Emirates NBD Bank PJSC (EMIRATESNBD) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to Emirates NBD's Results Call and Webcast for the Third Quarter of 2020. Today's call is being recorded. Please note that this call is open to analysts and investors only. Any media personnel should disconnect immediately. I will now pass the call over to our host, Mr. Shayne Nelson, Group CEO of Emirates NBD.

Thank you, Molly, and welcome, everyone. Joining me as usual are Patrick, the group's CFO; and Paddy, our Head of Investor Relations. Before we go through the results for the first 9 months of the year in detail, I'll update you on operational developments within the bank and the economic environment. Over the last 3 months, we've seen the economies we operate in gradually reopen. The way we work and do business has changed dramatically. We've coped well with the recent challenges and demonstrated great versatility by providing a full banking service, whilst a large number of our colleagues have continued to work from home or from contingency sites. During this time, more customers have utilized our digital banking offering as a secure and safe banking platform. As branches and offices reopen, we have maintained and enhanced deep cleaning and sterilization protocols and provided training in precautionary measures to frontline staff. Emirates NBD has remained strong throughout this year, and we have used that strength to support our customers affected by the severe disruption caused by COVID-19. Our philosophy has always been to support customers now in order to minimize credit losses arising later. At the beginning of Q3, we provided AED 8.3 billion of interest and principal deferral relief to over 90,000 customers. During the third quarter, we granted a further AED 225 million of interest and principal relief and nearly AED 2 billion of relief was repaid. To date, we have helped nearly 100,000 customers. So far, there has been a modest deterioration in credit quality. But as I mentioned last quarter, it will take several more quarters before the true credit picture becomes evident. Turning to the economy. The UAE government has issued clear, prescriptive and measured guidelines to reopen the economy with safety continuing to be the top priority. UAE economic indicators show that business activity improved slightly in September, while new orders remained flat and companies reduced their headcount at bid to curb costs. We have a strong balance sheet, and we will use this to actively play our part in supporting economic development in the coming quarters. Turning to performance. Total income grew 18% as the contribution from DenizBank helped offset margin contraction due to falling interest rates. Nonfunded income improved in Q3 as activity picked up post lockdown. Costs remain under control, but the increase in impairment allowances resulted in operating profit being 24% lower than last year. The bank's capital ratios remained strong and well above minimum requirements. We've maintained healthy coverage ratios in anticipation of any deterioration in credit quality in the coming quarters. The bank continues to have a strong liquidity profile supported by a stable deposit base and good access to the capital markets. During the last quarter, Emirates Islamic successfully issued a benchmark sukuk at competitive pricing, and DenizBank were able to issue a number of private placements from the recently established MTM program. I will now hand you over to Patrick to go through the results in more detail. Patrick?

