• Earnings down 5% Y-o-Y; ADCB and UNB key beats UAE banks’ earnings declined 5% Y-o-Y (we estimated -8%) as net interest income momentum weakened (-1% Y-o-Y), and provisioning climbed (+25% Y-o-Y). The key beats were ADCB (FX and derivative income) and UNB (provisioning), while the key miss was RAKB (provisioning and spreads). Overall, the 2Q16 results were better than expected, aided by decent loan growth and fee income trends, a focus on cost rationalisation and controlled provisioning. We continue to like ADCB, as it is well-positioned to compete effectively in a changing competitive landscape, (solid market share and greater domestic focus than FGB and NBAD), deliver recurring growth in FX income, and trades at attractive valuations. We are also positive on ENBD, encouraged by its improving credit quality metrics, relatively strong earnings momentum and undemanding valuations.
• Focus on 2Cs: Cost of funds and cost of risk With oil trending below UAE’s budget break-even level and a cyclical slow-down in the economy, UAE bank’s profitability is being shaped primarily by two drivers: cost of funds and cost of risk (credit quality).
Spreads weakened further this quarter, as banks generally struggled to pass on the increase in cost of funds to borrowers. Increased competition from foreign banks (Japanese, Chinese, French and American) in the corporate segment, a flight to low-risk credit from local banks due to credit quality concerns and a low interest rate environment have prevented upward re-pricing of assets, in our view. Two of the most liquid banks – NBAD and ADIB – have been most successful at keeping pressure on spreads at bay
Provisioning: Banks were generally able to keep cost of risk under control as corporate credit quality held up well. Partial repayment by Limitless and reported improvement of restructuring terms by Al Jaber were tailwinds in 2Q16. Provisioning in the retail segment, however, was elevated, due in part to de-risking of the SME book, and to growing deterioration in the consumer segment (layoffs and over-leverage at the low-end). We expect provisioning will continue to be a burden on profitability in 2H16.
• Decent loan growth; stable liquidity Loan growth slowed to 7% Y-o-Y in 2Q16 from 9% in 1Q16; however it was better sequentially (2% Q-o-Q vs. 1% in 1Q16). DIB (25% Y-o-Y), ADCB (13% Y-o-Y) and ENBD (12% Y-o-Y) were the key drivers. NBAD was the key drag (-7% Y-o-Y) on sector loan growth as it unwound its short-dated trade finance book. Liquidity (LDR) was stable Q-o-Q and improved slightly Y-o-Y, helped by recovery in government deposits, mainly at NBAD.

Shabbir Malik
Murad Ansari