Islamic banking research

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Financial Performance Analysis of Banks in UAE 2007-2009

No index entries found.

Internship Report

5/9/2012

Anand Adeppa

Table of Contents Abstract ................................................................................................................................................... 3

Economy of UAE ...................................................................................................................................... 4

External trade...................................................................................................................................... 4

GDP – on a growth trajectory ............................................................................................................. 6

Consistent growth pattern expected to continue… ............................................................................ 8

Banking Sector in UAE ............................................................................................................................. 9

Shariah Compliant Banking ( Islamic banking) ........................................................................................ 9

Principles ............................................................................................................................................. 9

Abu Dhabi Islamic bank ......................................................................................................................... 12

Analysis ......................................................................................................................................... 13

Abu Dhabi Commercial Bank ................................................................................................................ 14

Analysis ......................................................................................................................................... 14

Dubai Islamic Bank ................................................................................................................................ 16

Analysis ......................................................................................................................................... 16

Emirates NBD ........................................................................................................................................ 18

Analysis ......................................................................................................................................... 18

First Gulf Bank ....................................................................................................................................... 20

Analysis ......................................................................................................................................... 20

National Bank of Abu Dhabi .................................................................................................................. 22

Analysis ......................................................................................................................................... 22

Sharjah Islamic Bank ............................................................................................................................. 24

Analysis ......................................................................................................................................... 24

Union National bank ............................................................................................................................. 26

Analysis ......................................................................................................................................... 26

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

Market Share on Assets ................................................................................................................ 28

ROAA ............................................................................................................................................. 28

ROAE ............................................................................................................................................. 29

Cost to Income .............................................................................................................................. 29

Average ROE .................................................................................................................................. 30

Cost Efficiency ............................................................................................................................... 30

Net Interest Income to Total Income ............................................................................................ 31

Conclusion ............................................................................................................................................. 32

Abstract

Our study aims at analyzing UAE bank efficiency over the period 2007-2009. We found out

that during recession the banks have suffered drastically. The subprime crisis seems to have

impacted those banks indirectly. And market power and profitability had a positive impact on

Islamic banks efficiency, while it is the contrary for their size. The latter implies that they do

not benefit from scale economy, may be because of the specificity of Islamic financial

products.

This paper provides empirical evidence on the causes and timing of the recent 2007-

2009 UAE financial crisis. A persistent weakness in the economic fundamentals throughout

much of the pre-crisis period created necessary conditions for the financial crisis. However,

the timing of the financial crisis was determined by a unique combination of an increase in

leverage risk faced by the banking system and a decrease in foreign exchange reserves

(FXRES) that forced the government to bail out the troubles financial institutions.

Economy of UAE At $270 billion in 2008, the GDP of the UAE ranks second in the CCASG (after Saudi

Arabia), third in the Middle East—North Africa (MENA) region (after Saudi Arabia and

Iran), and 38th in the world.

There are various deviating estimates regarding the actual growth rate of the nation’s GDP,

however all available statistics indicate that the UAE currently has one of the fastest growing

economies in the world. According to a recent report by the Ministry of Finance and Industry,

nominal GDP rose by 35 per cent in 2006 to $175 billion, compared with $130 billion in

2005.

Although the United Arab Emirates is becoming less dependent on natural resources as a

source of revenue, petroleum and natural gas exports still play an important role in the

economy, especially in Abu Dhabi. A massive construction boom, an expanding

manufacturing base, and a thriving services sector are helping the UAE diversify its

economy. Nationwide, there is currently $350 billion worth of active construction

projects.The UAE is a member of the World Trade Organization.

External trade Major increases in imports occurred in manufactured goods, machinery, and transportation

equipment, which together accounted for 70% of total imports. Another important foreign

exchange earner, the Abu dhabi Investment Authority--which controls the investments of

Abu Dhabi, the wealthiest emirate—manages an estimated $360 billion in overseas

investments & an estimated $900 billion in assets.

More than 200 factories operate at the Jebel Ali complex in Dubai, which includes a deep-

water port and a free trade zone for manufacturing and distribution in which all goods for re-

export or transshipment enjoy a 100% duty exemption. A major power plant with associated

water desalination units, an aluminum smelter, and a steel fabrication unit are prominent

facilities in the complex. The complex is currently undergoing expansion, with sections of

land set aside for different sectors of industry. A large international passenger and cargo

airport, Dubai World Central International Airport, with associated logistics, manufacturing

and hospitality industries, is also planned here.

