EFG-Hermes updates its recommendations on UAE banks amid first half 2005 results

"It is remarkable to see how first half 2005 net profits for most of the banks we cover exceed full year profits from the previous year. However, the recent slashing of brokerage fees by the market regulator will have an effect on non-interest income moving forward, which has played an important role so far in boosting banks' net profits and growth. Moreover, earnings growth is likely to deteriorate over the medium term as the IPO pipeline dries up, with the probability of sustaining such phenomenal growth rates being low going forwards," comments Tammam Barbir, banking sector analyst at EFG-Hermes, the region's leading full service investment bank.

According to the firm's reports, which cover a basket of UAE banks, shares in Mashreqbank and Commercial Bank of Dubai (CBD) offer the greatest potential with EFG-Hermes maintaining short term and long term buy recommendations for both.

CBD's 1H2005 net profit increased 66% to AED249 million from AED150 million for the same period last year. Commenting on the bank's performance, Barbir observes, "The bank's strong growth is not reflected in the share price, and CBD continues to be "ignored" with the share price underperforming market peers. We see no reason to justify such a lackluster performance with the bank posting strong results that are in line with market peers."

Mashrebank's net income increased from AED338 million during 1H2004 to AED677 million during 1H2005, with the results continuing to reflect the bank's philosophy of aggressively growing non-interest sources of income and booking high loan loss provisions relative to income before provisions. The bank's shares are among the most tightly held, with a bid-offer spread above 10%. "Increasing the number of free float shares through a stock split or selling a part of the Al Ghurair family's 87% stake could act as a catalyst to increased movement in the share price," Barbir notes.

Another short term buy recommendation was given to Abu Dhabi Commercial Bank (ADCB), which posted a 178% increase in 1H2005 net profits to AED844 million. The bank witnessed a remarkable surge in fees and commissions, driven by subscription fees from two IPOs (Abaar and Surooh Real Estate), but also a widening in spreads as the bank is increasing its exposure to high yielding assets. ADCB has been amongst the most aggressive banks in rolling out new products or forming alliances, with the resulting increased operating expenses are more than covered by one-off IPO gains.

National Bank of Abu Dhabi (NBAD) is beyond any doubt the clear beneficiary of the appreciation in the prices of financial assets, impressive trading activity on the local bourses and the unprecedented IPO boom. The bank reported a 166% rise in 1H2005 net profit of AED1,338 million, compared to AED503 million posted during 1H2004. However, Barbir notes, "Earnings from investment banking operations, the main earnings generator for the bank, will be heavily challenged as brokerage commissions have been halved, prices of financial assets have fallen sharply and the number of IPOs coming on stream is likely to diminish. Consequently, the likelihood of the bank reporting negative earnings growth over the medium term or even a slowdown in earnings growth over the short term is now greater. We therefore maintain our short term neutral and long term reduce recommendations."

EFG-Hermes' coverage gave a short term accumulate recommendation and a long term reduce recommendation to both First Gulf Bank (FGB) and Union National Bank (UNB).

FGB's first half profits for 2005 have surpassed full year 2004 profits by 90%. The bank's 1H2005 net income stood at AED349 million compared to AED111million for 1H2004. "The strong results for 2Q2005 - both net interest income and IPO fees - are partly the result of the effect of the IPO of Sorouh Real Estate, for which FGB was the lead manager. We believe that underlying earnings will experience strong growth on the back of an expected increase in the loan to deposit ratio. However, we still believe that earnings will deteriorate as the IPO pipeline dries up," notes Barbir.

Strong growth in non-interest income helped UNB report a 131% increase in 1H2005 profits to AED523 million. "Our concern centers on the quality of non-interest income, the effect of declining spreads on the back of rising interest rates, coupled with the impact of increased exposure to government and public sector companies on profitability. Moreover, the effect of the planned expansion is yet to be seen given the highly competitive market."

EFG-Hermes has a short and long term reduce recommendation on Emirates Bank International (EBI). The trend of rapid credit growth that has been a characteristic of EBI was broken in second quarter of 2005, with the loan to deposit ratio declining from a sector high of 165% in 1Q2005 to 135% in 2Q2005. "The bank recorded strong 1H2005 earnings at AED715 million; however, a resumption of loan growth will be vital for maintaining profitability, given rising interest expenses, the negative impact of the recent halving in brokerage commission on non-interest income, continued growth in operating expenses, and the absence of the positive impact of loan loss recoveries," concludes Barbir.