Euromoney: Emirates NBD mirrors Dubai’s revival

Euromoney, April 2015

There is a museum on the 15^th floor of Emirates NBD’s head office in Dubai. Renowned for its extraordinary, priceless collection of pearls, once the lifeblood of Dubai’s economy and the main reason for the city’s very existence, the museum also chronicles the financial history of the city and its currencies through the years. But the truth is, for the best illustration of Dubai’s irrepressible rise and the bank’s pivotal presence within it, you just look out the window.

Down there’s the Creek, whose marshes you could wade across not so long ago, dredged in the 1960s with borrowed Kuwaiti money to attract the first traders to come. Here’s Deira, where the city’s first banks congregated, and on the other side of the water Bur Dubai, where NBD’s first branch managers would be rowed to in an abra at the end of the day with their ledgers and cash. Over there to the southwest along Sheikh Zayed Road are the spires of the newer towers, each more daring than the last, where a new Dubai based on tourism and consumption has taken shape. And overhead, passing the Creek which once couldn’t cope with a dhow, are flights from the world’s busiest airport for international passenger traffic. The whole process, from backwater to global hub, has taken half a century, or the lifespan of an average camel.

Or, for that matter, the lifespan to date of the banks that became Emirates NBD. National Bank of Dubai was founded in 1963, eight years before there even was a United Arab Emirates. Its first balance sheet was in Indian rupees, the next few in a stopgap joint venture of a currency called the Qatar and Dubai riyal; and when the newly-minted UAE was ready to invent its own currency in 1973, it went to NBD to help create and print it, through a currency board on the fifth floor of NBD’s building.

Dubai’s Sheikh Mohammed bin Rashid Al Maktoum had this instrumental history in mind when he told National Bank of Dubai and Emirates Bank to merge into a muscular national leader. “His vision was for Dubai to grow, and to be financed it needed a bigger bank with more capital,” says Ibrahim Sowaidan, head of group corporate affairs, and a proud guide to the museum. He points out the modest document that made it happen, two creased and slightly smudged pages of A4 lined paper with handwritten Arabic in blue ink, signed by the bank executives in front of the Sheikh in his Zabeel Palace in March 2007, after lunch and a spot of tea. The biggest deals can come from quiet beginnings in the Gulf.

But the deal suffered from dismally unfortunate timing. Emirates NBD’s shares were listed on October 17 2007; by the end of that year, sub-prime had taken hold, the global financial crisis was in full swing by the new bank’s first anniversary, and shortly after its second, the government put $59 billion of Dubai World debt on standstill, with Emirates NBD one of its biggest creditors. The years since have required the bedding in of two very different institutions at the same time as dealing with crippling levels of non-performing assets.

It has not been easy. But things are looking up.

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The Emirates NBD annual result, released on an uncharacteristically rainy Dubai day in January, showed the sort of numbers that make executives happy to jump on the analyst call. The man releasing them was Shayne Nelson, hired as chief executive in 2013 from his role as head of Standard Chartered Private Bank just a month after National Bank of Abu Dhabi hired his fellow Australian and Stanchart alumni Alex Thursby to be chief executive there.

Nelson was able to present a great result: net profit up 58% year on year to AED5.1 billion, with a pre-impairment operating profit over AED10 billion for the first time for a UAE bank, a 22% climb in total income to AED14.4 billion, improvements on both the interest and non-interest contributions, and impressive growth everywhere from retail and Islamic to trade finance, foreign exchange, brokerage, asset management and investment banking.

But the heart of the result was in the balance sheet. Alongside an improvement to an already-solid capital adequacy ratio, now 21.1%, the bank’s impaired loan ratio fell from a grim 13.9% a year earlier to 7.8%, and at the same time, the coverage ratio topped 100% for the first time in years. The biggest reason for this improvement, while not the whole story, was a reclassification of the bank’s Dubai World exposure from impaired to performing following a deal struck with creditors the previous week: as Dubai Inc has returned to health, the bank has come with it.

Asked what the result tells us, Nelson says: “The first thing it shows is that we are through the legacy. That was the key highlight of 2014, that we managed to get to 100% problem loan coverage, and that was something frankly I thought might take to the first quarter of 2015. That was a major milestone for us.”