Thank you, Shayne. I'll walk through the performance for the first 9 months of 2020, which is set out on Page 4 of the presentation, and the third quarter, which is detailed on Page 5. So starting with Page 4. Total income improved 18% year-on-year. Now this includes DenizBank income of AED 5.9 billion in the first 9 months of 2020 versus a AED 1.3 billion contribution for the 2 months since the acquisition in July 2019. Net interest income improved 21% and nonfunded income improved by 9% year-on-year, including the DenizBank contribution. Excluding DenizBank, net interest income declined 11% year-on-year due to lower interest rates and nonfunded income declined 19% year-on-year as a result of lower client activity during the acute disruption from COVID-19 in the second quarter. Costs increased 23% year-on-year with the inclusion of DenizBank for the full period. Excluding DenizBank, costs were 5% lower with the Q2 cost-management actions taking effect in Q3. The cost income ratio for the first 9 months at 31.8% is within guidance, and these combined to deliver an improvement in the pre-impairment operating profit, up 15% year-on-year. In the third quarter, there was a modest increase of 0.2% in the NPL ratio, increasing to 6.0%. And the credit impairment charges of AED 6.4 billion represents a 131% year-on-year increase. This has helped strengthen the coverage ratio to 120%. Now we continue to maintain healthy coverage level in this uncertain credit environment. However, we expect the impact of COVID-19 on credit quality will not really be fully evident until future quarters as deferrals roll off, and I will elaborate on this shortly. The increase in provisions has resulted in a 24% fall in operating profit year-to-date. And the reported net profit fell by 55% as last year's result included a AED 4.4 billion gain on the disposal of Network International shares. Now excluding the Network International disposal, the net profit was down 30% year-on-year. Net loans have grown by 1% during 2020 and deposits are down 3%, mainly due to Turkish lira depreciation. The liquidity coverage ratio of 161.7% and the advances to deposits ratio at 96.6% continued to demonstrate the group's strong liquidity profile. We have a strong diverse funding base, which we've used to support our customers through these challenging times. The profile of the quarterly results is set out on Page 5. It's affected by the same drivers as I have just outlined. So I don't propose going through each line item, but there are a number of points to note briefly. In Q2, we had seen a 17% drop in income over Q1, but in Q3, the quarter-on-quarter drop is just 2%. Now within that, nonfunded income actually grew by 10% quarter-on-quarter due to the gradual increase in business volumes during Q3, almost offsetting the continued reduction of net interest income. Q3 costs were down 7% over Q2 as management actions took effect. And Q3's impairment allowance is higher than the preceding quarter as we keep up our strong levels of provisioning and partly because of the benefit of a restructuring recovery in Q2. Slide 6 sets out our NIM, net interest margin, trend over the quarters. At the bottom left, we see the year-on-year lower interest rates adversely impacted loan spread by 132 basis points. This was partially offset by an 86 basis point improvement in net deposits and funding costs. Excluding DenizBank, margins would have finished at 236 basis points, but the 37 basis point contribution from DenizBank lifted margins to 273 basis points for the first 9 months of 2020. The chart on the bottom right shows that margins in the group contracted in Q3 as lower interest rates impacted loan spreads by 52 basis points, reflecting the fall in 1- and 3-month EIBOR rates of over 170 basis points during 2020. This was partially offset by a 30 basis point improvement in the funding cost and a modest contribution from DenizBank in Q3. We have maintained NIM guidance at 2.55% to 2.65%. We'll be -- we expect it to be near the top end as we anticipate a smaller impact on loan yields in the fourth quarter as recent declines in EIBOR rates being less than in earlier quarters. The full year NIM, even if it were at the top end, nearer the top end, does imply that Q4 NIM will be lower than Q3, and it also assumes no further Fed or CBUAE rate cuts. Turning to Slide 7. We see that the bank continues to operate with strong liquidity. We have AED 95.8 billion of liquid assets, which covers 16% of total liabilities and 21% of total deposits. The liquidity coverage ratio remains healthy at 161.7%, while the AED ratio was 96.6% at 30th September. As with Q2, we have not seen any material increase in EIBOR rates towards the end of Q3, and this is a good barometer of interbank liquidity and indicates the banks were not aggressively paying up for liquidity over the quarter end. The measures introduced by the UAE Central Bank earlier in the year have helped ensure orderly and stable liquidity within the UAE banking sector. In 2020, year-to-date, we have issued AED 17.1 billion of term debt in 7 currencies and with a 9.8-year weighted average life. This includes 3 benchmarks senior public bond and sukuk issues and private placements with maturities after 30 years. This covers not only 100% of the bank's maturities in 2020, but approximately 1/3 of 2021 maturities. DenizBank has also been successful in issuing a number of private placements under its newly established EMTN program. Now the pie chart on the bottom left shows that customer deposits continue to make up 3 quarters of liability, and that leads nicely on to the profile of deposits on the next page. On the bottom right side of Slide 8, we see that Emirates NBD's deposit mix continued to improve in the third quarter with CASA, current account, savings account, growing by AED 6 billion, essentially replacing the AED 7 billion reduction of fixed deposits. As I noted earlier, total deposits are down year-to-date, mainly due to Turkish lira depreciation. CASA, across the entire group, represents 50% of deposits, and the domestic CASA engine of Emirates NBD remains strong and represents 58% of domestic deposits. Gross lending increased 2% for the first 9 months. Within that, retail gross lending grew 1% during 2020, corporate lending grew 3% and Islamic financing grew by 7%. DenizBank's gross loans and deposits grew by 22% and 15%, respectively and in local currency, but declined in dirham terms due to currency depreciation. Slide 9 shows the diversity of the loan portfolio, particularly with the addition of DenizBank. The UAE comprises 76% of loans with international and GCC making up 24%. And at the segment level, 34% of loans is sovereign, 16% retail, corporate is 37% and Islamic represents 13% of gross lending. The pie chart on the right-hand side shows the diversity of the loan profile by sector and is broadly the same as H1. On Slide 10, as mentioned earlier, the NPL ratio increased slightly by 0.2% in Q3 and 0.4% year-to-date to 6.0%. Still too early to predict the level that NPLs will rise to, but in anticipation of a weakening in credit quality, we continue to maintain a strong coverage level. Coverage has risen by 7.3% to 119.6% in 2020 as the bank has taken AED 6.4 billion of impairment allowances. Now this equates to an annualized cost of risk of 176 basis points, with DenizBank continuing to boost coverage through an annualized cost of risk of 408 basis points for the first 9 months and Emirates NBD's comparable cost of risk of 125 basis points is up from 91 basis points in 2019. Overall, coverage remained strong in the third quarter as impaired loans increased by AED 0.8 billion compared to a AED 1.7 billion increase in provisions. We will continue to review the overall levels of provision as the impact of COVID-19 becomes more apparent in subsequent quarters. Turning to Slide 11. This provides more detail on our levels of Stage 1, 2 and 3 coverage. As with H1 results, for Q3, the macroeconomic variables forecast has been updated to reflect the impact of COVID-19. And our scenario weighting continue to be 40% baseline, 30% upside and 30% downside scenario. The group has also applied portfolio level ECL adjustments to wholesale exposures based on affected geographies and sectors as well as to our retail customers taking up deferrals based on employment status and levels of salary inflows. The group continues to assess individually significant exposures for any adverse effects of COVID-19. Now the chart on the top right shows that Stage 1, 2 and 3 impairment allowances have grown in total by a net AED 4.8 billion since the end of 2019 to AED 34 billion. Stage 1 ECL allowances increased by AED 0.4 billion to AED 5.1 billion. And this increased the Stage 1 coverage to 1.2% on 88% of gross outstanding loans. Stage 2 ECL allowances increased by AED 1.9 billion to AED 5.5 billion, and this increased Stage 2 coverage to 20.8% on 6% of total gross outstanding loans. We have increased Stage 3 ECL allowances by AED 2.5 billion during 2020, giving a strong 90.5 Stage 3 coverage. And finally, just touching on deferrals and the test or targeted economic support scheme. We have provided details of deferrals in note 25 of the financial statements. But in summary, we have provided AED 8.5 billion of deferred, principal and interest repayment support to our customers and clients. Customers have repaid AED 1.9 billion of support, meaning that at 30 September, the bank was still providing AED 6.6 billion of support to customers. And during Q3, Emirates NBD repaid just over AED 900 million of TESS 0 cost funding to the Central Bank of the UAE and continues to utilize AED 6 billion of the TESS 0 cost funding. Most of the repayments have come from the corporate and institutional banking clients. And total principal related to clients we're supporting with deferrals is AED 49 billion or around 11% of total UAE lending. We continue to be vigilant and take a cautious approach to our provisioning. We'll keep you up-to-date as the credit profile of the loan book evolves in the coming quarters. I'll just now hand over to Paddy to take you through the remaining slides.

