Cautious optimism for lenders in the UAE

01 February 2011

After being hit by a wave of non-performing loans and provisions in the past two years, UAE banks are reporting profits and healthy deposits 


7.2 per cent: Rise in total deposits in the UAE banking sector at the end of September 2010

AED1.06bn: ADCB’s provisions for Dubai World exposure

AED554m: ADCB’s provisions against exposure to Saad Group and AH al-Gosaibi & Brothers

Sources: MEED; ADCB

Abu Dhabi Commercial Bank (ADCB) is back in the black, reporting 2010 profits above market expectations. Meanwhile, US ratings agency Fitch Ratings has lifted its negative watch on Commercial Bank of Dubai.

Just early straws in the wind perhaps as the annual results season gets under way in the UAE . But at least the first news has been positive. After some of the most testing years in their history, UAE banks now have reason to feel upbeat. Deposits have noticeably increased, the cost of provisioning for some of the biggest exposures has largely been met and bankers are starting to identify future lending opportunities.

Yet there is clearly some way to go before the UAE economy and the banks that finance business activity recover the buoyancy of the pre-crisis years. Resurgence will be a steady affair, not least because some key sectors of the economy are continuing to experience problems.

Rise in deposits in the UAE

While the debt restructuring of state-owned Dubai World has now been agreed, some major groups still have to reach agreements with creditors. The lending climate remains uncertain at best.

Paradoxically, this has contributed to a strengthening of banks’ deposit bases. Lenders have continued to take in funds because savers and investors see cash as a safe asset during periods of economic fragility. Meanwhile, the opportunities to lend remain limited.

According to the UAE central bank, at the end of October 2010, the combined value of deposits held at the UAE’s banks was 7.2 per cent higher than October 2009.

In the drive to consolidate their positions, some banks  have even offered an interest premium, a tactic that seems to have paid off, for the most part. “Banks known to be aggressive, chasing deposits in the market, have outperformed others not interested in chasing these deposits or that did not really need to do so,” says a senior bank executive.

We would probably take the view that the worst is over. But I don’t think this year is going to be very easy

Philip Smith, Fitch Ratings

National Bank of Abu Dhabi (Nbad) decided not to participate in this “price-war” for deposits. Being 70 per cent owned by the government of Abu Dhabi, it is generally seen as a marker of strength and stability. This helped it to attract even more funds than the industry norm, boosting its deposit base by 9 per cent over the year to the end of September.

Meanwhile, ADCB took a more proactive approach to bolster its deposits by buying the retail business of the UK’s Royal Bank of Scotland for $100m in June 2010. The deal gave ADCB a 15 per cent share of the UAE credit card market.

UAE bank deposits and loans
 (AED million)
December 2008912,170924,383
December 2009982,579958,588
January 2010968,110957,291
February 2010958,329960,138
March 2010967,004963,950
April 2010972,263963,633
May 2010970,837962,662
June 2010985,438966,479
July 2010998,862968,086
August 20101,004,896974,639
September 20101,013,331979,224
October 20101,053,833976,578
Source: UAE Central Bank

The move should prove profitable once the economic recovery gets further under way and consumers start spending again.

Elsewhere, the financial position of banks in the country continues to be lifted by the substantial deposits transferred to them by the federal government. As the world financial system slid into crisis in 2008, governments across the region saw the need for action and took steps to support their banking sectors. The UAE was no exception.

UAE state support

“The government put a lot of liquidity into the banks, just in the form of deposits,” says Philip Smith, senior director for financial institutions, Fitch Ratings. “They wanted to make sure that there was enough liquidity in the system.”

Eventually the authorities may seek to unwind this deposit position. But it will be able to pace the withdrawals gradually, maintaining broad stability as the overall economy and financial sector strengthen. In the meantime, the strategy has certainly worked.

UAE banks have had to cope with significant volumes of non-performing loans, but no lender came close to failure, says Smith.

“No UAE bank got into really serious financial difficulties, even when you look at the major problem situations, like Dubai World,” he says.

However, that is not to say the good times are back again. Opportunities to engage in fresh lending remain limited and there are sectors of the economy, particularly real estate, that still face serious problems.

Fitch Ratings says the UAE banks can look forward to a relatively quiet year.

“We would probably take the view that the worst is over. But I don’t think this year is going to be very easy,” says Smith.

Dubai Holding, majority owned by Dubai’s ruler, still has to complete the renegotiation of its debts. A number of major corporates in Abu Dhabi have also warned that they may have to hold talks with creditors.

While announcing a return to profit in 2010, thanks to higher net interest income, ADCB revealed it had made a provision of AED1.06bn  ($287.3m) against its exposure to Dubai World. A further AED554m was set aside against its exposure to the troubled Saudi groups Saad Group and AH al-Gosaibi & Brothers in Saudi Arabia.

