U.S. Markets closed

Edited Transcript of FAB.AD earnings conference call or presentation 24-Oct-19 1:30pm GMT

Q3 2019 First Abu Dhabi Bank PJSC Earnings Call

Nov 13, 2019 (Thomson StreetEvents) -- Edited Transcript of First Abu Dhabi Bank PJSC earnings conference call or presentation Thursday, October 24, 2019 at 1:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Arif Shaikh

First Abu Dhabi Bank P.J.S.C. - Group Chief Risk Officer

* James Burdett

First Abu Dhabi Bank P.J.S.C. - Group CFO

* Shirish Bhide

First Abu Dhabi Bank P.J.S.C. - Group Chief Credit Officer

* Sofia El Boury

First Abu Dhabi Bank P.J.S.C. - Head of IR

================================================================================

Conference Call Participants

================================================================================

* Ankit Gupta

NCB Capital Company, Asset Management Arm - VP of Asset Management

* Aybek Islamov

HSBC, Research Division - Analyst

* Chiradeep Ghosh

Securities & Investment Company BSC, Research Division - Research Manager & Senior Analyst

* Deniz Gasimli

Goldman Sachs Group Inc., Research Division - Associate

* Naresh N. Bilandani

JP Morgan Chase & Co, Research Division - Research Analyst

* Shabbir Malik

EFG Hermes Holding S.A.E., Research Division - VP of Research, Director of Banking & Banking Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, and welcome to the First Abu Dhabi Bank Q3 2019 Earnings Conference Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Shabbir Malik. Please go ahead.

--------------------------------------------------------------------------------

Shabbir Malik, EFG Hermes Holding S.A.E., Research Division - VP of Research, Director of Banking & Banking Analyst [2]

--------------------------------------------------------------------------------

Thank you very much. Good evening, good afternoon, and good morning, everybody. On behalf of EFG Hermes, I would like to welcome you to First Abu Dhabi Bank's Third Quarter 2019 Results Call. My name is Shabbir Malik.

With us on the line is Sofia El Boury, Head of Investor Relations; and the senior management from the bank. Please note that this call is open to analysts and investors only. Any media personnel should disconnect immediately.

I will now hand over the call to Sofia, to commence the call. Please go ahead, Sofia. Thank you.

--------------------------------------------------------------------------------

Sofia El Boury, First Abu Dhabi Bank P.J.S.C. - Head of IR [3]

--------------------------------------------------------------------------------

Thank you very much, Shabbir. Good afternoon, everyone, and thank you for joining us on this Thursday afternoon to review FAB's financial performance for the third quarter and first 9 months of 2019.

You should have received all our disclosures about an hour ago, and the full deck is currently available on the corporate section of our -- on our corporate website, sorry, on the Investor Relations section as well as on our app. And the replay for this call will be available within the next hour or so. The full details of the replay are also available on the invitation that you received.

So we're very pleased today to have with us our Group CFO; our Group CRO, our Group Chief Risk Officer; as well as our Group Head of Subsidiaries, Strategy and Transformation. And as usual, we'll be going through the presentation, and then the senior management will be here to answer all your questions.

With this I will pass it on to our Group CFO, James Burdett, for the presentation.

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [4]

--------------------------------------------------------------------------------

Okay. Thank you, Sofia, and good afternoon, good evening, everybody. Thank you, as Sofia said, for joining us on a late Thursday afternoon.

What I'll do is as per usual, go through the investor deck at a pretty rapid click, just pulling out the salient points so we have more time for Q&A and proper dialogue at the end of my presentation.

So for those of you that have accessed the presentation, I'll start off with Page 3, which is just a quick third quarter summary of the key performance highlights.

And as you can see, NPAT was up 4% at about AED 9.4 billion, which was a solid set of results in the current environment and particularly so in line with the guidance that we put out to the market. You'll see as we go through the presentation that we've got good growth in a number of key areas that we focused on.

Just to give you an example of some of those, loans up 7%, Deposits up 5%, non-clients' income up 10%, and in fact, if you look at a good momentum in our personal banking business, which is up, I think, now 3 consecutive quarters in a row in terms of revenue.

We've done all this with a strong balance sheet and at the same time, enhancing our risk-adjusted returns. So you can see throughout the presentation, we're very much focused on stronger core equity Tier 1, higher return on tangible equity and higher return on risk-weighted assets.

The balance sheet fundamentals remain strong. The NPL ratio just over 3% with good coverage ratio. And I think what's happening is we're showing the benefits of having a diversified business. And we're well positioned to capitalize on the market and the current environment.