Thank you, Patrick. Slide 12 shows the core gross fee income for the first 9 months improved 15% year-on-year due to the full-year inclusion of DenizBank. Core gross fee income for the third quarter improved 24% over the previous quarter as increased activity -- on increased activity, but remained 7% below the level recorded a year ago. Income from foreign exchange rates and trade finance all improved quarter-on-quarter, reflecting increased activity. Fee income also delivered a quarterly improvement on higher retail transaction volumes and increased investment banking activity. Income from property shows a modest loss as we continue to write down the remaining inventory. And income from investment securities was also lower as Emirates Islamic revalued its investment portfolio. On Slide 13, we see that costs for the third quarter improved 4% year-on-year despite the inclusion of an additional month of DenizBank costs. Looking at Emirates NBD only, costs improved 12% year-on-year due to lower staff and operating expenses. Following earlier cost-management exercises, costs improved by 7% over the previous quarter on lower staff and operating expenses and lower costs from DenizBank. The cost-to-income ratio of 32% in Q3 is back within management range of 33% and gives an average cost-to-income ratio of 31.8% for the first 9 months. We expect the cost-to-income ratio to increase towards 33% due to lower expected income during the final quarter. This is not surprising given how rapidly global interest rates fell earlier this year and the immediate impact such cuts have on income, but the impact will be somewhat tempered by the earlier cost management actions. Slide 14 shows that the capital ratio strengthened between 0.3% and 0.7% in the third quarter. Common equity Tier 1 ratio rose 0.3% to 15.6% due to retained earnings and a 1% reduction in risk-weighted assets. The Tier 1 ratio rose by 0.7% and the capital adequacy ratio by 0.6% in Q3 as both also benefited from the issue of a $750 million additional Tier 1 perpetual note in July, which more than offset the call on a $500 million old-style additional Tier 1 note in September. The reported capital ratios for 2020 included an add-back from incremental Stage 1 and 2 ECL alliances as permitted by the UAE Central Bank. Excluding this add-back, the common equity Tier 1 ratio is at 15.1% and the capital adequacy ratio at 18.6%. TESS offers banks relief on capital buffers until the end of next year without supervisory consequences. And Emirates NBD's current minimum common equity Tier 1 ratio is 8% and minimum CAR's 11.5%. And even excluding the add-back, Emirates NBD's actual capital ratios are over 7% higher than this new minimum. On Slide 15, we see that RBWM year-on-year revenue fell by 7% due to lower fee income on volume -- as volumes were impacted by lower activity due to COVID-19. Customer advances reduced by 1% and deposits grew by 6%, supported by a successful marketing campaign. Year-on-year, the first half -- the first 9 months cost-to-income ratio for RBWM improved by 2% to 25.5%. Emirates Islamic grew financing and invested in receivables by 9% in the first 9 months of 2020. Customer accounts increased by 1%, and EI has a healthy 70% of deposits coming from CASA accounts. During the third quarter, EI returned to the capital markets with a successful $500 million 5-year sukuk issue. On Slide 16, we see that corporate and institutional banking income fell by 6% year-on-year as the 9% decline in net interest income was partially offset by an increase in investment banking activity. Loans grew 3% and deposits increased by 9%. Global markets and treasury revenue declined 204% as net interest income was adversely impacted by lower interest rates. Nonfunded income was also lower primarily due to a mark-to-market movement on hedges relating to term funding, although the credit trading desk continues to deliver a strong performance. As Patrick already mentioned, the global funding desk has fully covered term liabilities maturing this year and 1/3 of next year's maturities. Slide 17 shows DenizBank had a first -- had a good first 9 months, delivering nearly AED 6 billion in revenue and a net profit of AED 1.2 billion. DenizBank continues to take significant provisions to boost its coverage level. Margins contracted 12 basis points during the third quarter to 4.28%. The NPL ratio for DenizBank improved by 0.6% during the year as loans grew 22% in local currency terms and the credit performance of newly originated business remains healthy. With that, I'll pass you back to Shayne for his closing remarks.