Dubai World was not, Nelson says, the only reason for the improvement. “It was the financial restructuring unit recovering a lot, we had some old consumer loans that had been very historically fully provided for that we cleaned out, and we had a lot of asset sales.” But there’s no question Dubai World was the most important: a year earlier it had accounted for a 3.1% impairment of the bank’s total exposure, and in late 2011, 4.3%. “It’s always been on track with its restructuring. But getting that through was very important for the counterparty and for us. It was our biggest classified loan exposure.”

And, while a 7.8% bad loan book is hardly pristine – the 2014 figure at NBAD is 3.07%, for example – Nelson says he’s comfortable with what’s still on the books. “It’s pretty spread actually. A lot of it is property-related but there’s a lot of security in there as well. We are 100% covered, we’ve got a pile of security on those loans, and the environment is much better for working those through now.” While some may turn performing, “most of our recovery has been about disposing of those assets, either the clients or us,” he says. “Our strategy on property is pretty simple: we’re not a property company, and if we believe a deal is decent we will take it as it returns as capital and we can generate more revenue off the back of it.”

Results energized by Dubai World’s restructuring, a bad loan book improving on the back of revived real estate; it’s tempting to see Emirates NBD as a barometer for Dubai itself, its fortunes varying with the emirate. Is that fair?

“It’s probably a fair comparison,” he says. “If you look at the industries we’re exposed to, or our retail franchise, we have between 15 and 22% market share in most retail products, so we are a pretty good barometer.” Emirates NBD is the biggest bank in the UAE on most measures, but in Dubai itself, it is utterly dominant. And what does that barometer tell us now? “The economy is growing strongly, the population has been growing strongly, and consumer spending has been growing strongly. Retailers are doing well, hotels, logistics. Emirates Airlines is doing a fabulous job of making this a massive regional hub.”

All of that’s true, but Dubai’s volatile, too, even by the standards of the Gulf: its property and stock markets soar and trough, and never seem to just drift or grow sustainably. How does a bank deal with volatility like that in the economy it serves?

“Well, if you look at real estate in 2014 it was down year on year,” he says. “We saw a strong recovery in property prices in 2013, and then tapering in 2014; that’s showing the maturity of the market, and we’re certainly now seeing investors a lot more prudent about where they buy.” Nelson credits a number of macro prudential controls the central bank put in for this, such as strict parameters around loan to value and debt service cover ratios, as well as an increase in transaction fees on property. “That has helped to get rid of a lot of that speculation in the market. Developers are more prudent too: the industry has self-corrected. It is to their long-term benefit for the market to be stable, not gyrating around.” He points towards the big developments in Dubai’s west, the ones that flourished and then were mothballed and finally resumed over the last six years. “There are still cranes in the sky, but not as many as some people would think. The pace of development has slowed now to match the demand. It used to be: we’ll build a lot of supply and hope the market comes. I don’t think that’s the case anymore.”

Banks in the rest of the region are grappling with the effects of the low oil price, but in Dubai, which is not an oil economy, the situation is slightly different. While it avoids the direct hit that a commodity economy would feel, it’s also a trading and tourism hub, so the net impact is tricky to calculate. Emirates NBD’s own economists have cut half a percent off their overall UAE forecast to 4.3% on the back of the oil price, but think Dubai will outpace it at 4.7% GDP growth in 2015. “For Dubai, it [oil] is not a massive issue,” he says.

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As Euromoney discussed in detail in September, the modern trend among Middle Eastern banks is to grow regionally, and significantly. Rather than just having a few branch offices in neighbouring states, banks are building or buying major operations elsewhere in the region, in some cases (Arab Bank, Ahli United) deriving more revenue from outside the home base than within it. Qatar National Bank, National Bank of Kuwait and (more so for its ambitions than its presence today) NBAD all stand out.

Where does Emirates NBD fit into this? So far it has made just one acquisition, but it was a significant one: BNP Paribas’s Egypt unit, bought for $500 million in 2013, the same year QNB bought SocGen’s business in Egypt.