Turning to Page 4. Just to reiterate that. So profit for the third quarter, up 3% over the prior comparative quarter, at AED 3.1 billion, full year NPAT at AED 9.4 billion is up 4% year-on-year. But at the same time, we are generating greater returns, and you can see the graph on the bottom of Page 4, that the return on risk-weighted assets is now from 2.26% to 2.55%, which represents substantial improvement and balance sheet optimization. We are doing this, at the same time, maintaining a strong balance sheet in terms of liquidity and credit metrics.

Turning to Page 4, which just looks at our guidance and actual performance versus guidance for the 9 months. You can see broadly, we're performing in line with guidance, with revenue at mid-single digit, 4%, loan growth at 7%, which is getting up to high single digit. Cost income ratio is a slight miss at 26.5%, but it's more than offset by a lower cost of risk, which is at 50 basis points versus the guidance that we put out there of 55% to 65% -- 65 basis points, rather. Net profit growth for the full year, mid-single-digit at 4%, but the return on tangible equity and core equity Tier 1 ratios well above the top end range of guidance.

Turning to Page 6. As I've mentioned, we are showing very, very good growth when you look at the Central Bank metrics showing about 4.5% growth year-to-date, our growth is very strong at about 12%. So we are increasing market share. A lot of that growth is in the areas that give us a bit of return on tangible equity because there's public sector and government lending. So we are improving our risk-adjusted returns as we go through that.

But also, I mentioned earlier the benefits of a diversified business. We've got global markets growing at 28%. Transaction banking at 12%. And in fact, CIB revenue overall is up 13% year-on-year. So very good growth. And in Personal Banking, as I've mentioned before, we're now showing 3 quarters of sustainable incremental growth, which is good news, particularly on the back of the integration that happened over the last 18 months.

At the same time, we continue to execute strategy. We've earmarked quite a substantial amount of investment to put into our digital capabilities, and we are seeing an increasing amount of onboarded digitized customers through the digital channels, mobile engagement and so on. Obviously, we're also investing in some of the core strategies that we put out to the market before, like KSA and Egypt, and that's performing in line with expectations, and we also have the transformation plans we were looking to get more efficient, particularly in the back end processing and eliminating manual processes along the way.

All of that's culminated, and I think, a good set of results in the market. Particularly, if you look at the managed GCC syndicated loans. We're now the #1 book runner, cost efficiency ratio remains leading in terms of the industry. And our relationship and our position with the government and banker for the government holds us in good stead going into the environment as it stands at the moment.

Page 7, just looking at the balance sheet, as I said before, very strong momentum, up 7% year-on-year. CIB growth was at AED 25 billion, so 2x faster than the industry. And again, as I said earlier, it's efficient growth because a lot of that growth, about AED 20-odd billion of the AED 25 billion is the government private -- public sector. So that's very efficient in terms of the use of risk-weighted assets.

You can also see that we've got good growth in customer deposits, up AED 15 billion Q-on-Q, primarily driven by government liquidity flows, but we also see good strong growth in capital, which was up AED 16 billion or 10% year-to-date, AED 276 billion, so that's a good result for us. Overall, liquidity remains strong. The liquidity coverage ratio at 146%, and the cash deposit ratio flat, but just under 80%.

Turning into some of the financials in a bit more detail. On Page 8, just looking at the net interest income and the margin trends. You can see the net interest income is broadly stable versus last year, with basically NIM compression and competitive pressures in both the CIB book and risk optimization in the Personal Banking book, broadly being offset by the Fed rate hikes.

In terms of sequential NII, essentially you've got business growth being offset by lower one-offs and a lower cost of funds as we've redeployed some liquidity into that government exposure on the asset side. NIM itself was down 22 basis points year-on-year. That's mainly as a result of competitive pressures on the corporate banking book, basically being offset by rate hikes on our customer book.

In terms of -- the key point to note, though, I think, is the bottom of Page 8, which is we've put out some guidance for every 25 basis points, we're looking at about AED 250 million, AED 300 million headwinds for each 25 basis point rate cut in the Fed. But obviously, that's a very rough estimate based on a number of assumptions, and we believe we're well positioned to counter that with our business model.

On Page 9, looking at non-interest income. It's a very good story here. So NFI, overall, is up 10% year-on-year. Mainly on the back of strong FX and investment income, fees are down year-on-year, but up sequentially. Year-on-year, they're down mainly in trade because of the pricing and the balance sheet is diluted. But sequentially, we're up, mostly on the back of loan fees and good growth in personal banking.

Looking at the FX and investment income, you can see it's up 41% year-to-date. That's significant, and in 3 main areas. One is the ECB placement for the excess liquidity management. The other is, we're up considerably on our sales franchise in global markets, and we're also up in trading income. Sequentially, it's down an ECB short-term placements, with the benefit reflected in the net interest income line.