Thank you, Paddy. And to summarize, the positive income contribution from DenizBank has helped offset the decline in net interest income from lower interest rates and lower fee income due to the impact of COVID-19. The decline in NIMs is starting to flatten out, and we expect NIMs to close the year at the top end of the guidance. As activity picked up, nonfunded income improved 24% in the third quarter on higher volumes, but is still 7% lower year-on-year. Earlier cost-management action has brought the cost-to-income ratio back within the 33% management range. Liquidity and credit coverage ratios remain very healthy, and we delivered a further improvement in capital ratios. We have provided support to 1/10 of our customers primarily through the deferral, both interest and principal, for periods of up to 6 months. In addition, we have waived certain fees to help individuals and businesses cope with the disruption. The number of retail and corporate customers who regularly use our digital platform continues to grow. Emirates NBD delivered a net profit of AED 5.6 billion for the first 9 months of 2020. And this, coupled with the strong balance sheet, provides a platform to continue supporting our customers. With that, I'd like to open the call for questions. Operator, please go ahead.

[Operator Instructions] Our first question comes from Mr. Hootan Yazhari of Bank of America.

Gentlemen, I have a few questions. First of these really focuses around asset quality. We saw some big ECR model changes in Q2 given the disruption in economic growth expectations. Yet, we are faced in Q3 with another big provision charge, which obviously negatively surprised the market. . So the key question, I guess, is how long can we expect an elevated cost of risk to persist, particularly in Turkey? And what are the key trends that you're seeing in the corporate market in the UAE? It seems as if though the retail market benefited from the write-backs that you were talking about on the restructuring side. But maybe you can talk about the outlook for the corporate and the retail side in the UAE just so we can have an understanding of when this high level of provisioning could potentially abate, if ever. The next question I have is really regarding costs. You did a very good job in pulling costs down in Q3. Given that you have reassessed the growth outlook for 2021, how are you thinking about the cost base? Are you now in a position to further rationalize your cost base? Or do you feel that the activities you've taken are already optimal?

