Let's take a deep look at the Q3 financials reported by listed companies in the heart of the economy – the banking sector. I chose the heart as analogy because the heart keeps the blood in circulation which keeps the body alive, just as the banks keep credit in circulation, keeping the economy alive.
First up is Dubai Islamic Bank, which provided not only its financials early but also an investor presentation, showing DIB is a bank intent on providing useful information to its investors. DIB said "third quarter net income rose … thanks to strong growth in financing assets and customer deposits, even as impairments more than doubled". Group net profit, according to the financials, grew 15 per cent, a strong year-on-year increase, especially in these challenging economic times.
The issue with the above statement is that it states that net income was driven by asset and deposit growth. Asset growth seems to explain the increase in profit – net financing assets grew 14 per cent (total assets 15 per cent) matching the group net profit growth.
What about quality of assets? The actual return on assets (RoA) dropped from 2.43 per cent to 2.34 per cent. This might seem small, but a difference of 0.09 per cent on assets of Dh201 billion is about Dh180 million, which is over 5 per cent of Q3’s Dh3.3bn in net profit.
More intriguing is the total capital adequacy ratio for DIB dropped from 18.1 per cent to 16.9 per cent, indicating an increase in risk, but this is not reflected in an increase in RoA. You would expect that if a bank increases its risk levels then it should increase returns. Although DIB appears to have increased risk, the total capital adequacy ratio of 16.9 per cent is considered strong, reflected by Moody’s recent upgrade in the bank’s credit rating.
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So how did the return on equity increase from 17.8 per cent to 18.6 per cent when RoA dropped? It wasn't leverage, as one measure of that, net financing to deposit ratio, dropped from 94 per cent to 92 per cent. The answer lies in the differences between quality of returns and amount of returns. The profit increased because the balance sheet of DIB increased, as stated, with little increase on operating expenses. But the asset increase masks risk increases as measured not only by capital adequacy ratios, in relative terms, but also by impairment losses, as well as a deterioration in RoA. This is not sustainable.
For Union National Bank (UNB), let's take a look at its core revenue, which I define as interest revenue and revenue from Islamic financing, and core expenses. The net year-on-year growth for this is 1.2 per cent, nearly flat. What is of interest is that core revenues grew 4.13 per cent while core expenses outpaced that, growing at 9.18 per cent. This is a big gap and means that a lot of work needs to be done for it to reverse the flattening of profit growth. Looking at other sources of income the largest material variance is net fees and commissions, which grew 20 per cent, contributing Dh33m to the net profit. This is significant as the total net profit increased by about Dh12m. To be transparent, all other income generated a loss of about Dh13m.
So how did net fees and commissions grow by so much? It was driven by an even bigger gain of Dh45.8m in retail fees and recoveries, a growth rate of 87 per cent over the previous quarter. Overall capital adequacy ratio for the bank stood at 19.7 per cent.
I will round out with Mashreq. The first thing that catches the eye is a 36 per cent increase in total net profit year-on-year. Core revenue grew 3.33 per cent versus core expense growth of 2.11 per cent, a positive differential. So with such a great increase in profit and core revenue/expense differential is positive, why should we look further? Because such a large jump in profit merits further inquiry to understand the quality. There are two major movements in the incomes statement. The first is a 58 per cent drop in other income, amounting to Dh123m decrease.
The other is a 44 per cent drop in impairments to a decrease of Dh205m, which is a contribution to net profit. A quick check finds DIB's impairments increasing 132 per cent and UNB's impairments increasing 19 per cent. That is quite a large spread in the per cent change.
There does not seem to be a specific pattern to the results. But what is clear is that profit growth in each case was supported by something I do not consider within the ordinary course of business.
Sabah al-Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region You can read more of his thoughts at al-binali.com