Other income is down a little bit because of the one-off gains we realized in the second quarter of 2018. But overall, a good story, and non-fund income generally up.

Looking at costs on Page 10, broadly speaking, we've got reduction in integration costs offset by increase in costs and other areas. Most of that increase relates to depreciation on the amortized asset that was the integration. But we're also investing, as we've alluded to earlier, in those areas of key strategic focus, such as KSA, Saudi Arabia, Egypt, transformation, digital and so on. So let's push the cost income ratio up slightly outside the range, but we do have further synergies to achieve over the next several months with some of our transformation initiatives.

Turning to Page 11. Not much to say here. I think cost of risk broadly flat year-on-year, below guidance of the 55, 65 basis points that we've talked about. And the NPL ratio and the coverage ratio broadly stable at 3.09% and 109%, respectively.

On Page 12, where we look at the core equity Tier 1 ratio, you can see a pretty significant improvement post dividend to 14.2%. So I guess, it shows the strong organic capital generation capability of the franchise. Also, you can see we have optimized risk assets even further with asset growth or loan growth at 7% versus RWA growth at only 1%, which has clearly led to an improvement in the core equity Tier 1 ratio, but also an improvement in our return on risk-weighted assets and return on tangible equity.

So wrapping up on Page 13. I think we've got strong results from our core business. As we've said, profit up 4% year-on-year, despite some of the headwinds, slower GDP growth, the Fed rate cuts that are coming through. The fundamentals remain strong. The liquidity metrics are strong. The core equity Tier 1, strong. The risk metrics well within guidance. So I think we're well positioned relative to our competitors and we're obviously doing all of that while enhancing our returns to our shareholders, with the return on tangible equity and return on risk weighted assets going up.

We are continuing to make progress against the strategic agenda. And I guess, finally, we do have a market-leading franchise with close connectivity to the government. A conservative balance sheet, a diversified business. So we're well positioned for future growth, despite some of the headwind challenges that are out there in the market. Mainly, slower GDP growth, a bit of stress in the property market, and the Fed rate cut.

So look, with that, I'll hand over for a bit of Q&A. Thank you.

--------------------------------------------------------------------------------

Sofia El Boury, First Abu Dhabi Bank P.J.S.C. - Head of IR [5]

--------------------------------------------------------------------------------

Susan, can we move on to the Q&A please?

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) So we'll now take our first question from Chira Ghosh.

--------------------------------------------------------------------------------

Chiradeep Ghosh, Securities & Investment Company BSC, Research Division - Research Manager & Senior Analyst [2]

--------------------------------------------------------------------------------

Thanks for hosting the call, and congratulations for the results. I have 2 very small questions.

So I just read yesterday that UAE Central Bank have asked banks to cut their real estate exposure. So if you can throw some light, how are you placed? And how do you see your competition being placed because of that? That's one.

And second is in continuation to the theme that you are saying about the declining interest rate cycle, and I also see that CASA is also slightly under a declining trend? What are your strategy to handle your NIMs? And what would be your opinion about the NIMs going forward towards 2020?

--------------------------------------------------------------------------------

Arif Shaikh, First Abu Dhabi Bank P.J.S.C. - Group Chief Risk Officer [3]

--------------------------------------------------------------------------------

This is Arif Shaikh here. I'll take the first part of the question, and then James will pitch in with the second part.

There is no specific guidance from the Central Bank on the real estate management in terms of whether we should lend or not. There are various discussions which are going on at this point of time, in terms of the new potential regulation, which is being planned. So as you know, the real estate regulation was in terms of the union law, linked to the deposits based off the bank, which is now moving to the risk-weighted asset, as a percentage of risk-weighted asset.

So that's the debate. There's a discussion paper, which is -- which has been circulated, which banks at this point of time are studying. We'll go back to the banking federation, the banking federation will then feed into the Central bank and then a potential new regulation will be issued. At latest date, day before yesterday, we were at the Central Bank, and there is no specific guideline instruction from the Central bank on real estate's exposure, whether we need to increase or decrease. So it is BAU at this point of time.

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [4]

--------------------------------------------------------------------------------

Yes. And on your question regarding...

--------------------------------------------------------------------------------

Chiradeep Ghosh, Securities & Investment Company BSC, Research Division - Research Manager & Senior Analyst [5]

--------------------------------------------------------------------------------

Sorry, just before we go to the next one. Just to remind us, so the previous rule was 20% of the deposits? Or 30% of the deposit?

--------------------------------------------------------------------------------

Arif Shaikh, First Abu Dhabi Bank P.J.S.C. - Group Chief Risk Officer [6]

--------------------------------------------------------------------------------

Yes. That was a union law issued in 1980. It has not been revised. It was 20% of the deposit base of the bank.