Hootan, Patrick here. Maybe I'll just take the first part of that to start with. So you have the question of how long do you expect the impairment to be elevated. We were strong coming out of the blocks in Q1, where we made a AED 2.6 billion provision. We had weighted our ECL scenario to 100% on the downside. I think we are one of the banks being able to update the macroeconomic variables. And then in Q2, we had a AED 1.7 billion impairment, and that did have a benefit from a restructuring recovery in that. So with that AED 2.2 billion for Q3, we're maintaining a level of provisioning that is probably less than what it would have been in the previous quarter. I think I have said in the previous quarters as well that we do expect it to be, particularly through this year, still elevated. In Turkey, we have been going through the portfolio, making sure we have the right levels of impairment and building the coverage in Turkey closer to the overall group levels as well. So we're doing that consciously. And...

I'll just say on...

Sure. Yes.

On Turkey, Patrick, because I think it's a good question. You remember from our discussions on previous quarters on Turkey, that we took a long time to close this transaction. And part of the SBI that we had with Sberbank was that we looked at every significant file as it was coming through for approval or renewal. So because of that, the whole process took so long. We looked at every file of significance in that book, plus we did 2 credit due diligences on the portfolio. So I think it's fair to say that if we look at the risk profile that we expected, it is what we've got. And new problem formation that we've had there has been fairly low. However, having said that, obviously, if they were -- if that alone was in the tourism area, that has been more adversely affected than others. So I think it's fair to say that some of the stuff that we forecast as a problem has deteriorated at a faster rate than we would have anticipated there. But our whole push in Turkey is we want them to get their ratios up to the group standard of where we actually have our ratios. So Turkey has been outperforming the acquisition model on revenue. It's got a better cost-to-income ratio than our acquisition model. And we have been -- and that's enabled us to accelerate the build of provisioning there quite aggressively in Turkey, and we'll continue to do that whilst they have the room there to -- on the revenue side.

Thank you, Shayne. And Hootan, you also had the question on costs. Yes, Q3, they're down. We had management actions in Q4 last year, so that benefit's also coming through. And then in Q2, we took further actions to manage the cost base. We think it's in good shape. It's partly accelerated with the accelerated digital agenda. Some of those benefits are also coming through. So there, we're always looking at the cost base to run as efficiently as possible. We are below 33%, so that's already running very lean. But as far as the 2021 outlook goes, we'll be updating our guidance in January next year.

There was also a question on the retail side as how that's performing.

Oh, the outlook. Yes.

So if I just go through it product by product as to where we are, mortgages, surprisingly, are running at a better rate than they were in the first quarter. So we've fully recovered on that side. On credit cards, we're probably writing about 75% of new acquisitions that we work. And interestingly, the August numbers showed that we were #1 and #2 with new credit card acquisitions for Emirates NBD and then Emirates Islamic in the UAE market. Personal loans are getting close to above 80s and car loans sort of in the 60%, 70%, I think, is about the numbers. So the market has bounced back probably stronger than we would have anticipated. I mean, when we were looking at -- when we did the reshaping of the cost, we were sort of thinking that 60%, 70% would be the right range as to what recovery would be in the third and fourth quarters. Well, we've actually blown through that far sooner than we thought. Spending on credit and debit cards locally is about 95% of where it was. So there's been quite a -- the spending patterns have come back quite strongly. Obviously, online's very strong as well, but we have seen a recovery in the spending patterns of our customers on both debit and credit. Hopefully, that gives you a good view.

Yes. That was clear. If I could just take you back to what we were saying with regards to Turkey and how you want to get its coverage in line with the rest of the group. What I'm ultimately trying to understand is, at what stage can we start to see that coverage being reached and then cost of risk coming to what is going to be a more normalized level and the ROE, the underlying ROE of the bank, more reflective of what the bank can do in the mid-cycle environment. Or I'm also trying to understand, this is the way it's going to be for the foreseeable future, and Emirates NBD is going to be generating high single digit, low double-digit ROE for the foreseeable future. That's what I'm really trying to get at.

I think, from our perspective, the issue with any of this is how long is the piece of string. If you can tell me how long COVID will keep lasting and affecting the economy in Turkey, I can probably give you a better answer. But I think, for us, whilst we've got the above-budget revenue coming through that franchise, we think it's prudent to cover what we can. And I think that's a prudent measure that we always do. You know from history how conservative we are on the -- on the provisioning side, and we continue to build both here and in Turkey and in other franchises.

