Earnings Quality vs Quantum of Earnings UAE bank Q3 performance

The third quarter (Q3) is over and earnings season has begun as listed companies release their Q3 financials. We’ll take a deep look at these financials, starting with the heart of the economy – the banking sector. My main aim here is to look at the picture that the financials give and try to understand what might be going on in terms of a longer term trend. My focus is the quality of earnings and the direction that earnings are moving in.

I want to take a moment and clarify a few issues. I am looking at earnings and not at creditworthiness, which looks positive given the capital adequacy ratios of these banks. The second point is that I am selecting the larger banks that first released earnings, so selection is not based on financial performance. Indeed, the banks that released earnings first should be applauded for working to provide investors with important transparency and timely provision of information.

Dubai Islamic Bank

First up at bat is Dubai Islamic Bank and its performance appears to be consistent with the behaviour we saw from other banks in Q2 and that I described in detail in a previous article. I’ll use DIB’s presentation, as well as the financial statements, which will make it easier for readers to check what I’m saying for themselves. As an aside, DIB provided not only its financials early but also an investor presentation. This is a bank intent on providing useful information to its investors. Great job on that front.

The article linked to above begins with “[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 earnings, according to the financials, grew 15%, a strong year on year (YoY) 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 does seem to explain the increase in earnings as net financing assets grew 14% (total assets 15%) matching the group net earnings growth of 15%. What about quality of assets? The actual return on assets (ROA) dropped from 2.43% to 2.34%.  This might seem small, but a difference of 0.09% on assets of AED 201 billion is about AED 180 million. This is about 5% of Q3’s AED 3.3 billion in net earnings. That negative drop in returns is a third of the 13% growth in group net earnings.

What is more intriguing is that the total capital adequacy ratio for DIB dropped from 18.1% to 16.9% indicating an increase in risk. This risk increase, however, is not reflected in an increase in ROA. You would expect that if a bank increases its risk levels then it should increase returns. I’d like to point out that although DIB appears to have increased risk, the total capital adequacy ratio of 16.9% is considered strong. This strength is further supported by Moody’s recent upgrade in the bank’s credit rating.

So how did the return on equity increase from 17.8% to 18.6% when ROA dropped? It wasn’t leverage as one measure of that, net financing to deposit ratio, dropped from 94% to 92%. The answer lies in the differences between quality of earnings and quantum of earnings. The earnings increased exactly because the balance sheet of DIB increased, as they stated, with little increase on operating expenses. The problem is that the asset increase masks risk increases as measured not only by capital adequacy ratios, in relative terms, but also by impairment losses, and a deterioration in ROA.

This is not sustainable. Growing earnings by increasing market share in a riskier and deteriorating return market is not rational. Before rushing to judge DIB I think it would be wise to see how the rest of the banking system fairs. After all, the Q2 results showed some of the same trends in other banks.

Union National Bank

For Union National Bank (UNB), I’m going to look at the financials to follow-up on my review of their Q2 performance. I define core revenue as interest revenue and revenue from Islamic financing, and core expenses which I define similarly. Core earnings is simply core revenue less core expenses. The net YoY growth for this is 1.20%, nearly flat. What is of interest to note is that core revenues grew 4.13% whilst core expenses outpaced that, growing at 9.18%. This is a big gap and means that a lot of work needs to be done for it to be reversed and so reverse the flattening of earnings growth.

Looking at other sources of income the largest material variance is net fees and commissions which grew 20% contributing AED 33 million to the net profit. This is significant as the total net profit increased by about AED 12 million. To be transparent, all of other income generated a loss of about AED 13 million. So how did net fees and commissions grow by so much? In note 5 we see that it was driven by an even bigger gain of AED 45.8 million in retail fees and recoveries, a growth rate of 87% over the previous quarter.

A check on strength of bank: overall capital adequacy ratio stood at 19.7%, quite strong.


I’ll round out with Mashreqbank (Mashreq). The first thing that catches the eye is an astounding 36% increase in total net profit YoY. Core revenue grew 3.33% versus core expense growth of 2.11%, a positive differential which is good. 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 profits merits further inquiry to understand the quality of profits.

Looking for major movements in the incomes statement there are two.  The first is a 58% drop in other income, amounting to a decrease of AED 123 million. The other is a 43% drop in impairments amount to a decrease of AED 205 million, which is a contribution to net profit. A quick check finds DIB’s impairments increasing 132% and UNB’s impairments increasing 19%. That’s quite a large spread in the percent change in impairment between the three banks. These numbers are also material in terms of the change in net profit. For example for Mashreq the positive contribution due to the decrease in impairment equals 136% of the increase in net profit. For DIB and UNB impairment charges increased, so they had to generate more from profits to counter that.


So we’ve look at three of the larger banks. I’ll review the financials of other large banks as they disclose. What does this first batch tell us? There doesn’t seem to be a specific pattern. But what is clear is that the profit growth in each case was supported by something that I do not consider as in the ordinary course of business, be it large increases in fee income, large decreases in impairments or apparent increases in risk. In the next few weeks I’ll round out this view as more results come in.

This article was originally published in The National.


  1. Dear Sabah,,
    speechless and hat off to you..
    nice well detailed and well addressed analysis.
    Keep it up
    M Nabil, MSTA

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