--------------------------------------------------------------------------------

Chiradeep Ghosh, Securities & Investment Company BSC, Research Division - Research Manager & Senior Analyst [7]

--------------------------------------------------------------------------------

If you can go to the next question.

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [8]

--------------------------------------------------------------------------------

Yes. I think your second question was 2 parts. One was CASA growth. So I think if you look at Page 7, you'll see that we've had pretty significant CASA growth, up 10% year-on-year to AED 176 billion. You know as well as I do, it's a very profitable product. So obviously, we're looking to continue to grow it.

The second part of your question, I think, was around NIM. NIM is a complex thing to talk about because we have so much surplus government liquidity, plus we're growing in high-quality asset, plus the overlay of the Fed, whether it will cut and how many cuts it will do. Plus, we have balance sheet growth. So all of that churn into the mix is very difficult for us to predict.

And in any case, they're not coming out with guidance on NIM until early January or sometime next year. But I think the key message here is that we have a strong balance sheet, and we're well positioned relative to our competitors to capitalize on that.

--------------------------------------------------------------------------------

Chiradeep Ghosh, Securities & Investment Company BSC, Research Division - Research Manager & Senior Analyst [9]

--------------------------------------------------------------------------------

But you believe you can kind of manage this limit around current levels? I know -- I mean, you cannot give a guidance, but as much as you can foresee?

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [10]

--------------------------------------------------------------------------------

Yes. Look, we're focusing on our relationship with the government and government-related entities at the moment. So very, very high-quality exits. So zero cost of risk, zero risk-weighted assets, which means the NIMs are actually quite low.

At the same time, we're really pushing to grow our retail franchise, which in time will -- at the same time, you've got a yield curve debt pricing in 70 basis points cut and the Fed rates between now and July next year. And a year ago, it was pricing and 3 rate hikes. So it's very, very difficult to give you any kind of guidance around NIM at the moment.

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

(Operator Instructions) We'll now take our next question from Amit Mamtani with Goldman Sachs.

--------------------------------------------------------------------------------

Deniz Gasimli, Goldman Sachs Group Inc., Research Division - Associate [12]

--------------------------------------------------------------------------------

This is Deniz Gasimli from Goldman Sachs. I just had a quick question on your margins, please? So this sequential decline, 8-basis-point decline in margins, as you mentioned it, partially driven by -- or mainly driven by lower interest expense reversals.

Could you give us some, maybe, indication of how much were this interest expense reversals? Or how much would the decline be without adjusting for this reversals?

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [13]

--------------------------------------------------------------------------------

Yes. I think, look, we're not going to quantify the interest in substantive amounts because we've never done that in the past, but the blip up in the second quarter was partially due to interest and expense. The blip down in the quarter is the absence of that interest and expense, but also significant growth in the balance sheet at the end of the quarter in high-quality assets. So I think the best thing you can do in terms of guidance, is look at the dotted line, which is the year-to-date line, which smooths out some of those anomalies because there's always one-offs in and out that impact that, and I think it's better for you to look at the averages.

--------------------------------------------------------------------------------

Operator [14]

--------------------------------------------------------------------------------

(Operator Instructions)

--------------------------------------------------------------------------------

Shabbir Malik, EFG Hermes Holding S.A.E., Research Division - VP of Research, Director of Banking & Banking Analyst [15]

--------------------------------------------------------------------------------

Operator, if I may, as we wait for other questions, this is Shabbir Malik. If I may ask a couple of questions.

One of them is more of short-term in nature. So when you announced the 2Q results, you also made an announcement about removing your foreign ownership limit. I just wanted to hear if there are any updates since that announcement was made in 2Q? Can you give us some details of what progress has been made, and if possible, a time line on when this is going to be implemented?

And then I can ask my second question, which is more long-term in nature.

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [16]

--------------------------------------------------------------------------------

Yes. There's been no change since we made that announcement on the FOL. We've made our position very clear to MSCI. They've made their position clear. We're just in the waiting game. We know as much as you.

--------------------------------------------------------------------------------

Shabbir Malik, EFG Hermes Holding S.A.E., Research Division - VP of Research, Director of Banking & Banking Analyst [17]

--------------------------------------------------------------------------------

But in terms of the proposal of removing the FOL completely for, well not just FAB, but the whole banking industry, where are we in terms of that? Is there -- there has been any progress made on that front?

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [18]

--------------------------------------------------------------------------------

I think that -- I think we came out with those -- I mean, that came out in the second quarter, I think it's going to take some time to work its way through the system. I have no update on that at this point in time.

