United Arab Emirates banks are nearing a new paradigm where a quality customer is king and a strong cash position is a necessary burden. The first few months of 2011 saw banks consolidate their liquidity positions and pursue new lending opportunities, especially within retail and small business banking, signaling a heat up in what many expect will be a fierce competition for winning the business and loyalty of a limited group of good-quality consumers.
“I see ample liquidity in the banking system at present,” said Rick Crossman, head of personal financial services for UAE at HSBC.
“What we are seeing is [a] potential increase in lending competition, with supply more available and chasing a relatively small number of borrowers,” confirmed Daniel Cowan, Middle East and North Africa banks analyst at Morgan Stanley.
Supported by the early signs of a pickup in economic activity and by the UAE’s relative political stability, banks saw their deposits leap 14.3 percent at the end of March 2011 from a year ago and achieved an annualized growth rate of 23 percent in the first quarter. The rise in deposits, coupled with restoration of balance sheets through write-downs at most banks, brought down the loans-to-deposits (LTD) ratio to less than 100 percent in March for the first time since 2007.
Although it is difficult to estimate the exact value of deposit inflows resulting from the emergence of the UAE as a safe haven in the Middle East, bankers expect the funds to remain within the country’s banking system at least until confidence returns to revolt-stricken countries.
“It is hard to forecast exactly what will happen, but conventional wisdom tells us that it is probably going to take approximately a year and a half before there is enough confidence and stability to see a real reversal in terms of capital flows, so we expect the rise in deposits to be sticky for the medium term,” said Crossman. Until then, deposits at UAE banks are expected to continue to grow strongly, buoyed by high oil prices, with Cowan projecting growth in the range of 5 to 10 percent in 2011 across the sector.
“I certainly believe that banks have an appetite to lend, though I don’t think it would be prudent to return to pre-crisis levels”
Too much cash
Some experts even believe that deposits are slowly becoming more of an accounting liability given meager expectations for loan growth, and may not be as welcome anymore, at least not at current rates. “There is no more competition for deposits. On the contrary, banks are now able to turn away deposits because we have reached the situation of excess liquidity,” said Rasmala’s MENA banking analyst, Raj Madha.
But others argue that the sector is not yet well capitalized. Varun Sridhar, senior banking consultant at Value Partners said, “There is marginal liquidity improvement, but banks are still ready to pay 4 percent for deposits, implying that they are not so liquid.”
Regardless of whether the sector is already well capitalized, or will be later in the year, strong deposit flows mean banks are looking for channels to deploy those funds. “I certainly believe that banks have an appetite to lend, though I don’t think it would be prudent to return to pre-crisis levels. At HSBC we are lending to a broad section of customers, in line with the rest of the market,” said Crossman.
Despite the inclination of banks to offer more credit, limited loan growth so far reflects their continued sense of cautiousness amid a still fragile economic recovery. Loans and advances fell in five of the 12 months through March 2011, although they managed to inch up 2.6 percent year-on-year.
While banks in general are being selective with loans, quality demand, especially in the virtually dormant private sector, is yet to gain momentum. “For a meaningful increase in revenue, we will need to see the fragile recovery in the private sector actually pick up, even though some banks can continue to enjoy business from the government-related sector,” said Cowan.
To counter the weakness in corporate lending, banks are going after the few bright spots within retail, especially mortgage, cards and some personal finance. Growth in mortgage credit has been fairly strong, with the latest data available showing a year-on-year increase of 14 percent in the total value of mortgage loans through the end of January 2011.
Part of the increase is driven by more favorable lending packages by banks, but consumers may also be taking advantage of the decline in property prices in the past two years. In addition, mortgage loans still benefit from a low penetration rate in the UAE, unlike auto and personal loans, which are common.
However, recent central bank regulations forcing a cut in fees, capping retail loans at 20 times the borrower’s salary, and limiting the repayment period to 4 years, could potentially dampen growth in the retail segment, which generates an estimated 30-40 percent of the sector’s revenues. Industry experts do not deny the potential negative impact, but they believe the effects should be minimal given more stringent internal policies at most banks.
“I think recent central bank regulations potentially have some impact on fees and might put some slight pressure on margins, but I think the regulation matched most of the banks’ internal policies anyway so the impact may not be as bad as had originally been feared,” said Cowan.
