For Abu Dhabi Islamic Bank (ADIB), 2010 was a year of dramatic turnaround. Profits at the bank rose by more than 1,000 per cent as it recovered from the one-off provisions that ate into income in late 2009.
Unfortunately, the upswing in the last year at ADIB has not been mirrored in the rest of the banking sector. Most banks continue to be weighed down by provisions for bad loans made during the boom times of 2003-08, or struggle to get significant growth out of weak markets.
The top 20 banks in the Middle East have reported a nearly 8 per cent increase in profits for 2010. That would indicate that the long-awaited recovery in the banking sector is finally under way. However, on closer inspection, calling the improvement in bank results a recovery could be going too far. The next 12 months is more likely to see a modest upturn than a wholesale return to growth.
Some parts of the financial system have improved. During 2010, banks spent much time cleaning up their balance sheets from bad loans to Dubai World, and Saudi Arabia’s Saad Group and Ahmad Hamad al-Gosaibi & Brothers. Those provisions will no longer drag on earnings in 2011.
“There are signs that things are improving, but the pace of growth may never get back to what it was in 2006-07”
ADIB’s headline numbers show such a huge improvement because it took a lot of provisions in 2009. But the figures still disappointed analysts, who thought the bank would manage a better performance in 2010. In the end, it was still provisioning that ate into profitability.
According to the US’ Boston Consulting Group, loan loss provisions at GCC banks have risen by 49 per cent since 2005. They have started to fall since the end of 2009 and that alone should help banks start to boost their profitability in 2011, but more could be due.
Although growth in non-performing loans (NPLs) has probably peaked, more will feed through over the next 12 months. Dubai Holding, another debt-laden conglomerate, is currently working on a deal to restructure its debts. Bank executives close to the negotiations say the debt is not as bad as that found at Dubai World and that provisions should not have to be as severe.
Rises in NPLs should also be lower for 2011 as businesses increasingly go into voluntary refinancing and restructuring talks with their lenders, rather than waiting until they are already falling behind on payments.
An increase in profits is long overdue. The profit recorded by the top 20 banks in 2010, at about $14bn, was below that achieved in 2006 and 2007, when the figure was closer to $15bn. That trend is reflected across the entire GCC banking sector, although compared with international peers, whose profits are still well below 2005 profitability levels, the performance is remarkable.
Part of the reason why profit growth has been lacklustre for the Gulf banks is the continued weakness in asset and loan growth. During the boom years, assets were increasing at nearly 40 per cent a year, while loan growth accelerated to more than 50 per cent in 2007.
That all came to a spectacular halt with the financial crisis. “To varying degrees around the region, loan growth has almost completely dried up over the past two years,” says one banking executive. “There are signs that things are improving now, but the pace of growth may never get back to what it was like in 2006-07.”
Banks are still generally risk averse, preferring to focus on their key clients rather than chasing new ones. Total loans rose by just 4 per cent in 2010. Banking analysts expect lending in the UAE banking system to expand by only 6-8 per cent in 2011. Similar figures are predicted for the rest of the region.
The assets of the top 20 banks grew by 6.6 per cent last year, an improvement on 2009’s 5.8 per cent growth, but still well below the 17 per cent recorded in 2008, and the 37 per cent in 2007.
- 8 per cent – Increase in combined profit in 2010 of the GCC’s top 20 banks
- 49 per cent – Rise in loan loss provisions since 2005 at GCC banks
Sources: MEED; Boston Consulting Group
With slow loan growth, the opportunity to boost income from arranging debt and charging interest on it will be low. Some of the best performing banks, in terms of loan growth, are two state-owned institutions, Qatar National Bank (QNB) and Saudi Arabia’s National Commercial Bank (NCB).