Okay. We have full -- thanks, Hootan. We have a couple of questions coming through on the webcast, so I'll fill a couple of those, and then we'll open the call up for further questions. There's been a few questions on cost of risk. I think we've covered that and the difference between Turkey and UAE, et cetera, when we expect things to normalize, et cetera. We really covered that. Patrick, just more impairment charge -- or more impairment charges expected in Q4, given that we've already had -- or we already have a high coverage level. And why have risk-weighted assets reduced by 1%?

Paddy, just on the first part, I think the answer is, yes, we will have more credit impairments in Q4. I'd like to see a bank that doesn't, unless they've, however, provided previously. But as we've suggested before, it probably will be -- remain relatively elevated given the environment that's out there, probably too early to tell what that holds for next year. But as we know, we like to make sure we're well covered for the credit events that have occurred already. And with IFRS 9 running the models to make sure that we're taking into account most of the factors for that Stage 1 and 2-level provisioning. Even if something moves from Stage 2 to Stage 3, there is always a delta on the impairment on that. So far, we haven't seen the NPLs step up. So really, we'll have to see towards the end of the year how the NPLs are looking and the relative provisioning required the coverage for that. Just on the second part there, how have the risk-weighted assets reduced by 1%? The main impact has really been the Turkish lira depreciation. So when risk-weighted assets in Turkish lira translated back to AED, that really comes through in that. And we could see that in the deposit and the lending side as well that we showed you on Slide #8.

Great. There's a follow-up question on NIM compression. Is it fair to say post Q4 '20 that there would be further minimal NIM compression if there's no further rate cuts?

Well, we've benefited this year from lower cost of funding. So part of that depends on the profile of your funding base. So we'll see what the exit rate is at the end of Q4. I think we've given you enough information that you can pretty much calculate what that is. And we'll update guidance for next year as a whole when we come back in January.

The thing -- the only comment I'll make on that one would be, as rates rise in Turkey -- it's not a rise, there is a lag effect in Turkey between -- deposits there are pretty short versus the repricing of the loan. So you could see some compression coming out of the Turkish market if rates start to rise back in Turkey.

And Shayne, a question from Vijay. Are you seeing any indications of green shoots of recovery in the economy? Any specific sectors?

Green shoots of recovery. Well, I suppose spending has been a good surprise. When we're -- we wouldn't have thought we'd be back at 95% domestic spend when we're talking to the analysts last quarter. So I think that is a good thing. Housing, I'm not sure -- I mean, I'm not sure that, for example, just because we're running at over 100% of what we were writing in housing loans in the first quarter is a reflection of a recovery in the property market. I think that's more that there was quite a few projects finished and clients needed to finance them. So I don't necessarily see that, that's a drive into demand for property at the moment. I think it was contractual, that they needed, too. But I think if I look at the volumes that we're writing, I think, far better than we anticipated, but it's still not what it was. It's the truth. And I think we do need tourists back and the economy firing again to really get that big pickup that we're looking for. I think, alternatively, if you look at the growth that we've had in Turkey in lending and deposits, if you look at in local currency terms, if you look at -- Egypt, it still continues to perform strongly, so some of our offset strategies with acquisitions in Egypt and Turkey have actually -- I think they've got better shoots of growth at the moment than we have here.

Great. Molly, I believe there's a few more questions on the line. So if you want to open up the line again, please.

Our next question comes from Shabbir Malik of EFG Hermes.

Two or 3 questions from my side. Now that you have had about 6 to 9 months to go through your loan portfolio, what do you believe are the sectors that are probably most under stress? And what actions have you taken to kind of mitigate risk coming from these sectors? My second question is on your upgrade of the core banking system. According to some press reports and some anecdotal, there were some teething problems for -- on the consumer banking side. Did it have any material impact on your financial performance in the third quarter? And one last question. In terms of your -- the data that you've given in terms of deferrals, it seems like your Level 2 exposure has gone up in the third quarter -- sorry, the Group 2 exposure has gone up in the third quarter relative to the second quarter. I think it's now AED 1.4 billion versus AED 700 million in the second quarter. Any comment on that will be very helpful.