In addition to specific types of retail lending, the banking industry in Dubai is benefiting from a resurgence in global trade, shoring up non-interest income on the back of increased trade finance activity. Indeed, while government lending has been relatively weak following a major uptick in 2009, infrastructure projects are filling some of the vacuum by directly supporting the trade finance segment.
As Cowan explained, “every time a project is bid, you need some kind of trade finance.” Foreign contractors who are awarded projects typically secure their funding in the domestic market, a backdoor channel for government to support lending growth.
UAE bank indicators in 2010
UAE bank indicators in Quarter 1, 2011
Large UAE banks are not only benefiting from public projects within the emirates, but also stand to profit from lending opportunities in major infrastructure projects at their under-banked, cash-rich neighbor, Saudi Arabia.
Focus has also intensified on the thriving small and medium-sized enterprises (SME) banking segment at a time when larger corporate clients are grappling with liquidity issues. In particular, National Bank of Abu Dhabi (NBAD), Abu Dhabi Commercial Bank (ADCB), Mashreq and HSBC have been prominent in promoting SME banking services, which can potentially support cheaper growth in deposits through cash management services, but also fee income through trade finance.
Despite the availability of lending opportunities in several segments, banks are choosing to err on the liquidity side as concerns surround the current and future corporate restructuring environment. In particular, the takeover by the Dubai government of Dubai Bank in May confirmed what many had expected in terms of uncertainty surrounding several large government-backed entities.
“I think banks are worried about corporate defaults because now you see Dubai Bank folding up and you really don’t know which other government entities will ask their bank for restructuring some medium-term loans,” said Sridhar.
And the concern is not limited to Dubai-backed companies. “I think there are going concerns about Abu Dhabi as well, with rents falling consistently over some time, and we’re seeing some of the Abu Dhabi-based conglomerates with exposure to retail having some cash flow issues,” said Ansari.
In line with Abu Dhabi concerns, NBAD reported an 80 percent YoY increase in specific loan provisions to AED365 million [$99.4 million] in the first quarter of 2011, driving down net profit 10 percent for the period and putting in doubt some claims that Abu Dhabi-based banks would be immune from further provisioning.
Loans and deposits at UAE banks* ($billions)
*End of month, loans are net of provisions
Personal loans to UAE residents† ($billions)
†End of month, net of provisions for bad and doubtful debts, suspensed interest and general provisions
And according to Sridhar, more provisioning is yet to come: “Many banks have investments in Libya, Syria, Egypt, Yemen and Bahrain, but we haven’t seen yet in the first or second quarter any write-downs on investments. By the end of the year, we should start seeing some amount of write-downs at large companies with operations [in these countries] and therefore the loans linked to those companies.”
On the bright side, successful restructuring efforts at Dubai World (DW) have injected a heavy dosage of confidence into banks and investors alike. During the first few months of 2011, local equities showed enviable resilience after the UAE’s political stability was confirmed. This was reflected also in the country’s five-year Credit Default Swap (CDS), where the cost to insure against the government’s default on its debt reached a two-year low.
In parallel, Bloomberg data showed companies quickly and successfully rode the wave of investor confidence, raising $7.35 billion in bonds in 2011 through the middle of May, more than tripling the amount raised in the same period of 2010.
As a result of the political and asset price stability, assuming the fragile economic uptick doesn’t reverse, the consensus among industry experts points to a decline in the sector’s provision charges in 2011. “DW was by far the largest [provision charge], and you might see a couple of other names come through but they won’t be anywhere near comparable to DW. I think we have seen the worst,” confirmed Ansari.
The absence of bad surprises in the real estate sector is also a pre-requisite for lower provisions in 2011. Although analysts believe the real estate sector will continue to be a drag, they view it as a declining negative. Indeed, with less immigration and more expected supply, the sector appears to have some more red ink to draw in terms of property values, but not necessarily in the short-term.
Instead, the issue of commercial occupancy is increasingly on the radar, as a lot of groups, especially the high net worth group, have exposure in that segment. According to Madha, “the issue has moved from the declining asset prices to the particular focus of where those additional cash flow difficulties will be and specifically in the commercial property market.”