Except in the free trade zone, the UAE requires at least 51% local citizen ownership in all

businesses operating in the country as part of its attempt to place Emiratis into leadership

positions. However, this law is under review and the majority ownership clause will very

likely be scrapped, to bring the country into line with World Trade Organisation regulations.

As a member of the Gulf Cooperation Council (GCC), the UAE participates in the wide range

of GCC activities that focus on economic issues. These include regular consultations and

development of common policies covering trade, investment, banking and finance,

transportation, telecommunications, and other technical areas, including protection of

intellectual property rights.

UAE’s efforts to enter into various trade agreements is a part of its pro-liberalisation

approach. Along with this, restrictions on foreign investment in the country are getting

progressively relaxed with the expansions of free zones. However, the agency law is still

applicable in the country by which UAE firms have exclusive distribution rights of foreign

brands within most of the emirates. There are also rumours on abrogation of this law, and the

raising of the current ceiling of 49% stake that foreign companies can have in domestic

companies. The director of the Sharjah Chamber of Commerce said in an interview with Gulf

News that the limit may be raised to as high as 95% for ventures that promise to deliver

significant benefits to the economy. The change in laws on foreign ownership of real estate in

emirates like Abu Dhabi and Sharjah also signals the intent towards reaching the stage of

being seamlessly integrated with the outside world. In Abu Dhabi, expatriates can now own

surface property, but not the land within designated investment areas on a 99-year lease.

These anticipated regulatory changes evinced plenty of interest, as the country is developing

into an attractive destination for doing business. UAE is among the most competitive

countries in the world and a haven for businesses, as per rankings in the Global Competitive

Report 2004-05 issued by the World Economic Forum. UAE ranked third with regard to the

organized efforts to improve competitiveness, and second globally after Bahrain regarding

the tax burden on enterprises. Dubai in particular was judged as holding a rank higher than

many other developed countries in many crucial factors, and even surpassing them. This is

pretty much expected as Dubai is the hub of private sector activity within the UAE and is

often at the forefront of economic reforms. UAE also topped the World Bank’s governance

effectiveness list in the Middle East with a score of 86.1%.

The various initiatives towards privatisation have gone a long way in rendering the country as

an attractive investment destination. Many government owned firms are already being

privatised, or are at the doorstep. Abu Dhabi has taken the lead in privatisation, with the

power sector already having large private players in operation. The new rules illustrated a

similar approach by a series of privatizations of state-owned companies in Abu Dhabi,

including Agthia, Aldar Properties and Aabar Petroleum Investments Company. The

proliberalisation approach, excellent economic health and rapid improvement in the overall

wealth levels in the country have led to an improvement in the sovereign credit rating of the

country. Moody’s upgraded UAE’s country rating to A1, which is not bettered by any other

country in the region, and equaled only by Qatar. Factors like healthy corporate performance

and the deepening of the financial markets also helped the economy to improve its image on a

global platform.

Another interesting development is the dramatic increase in the number of HNWIs within the

country. Number of millionaires in the country is estimated at 52,800, form 1.2% of the

population, according to the World Wealth Report-2006 released by Merrill Lynch and

Capgemini. However, on the flipside, there has been a dramatic increase in the cost of living

in the country, already having a negative effect on the middle income group. Irrespective of

the cost scenario, there seems to be no respite to the wheels of change in the country, literally

through a slew of skyscrapers attracting money and people from all over the world.

GDP – on a growth trajectory UAE’s nominal GDP grew by 25.6% in 2005 to AED485.5bn (US$132.2bn),

according to the Ministry of lanning estimates. Real GDP grew by 8.2% to AED357.6bn, the

growth being one of the highest in the world. Tremendous growth in the last two years has

boosted the per capita income to an all time high and second highest within the GCC region

next to Qatar. Oil and gas, which contributed 35.7% to the GDP had a phenomenal growth of

40.5% in ’05, on the back of a 33.8% growth in the previous year.

This has been the prime reason for the high overall growth in the GDP. Among the various

sub-segments within the non-oil sector, the ‘Wholesale and Retail Trade’, ‘Restaurants and

Hotels’, Financial Corporation Sector’ and the ‘Real estate and Construction’ segments

recorded the highest growth rates.

The latter which contributes 14.6% to GDP had a growth of 20.2% in this segment, and a

CAGR of 17.6% in the period 2001-’05. This sector was buoyed by the increasing investment

in infrastructure, due to the country being positioned as an attractive tourist destination.

However, it should be noted that GDP growth was higher due to consumption expenditure

and trade surplus growth, rather than a major increase in investment. In the year 2005, the

non-oil sector contribution to GDP stood at 64.3%, while the oil sector contributed 35.7%

to GDP.

