Global Investment House – Kuwait – UAE Islamic Banking Sector Report –
The UAE economy continued to perform well on the back of the surge in oil prices in the past few years with the GDP recording high double digit nominal growth rates since 2003. In 2006, UAE’s GDP at nominal prices increased to AED599.2bn, recording a substantial increase of 23.4% over AED485.5bn recorded in 2005. Estimates from the Ministry of Economy (MOE) indicate that the nominal GDP increased by 16.5% to reach AED698.1bn in 2007. In terms of real GDP, estimates from MOE indicate that the UAE economy grew by 7.4% in 2007 to reach AED420.2bn.
The broad money supply, as measured by M2, has exhibited consistent positive trend during the past few years. The broad money supply (M2) increased from AED399.3bn at the end of 2006 to AED565.7bn at the end of 2007, an increase of 42%YoY.
Banking sector in the UAE depicts a rosy backdrop amidst a flourishing economy, riding high on the sky-scraping oil prices. With strikingly low interest rates harboring curiosity from willing borrowers, bank lendings have so far witnessed colossal volumetric growth which is expected to remain intact going forward, given that the current situation persists. Supplemented further by limited exposure to the US subprime and related structured investment products, nominal provisioning needs, adherence to best risk management practices and support and commitment from affluent sponsors regarding capital enhancement as and when required, we see no reason why the banking sector may not prosper.
The bottom-line of the banking sector has grown with a sublime 2003-2007 CAGR of 49%. The swelling bottom line has been attributed to effective deposit mobilization paving the way to meet the robust demand for credit. With M2 growth averaging at 27%YoY for the period 2004-2006 and reaching 42%YoY in 2007, the deposit growth has closely followed suit and grown by a similar 27%YoY average for the 3-year period ending in 2006. With a 29%YoY growth exhibited by the banking sector in 2007 and a 7.4%YTD (annualized 30%) growth in 1Q2008 the surge in banking deposits are expected to continue in the current year.
Deposit growth in turn has expanded the required capacity to lend, which coupled with the demand for capital, has led to an escalating growth in loans and advances, which averaged at 34%YoY for the 2004-2006 period. For 2007, the loans growth rate has gone beyond its due trajectory and exhibited a growth rate of 40%YoY. In 1Q2008, advances have already shown an escalation on 10%YTD which translates into an annualized growth of 39%YoY. Similarly, the total assets of banks operating in the country have grown by 43.4%YoY to reach AED1,232.5bn in 2007, making them the largest amongst the GCC countries.
Banks in the UAE have benefited from the rapid economic expansion currently happening in the UAE. The total banking sector profits increased by 24% in 2007. The return on equity (ROE) at 22% for the year 2007 too has improved over 18% reported in the previous year. The return on assets (ROA) has come down marginally to 2.0% at the end of 2007 from 2.2% recorded in the previous year. The banking sector’s balance sheet continues to remain strong with the regulatory capital adequacy ratio (CAR) at 14.4% at the end of 2007.
Islamic banks have become an increasingly important part of the UAE system making rapid strides along the way. Islamic banks have increased their share of total bank assets, from 8.8% at the end of 2002 to 13.4% at end of 1Q2008 (as per recent newspaper reports). A range of Shariah-compliant products was introduced in the market and Islamic products like Ijarah and Murabaha have become common in property transactions. The region has witnessed Islamic Sukuks attracting large investor volumes with subscriptions exceeding planned issuance, even in large-sized mandates. The significance of Islamic banking was further underlined as a few of the major banks started an Islamic banking wing or in some cases converted themselves into Islamic banks. For instance, EBI formed Emirates Islamic Bank by converting its subsidiary, Middle East Bank into an Islamic one. New issuance of licenses include Abu Dhabi-based Al-Hilal bank in 2007 and Ajman bank in 2008.
With the inclusion of more Islamic banks (IB) into the system coupled with improving profitability of the existing IBs, the share in profits of IBs in total banking profits for UAE has increased from 10% in 2003 to 13% in 2006 and is expected to improve further going forward. This can be gauged from the fact that profits of IBs have been rising with a 4-year CAGR of 68% and may very well continue. Deposits too witnessed a similar swell in volumes with the market share of Islamic banks consistently increasing against the conventional banking system. Deposit collection therefore saw a 22%YTD increase in June 2007 and grew at a 2003-2006 CAGR of 44%.
The listed UAE banking sector as a whole, has performed very well on the Abu Dhabi Stock Market (ADSM) with a 45%YoY appreciation in the prices of the banking scrips. Albeit this increase is slightly inferior to the growth in the index which grew 60%YoY during the said period, it is nevertheless substantial. While the banking sector exhibited healthy price appreciation, Islamic banks too made their presence felt by matching the banking sector’s performance, the only exception from our peer group being Sharjah Islamic Bank (SIB). SIB’s with it awe-inspiring performance, beat the sector and the index and made its investors 70% richer in the process. This was followed by Abu Dhabi Islamic Bank (ADIB) which grew by a remarkable 30%YoY. DIB which outperformed the banking sector till mid of April 2008, lost ground to the sector performance and hence exhibited a 26%YoY return. All in all, Islamic banks mostly performed well during the last 1 year, revealing the interest expressed by investors in this particular banking niche.
Going forward, we expect the Islamic banking segment to maintain its growth trajectory with volumes being the fore-drivers. Credit demand is anticipated to emanate from across the board including corporate and consumer/personal loan seekers. Changing demographics and the increase in expatriate population will drive personal loan demand while infrastructure development, growing interest in the manufacturing sector, need for accommodation and further development of tourism-linked industries is seen as the demand-pushers for corporate loans. With the DFM and the ADSM expected to grow further, fee based income and capital gains will consequentially follow suit and fuel to the bottom-line further. Demand for Sukuks and issuance of other innovative instruments for Islamic financing will promote generation of advisory/arrangement fee income. With growing awareness of Islamic banking products and aggressive steps for marketing and relationship building carried out by the Islamic banks, we see these banks to offer stiff competition to their conventional counterparts in the race for market share.
On the basis of the mentioned growth drivers, we believe that the Islamic banking assets, in tandem with the collective assets of ADIB, DIB and SIB will rise at a 2007-2011 CAGR of 21%. Furthermore, on similar grounds, we also expect the Net Commission Income and the bottom-line of Islamic banks to grow at a 2007-2011 CAGR of 26% and 21% respectively.
"Global" Valuation Matrix
AED Current Price Target Price Recommendation Potential Upside BVPS* EPS* P/BV P/E
ADIB 6.4 8.7 BUY 36% 2.9 0.6 2.2x 11.0x
DIB 9.2 11.2 BUY 22% 3.5 0.7 2.7x 12.5x
SIB 2.8 3.9 BUY 39% 2.0 0.2 1.4x 14.2x
Source: Global Research, Market prices as on May 08, 2008 *2008E