--------------------------------------------------------------------------------

Shabbir Malik, EFG Hermes Holding S.A.E., Research Division - VP of Research, Director of Banking & Banking Analyst [19]

--------------------------------------------------------------------------------

Okay, great. My other question is more long-term in nature. I think a couple of things. You seem to be in a very good spot right now in terms of scale and profitability. But looking forward, where do you see the opportunities, really, for the bank? Domestically, are you thinking about any new lines of businesses or expanding your existing businesses, maybe going into wealth management, asset management, cross-border money transfer, consumer banking? Or even are you thinking about beyond UAE, outside the GCC, maybe even Africa? Egypt, I think you have already a presence there, but are you thinking about expanding geographically, be it organically or maybe through even acquisitions?

I just want to hear your thinking -- thought process behind that. How are you thinking about the long term?

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [20]

--------------------------------------------------------------------------------

Okay. That's an incredibly complex question. That's the whole strategy of the bank. But look, to sum up, I think if you split it into 2 parts. One is UAE and one is international. If you look at the UAE, I think, it's the story I've been consistently saying, as we get better people, product distribution. We're looking to do more and more of the business that was traditionally held and held by the foreign banks, like an HSBC, for example. So -- and I think you can see that coming through that we're doing more business with the same customers than we do before. So that's reflected in the results, where GTB is up 13%. Global markets is up 20-odd-percent. So we are doing more than just the traditional intermediation of loans and deposits.

In the retail space, we absolutely want to dominate. We've had a major disruption over the last 2 years, where we've managed 2 banks onto one platform. And now we're enhancing our digital capability. We're in a unique position with the lowest cost of funds in the market, we should be able to go out there and really dominate the retail market, and we are looking to do that, particularly with our -- the broader picture of our corporate relationships, the ADNOCs and so on and so forth, where we go in and do your employee banking, and so on and so forth.

So we are -- we still see the UAE as a very much a growth economy. Whilst the economy is slowing and there's volatility in the oil prices and so on and so forth, we still think we can grow market share.

And if you look at the Central Bank stats, you'll see, in the UAE, we have grown market share. We're growing twice the market, which implies that we've improved market share. Internationally, we've set up 2 key markets at KSA and Egypt. It's important to note that KSA is, in its infancy, it'll take a long time for that to germinate and deliver the returns that we eventually expect, but there's a close relationship between the 2 countries, that's a huge GDP, there's a huge market out there, and there'll be opportunities.

The rest of the network franchise is more of a CIB franchise. We're not doing retail in any other area, except KSA and Egypt. And that CIB proposition will be the support flows to and from the UAE, and I think there's a credible business case there for us to be able to do that.

In terms of M&A or inorganic, we never say never. Obviously, if there's opportunities, we would jump into them. I think in terms of opportunities. You know as well as I do, it's very difficult to get an M&A deal over the line. It's got a separate strategy. It's got to be financially -- makes sense. It's got to fit with the various shareholders and the politics.

So we're always looking at something. But it's difficult to get it over the line. But we do support consolidation in the local market. We think it makes a lot of sense for the economy.

--------------------------------------------------------------------------------

Shabbir Malik, EFG Hermes Holding S.A.E., Research Division - VP of Research, Director of Banking & Banking Analyst [21]

--------------------------------------------------------------------------------

And if I may, one more thing. I think you talked about good traction in terms of revenue growth in the consumer banking business. I think if I look at the loan growth, specifically in the consumer bank, I think it was pretty flattish. Can you tell us a bit about the consumer growth story? Not just for FAB and the sector, what are the trends you're seeing? And if it hasn't been due to loan growth, what has been driving the revenue growth in the consumer banking business?

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [22]

--------------------------------------------------------------------------------

Yes. So I think the general big picture change for us is that we've gone through this integration. And through that last 18 months, revenue fell or sales fell, and therefore, revenues fell. At the same time, we had a double whammy because we were repositioning our books from a portion that was unsecured, be it unsecured retail or SME lending, both high-risk assets into higher quality, lower risk assets, which obviously had a revenue impact that we expected to be a cost of risk-benefit for us and a high risk-adjusted returns in the future.

So that's the big picture strategy. Now if you look at the growth, yes, it looks sort of anemic. But for us, we're seeing a significant uptick in our sales over the last several months, and that will eventually generate higher risk-adjusted returns for us, but it's not a -- you do 100 deals in retail, it's equivalent to one deal in CIB. It's going to take time for those numbers to come through and there's a lagged effect.

--------------------------------------------------------------------------------

Shabbir Malik, EFG Hermes Holding S.A.E., Research Division - VP of Research, Director of Banking & Banking Analyst [23]

--------------------------------------------------------------------------------

Sure. Operator, are there any other questions in the queue?

--------------------------------------------------------------------------------

Operator [24]

--------------------------------------------------------------------------------

You do have 2 questions. We will take our next question from Naresh Bilandani.