Consistent growth pattern expected to continue… The most positive aspect about the growth in the UAE is the fact that it has not been totally

dependent on oil. For instance, Dubai economy, of which oil contributes just 6.1%, grew at

high rates. We believe that the growth of the economy would be moderate in the longer term

compared to the current high levels, though it would remain at rates higher than average. The

oil sector can be expected to record high growth rates in 2006 due to the planned expansions.

Growth in sectors like real estate and some of the other service-related sectors

could be expected to be moderate in about two years from now. On the other hand, we expect

manufacturing and trade to continue growing at high rates, in turn keeping the overall

economic growth afloat. Spending in capital-intensive industries, especially petrochemicals

and gas would prop up the economy in the longer term.

Banking Sector in UAE

Banking in UAE has two types of banks ie, sharia compliant ( islamic banks) and

conventional banks

Shariah Compliant Banking ( Islamic banking)

Islamic banking (or participant banking) (Arabic: ية صرف م is banking or (ايمالسية ال

banking activity that is consistent with the principles of Islamic law (Sharia) and its practical

application through the development of Islamic economics. Sharia prohibits the fixed or floating

payment or acceptance of specific interest or fees (known as riba or usury) for loans of money.

Investing in businesses that provide goods or services considered contrary to Islamic principles is also

haraam (forbidden). While these principles have been applied in varying degrees by historical Islamic

economies, it is only in the late 20th century that a number of Islamic banks were formed to apply

these principles to private or semi-private commercial institutions within the Muslim community

Principles

Islamic banking has the same purpose as conventional banking: to make money for the

banking institute by lending out capital. Because Islam forbids simply lending out money at

interest (see riba), Islamic rules on transactions (known as Fiqh al-Muamalat) have been

created to avoid this problem. The basic technique to avoid the prohibition is the sharing of

profit and loss, via terms such as profit sharing (Mudharabah), safekeeping (Wadiah), joint

venture (Musharakah), cost plus (Murabahah), and leasing (Ijar).

In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item,

a bank might buy the item itself from the seller, and re-sell it to the buyer at a profit, while

allowing the buyer to pay the bank in installments. However, the bank's profit cannot be

made explicit and therefore there are no additional penalties for late payment. In order to

protect itself against default, the bank asks for strict collateral. The goods or land is registered

to the name of the buyer from the start of the transaction. This arrangement is called

Murabahah.

Another approach is EIjara wa EIqtina, which is similar to real estate leasing. Islamic banks

handle loans for vehicles in a similar way (selling the vehicle at a higher-than-market price to

the debtor and then retaining ownership of the vehicle until the loan is paid).

An innovative approach applied by some banks for home loans, called Musharaka al-

Mutanaqisa, allows for a floating rate in the form of rental. The bank and borrower form a

partnership entity, both providing capital at an agreed percentage to purchase the property.

The partnership entity then rents out the property to the borrower and charges rent. The bank

and the borrower will then share the proceeds from this rent based on the current equity share

of the partnership. At the same time, the borrower in the partnership entity also buys the

bank's share of the property at agreed installments until the full equity is transferred to the

borrower and the partnership is ended. If default occurs, both the bank and the borrower

receive a proportion of the proceeds from the sale of the property based on each party's

current equity. This method allows for floating rates according to the current market rate such

as the BLR (base lending rate), especially in a dual-banking system like in Malaysia.

There are several other approaches used in business transactions. Islamic banks lend their

money to companies by issuing floating rate interest loans. The floating rate of interest is

pegged to the company's individual rate of return. Thus the bank's profit on the loan is equal

to a certain percentage of the company's profits. Once the principal amount of the loan is

repaid, the profit-sharing arrangement is concluded. This practice is called Musharaka.

Further, Mudaraba is venture capital funding of an entrepreneur who provides labor while

financing is provided by the bank so that both profit and risk are shared. Such participatory

arrangements between capital and labor reflect the Islamic view that the borrower must not

bear all the risk/cost of a failure, resulting in a balanced distribution of income and not

allowing the lender to monopolize the economy.

Islamic banking is restricted to Islamically acceptable transactions, which exclude those

involving alcohol, pork, gambling, etc. The aim of this is to engage in only ethical investing,

and moral purchasing. The Islamic Banking and Finance Database provides more information

on the subject.

In theory, Islamic banking is an example of full-reserve banking, with banks achieving a

100% reserve ratio. However, in practice, this is not the case, and no examples of 100 per

cent reserve banking are observed.