Maybe I'll take some of those in reverse order. Just on the deferrals, we have set out the staging of the deferral buy CIB and retail on Page 37 of the accounts, so it shouldn't be much of a surprise that there has been a movement between some of the stages between the 12-month and the ECL. So the migration to Stage 2 is not necessarily an indication of potential NPL as we've -- at all. Okay. Sorry about that. So you can also see that there've been a movement going the other way from Stage 2 to Stage 1 as well. So there will be movements between the stages. But overall, they aren't large amounts, considering what's going on in the environment. The financial impact from the system upgrade and whether that changed financial performance, no. That did not impact the financials themselves. And your first question was around stress in various sectors. Now obviously, there's probably not a sector not under stress in the environment, so we are having to be very vigilant across all of the sectors with our underwriting standards and our risk review processes as well. Where there are some particular levels of stress where it might be those in deferrals that have less salary coming into their accounts, we have made sure that we have made some adjustments to account for some of those specific stress points.

Just on the system thing, I'll just say that any of you out there that are in the UAE and bank with us, my apologies on the system outages. It's pretty disappointing for us, even though it didn't cost us money financially, reputation -- we're pretty disappointed because we have been the leading digital bank in the region and had those teething problems when we cut over to what was a new core operating system. So this was a heart transplant for us. It didn't go as smoothly as we wanted, as we obviously planned, and I'm pretty disappointed with the outcome. But we recovered pretty quickly. It's all systems go at the moment. We're on track with our transformation journey, but it was -- even though financially, it was -- it didn't hurt us. Reputationally, we're pretty disappointed because it's certainly -- reputationally, it's hurt us.

Our next question will come from Aybek Islamov of HSBC.

Yes. I just have 1 question. You report the group 1 and group 2 loans in quite interesting disclosure. So according to that, group 2 loans, which is structural credit risks still remain low as a percentage of total. So group 1 loans is the majority, right? And group 1 is loans which have temporary liquidity issues rather than any structural credit risk. . So if that definition -- if I follow by that definition, does it mean that if you provide new financing to your customers, you provide additional liquidity, you could actually avoid a lot of formation of Stage 3 and Stage 2 loans in 2021? And if that's the case, how much liquidity do you think you need to extend to your troubled customers so they avoid any structural credit issues next year?

The -- yes, thank you for that. So the disclosures we have in there are based on the definitions from the Central Bank of the UAE. The key part there is the staging under IFRS 9 about -- that will really show the risk level, so the 12-month low credit deterioration and then the lifetime ECL, where there has been a downgrade. So if something has been downgraded to Stage 2 and you have to lend some more, then that would also be in Stage 2 as well. Maybe I've missed the nuance of your question.

I think what he was trying to say is, what -- can you artificially lend more money to keep something in Stage 1, for example, that should have migrated further down?

Well, the answer has to be no. Because you have to follow the IFRS 9 staging criteria. So if there has been a deterioration, if that hit 30 days past due or have had a credit downgrading of it in the corporate sector, then you have to downgrade that. And if you lend more, then that goes along with it and you get the lifetime losses on that. But I don't think you can artificially avoid any staging downgrading because it's IFRS 9 determining those stages.

Okay. Aybek, thanks for that. Molly, is there any further questions?

We'll take our next question from [ Faruna ] [indiscernible] of [ Secco Bank ].

I have a follow-up on the earlier question on deferred accounts. So as you mentioned, now there is a shift deeper from group 1 to group 2, which is more severely impacted during the third quarter. I think the gross increase is over about AED 1 billion total. These are not the deferred amount of the total exposure. And at the same time, the retail accounts, which are enjoying the deferrals, has also again increased from, I think, about 90,000 to about 98,000. So I mean how do you interpret in terms of -- I mean, do -- does it mean that going forward, I mean, these accounts would create more -- result in more provisions and ECL provisions going forward?

Yes. Could you point perhaps to which particular numbers you are looking at specifically?

I'm looking at the group 2, the total value of the accounts, which are enjoying these deferrals in group 2, both retail and corporate. So total of which, I think, has grown from AED 1 billion in June to about AED 2.2 billion in September. So that is the number that I was referring to. And if you net off the ECLs in that group, the net exposure is about -- from AED 0.5 billion, it has grown to around AED 1.2 billion. So I want to understand what potential implication of this can have going forward into cost of risk going forward.

Okay. Look, as there's a -- regardless of those grouping, the key thing is the -- whether it's in Stage 1 and Stage 2, if it's being downgraded, whether it goes to Stage 3 and has specific impairment against it depends on the credit factors. In retail, if it's being past 180 days past due, then we have a charge-off in the corporate lending. It's more if there is a downgrade or specific events that means it needs to go to Stage 3. But I think, as I said before, and it's not surprising through this period of time, there will be a migration from Stage 1 to Stage 2. The good thing you should note from this is that even though there is the credit deferrals, we are still applying the downgrade criteria that you're supposed to and not in some way retaining them unnecessarily in Stage 1.