Egypt is not an easy place to do business, but the bank almost doubled the income it achieved from Egypt last year, and more than doubled operating profit. The operation is significant, covering 4,000 corporate and 246,000 retail clients through 61 branches. It’s also, perhaps, a template for further expansion.

Why are you in Egypt? “If you look at the population growth, the demographics, the unbanked, it’s a big opportunity for us,” he says. “We will be expanding in that market, we want to get to 100 branches,” although at the same time he’s keen to roll out non-branch infrastructure through internet and digital in Egypt, seeing a clear competitive advantage compared to local competitors. This, he’s sure, is the future, in Egypt as much as anywhere else. “I look at my son. I think he’s been in a bank once, to open an account, and he’s 21. The generation now is not so interested in standing in bank queues to get service.”

Egypt is clearly only the first step in what should be expected to be a more expansive view when opportunities arise. “When His Highness Sheikh Mohammed had the vision to put the two banks together, he was trying to create a regional champion,” Nelson says. “Unfortunately that vision was delayed somewhat by the financial crisis, but that’s now behind us. If you look at our capacity to deliver bottom line profitability, and therefore capital, it has expanded dramatically. When we bought Egypt it was quite a big chunk for us to bite off; now that sort of transaction is not significant for us at all, and we have the capacity to go out and expand regionally.”

Where? “Mainly Middle East, North Africa and East Africa would be our preferred markets to look in. But those buses do not come along very often. I think it took us five years to find Egypt, and we won’t over-pay.”

Iran, if sanctions were lifted? “It would certainly be of interest, subject to the sanctions coming off. It’s an underbanked market, the demographics are strong, the banking system needs quite a bit of work there and we can add a lot of value to that. There’s a natural affinity between Iran and Dubai historically with the trading.” But: “We certainly wouldn’t even think about it until we’re very clear on where the sanctions are. And if anything they are getting tougher, not easier.”

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Growth has a lot of channels for a Dubai bank. Islamic finance continues to gain in popularity, at least at the retail level; capital markets (and sukuk in particular) are growing, though off a low and underdeveloped base; private wealth and asset management raises potential on both the onshore and the offshore side, through the Dubai International Financial Centre.

One imagines there must be challenges for a straight-talking Australian chief executive though, and it is tempting to wonder just how free the role in management is, in a place where the Emiritisation programme sets clear parameters around hiring practices, and where the chairman of the bank is also the ruler of the whole of Dubai.

“I was asked what the biggest difference was between my outward impression of the bank before I joined, and the reality when I did join,” he says. “I thought, when I was outside, that there would be interference in the day-to-day management of the bank from the board. And my inside perception is that’s not true. We are run as a professional bank. That’s how it works.” He says that, although Emirates NBD has a board that approves strategy like any other board, with a risk committee, “we make the decisions. All I can say is I have been very pleasantly surprised that the decision-making is devolved to management, not at the board level. It’s run as a professional bank as I would expect as an international banker.”

Is he ever over-ruled?

“We’ve made decisions that may not be popular with certain people in society. So the answer is no.”

Asked about the challenges ahead, he focuses on liquidity. “If oil stays as it is, where’s the liquidity coming into the system to fuel growth? Liquidity is always something that worries me in any market. I come from a background where you get your dollar first, then lend it. You don’t lend it and then try to find the dollar deposit.”

He says that’s a challenge in any market, but perhaps it’s particularly relevant in the Dubai economy, a place, you might legitimately say, that is partly built on sand. Lacking the voluminous hydrocarbon wealth of Abu Dhabi or Qatar, there’s always that question in Dubai of what people (or even the state) really own to underpin their borrowing, and the fear that once one person stops repaying, an awful lot else goes wrong. This, indeed, was partly borne out in 2009.

“But we are in a very unique position here, with the biggest branch network, the biggest retail customer base, the biggest ATM network; our capacity to attract CASA [current and savings accounts] is very high. One key to our success has been our ability to grow current account savers as a proportion of our funding. It’s stable funding, and very effective for us.” The inference is that not everybody is in that condition. “It’s going to be a challenge for all banks going forward, making sure they keep that liquidity in check, and not getting to a stage like we were pre-crisis of banks having a 150% loan to deposit ratio.” (Emirates NBD’s is 95%.)