Islamic banks have grown recently in the Muslim world but are a very small share of the

global banking system. Micro-lending institutions founded by Muslims, notably Grameen

Bank, use conventional lending practices and are popular in some Muslim nations, especially

Bangladesh, but some do not consider them true Islamic banking. However, Muhammad

Yunus, the founder of Grameen Bank and microfinance banking, and other supporters of

microfinance, argue that the lack of collateral and lack of excessive interest in micro-lending

is consistent with the Islamic prohibition of usury (riba).

Abu Dhabi Islamic bank

The Organization

Abu Dhabi Islamic Bank was established on 20th May 1997 as a Public Joint Stock

Company through the Amiri Decree No. 9 of 1997. The Bank commenced commercial

operations on 11th November 1998, and was formally inaugurated by His Highness Sheikh

Abdullah Bin Zayed Al Nahyan, UAE Minister of Information and Culture on 18th April

1999. All contracts, operations and transactions are carried out in accordance with Islamic

Shari'a principles. ADIB commenced its operations with a paid-up capital of One Billion

Dirhams divided into hundred million shares, the value of each share being ten dirhams. The

shares are quoted on the Abu Dhabi Securities Market.

2007 2008 2009

Return on Equity(%) 19.9 16.5 1.5

Net Interest Income(%) 66.2 78.6 83.7

Net Spread(%) 2.8 4.4 4.6

Net Interest Margin(%) 2.8 4.4 4.5

Cost to Income Ratio(%) 38.4 40.4 39.4

NPL to Equity(%) 3.3 23.3 49.2

P/E(x) 16.2 6 73.3

P/BV(x) 2.4 1 1.1

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Analysis

Loan growth At the end of 2009, the stable of funds ratio stood at 91%. In same time,

net loans to deposits ratio (LTD) stood at 84%. The bank loan portfolio is expected to

experience a modest growth in 2010.

Strength on retail segment, weakness on corporate The bank was able to maintain

the asset quality of retail segment above peer average, but the corporate segment

witnessed massive jump in corporate NPLs. Thus, the retail sector is expected to

continue to be the driver behind the bank’s growth.

High NPLs ratio Among our coverage, ADIB has the second highest NPL ratio

which reached 5.98% (AED2.5bn) in 2009 compared to 3.5% in 2008. ADIBs NPLs

constituted 12% of our collective UAE banking coverage, despite having only 6%

market share of the sector’s gross loans.

Provisions to weigh in High level of provisions is expected to continue, as the bank

will try to close the gap between NPLs and cumulative provisions. ADIB current

coverage ratio is seen at 70% (as per 1Q2010 figures). Besides, current credit

environment will force the bank to sustain more NPLs, but at a slower pace.

Highest spread ADIB has the highest spread among our UAE coverage, which stood

at approximately 4.6% in 2009. Higher spread was a major factor in the rise of net

financing income in 2009 by 22% to AED2.1bn. High spread could be attributed to

the retail focus.

Stable growth in core operations Net funding income (NFI) is estimated to have

about 13.3% CAGR over 2009-2013. Meanwhile, non-funding income will follow the

foot-steps of NFI, as investment income improves over the coming years. Non

funding income is estimated to have about 12.7% CAGR over 2009-2013.

Profitability improvement Lower provisions combined with stable core operations

growth will result in profitability improvement. Profits are expected to rise by 18.1%

CAGR over 2008- 2013, as per our forecast.

Abu Dhabi Commercial Bank

2007 2008 2009

Return on Equity(%) 20.3 9.7 -3.7


Net Spread(%) 2.8 2.3 2.5



NPL to Equity(%) 10.5 8.2 41.6

P/E(x) 11.7 25 na

P/BV(x) 2.3 2 0.5

Analysis

Overwhelmed by asset deterioration ADCB has one of the highest NPLs ratio in

our UAE banking universe with NPLs ratio jumping from just 1.1% in 2008 to 5.2%

in 2009. We believe that ADCB’s NPLs will increase by another 200bps in 2010

leading to continuation of high provisioning, though marginally lower than that of

2009.

Possibly the second most exposed bank to Dubai World As per newspapers,

ADCB’s exposure to DW is US$2.7bn (approx. AED10bn). An assumed 10%

reduction in the PV of future payments from DW (and affected entities) on account of

extension of loan maturities, could lead to an increase of AED800 – 1,000mn in the

NPLs.

