• Valuations reflect weak ROE outlook; reiterate Neutral UNB’s earnings dropped 27% Y-o-Y in 1Q16, owing to i) pressure on revenue; and ii) higher provisioning. The key negative surprise was spreads, which tightened 24 bps Q-o-Q to 2.30%, driven by an increase in cost of funds. Lack of pricing power on deposits (market share less than 5%) and a high composition of term deposits (80%) make UNB’s cost of funds more sensitive to systemic liquidity pressures, in our view. Fee income was sluggish, as economic growth softened and management reigned in loan growth. We cut our 2016 estimates by 3% to factor in tighter spreads and slower fee income. Trading at 2016e P/BV of 0.6x, we believe UNB’s valuations are undemanding; however, the headwinds to revenue and credit quality are likely to persist. We cut our FV to AED3.8 from AED3.9, but we maintain our Neutral rating on the stock.
Macro, liquidity constraints to weigh on loan growth We cut UNB’s 2016e loan growth to 3.0% from 4.5% earlier. The bank’s loan book was flat Q-o-Q and up 2.0% Y-o-Y in 1Q16, well below sector average growth of 2% Q-o-Q. We do not expect a meaningful recovery in loan growth this year, as UAE’s economic growth is set to decelerate this year (led by Abu Dhabi). UNB’s SME loan book (c3% of total) is contributing to the slowdown, as management keeps new lending on hold and the NPLs get written off. Liquidity has also tightened, as deposits were down 4% Q-o-Q in 1Q16, which pushed up LDR to 95% from 92% in 4Q15.
• Corporate recoveries mitigate provisioning pressure UNB’s provisioning surprised positively, owing to recoveries of AED43mn from the corporate segment. In 1Q16, cost of risk was 47bps (34bps in 1Q15) vs. our expectation of 190 bps. The NPL ratio, however, deteriorated to 3.7% from 3.5% in 4Q15, as non-performing loans rose 6% Q-o-Q. We continue to be cautious on credit quality in 2016, in light of the risks in retail (job cuts in certain industries) and corporate (Al Jaber) segments. We cut 2016e cost of risk to 110bps from 165bps.

Shabbir Malik
Murad Ansari