune of Rs. 2.26b (FY05: Rs. 1.92b), almost 50% of which is represented by the banks core holding in the mutual funds launched by its subsidiary asset management company. Liquidity Risk Rate of increase in total deposits of scheduled banks was lower during FY06 with the total markets deposit base increasing by about 12% to Rs. 2.9 trillion as compared to a growth of 23% during the preceding year. While growth in deposits of UBL was about 16%, it was partly driven by deposit taking from overseas operations. Total deposits as of December 31, 2006 amounted to Rs. 335.8b (FY05: Rs. 289.2b). Of this, deposits from domestic operations amounted to Rs. 271.6b (FY05: Rs. 249.7b), translating into a market share of 9.1% and

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placing UBL as the third largest bank in the country in terms of total deposits held. In recent times, the private sector has mainly led the deposit growth. UBL has maintained its share of public sector deposits which represent 15.98% of total deposits (FY05: 15.11%). Much of the increase in the total deposit base of the bank came in term deposits aggregating Rs. 114.9b (FY05: Rs. 79.8b) and constituted 34% (FY05: 27.6%) of the total deposit base. Growth in low cost deposits (current and savings) was lower during the year, although these still comprise a significant 63.4% (FY05: 70.2%) of the total deposit base. During 2006, the bank has strategically focused on developing a liability book in the overseas market, particularly in the UAE, where the bank has had lending operations for a long time. Approximately 19% (FY05: 14%) of the total deposit base has been generated from foreign branch operations and amounted to Rs 63.5b (FY05: Rs. 39.5b). The deposit base is fairly diversified client wise as well as branch wise. Top 100 depositors from the banks domestic operations held about 16.1% (FY05: 14.8%) of total deposits, of which almost 55% represent those mobilized from government/semigovernment institutions (FY05: 46%). Of the total domestic branch network, only 11 branches hold deposits of more than Rs. 2b. Including the deposits raised from overseas branches, top 100 depositors represented a higher proportion at 18.8%. Deposit growth has not been uniform in all the regions with most of the growth in domestic deposits coming about from Karachi & Azad Kashmir regions, while deposits in the Islamabad region have reduced significantly. Nevertheless it continues to be one of the largest sources of funds for the bank and accounts for 12% of the domestic deposits, while the largest region is Karachi with 27% of domestic deposits. Even though a sizable increase has been witnessed in deposits, with a greater increase in the lending book, the loan to deposit ratio (LDR) stood higher at 73.8% as compared to 70.8% at the end of the previous year. The average LDR for the banking industry stood even higher at 82%. Deposit cost has increased

during the year with the increasing competition in the market and various lucrative investment opportunities available for depositors. The cost of deposit increased to 3.2% (FY05: 1.9%) for the year ended FY06 and is likely to continue to increase in the current year. Liquidity indicators have improved on a year on year basis with liquid assets as a proportion of total borrowings and total assets higher at 41% (FY05: 39.5%) and 36.8% (FY05: 35.8%) respectively, at year end 2006. The maturity profile reflects a satisfactory situation based on the historical withdrawal pattern experienced by the bank in its demand deposits. Capitalization Paid-up capital of the bank was increased to Rs. 6.5b (FY05:Rs. 5.18b) by way of a 25% bonus issue during the year. Tier-1 equity increased to Rs. 25.9b (FY05: 17.7b) on account of healthy reserves and retained earnings. Though surplus on revaluation of assets slightly decreased, total net worth of the bank stood increased by 38% at Rs. 29.9b (FY05: Rs. 21.7b). As a proportion of total resource base of UBL, equity contributes about 7.1%. Though the total risk weighted assets of UBL increased by over 30%, but with a significantly higher increase in the eligible regulatory capital, the Capital Adequacy Ratio (CAR) saw an increase to 11.1% (FY05: 9.3%). The increase in the total eligible capital came mainly from the increased core capital. CAR adjusted for the final dividend payout for FY06 is still notably higher than minimum required at 10.5% (FY05: 8.7%). TFCs The banks capital structure is supported through three subordinated TFCs issued in 2004, 2005 and 2006, each for a tenor of 8 years. The first of these is maturing in August 2012 and has a total issue amount of Rs. 2b, while the maturity of the remaining two having issue amounts of Rs. 2b each also, would follow in March 2013 and September 2014. The total outstanding amount was Rs. 5.9b (FY05: 3.9b) as of December 31, 2006.

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The first two issues carry fixed rates of 8.5% and 9.5% respectively, while the third issue was priced at floating rate linked to 6 month kibor and carries a spread of 170bps over the base rate. The weighted average cost of the three TFCs stood at 10.2% for the year 2006. Profitability Continued growth in the banking book of UBL led to an increase in markup income to Rs. 32.9b during FY06 from Rs. 20.2b in the preceding year. The consumer portfolio yielded 12.4% for the year where a significant proportion of the portfolio has been deployed and the corporate loan book is also generating healthy returns. While the deposit cost also increased to 3.2% during the year from less than 2% in the year before, spreads nevertheless widened to almost 5.5% for the year (FY05: 4.5%). While the bank has accessed relatively expensive deposits from overseas operations, its aggregate cost of funds compares favorably to sector averages in the domestic market. Net finance income for the year ended December 31, 2006 increased by approximately 48% to Rs. 20.9b (FY05: Rs. 14.1b). Profitability was supported by increased fee and commission based income totaling Rs. 3.9b (FY05: 2.5b) with significant increase in trade volumes and higher commission on third party bill collections. Dividend income also saw an increase to Rs. 837m compared to Rs. 202m during FY05. The average yield on equities was about 18% for the year 2006 as against 11.4% for FY05. Capital gains were however lower and have shown a declining trend for the past 2 years as loss has been booked on the sale of fixed income government securities. Administrative expenses increased by nearly 40% to Rs. 10.9b (FY05: Rs. 7.9b). The efficiency of branch structure has room for further improvement. Almost 360 branches held less than Rs. 100m in deposits at year end, aggregating Rs. 22b. Operating efficiency for the year was about 39.4% (FY05: 41%). With a healthier total revenue base, basic earnings of the bank for the year have improved to Rs. 16.3b (FY05: Rs. 10.5b), improving basic ROAA to 4.3% (FY05: 3.4%). Additional provisioning against non-

performing advances amounted to Rs. 1.9b (FY05: Rs. 1.3b) while bad debt directly writtenoff against the profit and loss account totaled Rs. 269m (FY05: Rs. 38m). Net profit after tax for the year ended December 31, 2006 was higher by 60% at Rs. 9.5b (FY05: 5.9b). In future years, the bank is likely to sustain strong profitability indicators with the persistent growth in lending and continued investment in high margin consumer lending. Even though deposit cost may increase, the banks deposit mix is likely to remain cost effective over the foreseeable future J C R -V IS