Additional burden from investments in structured products The bank has a gross

exposure of over AED700mn to CDO’s and FRN’s and another AED2,400mn to

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CDS. Being the only bank in our UAE universe with exposure to the sub-prime

mortgage, the bank has taken heavy provisioning arising from these asset classes. We

believe that impairments from CDS will maintain 2009 levels and those from other

investments will reduce considerably during 2010.

Debt maturities to stifle asset growth ADCB is expected to see heavy debt

repayment over the forecast period, with maturities of over AED23.7bn scheduled

from 2010 – 2013. The bank is scheduled to repay AED8.8bn in 2010 and AED4.9bn

in 2011, which forms over 58% of the repayments during our 4 year forecast period.

Voluntary adherence to possible changes in NPLs related regulation ADCB

follows the 90+ day non-performing aging schedule. While that mitigates the chances

of any increase in NPLs (and provisions) from the change in classification, additional

provisioning will nevertheless be required if the Central Bank asks the banks to

provide the 1.25% of RWAs (addition of AED200 – 250mn to provisions).

Fate is intertwined with that of Dubai World ADCB is the only bank in our UAE

banking universe that reported losses in 2009, despite a 32%YoY jump in the NII and

a 9%YoY rise in the total income. With a slight ease off in provisioning levels

expected in 2010, with healthy growth in net interest income and non-interest income,

the bank may turn to making profits in 2010. This is nevertheless highly contingent to

the outcome of Dubai World’s restructuring.

Dubai Islamic Bank

2007 2008 2009



Net Spread(%) 2.8 3.7 4.1

Net Interest Margin(%) 2.8 4 4.4

Cost to Income Ratio(%) 40.8 40.6 40

NPL to Equity(%) 15 28.2 36.8

P/E(x) 13.2 3.7 7

P/BV(x) 3.5 0.7 1

Analysis

Highest NPLs ratio Among our coverage, DIB has the highest NPL ratio which

reached 6.0% (AED3.1bn) in 2009 compared to 4.1% in 2008. Its NPL’s constituted

14% of our collective UAE banking coverage, despite having only 7% market share

of the sector’s gross loans. This high NPL will negatively affect the bank’s

profitability.

Exposure to real estate The lending portfolio of DIB is heavily dominated by the

real estate sector. Even though overall gross lending in 2009 decreased, real estate

lending rose by 5.1%YoY to AED21bn to constitute 40% of overall loan portfolio.

The performance of this sector will have additional negative ramifications for the

bank.

Balance sheet to be stagnant DIB’s total assets stayed almost flat in 2009 at

AED84.3bn. DIB struggle to maintain a healthy balance sheet growth is due to slower

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economic activities in the UAE (specifically in Dubai), and weakening assets. Total

assets are expected to increase only by 1.1% in 2010, and the speed of growth will

increase over the years.

Deposits to remain steady DIB’s deposits are estimated to stay flat for two main

reasons. First, the bank does need cash to improve its liquidity, as the cash balance

stands at 15% of total assets (as per 2009). In addition, the current economic

conditions do not offer ample opportunities for the bank to re-channel any excess

liquidity into the marketplace in the form of loans.

Heavy provisions ahead The increase in provisions is expected to continue due to

failing asset quality. Our estimates show that provisioning will be at 38% of operating

income in 2010.

Weak net funding income Net funding income is estimated decrease because of the

stagnancy in balance, and this decrease in NFI will continue until 2011. Thereafter,

NFI will start improving gradually when asset growth picks some momentum.

Bottom-line decline in 2010 Higher provisions and lower NFI will cause DIB to

have a third consecutive year of profit decline. Post 2010, the bank will witness lower

provisions and better core operations, which will cause profits to improve. Profits are

expected to have 8% CAGR over 2008-2013, but in a volatile fashion.

Emirates NBD

2007 2008 2009

Return on Equity(%) na 14.5 12.5

Net Interest Income(%) na 66.4 69.4

Net Spread(%) na 2.7 3.1

Net Interest Margin(%) na 2.6 3.1

Cost to Income Ratio(%) na 39.3 34.7

NPL to Equity(%) na 12.8 20.9

P/E(x) na 4.2 4.9

P/BV(x) na 0.6 0.6

Analysis

Direction of profitability is contingent to outcome of Dubai World We expect

ENBD’s profits to remain stagnant for 2010 due to heavy provisioning. With possible

ease-off in provisioning beyond 2010, and improvement in the general economy of

the country, we expect the bank’s profits to grow with a 4-year CAGR of 21% over

the forecast period. Earnings however are highly sensitive to the impact of the

restructuring of DW’s loans, which can be much higher than our expectations.

