The ongoing financial turmoil in the Gulf has triggered a rapid increase in the amount of money the region’s banks are setting aside to compensate for a rise in bad debts, known as non-performing loans.

Since the downturn struck in October 2008, the credit quality of banks’ clients has gradually deteriorated and GCC banks are now reporting a sharp increase in both corporate and retail non-performing loans. Most loans become non-performing after being in default for three months, which means interest payments are overdue after 90 days or more.

Dubai’s Emirates NBD, the region’s biggest bank by asset size, announced in July its second-quarter bad loan provisions were more than four times higher than for the same period in 2007. As a result, the bank took a $313m hit in net impairment losses on its financial assets between April and June.

Emirates NBD’s high level of provisions has set alarm bells ringing as the bank is the first where provisioning has jumped significantly above market expectations.

In a report published in July, Egyptian investment bank EFG-Hermes cites Emirates NBD as “the first bank to substantially break the 1 per cent annualised provisioning rate, with net provisioning in the first half of 2009 averaging an annualised rate of 1.4 per cent, significantly higher than our 1.15 per cent full-year forecast.”

Rapid increase

Meanwhile, National Bank of Abu Dhabi (NBAD), the UAE’s largest lender by market value, made $136.1m in provisions in the first half of 2009, a 244 per cent increase from $39.5m in the same period in 2008.

The rise in provisioning has been most apparent at UAE banks, where provisions for non-performing loans increased by 27 per cent from $5.14bn when the downturn hit in October 2008 to $6.50bn at the end of June 2009.

In the second quarter of 2009, provisions at Emirates NBD and NBAD, Abu Dhabi Commercial Bank, First Gulf Bank and Union National Bank -which between them account for 65-70 per cent of the loan books in the country -increased by 86 per cent compared with the first quarter.

UAE banks illustrate the trend across the Gulf of banks making greater provisions for non-performing loans in anticipation that they will increase. “In 2008, loan books grew rapidly across the GCC, with UAE banks recording the highest sector-wide growth in loans, of 49 per cent,” says Deepak Tolani, senior associate, equity research, at Dubai-based Al-Mal Capital. “The subsequent slowdown in the economy means non-performing loans are now picking up and significant provisions are being made.”

Profit erosion

This high level of provisioning is fast eroding the profitability of banks. For example, Kuwait’s Gulf Bank made a loss of $26.2m in the first two quarters of this year after booking $204m in provisions in the period.

Analysts predict that the UAE and Kuwait will be the hardest hit markets in terms of non-performing loans because of their weaker credit environments and sharper corrections in their real estate sectors.

The UAE’s real estate market has dropped in value by about 35 per cent since October 2008. Construction and real estate sectors comprise 30 per cent of the banks’ loan portfolios, which is a sizeable exposure.

By contrast, Qatari banks are expected to display less risk on their balance sheets and report the best earnings in the GCC. For example, non-performing loans at Qatar National Bank (QNB), Qatar’s largest financial institution, have registered negligible growth since the downturn -comprising 0.73 per cent of total loans at the end of 2008, marginally increasing to 0.87 per cent at the end of the second quarter.

“Qatar has had the most aggressive government intervention into the banking system,” says Tolani. “So a lot of the risks for the Qatari banks have been removed.”

In June, Doha announced it had reserved $4.1bn to buy local banks’ property portfolios.

Even so, Qatari banks have been making sizeable provisions, with QNB’s increasing from $3.8m to $28m in the first half of 2009.

Saudi Arabia’s banks have also been ramping up their provisioning levels. National Commercial Bank, the kingdom’s largest bank by assets, booked provisions for loan losses of $113.4m in the second quarter, about eight times the $15.32m it had taken a year earlier.

But with the number of bad loans expected to accelerate in the coming months, the consensus among analysts is that non-performing loans will not peak until the end of 2009 at the earliest. “We will see most of the pressure on the non-performing loan level by the end of the year as it will coincide with banks’ annual results and end-of-year accounting adjustments,” says Sofia el-Boury, a banking analyst at Dubai-based Shuaa Capital.

“The full effect of the 2009 economic difficulties will impact on banks’ asset quality at the end of this year.”

However, Tolani predicts that the full extent of non-performing loans will not become apparent until the first or second quarter of 2010.

“Many of the banks are giving their customers an extra window of time to repay their loans or are forgiving some interest payment for a couple of terms,” says Tolani. “There is a lot of restructuring going on and many non-performing loans have not started hitting the banks.”

Credit ratings agencies Moody’s Investors Service and Standard & Poor’s (S&P) have warned that loan defaults could jump as much as four times between now and the end of 2010. “A fourfold increase in non-performing loans is very reasonable,” says Mardig Hala-dijan, general manager of the financial insti-tutions group at Moody’s.

Non-performing loans at the UAE’s five main banks comprised 1.2 per cent of total loans at the end of the second quarter.

“I predict that will increase to 2.2 per cent by the end of this year and higher still going into next year,” says Tolani. 

This is echoed by Sanjay Uppal, chief financial officer of Emirates NBD, who said in July that the bank’s non-performing loans could peak at 2.5 per cent in 2010.

In early August, Moody’s announced that the ratings of four UAE banks, including Emirates NBD, had been placed on review for possible downgrade in response to the challenges facing the sector. However, the GCC banks’ high capitalisation levels should bolster their capacity to cope with significant shocks. The UAE government’s quantitative easing -a fund of $32.7bn has been made available to shore up banks by boosting their liquidity levels -has no doubt played a key role in staving off the effect of bad debts.

Cash injections by the Saudi and Qatari governments have also proven invaluable. But the second wave of the downturn, linked to deterioration of asset quality in the retail and corporate markets, has yet to fully hit regional banks.

“I am expecting a 20 per cent reduction in profitability in 2009,” says Tolani. “Profits in 2010 depend on how many provisions are made in the second half of this year, but profits are unlikely to start picking up until 2011.”

Looking ahead, the key challenge for banks in maintaining profit levels will be their ability to deal with a rising volume of non-performing loans. Prudent levels of provisioning will be essential in the short term.