The final three months of 2008 marked a watershed in the fortunes of GCC banks. Despite displaying enduring optimism about their profitability throughout most of last year, it became apparent in the final quarter that the region’s banks would have to brace themselves for a hostile operating environment in 2009.

After years of strong asset growth - the top 20 banks’ assets grew by 15 per cent from $654bn in 2007 to $752bn in 2008 - and fuelled by the Gulf economic boom of 2003 to mid-2008, the onset of the credit crunch in the region sent stock markets and real estate prices plummeting.

These factors have since conspired to create unprecedented challenges for GCC banks, prompting all three major credit agencies – Standard & Poor’s (S&P), Moody’s Investors Service and Fitch Ratings – to downgrade the ratings of some of the Gulf’s biggest banks (see table).

In November last year, S&P downgraded the ratings of six GCC banks from positive to stable. Those affected include the GCC’s biggest bank by asset size, Emirates NBD, as well as Kuwait Finance House, and Oman’s largest bank by assets, Bank Muscat.

Relative health

In December, Fitch downgraded the individual ratings of 16 GCC banks, including eight Saudi banks, such as Arab National Bank and Banque Saudi Fransi.

The same month, Moody’s downgraded the ratings outlook for four UAE banks: Abu Dhabi Commercial Bank, First Gulf Bank, Dubai Islamic Bank and Dubai Bank. It also revised its outlook for the Kuwaiti banking system to negative from stable, on the grounds that Kuwaiti banks had high exposure to the weakening domestic property market, indirect exposure to local equity markets, and there was an overall tightening of credit conditions.

Moody’s also announced it would be carrying out a review of all its Gulf bank ratings in light of the new economic environment.

Of course, there have been significant variations in the performance of GCC states’ banking sectors, and the banks themselves. Qatar is widely expected to rank as the world’s fastest-growing economy in 2009, with the International Monetary Fund (IMF) predicting real gross domestic product (GDP) growth of 11.5 per cent. Given that the performance of a country’s banking sector normally mirrors the overall health of its economy, it should come as no surprise that Doha’s banks have received the fewest downgrades from the ratings agencies.

Ratings agencies assess both the operating environment for banks, and the individual performance of financial institutions.

“Our agency has not downgraded any Qatari banks,” says Mohamed Damak, credit analyst at S&P. “We have only changed the outlook on one bank.”

In February, S&P changed the outlook on Commercial Bank of Qatar (CBQ), the state’s second-largest bank, from positive to stable. The change was to reflect the “less supportive operating environment”. However, the agency affirmed CBQ’s A-credit rating, citing the bank’s “good commercial position and satisfactory financial profile”.

Fitch also continues to rate Qatar’s banks highly. “The Qatari banks are generally sound and well capitalised,” says Philip Smith, senior director at Fitch Ratings.

In September, Fitch affirmed a long-term issuer default rating, which reflects a bank’s relative vulnerability to default on financial obligations, of A+ with a stable outlook for Qatar National Bank, the state’s largest bank.

The agency said the rating was driven by Qatar’s strong economy. The state recorded a $27bn budget surplus last year, and there is a high probability of government help should Qatari banks need financial support due to defaults on bad loans, for example.

“We are expecting an increase in non-performing loans in the coming quarters, driven by the retail sector”

Mohamed Damak, credit analyst, S&P

However, Damak cautions that “not everything is rosy for the Qatari banks” and predicts some deterioration in their asset quality.

“In particular, we are expecting an increase in non-performing loans in the coming quarters, driven mainly by the retail sector, because of an increase in job losses,” says Damak. “This will definitely have an impact on the cost of risk for Qatari banks, but I do not expect it to significantly weaken their credit profile.”

The Saudi banking system has also continued to demonstrate resilience to the credit crisis. Despite its raft of downgrades on Saudi banks at the end of last year, most of the banks rated by Fitch are still on a B/C individual rating – a strong rating by the agency’s standards.

“We have downgraded the individual ratings of a number of banks in the kingdom,” says Smith. “But they remain among the strongest in the region.”

In July, Fitch affirmed a stable outlook and long-term issuer default rating at A+ for National Commercial Bank (NCB), the country’s biggest bank by assets. This was in line with the A+ rating granted to the bank by S&P in April.

As with Qatar’s banks, S&P has not downgraded any Saudi banks’ credit ratings. But in June, it revised the outlook of Saudi Investment Bank from stable to negative.

The same month, the revelations of Ahmad Hamad Al-Gosaibi & Brothers and Saad Group’s debt problems surfaced, which makes the future health of  Saudi banks harder to gauge. The two Saudi conglomerates are estimated to owe about $24bn in total to dozens of regional and international banks, and are currently restructuring their debt. Consequently, Saudi banks more than tripled provisions against loan losses in the first three quarters of this year to $1.61bn, compared with $400m one year earlier.