Asset quality troubles are also from retail loans ENBD has taken a strong hit in its

retail portfolio with consumer NPLs jumping from 4.8% in 2008 to 10.2% in 2009.

The mortgage segment forms 18% of the retail portfolio and could be the next

problem area. Moreover, AED1.5bn consumer loans are currently marked under the

past-due-but-not-impaired category, a sizeable portion of which is highly likely to

make it to the non-performing category during the year.

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Exposure to Dubai World could be the largest ENBD has not disclosed its

exposure to DW; market news says that it could be around US3.0bn (AED10.0-

11.0bn). The bank’s exposure to UAE related GREs is roughly 20% or AED40bn

signifying that the unconfirmed exposure figures are not unfathomable.

Heavy debt maturities to keep asset growth in check ENBD is expected to undergo

extensive debt repayment over the forecast period, with maturities of over AED20.0

scheduled from 2010 – 2013. The bank is scheduled to repay AED7.2bn in 2010 and

AED4.1bn in 2011, which forms over 55% of the repayments during the 4 year

forecast period. Asset growth is therefore highly dependent on the bank’s ability to

tap funds.

Spreads to shrink in 2010 We believe that since the bank already has a near-sector-

average cost of funds, an increase from current levels can be delayed despite

aggressive mobilization of deposits. However spreads are expected to come under

pressure, contracting 35 – 40bps, as asset yields shrink on account of treasury

placements in 2010.

Enticing valuation multiples Trading at a P/BV of 0.5x and P/E of 5.0x, we believe

that the bank is being over-penalized for its exposure to DW and the Saudi

conglomerates and investment in Union Properties. Moreover, the bank has most to

gain, if the CBUAE chooses to be lenient regarding DW related provisioning. The

risk reward trade-off nevertheless needs to be gauged very closely in ENBD’s case.

First Gulf Bank

2007 2008 2009



Net Spread(%) 2.9 3.5 3.7



NPL to Equity(%) 4.6 3.1 8.1

P/E(x) 13.8 4.2 6.7

P/BV(x) 2.8 0.8 1.3

Analysis

Top-line trajectory is robust FGB managed to post a 49%YoY jump in its net

interest income in 2009, signifying a 2005 – 2009 CAGR of 45%. Robust top-line

growth is FGB’s key strength which is anticipated to perform in a healthy fashion

over the forecast period (4-year CAGR: 14%).

Asset growth outpacing peers FGB’s assets have sky-rocketed with a 3-yr CAGR of

38% till 2009 and grown by 17% in 2009, clearly outpacing our UAE banking

universe which posted figures of 28% and 9% respectively. The bank is expected to

maintain its edge of outpacing asset growth over the forecast period. Our call is

further supported by the fact that FGB does not have any heavy debt maturities lined

up over the forecast period.

Strong return ratios FGB offers the highest returns in our UAE banking universe,

with expectations of an average ROE touching 25% within our forecast period. Since

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FGB has also highlighted its superior asset utilization leading to high ROEs in the

past, we believe that an ROE in the mid-twenties is within FGB’s easy reach.

Asset deterioration is imminent FGB’s non-performing loans almost doubled in

2009 to reach AED1.5bn which forms 1.6% of gross loans, up from just 0.6% in

2008. Incorporating a phased implementation of expected changes in NPLs

regulation, we believe that FGB’s NPLs ratio will hit 2.5% by end of 2010 and 2.9%

in 2011 before tapering down gradually over the remaining forecast period.

Follows 180 days non-performance schedule FGB is one of the 2 banks in our

universe that does not adhere to the 90+ day non-performing aging schedule which

exposes it to risks relating to heavy provisioning in case of compliance. Having over-

provided (1.7% of RWA against 1.25%) in terms of collective provisions nevertheless

works in the bank’s favour which might lead to reversals if the bank so wishes.

Profit growth expected to survive high provisions FGB recorded a growth of

10%YoY in profits in 2009, a feat matched by just another bank under our UAE

universe. While the level of provisioning taken by the bank remains the core

discerning factor, we believe that the bank may just churn up a small profit growth in

2010 (9%YoY) before embarking on a more attractive bottom-line trajectory; 2009 –

2013 CAGR expectations of 20%.

National Bank of Abu Dhabi

2007 2008 2009



Net Spread(%) 1.8 2.4 2.7



NPL to Equity(%) 7.7 7.5 10.3

P/E(x) 14.9 5.8 8.9

P/BV(x) 3.3 1.2 1.6

Analysis

Profitability to rebound We expect the top-line of the bank to lose some steam in

2010; a healthy growth of over 14%YoY in the same followed by a slight let-off in

provisioning requirements is anticipated to add certain buoyancy to the bank’s profits.