--------------------------------------------------------------------------------

Naresh N. Bilandani, JP Morgan Chase & Co, Research Division - Research Analyst [25]

--------------------------------------------------------------------------------

It's Naresh Bilandani from JPMorgan. Just 2 questions, please. And both on -- mainly on asset quality.

So first of all, could you please talk about the sustainability of the low-cost of risk that you've been enjoying currently. What we hear from your peer banks in the system, which mainly is ENBD, actually, is that they are getting more conservative on asset quality outlook for the real estate exposures. But clearly, it seems that you continue to beat the trend overall. Do you believe that this low-cost of risk is sustainable going into the fourth quarter, especially given the fact that you are well below the guidance that you have set for the full year? Or say beyond into 2020, do you think these levels are sustainable? Or should we build some deterioration into our models? And if yes, where do you think this pressure could potentially come from?

That's the first part of the question. The second part, on a related note, can you please share some insight into the level of collateralization and coverage that you have for the construction, real estate and the mortgage exposures? I'm specifically referring to the slide where you had, towards the end of the appendices, where you showed the breakdown of the loans. And if I have it right, you have roughly about 21% in real estate, 3% in construction and 5% in mortgages.

So I know while you disclose this -- some information at the year-end, some information in this regard on the provisioning or the collateralization on this entire real estate exposure, throwing all this into one bucket, that indicate a number also would be extremely helpful.

--------------------------------------------------------------------------------

Shirish Bhide, First Abu Dhabi Bank P.J.S.C. - Group Chief Credit Officer [26]

--------------------------------------------------------------------------------

This is Shirish. Your first question was around the overall cost of risk and sustainability. I think the way we see it is, obviously, got a headwind. I think James, in his presentation, alluded to that in terms of -- when you look ahead, there's obviously an economy that has been slow, and therefore, there are headwinds in the economy. We recognize that. And our approach and orientation to loan growth has taken that into account and which is why if we look at our strategy of growth, it's largely playing to our own strength of being a banker to the government and focusing on government GRE-related exposures.

Our policy on real estate, which you alluded to in that same question, has been consistent. As we've explained in the past, we've always approached real estate -- the real estate sector on the base of its underlying cash flows. We've looked at relationships holistically, and entered real estate transactions only on the basis of an overarching relationship, which is broader than just the RE deal on the table. And hence, we've always benefited from direct and indirect cash flows that supported the debt in these types of transactions.

I mean, if you look at our construction financing book as well. We've always benefited from sort of direct/indirect cash flows, which far exceeded the isolated debt component towards the construction of the contracting finance business itself.

So overall, I think that had given us the stability through these times. And we continue with that approach. So we've been very selective in our approach, and with all the guidelines that are already in place and the new guidelines coming out, is only going to strengthen this sector and this line of questions that usually come -- it's going to make the whole approach for this sector even stronger going forward.

So we don't have any significant concerns on this front. And our guidance actually factors in our forward-looking view of how we continue to look in our portfolio outlook, whether domestically in the UAE as well as internationally.

--------------------------------------------------------------------------------

Naresh N. Bilandani, JP Morgan Chase & Co, Research Division - Research Analyst [27]

--------------------------------------------------------------------------------

So just to -- if I build into what you say, the numeric numbers. 49 bps is very much sustainable going forward into the fourth quarter of this year. So there's a fair chance that you could still remain below your guidance because if you say your guidance builds in the way you have, do you think the asset mix could evolve into the medium term? I'd say you're probably at the start of the year, thinking of a much more aggressive growth on the retail side, but that did not materialize. And so there's a fair chance that you could actually stay below the guidance for the full year. And given the fact that you remain conservative on booking the real estate and the construction portfolios and trying to collateralize that with the cash receipts, you expect a good trend or this trend to be sustainable into 2020?

I'm sorry, I'm trying to put words in your mouth, but I'm trying to look for some numbers here. How should I be thinking of the trend going forward?

--------------------------------------------------------------------------------

Shirish Bhide, First Abu Dhabi Bank P.J.S.C. - Group Chief Credit Officer [28]

--------------------------------------------------------------------------------

Don't worry I'm not going to take any of those words, Naresh. So just to reiterate what I said and to answer your questions specifically, at this point, anyway, in terms of cost of goods, we're well below the guidance. So even if we see the headwinds and factor those in. Again, just to be clear, our approach and orientation or reorientation to a slowing market has not been to expand our risk appetite in any of the sectors that we've not chosen to in the past. So we've never changed our direction on that. So it's not to say that with a slowdown, in order to gain traction and to continue with the loan growth we've diluted any of our risk acceptance criteria. We stayed true to our approach to real estate as an example. But for that matter, for any other sectorial exposures we did. So that's one.

