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The First Gulf Bank: an undervalued bank growth stock?

Though the bank was founded in the 1970's and originally based in the emirate of Ajman, the modern history of the First Gulf Bank began with the strategic restructuring that led to the transfer of its head office to Abu Dhabi, the appointment of veteran Citibanker Abdul Hamid Saeed as the CEO, shareholdings by prominent members of the Abu Dhabi ruling family and a management team empowered to reinvent the bank with a focus on growth, profitability and product innovation while incorporating the sort of sophisticated risk management protocols usually associated with international banks in the UAE.

This is a tribute to one of the best management teams in the Gulf, a subject on which I have insights as some of the bank's leading executives have helped me understand the idiosyncrasies of the global capital markets, particularly Zafar Habib, my colleague and dear friend when I was Chief Dealer at UNB and guide in the arcane worlds of debt arbitrage, Arab Eurobonds, multi-manger hedge fund investing.

The most remarkable aspect of the new First Gulf Bank is its sheer growth momentum. Net profits for the bank were 244 million dirham in 2004. (almost half the net profit emanated from Treasury and investment banking, making the bank a quintessential “corporate/merchant” bank, like the old J.P. Morgan or Bankers Trust on Wall Street.) Not only were the 2004 profits double the previous year, they were five times the size of profits when Abdul Hameed Saeed and his management team took over at the bank. The profit growth curve for First Gulf Bank is clearly accelerating. Net profit was $465 million for the first half of 2005, an incredible 350% above the same period last year. Normally, such hyper- kinetic growth in banking is a red flag to rating agencies and institutional investors. But First Gulf Bank's debt ratings were actually upgraded by Capital Intelligence and some of the leading institutional investors in the UAE scrambled to invest in its latest convertible bond issue.

The banks growth was the result of excellent risk management, rise in both fee income and net interest margins, and, above all, a huge rise in deposits and assets. Equities, foreign exchange, project finance, structured notes, retail banking, regional and global capital markets are some of the high margin niches where First Gulf has successfully made a strategic commitment for long term growth. Ironically, in my first job out of Wharton as a derivatives trader in Chicago. I used to cover the old Ajman bank so its transformation into the fastest growing corporate bank in the UAE is a matter of deep personal interest and delight. Think about it. First Gulf Bank could well earn a billion dirham in 2005, a milestone only achieved by NBAD, the leading bank in the UAE. If so, then the bank's shares could well command the cheapest valuations on a price/book or price/earnings basis in the UAE

Naturally, First Gulf has benefited from the First Gulf has benefited from the extremely high GDP growth in the UAE economy and bank credit off take in everything from IPO finance to construction leading to project finance. Yet the bank has clearly gained market in retail and corporate deposits and assets. Moreover, the bank's credit underwriting culture and risk management systems also are among the best in UAE finance. Nor is the growth stage in the evolution of first Gulf's banking franchise necessarily over. In June 2004. First Gulf Bank structured 800 million dirhams five years convertible bonds to a handful of the biggest and most powerful government institutional investors in the UAE and the recent rights issue of 500 million shares has raised an additional 5 billion dirhams. There are manifold growth opportunities available for First Gulf-regional corporate finance and merger advisory, Islamic banking products, real estate and home mortgage lending. The bank is scaling up its retail banking footprint in the UAE, opening new branches.

As an active investor in GCC, emerging markets and global money centre bank stocks, I diligently follow their capital structure management policies and consider rating agency analysis far more valuable than broker research to evaluate franchise strength. So it did not surprise me that Capital Intelligence upgraded the foreign currency and long term positioned to benefit from the multi-billion dollar infrastructure growth in Abu Dhabi as well as the new properties ownership milieu.

Paradoxically, First Gulf Bank has actually empowered its credit risk profile as it has expanded its asset book, as the rating agency upgrade demonstrates, a testament to its strategy to lend to the top public sector borrowers in the UAE.

Moreover, as Capital Intelligence pointed out, the bank's ability to raise such huge amounts of new capital reflects its Abu Dhabi strategic shareholders confidence in the banks management team and growth strategy. What next for First Gulf Bank? Why not a Euro MTN program, for instance? It would enable the bank to diversify its funding base, extend the duration of its liability book (a major benefit as Abu Dhabi project finance scales up) and above all, tell the most stellar improving credit story in UAE banking to the Eurobond market.

Naturally, a Euro-MTN program would not exactly hurt First Gulf Bank's share price. After all, RAK bank (a retail banking re-branding story in UAE banking) jumped 10% when it announced its Euro-MTN issue. Long-term investors should look beyond balance sheets, accounting ratios, stock market manias, even the liquidity cycle. Banking success stories are all about a management team empowered to execute as Abdul Hameed Saeed and his team at First Gulf have demonstrated all to well.