Banking Special: Stable Times For The UAE
The UAE is well capitalised but banking asset quality remains a concern.
The UAE’s economic growth may slow slightly in 2012 to three per cent due to lower growth in the oil sector but the non-oil sector GDP growth rate is expected to strengthen to 3.5 per cent on the back of buoyancy in the trade, travel and tourism sectors as well as some growth in the manufacturing sector.
Business confidence in the UAE has risen following the successful restructuring of Dubai World’s debt and the UAE, particularly Dubai, has benefited from the flight of wealth and people from Arab countries affected by the Arab Spring.
UAE bank margins have declined in recent periods and this, coupled with lower lending volumes over the last few years and high risk charges, has resulted in only modest profit growth for many banks with some banks recording declines.
UAE bank non-performing loans continued to rise in 2011. Most of the accretions to the impaired loan portfolios came from trade sector exposures (which includes trading in real estate) with smaller contributions made by personal loans.
Restructured and renegotiated loans, which are not always booked as non-performing, have risen significantly over the last few years. The challenge for UAE banks will be to maintain them as ‘performing’.
The real estate sector stabilised in 2012. Emaar Properties and Nakheel, Dubai’s two major real estate developers, have begun marketing new projects and certain built-up areas have reported an improvement in rental prices.
Nonetheless, the excessive supply of commercial and residential real estate in both Dubai and Abu Dhabi continues to hinder a stronger recovery of this sector.
Sanctions on Iran, one of Dubai’s largest trading partners, could slow the recovery of the trade sector and further impact the real estate sector since Iranians are major real estate investors in the emirate.
Also, local banks may not be able to provide fresh loans following a central bank circular limiting a bank’s total funded and non-funded exposure to government related entities (GREs) and local governments to 100 per cent of its capital. In the absence of any restrictions earlier, Dubai and Abu Dhabi banks had built up substantial exposures to their respective governments and to GREs.
The substantial increase in public sector pay in 2011, following the Arab spring uprising in other countries, is being met through savings in other areas. Abu Dhabi remains committed to its ‘Plan Abu Dhabi 2030’ document, which envisages an ambitious investment of $400 billion through to 2030 in energy and non-oil sectors. The government has identified its funding priorities and will focus in the short-term on social and infrastructure projects while other projects have been pushed to future years. Most banks in the UAE expect to benefit from this spending, although the banking sector has been disappointed at the level of government spending in 2012.
The pace of lending for UAE banks accelerated in 2011; net loans increased by four per cent up from two per cent in the previous year, but this was driven mainly by borrowings by governments and GREs, while loans to the private sector actually declined last year. In view of the reduced demand from local businesses, banks in the UAE concentrated on expanding their retail loan portfolios, which grew by six per cent despite a central bank circular issued in 2011 which tightened lending criteria.
The UAE banking sector is very well capitalised with the capital adequacy ratio for the banking sector above 20 per cent. Banks retained earnings have grown at a healthy pace and dividend payouts, which were closely watched by the central bank, have been reasonable.
The high capital adequacy ratio is attributed partly to the conversion of federal government deposits (received as liquidity support at the start of the global financial crisis) into subordinated debt. The debt is due for repayment in 2016 and 2017, and capital ratios of local banks could start declining from 2012 as the portion eligible for inclusion under regulatory capital falls.
The central bank placed limits on bank lending to individuals in 2011. Banks can extend personal loans only up to 20 times a customer’s salary and for a maximum period of 48 months. Car loans have been limited to 80 per cent of the value of the car and tenors cannot exceed 60 months. Loan repayments cannot exceed 50 per cent of salary and other income and no top-ups are allowed for a year. Credit cards can be offered only to individuals with annual income of over Dhs60,000 or against a pledged deposit of the same amount. The central bank also prescribed maximum fees on several
retail banking activities. The new rules have slowed the growth of retail lending and reduced fee income for many banks.
The central bank has introduced a new framework for liquidity risk measurement based on Basel III standards. The Liquidity Coverage Ratio was introduced on 1 January 2012, with a 50 per cent compliance rising to 100 per cent by 1 January 2015 in line with Basel III. The central bank has also introduced other new minimum ratios. The new liquidity rules are expected to pose a challenge to some of the banks. The rules encourage UAE banks to raise retail deposits and relationship-based long-term wholesale funds, and to reduce dependence on interbank and short-term wholesale funds.
Customer deposits, capital and medium-term borrowing are principal sources of funding for UAE banks. The net loans to customer deposits ratio of most of the banks in the UAE are typically high. This is partly due to the banking sector’s large capital base and the fact that the larger banks also have access to medium- and long- term borrowings from the regional and international markets.
The UAE’s largest bank, Emirates NBD (ENBD) produced steady results for the third quarter of 2012 with net profit for the quarter of Dhs640 million, broadly stable compared to both Q1 and Q2 2012. Although ENBD experienced loan spread compression during the previous quarter, the bank was able to reverse the trend in the third quarter through active Asset Liability Management. In addition, ENBD has continued to focus on cost optimisation, with the level of operating costs in Q3 Dhs150 million below the cost base of Q4 2011.
Impaired loan formation was modest during the quarter but the bank has continued to boost provisions to improve overall coverage ratio. In addition, similar to the previous two quarters of 2012, there was no need to take any further write-downs on either associates or investment properties.
ENBD’s NPL ratio increased modestly by around 10 basis points during the quarter, taking the total increase year to date to 60 basis points. This is in line with the bank’s expectation of around one per cent increase during the full year 2012. The increase in the absolute number of NPLs during Q3 2012 of about Dhs900 million was primarily driven by the recognition of new NPL of around Dhs600 million in its conventional corporate portfolio and another Dhs200 million in its Islamic corporate portfolio.
As expected, the retail portfolio continues to perform very well and NPL formation in retail was negligible. Overall, however, ENBD’s NPL ratio remains very high and coverage is low compared to most peer banks in the UAE.
For National Bank of Abu Dhabi (NBAD), net profit on a cumulative basis rose by 7.6 per cent to Dhs3,212 million for the first three quarters of 2012. Non- interest income was a good performer with stronger contributions from international and wealth management divisions. Total assets grew by a strong 19 per cent for the nine months. Non- performing loans rose to Dhs5,578mn at end September 2012 against Dhs4,839 million but represent a low 3.3 per cent of gross loans, much below the level than
ENBD which is around 15 per cent.
Banks that have significant exposures to government entities will need to look at other areas for growth, such as retail banking, given the continuing weak demand from the private sector.
Overall, the banking sector continues to be well managed and, on the strength of the recovery of the non-oil sector so far, UAE banks are expected to report slightly better operating results in 2012 compared to the previous year.
However, asset quality remains an unknown factor, particularly within the real estate sector.
Both NPLs and provisioning requirements could increase, but these are not expected to be significant and most banks should be in a position to absorb without any problems.