That coupled with lower provisioning requirements and improving non-interest

income is expected to produce a 4-year CAGR of 19% over the forecast period.

Strong performance indicators NBAD is expected to maintain an average ROE of

over 21% for the 2010 – 2013 period. A robust ROE, approaching NBAD’s target of

25%, remains one of NBAD’s many key strengths. The bank is expected to maintain

its spreads and project a top-line CAGR of 13% over the forecast period.

Asset quality underpins smart lending strategy NBAD’s NPLs ratio in 2009 stood

at 1.2% (UAE universe average: 2.9%), which is the lowest amongst its peers. The

bank was trivially exposed to the Sa’ad & Al-gosaibi groups (US$11mn), which is by

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far the lowest exposure by a bank under our coverage. A well-diversified loans

portfolio and low retail exposure also offers certain cushion from delinquencies.

Asset quality likely to deteriorate, but within manageable limits We expect

defaults in retail, real estate and construction sector, driven by economic reason and

expectations of further drop in property prices. Moreover, the bank’s exposure to

Dubai World (US$345mn), though limited as compared to peers may require

provisioning. NPLs ratio is projected to top in 2011 to 2.2%.

Neutral to any change in NPLs regulation The bank has pre-emptively opted for a

90+ day non-performing aging schedule and as of 2009 has provided collective

provisions to the tune of 1.25% of the Risk Weighted Assets (RWA). NBAD’s

upcoming profits are therefore immune to the expected changes in the provisioning

requirements from the Central Bank.

Lending to get a boost from relaxation in LTD ratio Maturities of NBAD’s

deposits are highly tilted towards those of less than 3-months. With 81%

(AED98.6bn) of deposits falling in this category, NBAD has a lot to gain from a

relaxation in the Central Bank’s lending cap requirements. A change in the cap of

85% on deposits with maturities of less than 3 months, to 100% can help release

approximately AED14.8bn, allowing NBAD to lend excessively.

Sharjah Islamic Bank

2007 2008 2009



Net Spread(%) 3.5 4.1 3.5



NPL to Equity(%) 12.6 8.8 9.3

P/E(x) 24.7 8.7 8.4

P/BV(x) 3.3 0.5 0.5

Analysis

Lending to resume SIB is expected to continue to hold onto its cautious strategy only

temporarily, and will start gradually to loosen up. We expect that the bank will

witness a growth in its loan portfolio in 2010 by 8%. Then, growth rate will increase

into double digits, as the economy improves. In addition, the bank will have

approximately AED1.2bn ready to be lent, if the Central bank raises the cap to a

100% of loans to less than 6- months deposits.

Impact of Saudi groups Excluding exposure to Sa’ad & Al-gosaibi, the bank’s NPLs

were seen lower by 7.6% and NPL ratio was also seen lower by 21bps to 3.19%.

Thus, we estimate that the bank will be able to decrease its NPL ratio starting in 2010.

Profitability improvement Earnings are expected to grow in 2010 due to better core

operations income, but higher provisions will slow down this growth. Thereafter,

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profits growth is expected to accelerate, as provisions decrease gradually. Net income

is expected to increase by 22% over 2009-2013.

Top-line growth The gradual increase in the loan portfolio and the improvement in

spreads will result in growth in net funding income (NFI). The bank’s NFI is expected

to have 11% CAGR over 2009-2013. Meanwhile, non-financing income is estimated

to have 20% CAGR over the forecasted period.

Lowest P/BV Excluding banks which experienced major provisioning in 2009, SIB

scored the lowest ROE of 6.3% in 2009. This low level of ROE is factored in P/BV

which stands at 0.5x, the lowest among our UAE banking coverage.

Highest CAR ratio SIB has the highest CAR among our UAE coverage. This can be

attributed to the equity size relative to the overall assets. Based on Basel II, the bank’s

CAR stood at 34.5% in 2009.

Ability to distribute high dividends Even though 2009 dividends were revised

downward, the bank strong’s capital base provides the bank the ability to distribute

higher dividends, regardless of short term fluctuations.

Union National bank

2007 2008 2009



Net Spread(%) 2.3 2.6 2.3



NPL to Equity(%) 5.3 5 9.3

P/E(x) 15 3 5.7

P/BV(x) 2.7 0.6 0.8

Analysis

Profitability to remain under pressure in 2010 UNB saw a 17.4%YoY decline in

profits in 2009 despite a 10%YoY jump in the top-line, attributed to higher

provisioning and lower non-interest income. The year 2010 however does not seem

very positive in terms of profits; projected to tank by 13%YoY. A dip in the profits

may ensue as the bank takes higher provisions arising from a multitude of reasons.

