• Cut 2016-17 earnings c18%; Reiterate Neutral UNB’s stock price is down 25% YTD versus 2% for ADSMI, as the bank reported weak 4Q results (earnings down 60% Q-o-Q, 55% below estimate) and cut its 2015 cash dividend 20% Y-o-Y. While UNB’s valuation has become relatively attractive – 2015 P/BV of c0.6x – we believe the stock is unlikely to re-rate meaningfully in the short term, as we expect sustained provisioning pressure in 1H2016, driven by the SME loan book. We cut UNB’s 2016-17 earnings estimates by c18%, primarily to reflect higher provisioning. We cut our FV to AED3.9/share from AED5.8/ share as we raise our cost of equity (+50bps to 11.5%). We reiterate our Neutral rating on the stock. A steady recovery in oil is a key upside risk to our rating.
• Focus on rehabilitating distressed SME loans UNB is likely to focus on generating recoveries from the delinquent SMEs by restructuring their loans. However, we expect the bank’s overall recoveries (AED200 million in 2015, driven primarily by large corporate accounts) to decline in 2016. We also have concerns over a pick-up in delinquencies in the retail segment, which represents c20% of the bank’s loan book. We expect UNB’s cost of risk to climb to 165bps from 114bps in 2015. UNB is well-positioned to withstand pressure on credit quality, in our view. Its capitalisation is robust – CET1 ratio of c16.0% - and the risk of capital erosion is low – 2016e pre-provision ROA of 2.6%.
• Revenue growth likely to be challenging We forecast revenue growth to nearly halve to c4.0% in 2016 on account of a slowdown in loan growth and a contraction in spreads. In light of the risks, new lending to SMEs continues to be suspended. Loan origination in the retail segment is likely to be selective and limited to lower-risk collateralised products (autos and mortgages). We expect pressure on spreads as the reversals of suspended interest, which propped up spreads in 2015, are likely to decline.

Shabbir Malik
Murad Ansari