So we remain fairly confident, but having said that, and you're right, having said that, we can't be in isolation or be isolated from market trends and overall sort of macro factors in the economy. And with that, we've already said that as we go into 2020, there is a possibility that we enter that zone of cost of risk guidance. Though, it's always at the lower end, at all times. And then there's still a lot of headroom in there. Essentially if we're already below that kind of dilemma. So nothing that we feel that we need to do differently.

--------------------------------------------------------------------------------

Operator [29]

--------------------------------------------------------------------------------

We'll now take our next question from Aybek Islamov with HSBC.

--------------------------------------------------------------------------------

Aybek Islamov, HSBC, Research Division - Analyst [30]

--------------------------------------------------------------------------------

Yes. I'll just raise, I guess, with 3 questions, if I may. The first one, I wanted to ask you about the business as usual costs. You always give them in the presentation slides. So the question is, there is quite a decent acceleration in them, in fact, from Q1 '19 from the first quarter. And Q3, as you showed, increased 13% year-on-year. Yes. So that's -- so as the integration process completes and all the synergies are sort of in the numbers, what sort of normalized cost growth do you expect to see for the bank? That's the first question.

Secondly, I wanted to ask you on your lending spreads. Given that you're increasingly focusing on public sector loans. Does it mean that you're going to see more pressure on your lending spreads as we go into 2020, 2021. And these public sector loans, I don't know how you price them, but let's say, if it's benchmark plus spread, then can you hedge your downside risk when rates fall using interest rate swaps. Right? That's my second question.

And I think the third one, I've noticed an increase in your stage 2 loan ratio in the third quarter. So I'm wondering what's behind the increase in the stage 2 loan ratio and stage 2 loans in Q3?

And very easy fourth question. Investment securities, there's a reasonable growth in investment securities. So what do you expect in terms of your strategy of investment securities purchases, 2020, 2021? It's a reasonable engine to grow assets for the bank and make earnings. So I'm just curious what you see here.

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [31]

--------------------------------------------------------------------------------

Okay. I'll take 1, 2 and 4 and half the stage 2 things for my colleagues in risks.

So the first one on the costs, you're asking for guidance on the cost next year, which we will not provide. What I would say to you is we are investing in our strategic areas. We're very, very acutely aware that we're looking to maintain a leading-edge cost income ratio. A lot of the investments we are putting money into, i.e., digital, transformation are all designed to improve our efficiency and our effectiveness, particularly in the operations, i.e., we want to do end-to-end customer journeys without sort of human intervention. And that's why we're focused on getting this done because we know there's a big reward at the end, you have to digitize. So we're investing upfront. And I can assure you that there's further synergies to be made next year.

On your question about lending spreads. I think what you need to do is look at the overall risk-adjusted return of those assets. So in many cases, they are track zero risk-weighted assets, they're in fact, zero cost of risk and the spreads are off benchmark based on external ratings or whatever the case may be. So for us, it's very, very profitable lending and leads to an improvement in both the core equity Tier 1 as well as the return on risk-weighted assets. So that's very profitable.

I think your question was specifically around pricing. Pricing, obviously, is dependent on the risk profile of particular entities that we're lending to.

Your last question on investment securities. Yes, I agree there's potential upside for us there to take on a little bit more risk and generate a little bit more return. And I think that's what you've seen come through in some of those numbers.

So we've taken our very conservative fortress-like balance share and deployed a little bit more into investment securities, which will obviously generate a pickup in yield -- revenue yield going forward. And then in terms of the stage 2...

--------------------------------------------------------------------------------

Shirish Bhide, First Abu Dhabi Bank P.J.S.C. - Group Chief Credit Officer [32]

--------------------------------------------------------------------------------

So on the stage 2 bit, just in terms of the IFRS 9 staging criteria. We follow the same process, which means there are accounts that move in and out from stage 1 to stage 2 and vice versa. So in a sense, there's nothing very specific. It's not a specific concern that we have, obviously, depending on the nature and the amount involved, you could have a couple of accounts that can be slightly bulky and caused some variations and variances, and that's all that happens. They move in and out. And based on the sustaining criteria, which gets reviewed by multiple stakeholders, accounts move in and out. So other than that, I mean, we don't really -- it's not a specific concern to us. In terms of -- if you look at the percentage, it really doesn't show...

--------------------------------------------------------------------------------

Aybek Islamov, HSBC, Research Division - Analyst [33]

--------------------------------------------------------------------------------

So if I may just add on Stage 2. Maybe you can comment, are there any particular sectors or segments which are driving the increase? What drove the increase in stage 2 loans in the third quarter?

