Understanding First Abu Dhabi Bank's Q3 Financials The numbers show the bank's management is optimising the balance sheet

I often try to provide alternate ways of looking at issues as a way of adding to the dialogue. Two weeks ago earnings season began and in my first article I looked at the income statement of some banks and in a subsequent article I examined the balance sheet of a bank. This week I link the income statement to the balance sheet statement using First Abu Dhabi Bank’s Q3 financials.

Banking Sector Review

Two weeks ago I looked at the first banks to report their Q3 financial performance. The main thing that I was looking at was source and quality of profits and the increase in profits. If profits came from core business, which is lending, then I considered this better quality profits. If the source of profits was due to sources that were difficult to repeat or maintain, such as operating expense efficiencies, large increases in investment or fee income, or a large decrease in the impairment charge, then I considered this lower quality profits, even though they might be important.

Last week I took a look at another bank but this time examining it from my long running worry that banks might be increasing profits by increasing their loans at a time when the return on assets for some was deteriorating. I was concerned about why some banks might be lending more in a more challenging market. Looking at the balance sheet of the bank that I reviewed, ADCB, it was clear that there was a conscious de-risking of the balance sheet by management followed by a balance sheet optimisation strategy that looked like deploying their balance sheet into stable markets.

This week I look at First Abu Dhabi Bank’s Q3 performance. I’m not trying to make an absolute judgment about performance but rather to explore ways in which to study the performance. Also, keep in mind that FAB completed its merger earlier this year and this will have one-off effects. All numbers are quarterly year on year, i.e. comparing Q3 2017 to Q3 2016.

Linking FAB’s Income Statement to the Balance Sheet

The income statement stands out with a 5% drop in net interest income. To understand this I look at the components and see that interest revenue dropped slightly by 0.8% but interest expense increased 9.85%.

What could cause such a big increase in the interest expense? Look at what generates an interest expense and we do that by going to the balance sheet. The main component of this is customer deposits, which is about flat. Looking at the other entries there are three large movements of note. Due to banks dropped 34.8%, repurchase agreements (repos) increased 16.3% and commercial paper (CP) increased 56.1%.

FAB’s Funding Structure

Let me explain what repos and CPs are. A repo is when you sell a security, usually bonds, to another party with an agreement to buy them back for a specified price at a specified time. It is a form of borrowing that is relatively low risk as the collateral is transferred to the ownership of the lender and furthermore the collateral is liquid.

Commercial paper you can think of as similar to a bond with a short tenor, so another form of borrowing. The interbank borrowing (due to banks line item) is usually low cost and extremely short tenor.

The 34.8% drop in cheap, short-term interbank funding was replaced partially with cheap repos but mostly with longer-term CPs. In absolute terms CPs increased AED 7.7 billion. Can this explain the interest expense increase of AED 130 million?

FAB’s Risk / Return Decisions

It can if CPs are more expensive than the interbank borrowings by about 1.7%. Not everything is about revenue and expense. Because commercial paper usually has a far longer tenor than interbank borrowings the bank’s funding risk has decreased. This needs to be weighed against the expense. And in this market, decreasing risk should be the priority.

Let’s look at what is happening to interest revenue. Remember, just because a number doesn’t change this doesn’t mean that nothing worthwhile is happening. The first place to look at is again the balance sheet and the loans and advances line item which shows a drop of 1.84%.

FAB’s Quality of Income

In expansionary economic times this might be considered a bad thing. But in an economy that is adjusting to the change in oil price, I would argue that this is the smart thing to do. The more important conclusion is that loans and advances, the highest interest earning asset, went down 1.84% but interest income went down only 0.80%.

This indicates that FAB increased the rates it charges, but there might be other explanations. The last step is to understand whether the interest increase is due to a risk increase or better marketing. Given the conservative heritage of FAB, I’m leaning towards the latter explanation.

There is much more to FAB’s financials and using some of the ideas you should be able to improve your understanding even more. I have not covered the important cash flow statement but this is simply because I have run out of space. Perhaps in a future article.

This article was originally published in The National.

