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Abu Dhabi Islamic Bank (ADIB): Upgrading to Hold - Growth Downplays Risk
(6 September 2009)


ADIB’s core operating performance remained strong during the first two quarters of this year as the bank grew its loan book by 5% QoQ during 1Q and 2Q. Meanwhile, deposit base rose by 6% in 2Q09 and 10% in 1Q09. As a result, 2Q09 and 1Q09 operating earnings are 20% and 30% above our estimates, respectively. Net income, however, continues to lag behind due to the performance of its real estate subsidiary, Burooj, and increased provisioning charges. Burooj generated losses of AED14.4 million in 1H09. This compares with net income of AED141.8 million in 1H08, which represented 31% of its bottom line. Despite this, the bank managed to post a 20% better than expected operating profit in 2Q09. With 85 per cent exposure to the Abu Dhabi property market,
we expect the downside risk from Burooj to be limited moving forward. Moreover, a turnaround is expected by next year, when the infrastructure work is resumed in Reem Island. While this should provide a significant upside to bottom line estimates for FY10e, we have not included it in our forecast due to the uncertainty involved.

Asset quality should continue to weigh in on earnings as approximately 20% of the bank’s loan book is exposed to real estate. Additionally, the economic slowdown is impacting the quality of the corporate books as well. The quarter’s provisioning charges of AED171 million, the highest since 1Q07, amounts to 47% of its pre-provisioning profits. This, however, proves the bank’s resilience in its core operations. During our forecast period of FY09e – FY13e, provisioning charges to pre-provisioning profits stand at an average of 33%. We have also increased our NPL ratio (non-performing loan to total loan) and provisioning charges assumptions in our model to reflect the current operating environment. Strong core operating performance appears to allow the bank to increase
its provisioning charges without making losses. In addition, following the issuance of AED2 billion of Tier 1 sukuk in 2Q, capital adequacy ratio has improved to 15.3% from 10.8% in 1Q09 and 11.8% in 4Q08. Thus we find the bank’s current capital base adequate to absorb any unexpected increase in losses.

2Q09 net interest income is 21% above our expectations due to higher volume and better margins. This translated to 20% better than expected operating income, though noninterest income was slightly below our estimates. Cost to income ratio is 39% vs. our expectation of 41%. Despite strong operating performance, we believe the bank will
continue to face strong headwinds due to its real estate exposure and asset quality deterioration. Signs of a turnaround in the performance of Burooj would compel a rerating, in our view.

We are upgrading the stock to "Hold" from "Sell" based on growth factor. Yet, we remain cautious on its asset quality and real estate exposure. Our new TP is AED3.22 which
gives an upside of 12.2%.

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