Restructurings … have made the banks focus on their current portfolio rather than on new lendings

Banking sector analyst

Conditions also remain challenging for retail financial services. In November last year, the Dubai debt counselling firm ISDM said it expected to see a continuing flow of mortgage defaults. This would force banks to increase provisions, unless they repackaged mortgages to make them more flexible and help customers to avoid payment failure, it said.

Besides their exposure to debts that have recently turned bad or are about to do so, UAE banks are also finding they have to increase provisions against some exposures that they had already categorised as problematic.

Losses absorbed

In some cases it is only now that the full scale of potential loss is becoming apparent, as the impact of the downturn and the real-estate collapse works its way through the UAE’s economy.

As one analyst points out, if overdue corporate loan repayments remain unserviced for longer, banks feel they should boost their impairment coverage because the prospect of repayment in full looks increasingly unlikely.

However, the news is certainly not all bad. With the Dubai World restructuring talks complete, banks now know the full impact of the group’s problems.

“It’s not quite as bad as it seemed to be when we first knew about the need to restructure a year ago,” says Smith of Fitch Ratings.

Much of the cost of bad debts is now being absorbed in the 2010 results. Overall, the position seems to be stabilising. Today’s situation provides a foundation for future growth.

With non-performing loan (NPL) costs largely absorbed and substantial deposits in their coffers, banks will be well placed to resume lending, albeit on a cautious level, as the business climate improves and the credit risk outlook becomes more favourable.

This will depend to a large extent on new opportunities in the local market because the international presence of UAE banks is relatively limited.

However, there is some scope for development further afield. Dubai-based Emirates NBD has a branch in Saudi Arabia and in 2010, it became one of the first foreign banks to join the kingdom’s Sadad scheme for electronic bill payment. Such service improvements should help to grow its Saudi client base.

In November 2010, Emirates NBD opened a branch in Singapore. The prime focus of the new facility will be asset management for Middle Eastern high-net worth customers, wishing to invest in southeast Asia.

Nbad, which has a substantial Middle East network, as well as operations in Hong Kong and Europe, places a big emphasis on wealth management. The bank has developed a strong trade finance business, and this may offer scope to further develop specialist niche lending opportunities.

However, fundamentally, it is the home market that will determine the pace at which UAE banks can grow their business.

There could be a trend towards geographical risk diversification within the country, says a banking analyst. Dubai banks will look to expand their exposure to customers in Abu Dhabi, while banks that are actually based in the capital try to develop more lending in other emirates.

Yet with the real-estate market still sluggish and many customers cautious about taking on new credit, UAE banks are likely to look towards government for a strong lead.

The major programme of infrastructure projects planned by the federal and emirate authorities will create important new opportunities to lend on a large scale and in a relatively secure risk context.

Transport infrastructure, power generation projects and offices and housing for new urban development zones could all offer good opportunities. Bankers talk optimistically of the Abu Dhabi 2030 development vision for the capital. The key tests, after the traumatic crisis in Dubai, will relate to the underlying risk for each project. Is it, for example, targeted at the domestic home market or more speculative international demand? To what extent is each development essentially just a real-estate play, or how far is it based around a planned public development push? And for infrastructure, what do the project economics look like?

New opportunities for lending in the UAE

“The UAE and Abu Dhabi in particular, still has ample opportunities to offer for lending. These are being led by the Abu Dhabi government and … the objectives and vision of Abu Dhabi 2030 plan,” says the banker.

However, he advises caution. “Banks in UAE will have by now realised the importance of diversification to provide the stability to their businesses,” he says.

The problems of recent years have highlighted the dangers of becoming over reliant on any one sector, however buoyant.

It is banking groups with an international presence, such as Nbad or Emirates NBD, that may be best placed to diversify their portfolios by taking up new lending opportunities in foreign markets to offset risk at home.

Despite the strengthening of their deposit base and whatever new avenues they identify, UAE banks are likely to take a careful look at the lending options before deciding which to pursue.

Banks have good reason to ask some careful questions before entering into new loan commitments.

“Restructurings among the Dubai [government-related enterprises] and the UAE corporate sector have made the banks focus on their current portfolio rather than on new lendings,” says a banking sector analyst.

And it is not just a question of lending risk. The banks may also want to wait to see just how enduring their current healthy deposit base will prove to be.

“In 2010, it certainly did seem that the local personal and corporate depositors were more interested in keeping their assets in cash or liquid form rather than venturing into longer-term riskier investments,” the banker says.

“It’s worth noting that the deposits increased significantly only in October 2010 [on a month-on-month basis]. There is still some more clarity required on the source of these deposits and the balance between local and foreign originating funds.”

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