--------------------------------------------------------------------------------

Shirish Bhide, First Abu Dhabi Bank P.J.S.C. - Group Chief Credit Officer [34]

--------------------------------------------------------------------------------

Without wanting to be very specific. Overall, I think it's just contracting construction as a sector. If I have to highlight one.

--------------------------------------------------------------------------------

Operator [35]

--------------------------------------------------------------------------------

So we'll now take our next question from Ankit Gupta with NCB Capital.

--------------------------------------------------------------------------------

Ankit Gupta, NCB Capital Company, Asset Management Arm - VP of Asset Management [36]

--------------------------------------------------------------------------------

Yes. Can you hear me?

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [37]

--------------------------------------------------------------------------------

Yes. You're coming through loud and clear. Thank you.

--------------------------------------------------------------------------------

Ankit Gupta, NCB Capital Company, Asset Management Arm - VP of Asset Management [38]

--------------------------------------------------------------------------------

Yes. I was just wondering on the (inaudible) addressing the piece cap on different banking products, that's processing mainly retail. Are you expecting any impact from these changes? Or are they coming through this year? If you can comment on that.

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [39]

--------------------------------------------------------------------------------

Yes. It's basically immaterial for us. So from your financial model perspective, ignore it.

--------------------------------------------------------------------------------

Operator [40]

--------------------------------------------------------------------------------

And we'll now take our next question from Naresh Bilandani from JPMorgan.

--------------------------------------------------------------------------------

Naresh N. Bilandani, JP Morgan Chase & Co, Research Division - Research Analyst [41]

--------------------------------------------------------------------------------

Sorry. My -- the second question that I've asked previously was -- I don't think was answered. Can I please just check, again, some insight that you can share into the level of collateralization in rates that you (technical difficulty) construction, real estate and mortgage exposures? Even some indicated numbers that you may have on these values would be very helpful.

--------------------------------------------------------------------------------

Shirish Bhide, First Abu Dhabi Bank P.J.S.C. - Group Chief Credit Officer [42]

--------------------------------------------------------------------------------

Naresh, we, as a general policy, we approach this sector with 70% loan-to-value as our policy, which is in line with the Central Bank guidelines of 143% collateralization. So that's the opening norm.

--------------------------------------------------------------------------------

Naresh N. Bilandani, JP Morgan Chase & Co, Research Division - Research Analyst [43]

--------------------------------------------------------------------------------

And this is related to which portion you're talking about, please?

--------------------------------------------------------------------------------

Shirish Bhide, First Abu Dhabi Bank P.J.S.C. - Group Chief Credit Officer [44]

--------------------------------------------------------------------------------

Sort of the exposures that we take.

--------------------------------------------------------------------------------

Arif Shaikh, First Abu Dhabi Bank P.J.S.C. - Group Chief Risk Officer [45]

--------------------------------------------------------------------------------

Any real estate exposure.

--------------------------------------------------------------------------------

Naresh N. Bilandani, JP Morgan Chase & Co, Research Division - Research Analyst [46]

--------------------------------------------------------------------------------

This is on marketed you mean? Any real estate exposure? 30% LTV, 143%...

--------------------------------------------------------------------------------

Shirish Bhide, First Abu Dhabi Bank P.J.S.C. - Group Chief Credit Officer [47]

--------------------------------------------------------------------------------

That's right, 143% cover.

--------------------------------------------------------------------------------

Arif Shaikh, First Abu Dhabi Bank P.J.S.C. - Group Chief Risk Officer [48]

--------------------------------------------------------------------------------

That's the minimum.

--------------------------------------------------------------------------------

Shirish Bhide, First Abu Dhabi Bank P.J.S.C. - Group Chief Credit Officer [49]

--------------------------------------------------------------------------------

That's the norm. I mean, that's the minimum. You could have tighter structures, but at the very least, we'd expect 143% cover.

--------------------------------------------------------------------------------

Operator [50]

--------------------------------------------------------------------------------

(Operator Instructions) So that is all the time we have for questions. I will turn it back over to Sofia for any additional or closing remarks.

--------------------------------------------------------------------------------

Sofia El Boury, First Abu Dhabi Bank P.J.S.C. - Head of IR [51]

--------------------------------------------------------------------------------

I think if there are no further questions, I think we can end this call. Thank you very much, Shabbir, for hosting. And please, if any of you have any additional questions, the IR team's at your service. Feel free to contact us.

Thank you very much for your time, and have a good weekend.

--------------------------------------------------------------------------------

James Burdett, First Abu Dhabi Bank P.J.S.C. - Group CFO [52]

--------------------------------------------------------------------------------

Thank you.

--------------------------------------------------------------------------------

Operator [53]

--------------------------------------------------------------------------------

This concludes today's call. Thank you for your participation. You may now disconnect.