Embracing evolution

UAE banks must seek new strategies for wealth

In an economy such as the United Arab Emirates, where the government has significant stakes in several of the largest banks, it is hard to isolate successes and attribute them fairly. Still, the success of UAE banks at surviving what have been trying times earns them at least part of the financial accolades of the emirates in 2010; the orderly restructuring of nearly $25 billion of debt was a major achievement on the part of the UAE banking sector and September’s announcement that all 90 of Dubai World’s (DW) creditors had agreed to a restructuring agreement sent positive waves across financial markets. 

“Common sense prevailed, and it was therefore an achievement to get all the banks to agree to the restructuring terms, which reflects the pragmatic structure of the agreement,” says Jeremy Parrish, chief executive officer of Standard Chartered UAE. Emirati banks also withstood exposure to a still-ailing real estate sector and what Parrish describes as “very tight liquidity” in 2010.

Return to liquidity

After the DW debt rescheduling, liquidity was scarce for Dubai’s banks. But in the second half of 2010, banks and sovereign authorities were able to tap into international capital markets. Dubai’s Department of Finance raised $1.25 billion in 5-year and 10-year bonds in September. Emirates NBD raised $221 million in August through securities backed by auto loans, a first in the Middle East, and then followed through in November by raising $410 million in 5-year multi-currency notes. At the same time, banks have actively sought out solutions and new strategies to mitigate the dismal financial and credit conditions.

 EFG Hermes banking analyst Murad Ansari points out that UAE banks, namely in Dubai, offered competitive returns on deposits and organized road shows to raise deposits.

This national increase resulted in an improvement in the loans-to-deposits (LTD) ratio, which slipped into positive territory again at the end of October and is another indicator bankers view as an achievement in a country that has historically been highly leveraged.

Michael Tomalin, CEO of National Bank of Abu Dhabi (NBAD) attributes the decline in the LTD ratio to proceeds from corporate bond issuances and to the attractiveness of interest rates on dirham deposits, especially given the fixed exchange-rate regime.  Tomalin adds that “some of the banks in the country — not NBAD, but other banks in the region — have been quite aggressive at going out into international markets and raising institutional deposits through programs offering relatively high rates of interest in dollars.”

Banks have been actively adopting strategies to align themselves to a new operating environment. Many are focusing on growth sectors such as trade finance, tourism and project finance for infrastructure. Standard Chartered is targeting small and medium-sized enterprises to mitigate exposure to large real estate developers, while Emirates National Bank of Dubai and NBAD are also focusing on their fee-based business.

“We are a local bank that has connections and access, can guide, help and advise on how best to structure a project and so on,” says Tomalin.  “Our international lending activities are directed to advance our client who wants to invest abroad, or an overseas client who wants to sell something, so we support him in that sale.” Tomalin adds that while interest income relative to fee-based income is currently at a ratio of 70:30, he would like to see it at 60:40.

Taking on the big boys

The local banks’ new strategies mean pitting themselves against international banks who have historically dominated the lucrative fee-based businesses such as investment banking and corporate finance. Tomalin admits that local banks have to be smart and realistic in that regard.

“We have to ask ourselves, if we want to compete with Goldman Sachs, Barclay’s or Deutsche Bank, etc, how are we effectively going to compete with these people? They are huge, we are a little bank,” says Tomalin. “Our point of differentiation is that we are a bank in the Arab world. We are here in Abu Dhabi. That makes us different.”

Emirates interbank offered rates

At the same time, expanding deposit bases may prove to be expensive, especially when many banks are rushing to cut their LTD ratio and add more lending capacity. According to Tomalin, “some banks… have been paying very high rates of interest for deposits to get their ratios sorted out. We haven’t been paying this sort of interest [at NBAD] but other banks have.”

Nonetheless, banks may be able to attract deposits through other means than interest rates. Sanjoy Sen, Citibank’s Middle East Consumer Bank Head, believes that customers are increasingly sensitive to the reputation, brand name, financial stability and strength of their bank. “Banks that are in a comfortable liquidity position will not necessarily need to pay high rates for mobilizing retail deposits,” says Sen.

In parallel, fears of rising competition for deposits between international and local banks appear unfounded. “There is an increase in competition between banks but it is a level playing field and all players have equal opportunities to get a ‘share of the wallet,’” says Sen. Parrish adds that “there has always been a healthy competition between international and local banks, but we do not see any shift in the paradigm.”  

On the other hand, the sought-after deposits have already begun to affect profitability. Banks usually seek to attract retail deposits first because they are cheaper compared to their corporate counterparts, which are more interest rate sensitive. But retail deposits are notoriously harder to attract, and given the pressing need to raise long-term debt in order to finance maturing obligations and increase lending, some banks have been aggressive, at the expense of their operating margins.

What make matters even more complicated are speculative capital inflows. Although hedge funds are happy to park their money in high-interest dirham deposits, banks are all too familiar with the 2008 scenario and will not lend against hot money, thus creating an added cost.

As a result, and despite discernible improvements in the ability of UAE banks to counter credit and economic crises, the list of concerns continues to cloud what many bankers view as the emirates’ strong fundamentals.

Tight liquidity is a major concern at banks looking to refinance and lend. Widening credit default swap spreads and expectations of a stable emirates interbank offered rate spread do not support an increase in liquidity. There seems to be a general consensus among bankers and analysts that a continued orderly restructuring and refinancing of large corporates without massive and surprising provisions will go a long way in re-establishing confidence in financial markets and especially banks.

Analysts are carefully tracking developments in asset quality, especially at Dubai banks whose non-performing loan ratios are among the highest in the country, given their tilt toward the embattled real estate sector. Still, the shift to the resilient sectors of the economy such as tourism, trade finance and government, should improve overall asset quality at UAE banks.

 However, fear of additional provisioning and general weakness across some of the largest sectors in the economy, especially in Dubai, may shift the focus of banks more toward stabilizing their balance sheet and liquidity ratios than toward taking on additional risk, unless on a highly selective basis.

At the same time, a 98 percent national LTD ratio, which goes even higher by the central bank’s loans to stable deposits, does not provide much leeway for banks to grow their loan books in 2011. But there is room for measured growth, according to Parrish, who says: “The drop in the LTD ratio is not a signal for the flood gates to open, but we will see a measured increase in loans after what so far has been a flat growth in the last 18 months.”

The general mood of investors and analysts covering UAE banks remains largely skeptical, with several exceptions in the banks and some economic sectors. Nevertheless, the rush of positive news, including airport and port traffic in the second half of 2010, has boosted confidence at the business and consumer levels, generating strong support for the belief that today’s concerns, such as asset quality deterioration and profitability, may form the achievements of 2011.