Decision making and risk

My willingness and ability to take risks and manage them often comes up as a topic of conversation.

Let me explain how I got here. In 1989, after completing my first year at university, I spent the summer as an intern at the Abu Dhabi Investment Authority (Adia). I found the world of investments fascinating and as part of that education I was told to read the book Market Wizards by Jack Schwager, a compilation of stories about traders.

One story that stuck in my mind was about a new trader who could not get himself to start trading. He did not know how to make or take a decision. So his manager walked over to his desk, picked up the phone and executed a trade on behalf of the trader. The manager then informed the trader that if the trader sold the position and the price went up, then the trader would be held responsible but if he held the position and the price went down he would also be held responsible. The manager’s tactic was brilliant, he did what should happen to all of us – he took away the trader’s option to do nothing. Continue reading

How can government acclimatise lenders to SMEs?

Over the past six months leaders in the banking sector have announced that SME owners and managers were departing the UAE with their companies in trouble and defaulting on their loans.

The implication was that the SMEs were in trouble because of a contraction in the economy.

However, the banks clarified that a portion of the defaults was because of banks getting a clearer picture of the SMEs’ borrowings thanks to the UAE’s Credit Bureau, and then calling in or not rolling over credit facilities – although there was no clarity on what percentage of the defaults were because of banks behaving in this manner.

There was also no clarity on whether the numbers mentioned in terms of SME defaults were gross or net – did the banks subtract out the value of the collateral and provisions already booked?

To their credit, the banks came together and developed a framework, the “mini bankruptcy law”, that is supposed to discourage banks from acting prematurely against SMEs and instead to try to work out a more effective solution by talking to the other banks involved as well as the SME.

Although seeing the banks work together to stave a wholesale rout in the SME sector, considered strategic by the government, is quite salutary it is disappointing to see the SME sector take yet another hit.

As the SME sector is strategic to the government, which not only talks about it but also has developed institutions to help its growth such as the Khalifa Fund and the Dubai SME 100, then how might the government work to better develop private sector lending to SMEs?

There are more than 50 banks in the UAE, which has a population of about 9.5 million, the majority of whom are blue-collar workers.

With that much competition one would expect that the lenders, both banks and non-banking financial institutions, would be forced by competitive pressures to expand into every sector, including SMEs. But this is not the case.

There are at least three ways that the government can incentivise lenders into lending to SMEs.

The first is to guarantee the principal of SME loans. This approach has been used the world over to help shepherd banks into lending to parts of the economy they might initially be wary of.

Guarantees, of course, create a moral hazard, in that if the lender has nothing to lose then they might lend recklessly, wasting government money and lending to the wrong SMEs.

The idea would then be to create some level of risk, such as a co-pay or a deductible on, say, the first 10 per cent loss.

Other moral hazard busters include charging for the guarantee – in other words, credit insurance. Or some combination of the above.

This can lead to lenders familiarising themselves more thoroughly with the SME market before taking the plunge of lending without guarantees.

The second way governments can incentivise lenders is extrapolated from the 50-plus banks surviving in a relatively small economy.

The only answer as to why competitive pressure has not culled this number is that the government supports lenders through outsize deposits, possibly at below-market rates, and huge loans for infrastructure development, possibly at above-market rates.

If this conclusion is true, then the government can steer this lucrative business to banks that are more attuned to its policy objectives. If one such objective is developing the SME sector, then government business can be steered to those banks supporting such an objective.

The third way is through education.

As I have written in detail in previous articles, SME lending is different from large corporate lending. A real-world example is a board member who was not used to the volatility in non-performing loans demanding that the credit risk be decreased by lending smaller amounts.

The unintended consequence is that the client demographic moved sharply to small SMEs.

To understand why, consider an SME that wants to purchase a piece of equipment for Dh1 million. It does the company no good to be offered a loan for Dh200,000. So it doesn’t take it. Only a smaller firm with smaller needs would be interested in such loans.

The problem with sliding down the size curve is that although any individual loss is smaller, the probability of loss increases tremendously. This can lead, and has led, to large losses at a portfolio level.