The Saudi banks have not disclosed the level of their exposure to the conglomerates, but their increased provisions are a sure sign that banks are feeling vulnerable.

NCB booked $205.3m in provisions for loan losses in the third quarter of 2009, the highest provisions made by a Saudi bank in the July to September period. This brings its total provision to date this year to $506m, a near nine-fold increase from a year ago.

Corporate scandals

“The Saudi banks have been performing well but the very well-publicised corporate scandals have muddied the waters considerably,” says David Kinsey, an equity analyst at HSBC Middle East.

The conglomerates’ misfortunes have also had repercussions across the region. In July, two Bahraini banks, International Banking Corporation, owned by the Al-Gosaibi group, and Awal Bank, owned by the Saad Group, were put into administration by the Central Bank of Bahrain.

In September, Abu Dhabi Commercial Bank revealed it had $609m exposure to the two Saudi businesses. As a result, it has made AED1.7bn provisions against bad loans so far in 2009. 

However, it is Dubai and Kuwait’s banking sectors that are considered by the ratings agencies to be under the greatest stress.

In March, S&P placed its long-term credit ratings on four Dubai-based banks – Emirates Bank International (EBI), National Bank of Dubai (NBD), Mashreqbank and Dubai Islamic Bank – on ‘credit watch’, a warning from the agency that a bank’s credit rating could change in the wake of a review

“The outlook on these four banks remains negative because of the less supportive economic environment,” says Damak. “This signals to the market that there is the possibility of a downgrade further down the road.”

Damak says the current status of ratings on these banks reflects its concerns that the government may use them to support the refinancing needed for the impending maturity of the debt of government-related entities.

These banks have already participated in the refinancing of Borse Dubai’s debt $3.78bn loan, which matured in February 2009.

A series of state-owned entities are due to repay loans that mature in late 2009. UAE developer Nakheel must repay a $4.05bn Islamic bond in December.

In September, Fitch downgraded the long-term issuer default rating of seven UAE banks, including EBI and Mashreqbank. It did so to reflect its view that Dubai’s ability to provide financial support to struggling banks had weakened. “This was unique in the past year because we have not changed our views on other sovereigns in the GCC, despite the economic downturn,” says Smith.

“Dubai’s creditworthiness is weakening as public sector obligations migrate to the sovereign balance sheet,” says a Fitch statement about the bank downgrades issued on 24 September.

Fitch forecasts that by the end of 2009, Dubai government debt will have tripled from one year ago to $30bn, approaching 40 per cent of GDP.

The issuance by the end of this year of the second tranche of Dubai’s $20bn bond programme will be watched closely by international bankers.

Whether Dubai-based banks benefit from a successful bond issuance as a result of the improved outlook for Dubai’s economy will of course have a significant bearing on their future credit ratings, with Moody’s currently having four UAE banks – EBI, NBD, Mashreqbank and Dubai Islamic Bank – on review for downgrade.

Meanwhile, Kuwait’s banking sector is coming under increased stress due to its exposure to risky sectors such as real estate.

The value of real estate transactions in Kuwait has dropped by 20 per cent in 12 months and the market capitalisation of the Kuwait Stock Exchange index is about 40 per cent below its June 2008 peak of $206bn.

“Kuwait’s banks are suffering from deteriorating asset quality, reflected in higher loan impairment charges, and are showing signs of stress due to elevated loan-loss provision charges,” says Smith.

In August, Moody’s downgraded three Kuwaiti finance houses: Gulf Bank, Burgan Bank and National Bank of Kuwait (NBK), which has the country’s largest market share of assets. NBK’s financial strength rating was changed to C+ from B-, reflecting its performance in recent months.

For the first nine months of 2009, NBK booked losses of $33m in local investment portfolios and a further $66m in voluntary loan loss provisions. This resulted in a net profit of $706m for the nine months to September 30, compared with $852.5m in the same period last year. 

Deteriorating asset quality and a rising number of non-performing loans will pose problems for all GCC banks. But there are signs that the operating environment has started to improve in the Gulf, helped by the rise in oil prices to $77 a barrel in November, from lows of $38 a barrel in February.

“The GCC economies are definitely stabilising,” says Kinsey. “We see it in the improved prices in property and equity markets, and greater liquidity, with the banks’ ability and willingness to lend increasing in the last quarter.”

Meanwhile, S&P has downgraded only one bank since July: Kuwait’s Gulf Bank, for which it changed its rating on 10 November to BBB- with a negative outlook. Damak says he is not expecting “any major deterioration of the rated banks in the coming months”.

However, the financial troubles of the two Saudi conglomerates will continue to cast a shadow for months to come.

Furthermore, while Gulf banks have historically enjoyed a high level of government support where necessary, there remains considerable cause for concern as the global financial crisis continues.