“Now loan-to-deposit ratios are under 100 per cent and the Eibor rate is … coming down, there will be more demand”
Shabbir Malik, EFG Hermes
QNB benefited from significant government support during the financial crisis. The state bought the real-estate and equity exposures of the local banks, allowing them to avoid making any major writedowns from betting on the property and the stock markets. That left QNB clear to carry on booking new business. NCB made significant loans as the bank tried to buy back market share after a stagnant 2009, when loans rose by only 3.9 per cent.
Banks are not entirely to blame for the poor loan growth. In addition to banks being reluctant to extend new loans, customers are generally less willing to take them. The corporates that are able to are instead looking at the capital markets to refinance their debts, rather than using bank loans.
The other factor limiting loan growth is the slower than anticipated progress many regional governments have made with their investment programmes. Although huge state spending plans have been announced in most GCC countries, the pace of infrastructure development has not accelerated noticeably.
“Generally we need more commitments from regional governments to start spending money,” says one banking executive in the UAE. “There is a substantial pipeline of investments planned, but as of now progress has been slow and that means a key potential growth sector has not really been there.”
There has been one big advantage from the past two years of poor loan growth. Deposits have continued to grow over the past few years, meaning most banks previously sitting on big mismatches between their loans and deposit ratios, have been able to concentrate on building up deposits.
Some banks, notably in the UAE, were well above loan-to-deposit ratio guidelines of 100 per cent. Abu Dhabi Commercial Bank (ADCB) and Emirates NBD were at 143 per cent and 120 per cent respectively in 2006. Emirates NBD managed to push that figure below 100 per cent by the end of 2010, while ADCB was able to get its loan-to-deposit ratio down to 115 per cent.
Coupled with the rising deposit base, interest rates are also beginning to normalise as liquidity improves in the banking system. The Emirates interbank offered rate (Eibor) had fallen to 1.9775 per cent by 8 May, the lowest it has been since January 2010. Lower interest rates will help bolster retail demand for loans, especially mortgages, which are a key part of the consumer loan book.
“We have not seen much loan growth, but now loan-to-deposit ratios are under 100 per cent and the Eibor rate is slowly coming down then there will be more demand on the retail side,” says Shabbir Malik, banking analyst at Cairo-based investment house EFG Hermes.
For UAE banks, extending retail loans will be tougher. The Central Bank of the UAE recently issued a ruling that banks were not allowed to lend customers more than 20 times their salary and loan periods should not exceed 48 months. US Ratings agency Moody’s Investors Service said the move would put further pressure on the profitability of UAE banks.
It is a similar story in the rest of the Gulf, a slow recovery in loan growth coupled with low base interest rates and high provisioning is making for an uninspiring return to growth.
The table of the top 20 banks also shows that bigger is not always better. Emirates NBD, while remaining the largest bank by assets in 2010, only just scrapes into the top 10 in terms of profitability. Saudi Arabia’s Al-Rajhi Bank was the most profitable bank in 2010, earning more than $1.8bn, nearly three times the $637m made by Emirates NBD.
Overall, the figures for the top 20 banks show that no clear trend yet exists for the banking sector. Some banks have managed to overcome provisioning and are getting back to profitability. Others continue to be hampered by bad debts. By the end of 2011, a clearer picture should have emerged. What is likely is a banking sector that is more modest and more comfortable with lower growth rates than the one that went into the financial crisis in 2008.
As in other regions of the world, several banks are lucky to have survived. Without state aid, they probably would not have done so. Regulators in the region are also showing signs of having learnt a lesson from the financial crisis. They are trying to ensure banks do not become over-leveraged in the future and that more sensible lending and financial reporting policies are in place to make sure banks cannot hide their bad loans from investors.
The problems with the two Saudi family groups in default and Dubai’s debt crisis have also shown the error of deals based on reputation or an assumption of state-support. Banks are now putting far more due diligence into their deals, which can only be a good thing.
If regulators succeed in weaning banks off an over-reliance on real estate and building a more stable and mature financial sector, then at least one benefit will have come out the past few years of difficulty.