This is why erroneous thinking with regard to the SME market needs to be corrected.

This article was originally published in The National.

The Investor’s Edge

Many of the ideas used by the investment community are adopted from the horse track and casino betting communities. Much of the failure that has dogged the investment community is due to rocket scientist PhDs misunderstanding the successful models of plebeian punters. The use of betting as an example is not an endorsement, just history.

To understand how the securities markets work you have to look no further than the horse bookies. Bookies take the bets from the bettors. This is the first point that the public begins to misunderstand how betting, and therefore investing, works.

There are two potential misunderstandings: The first misunderstanding is assuming that each horse has a uniform probability of winning, i.e. they are all just as likely to win. The second misunderstanding is assuming that the bookie offers one to one payout odds, i.e. pays $1 for each $1 that is bet. Grasping the significance of these statements is the key to successful investing.

The bookie, equivalent to the investment bank or broker, will always make money. Always. They do this because they do not set payout odds depending on which horse they think will win, they set payout odds based on how people bet.

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Entrepreneurs Face Trust Challenges in the Middle East

Trust in the Middle East is based on social networks: how much I trust you depends on how often I have interacted with you and whether people I trust also trust you. Essentially, trust is a commodity that is built up over time. This model is found globally but there exist alternatives and substitute models that are applied when appropriate. One such model is the swift trust model that Americans often use when faced with situations where trust is needed but there is no time to build it up using a conventional model. This is a trust first, verify later model. A simple example is disaster relief groups which are composed from various sources who need to act immediately. This model is precisely why Americans seem to be able to repeatedly launch successful start ups, whilst in the Middle East many start ups seem stuck.

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Cost Management Insights for Entrepreneurs

My basic philosophy on business is that opportunities and challenges are continuously presented to us and we need to respond appropriately. When it comes to managing challenges it makes sense to prepare in advance. My experience is that many entrepreneurs have difficulty doing this at two key points: right after a round of funding and when their business goes cash flow positive. The idea of saving for a rainy day goes right out the window and the dangerous assumption that the business will never go cash flow negative again sets in. This has destroyed many a promising start up.

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Adaptive Strategy Construction

This entry is part 2 of 3 in the series Strategy

In a previous post, Deconstructing Strategy, I discussed some of the difficulties in developing a strategy. In this post I present a method that has worked well for me. The philosophy behind this method is based on the two ideas that the Pareto principle, also known as the 80/20 rule, applies to business strategy and that strategies must adapt to new information and changes to the business environment.

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Monetising Business Opportunities


The ups and downs of a professional life, either as an employee and even more so as an entrepreneur, are quite often blamed on luck. If something positive happens it is good luck and if something negative happens it is bad luck.

his language is unfortunate as it implies that large portions of a person’s professional life are out of his hands. Although there are external events that are always out of a person’s hands, this does not mean that one has no control. Indeed, how one prepares for, recognises and responds to these events can alter the outcomes completely.

A helpful change in language can go a long way to improving one’s ability to manage unforeseen external events. Instead of calling them good luck and bad luck it is useful instead to call them opportunities and challenges. This small change immediately reframes the issue in a way that accepts the randomness of external events but still allows for the possibility that although the event is uncontrollable the outcome can still be influenced if not managed. Continue reading

The Principal–Agent Problem in Risk-Taking

The single greatest driver of business success is not a unique idea, innovation, marketing, networking, leading or managing. It is the willingness and ability to take calculated risks. There are many different definitions for risk but a useful one is: risk is the presence of an unknown negative outcome. Another point to make clear is that the key success factors are taking and managing risk, as opposed to simply the existence of risk. An example of this crucial point is the decision to introduce a new product is taking risk, whereas a new competitor entering the market is just the introduction of risk. Continue reading

SMEs: The Ignored Middle Child of Banking?


In developing various business plans for SME credit I often review why the commercial banks do not lend to this sector proportional to its contribution to GDP. I have written at length about some of my main ideas but I think there are several secondary issues that also play a role. One is the positioning of SME loans on the risk/reward curve relative to the two main alternatives: corporate loans and retail loans.

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