And that's important. I'm not sure all the analysts get that, that we are we are not taking those deferrals in a way we appellate the staging. Hence, we're quite conservative there.

Molly, any further questions on the line?

We'll take our next question from Alok Nawani of Ghobash Trading & Investments.

Just 1 broad question from my side. The cash deferral duration, if you could just remind us where it stands for retail and corporate customers, when it ends? And at the point in time when it does end, how do you expect your ECL models to react? And then finally, has there been any discussions or perhaps your view on possible extension of the test program in terms of durations of deferrals beyond what's in place?

I'll take the TESS one. You take the perhaps the -- on TESS, there has been certainly lobbying from the banks to extend the TESS program. As you can see from our comments, we're already getting customers paying down. So what we have outstanding is actually reduced. But certainly, I think the banking industry as a whole -- TESS was an important part, not only for the customers, but for the banks, because it provided liquidity at 0 cost. So the other thing with the other ratios, and most importantly for us was the CRR ratio, the cash reserve ratio. In the UAE, that was 14%. They halted to 7%. That's still actually about double what most markets have even at 7%. But that provided a lot of liquidity. So I think from -- the important factor to us and TESS, besides the customer impact which -- supporting customers in this environment is obviously critical, is the liquidity it provides the system. And what the Central Bank has provided both through TESS and through the CRR and some other realization ratios is better liquidity in the market, which is, for us, has been important. So we hope they do extend it. But at this stage, we haven't got no clarity on whether that will happen.

And just on the first 2 parts that you asked about the timing of the deferrals and then how we expect the models to behave once the deferrals finish. So on the retail side, they were up to 3 months interest in payments relief. A substantial amount of that deferral period from Q2 has expired. And therefore, customers have resumed repayments. It stays as part of the deferred or forborne facilities in total until the loan is fully repaid. So it could be 1, 2, 3, 4, 5 years, depending on which product that relates to. But from a model behavior point of view, as they resume those payments, as with IFRS 9 requires, if it's 30 days past due on the retail side, then it would be downgraded to Stage 2. And when -- in Q1, when globally, regulators were looking at IFRS 9 and what that might mean for the models, they were encouraging everyone not to be too mechanical about it and to use judgments and overlay to make sure, at that point in time, the provisions really weren't overdone. So that -- and it was basically also saying that just because there's a deferral, it doesn't mean that there's been a significant increase in the credit risk. But once our customers have started repaying, yes, if they hit 30 days past due, you then have that observable point, so you'd be able to do the staging determination at that point. On the CIB or wholesale side and the corporate, a number of the payments were out to 6 months. So a substantial amount of those balances are still under deferral. We did note earlier that almost AED 2 billion has been repaid of the actual deferred amount. That's not the gross lending. That's actually the deferred amount. So that's quite a positive point from that point of view, but we'll have to see what that looks like in Q4. Having said that, actually, if a corporate client is downgraded and its credit rating actually downgrades, then the models and the IFRS 9 ECLs will also downgrade that by staging. So deferral does not really meaning that everything is sitting in Stage 1 if there has been a credit downgrade.

I believe that's all the questions on the lines. There's 1 further question on the web. Do you have any exposure to Arab Tech or related contractors? Patrick, do you want to maybe take that? Do you want to speak to that?

I'm happy to take it because we can't answer it. As you know, we're not allowed to talk about individual customer exposures. And apologies, but what I will say is our concentration in the contracting industry is pretty small, especially in the civil contractors. So we don't have high-risk concentrations in that sector. I can't really say any much more on that.

Yes. And just to add to that, the economic activity -- so the various sectors are shown in the financial statements in Note 6 and Note 7. So I believe that's all the questions.

Well, if there's no other further questions, I'd like to thank you all for joining us here today and participation in today's call. As per usual, you all ask good hard questions. And I'll now hand you back to the operator. And if you have any further queries, you can also come back to Paddy and Investor Relations. Thank you, operator.

For any further questions, please contact our Investor Relations department, whose contact details can be found on the Emirates NBD website and on the results press release. A replay of this call and the webcast will also be available on the Emirates NBD website next week. Ladies and gentlemen, that concludes today's conference call. Thank you for your participation.