“Then, if oil keeps at the current prices, how does that effect the long-term investment in the region? In the short to medium term it’s not an issue; if it stays where it is long term it becomes problematic.”

Those are valid concerns, but is that all? There’s something else you can see from that top-floor window at the museum: an unfinished clump of reclaimed land reaching into the Arabian Gulf off Deira. This was supposed to be the Deira Palm, a huge, visible-from-space reclamation and real estate project filled with homes and hotels fanning out on the fronds of a palm shape, far bigger than its Palm Jumeirah counterpart which has been built further southwest.  But its developer, Nakheel, axed it along with other similarly preposterous reshapings of the city’s coastline. Granted, Nakheel has new ideas on how to use the space, but for now it’s a reminder that no matter how big Dubai’s ambitions, not every bold project makes commercial sense, nor reaches the finish line, no matter how much money is committed to it.

Which makes us wonder if something is missing from Nelson’s list of concerns. What about asset quality?

Nelson pauses for a moment to consider the answer. “The positive thing is, the industry has learned its lesson,” he says. “If you look at the deals that have been done, they are better structured, far more conservative, have better coverage ratios and better covenants than before. The industry learned a pretty tough lesson with the global financial crisis and is in a much better position now.” If he’s right, then his bank’s star will continue to rise with that of its home city; but as an investment disclaimer might have it, Dubai can go down as well as up.

BOX: The merger

Much has been said about the unfortunate timing of the Emirates NBD merger just before the global financial crisis, but what is often forgotten is just how challenging that merger would have been in any conditions.

The two banks were very different. National Bank of Dubai was pretty much an organically grown expansion of exactly the same bank it was in 1963. Sultan Al Owais – the pearls in the museum are mainly from his family’s collection – founded it with a group of merchants, together approaching the then-ruler of Dubai, Sheikh Rashid bin Saeed Al Maktoum with the idea of a first indigenous national bank (the nation in question being the emirate of Dubai, since the UAE would not be formed for another eight years) to compete with the British Bank of the Middle East, now HSBC. Al Owais brought in Abdullah Saleh, who advised on the bank’s formation and was later its managing director for 22 years and subsequently its chairman. We mention this because the team at the bank’s inception – Al Owais and Saleh – was pretty much still the team in place at the merger with Emirates Bank more than 40 years later. That’s continuity for you.

Contrast this with Emirates Bank, whose existence and growth has largely come about as a result of being asked to fix other failed institutions, starting with Union Bank Middle East in the early 1970s. Two other problem banks, Emirates National and Dubai Bank, were merged into the institution in the 1980s, followed by still another, Middle East Bank. “Every time there was a problem with a bank they would take it in,” says Sowaidan, “so it has grown inorganically through mergers and acquisitions with troubled banks.”

So the two had markedly different backgrounds and cultures which made a merger difficult. Indeed, the 2007 instruction by Dubai’s ruler to merge followed at least two earlier unsuccessful attempts to bring them together. Even well after the merger, it was easy to discern which business units came from which legacy, and still people are associated with which side they came from: the CEO of the Islamic bank, Jamal Bin Ghalaita, for example, from the Emirates Bank side, and the head of retail and wealth management, Suvo Sarkar, from NBD. Still, it helps that in a small market several executives worked for both places pre-merger, and by now, it’s much easier to consider it a homogenous institution.

And did it work? Nelson wasn’t there for the merger – though he can see that “bringing two quite different cultures together was certainly challenging” – but he also notes it is “over six years ago now, a long way behind us.”

“What it gave us,” he says, “was scale, and an expanded customer base.” And scale is about more than just customer numbers. He uses the example of foreign exchange. “Even 18 months ago, we were a vanilla FX bank. We had all the clients, we were doing all the hard work with the lending, but the international banks were the ones taking all the cream with their foreign exchange hedging because we didn’t have the capability.

“That’s no longer the case. We’re pushing hard into that and it’s paying off.” And that, he says, is a function of scale bringing capacity. “Our hedging capability has improved dramatically. Before, we had very little product and most of the time we backed it out to someone else who did the spreads. We’re looking forward now to writing more business.”