Still, relative to 2010, which included large provisions for Saudi Arabia’s Saad and Ghosaibi, in addition to DW, net profits in 2011 are poised to rebound on lower provisioning charges. “Profitability will recover from 2010 levels, but the major support will come from falling provision costs, not volumes which will likely be slow because the consumer is still constrained,” said Ansari.
“We’re seeing some of the Abu Dhabi-based conglomerates with exposure to retail having some cash flow issues”
Abu Dhabi Banks Favored
Although the recovery in profitability in 2011 is expected to include most banks, structural differences between Dubai and Abu Dhabi are seen favoring the latter, especially as a result of faster loan growth. Abu Dhabi’s government controls almost 90 percent of the country’s oil reserves and is secured by one of the world’s largest sovereign wealth funds, Abu Dhabi Investment Authority, with an estimated $625 billion in assets under management.
On the other hand, Dubai has limited resources to support an expansionary fiscal policy, and continues to grapple with debt restructuring at several of its large holdings. Still, according to Ansari, “If you look at trade finance, which is where Dubai has positioned itself as a leader in the growing transport and logistics sector… Dubai will do better than Abu Dhabi.”
General provisions versus specific provisions for NPLs ($billions)
Growth in real estate mortgage loans to UAE residents (year-on-year)
Bank earnings in 2010 support the trend that most analysts and investors expect — a divergence in performance between Abu Dhabi banks benefiting from oil wealth and a strong economy, and Dubai-based banks hung over from the emirate’s debt restructuring and weak real estate sector.
Abu Dhabi’s five largest banks all reported solid growth across a multitude of financial metrics during the year, including assets, deposits, loans and earnings per share, while profits at Dubai’s biggest trio fell significantly, with loans plummeting 8 and 14 percent at Emirates NBD and Mashreq respectively. The trend continued into the first quarter of 2011 but with weaker loan growth at Abu Dhabi banks than in 2010 compared to a slower decline in credit at their Dubai-based peers.
“Most Dubai banks contracted their loan books last year, so this year we are looking at smaller declines, but growth remains centered in Abu Dhabi [which] will therefore grow at a slightly faster pace,” said Ansari, who expects loan growth in 2011 to be between 6 and 8 percent.
Another positive for Dubai-based banks is the recent pick-up in Initial Public Offerings (IPOs). By May 20, three IPOs had been closed in UAE in 2011, raising a total of $271 million, compared to absent activity during the whole year 2010, according to Zawya. “The IPO market is starting to come back, so some banks that have in the past couple of years not had any IPOs would have some additional fee income, especially some of the [Dubai International Financial Center] banks which are very good book runners,” said Sridhar.
If the growth story for UAE banks is rightfully not compelling yet for investors, a look at valuations should be tempting enough, with analysts generally favoring Abu Dhabi-based banks and Emirates NBD.
“Stocks are trading at or near book value, so the story for UAE banks is centered on valuations. As investor confidence and asset quality begin to improve, we will see a rebound in multiples,” said Ansari, who is recommending First Gulf Bank (FGB), ADCB, and Emirates NBD to his clients.
According to analysts monitoring UAE banking stocks, there is upside potential to the market’s revenue expectations at ADCB following three years of restructuring. In the case of FGB, the lender is seen as supported by a strong retail business in the short term while strong links to business are expected to serve as an advantage once the recovery is underway.
In addition, NBAD is favored by nine out of 10 surveyed analysts with a consensus price target of AED13.63 [$3.70], an upside potential of 24 percent over its May 19 closing price; Abu Dhabi Islamic Bank is recommended by the four analysts who follow the stock.
In effect, banks in Dubai and Abu Dhabi expect to have a good showing in bottom lines on lower provisions in 2011, barring a significant unexpected deterioration in property prices or commercial occupancy rates. Operationally, with corporate loans still posing impairment risk to the country’s largest banks, the focus has shifted to the development of the retail (especially mortgage) and fee-based businesses, as well as SME banking. Furthermore, continued political stability, high oil prices, strengthening signals of an economic recovery and the thorough cleansing of balance sheets in the past two years place the banking sector on the doorsteps of a new spring and a new cycle.
“If you look at trade finance… Dubai will do better than Abu Dhabi”