Good asset quality UNB’s NPLs ratio stood at 1.5% against an average of 2.9% for

our UAE banking universe, in 2009. Like all other banks, UNB was also exposed to

the Al-gosaibi group to the tune of US$60.5mn (approx. AED220mn). We expect

UNB’s NPLs ratio to increase by 70bps to 2.2% in 2010 and coverage to increase to

128% due to collective provisions.

Dubai World exposure & non-compliance with possible regulatory changes

UNB’s exposure to public entities is AED6.4bn. An exposure to DW in the range of 5

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– 10% of this amount, which can be quantified to AED300 – 600mn cannot be ruled

out. As per 2009 financials, UNB’s portfolio provisions amount to only 0.48% of

total RWAs; an increase to 1.25% may lead to an additional charge of AED520mn.

Expected to react very positively to increasing interest rates As per our

calculations, UNB’s spreads declined by 25bps in 2009 on account of a sharp rise in

the cost of deposits. UNB’s cost of funds (highest amongst peers) is not likely to

jump much higher than current levels, even if the bank desperately mobilizes

deposits. An increasing interest rates scenario therefore bodes even better for the

bank’s spreads and consequently for the top-line.

Operating income to fare much better UNB’s pre-provision operating income

declined by 8%YoY in 2009 owing largely to decline in fee & commission income.

Given that net interest income is forecast to grow healthily and investment losses

from properties will be reduced, we expect operating income to jump 17% in 2010

and post a 4-yr CAGR of 14% from till 2013.

Attractive valuation multiples UNB stands at a very low P/BV, trading at an

enticing discount to the industry average and to the justified multiple of the bank. The

bank’s exposure to equity and property investments poses some concern but is limited

to 4% and 7% of equity, respectively. With limited known exposure to troubled

entities and high dependence on recurring income, we see little reason why the

multiples should not reach justified levels going forward.

Peer Group Comparison

Market Share on Assets

ROAA

ROAE

Cost to Income

Average ROE

Cost Efficiency

Net Interest Income to Total Income

Conclusion

Profitability likely to resuscitate in 2010 After profit decline in two consecutive

years, keeping a realistic view, we believe that our banking universe will be able to

muster up a growth of 18%YoY in 2010, despite a slow-down in the top-line. Profits

are expected to follow a stronger trajectory going beyond 2010, exhibiting a 4-yr

CAGR of 26%. Profit growth could exceed expectations if Dubai World issues are

resolved sans requirement for higher provisions.

Asset growth to remain subdued in 2010, eyes fixated at 2011 The recent cooling off

seen in asset growth has earmarked the end of the era of supernormal growth in

banking assets. Albeit forecasts see oil at a higher average price than that in 2009 and

the year in progress to see a GDP growth of 2 – 3%, asset growth may remain in

single digits for 2010 as banks adopt a cautious stance. Improvement is nevertheless

expected beyond 2011 as the economy pick up pace and the general mood on the

ground turns positive.

Asset quality woes to remain Asset quality of UAE banks is anticipated to worsen by

another 130bps in 2010 to reach 4.3%. A confluence of factors including expected

changes in CBUAE regulations, shortfall in PV of future payments from restructured

loans of DW and further delinquencies in retail and real estate segments, are expected

to weigh in on asset quality. After peaking out in 2010, we believe that asset quality

will maintain status quo in 2011 and start improving in 2012 as loans growth resumes

Issues are plenty but issues are manageable We understand that 2010 will be a

difficult year for the UAE banking sector as a whole, yet positivity does remain. As

per our forecast, the banking sector is expected to show an increase in profits despite

high provisions, culminating from the incorporation of DW debt, highlighting the fact

that the current issues are manageable. Moreover, the CAR of the banking system as a

whole stands at comfortable 19% as of 2009, further underpinning the robustness of

the banking system.

Recommendation – Selective optimism While we remain cautious over the UAE

banking sector for the time being, we believe that some banks, particularly those in

Abu Dhabi offer attractive upside potential while operating in a safer environment.

Stretching our horizon beyond the troubles seen in 2010, a healthy growth in the top-

line, reduced provisioning requirements, robust earnings trajectory and attractive

valuation multiples, entice us toward our top picks. We remain selectively bullish on

NBAD, FGB and UNB.

Business

Islamic banking research