With the tumultuous ride of 2008 fading, banks in the UAE are unsure of what awaits them in the New Year. Slower growth? Check! Tightened liquidity? Check! A troubled real estate sector? Check! The uncertainty comes in what else will banks operating in the Emirates have to deal with and how exactly will they weather the aftershocks of last year?
Waiting with baited breath, investors and analysts alike are anticipating the disclosure of fourth quarter 2008 results in the coming weeks. Before making any sudden moves, experts across the board agree that this year’s first quarter results will have an enduring affect on the banks’ performances for the remainder of the year. Moody’s Investors Service has already declared a “negative outlook” for the UAE banking sector in 2009. While statistics are momentarily unavailable, there are a few indubitable issues that banks in the UAE will be facing in 2009; with the sharp decline in oil prices and the ensuing oil production cuts, the fiscal surplus and real economic growth of the UAE in 2009 are expected to be notably weakened. Thankfully, the country’s “high levels of accumulated oil revenues, over the past five years have served as a catalyst for growth and the accumulation of substantial financial reserves,” Moody’s said. Once the international financial crisis washed ashore on the Gulf coast, a major slowdown in growth in the UAE — and across the GCC — was inevitable. During the five years up to mid- 2008, banks in the UAE were growing so quickly that their “funding growth couldn’t keep up with lending growth, which clearly was unsustainable,” notes Robert Thursfield, a director in the financial institutions group at Fitch Ratings. According to the UAE Central Bank, banks in the Emirates lent a staggering $70.7 billion in just the first nine months of 2008; but this year, lending conditions are being reigned in. The economy’s expeditious growth created a major liquidity problem throughout the UAE.
Where the trouble began
Backtracking to 2007, banks in the Emirates were awash with liquidity as foreign ‘hot money’ was streaming into the country, expecting a revaluation of the dirham. Cash deposits thus surged and the streaming liquidity empowered banks to go on a lending binge. According to Moody’s, the banks used short-term deposits to fund long-term loans. Then, after letting go of the idea of a currency revaluation, foreign funds briskly withdrew their money and liquidity in the country began drying up. The ratings agency estimates that liquidity fell to around four percent of total banks’ assets and it was in late 2007 that the UAE started feeling the brunt of tightened liquidity. Conditions worsened in 2008 once the financial crisis shook the foundations of the UAE economy and banks were one of the first to feel the effects. The continued “liquidity constraints observed [in] the last two quarters of 2008 are expected to have severe consequences, curtailing future asset growth and profitability,” exhorted Moody’s.
To support the mounting cash crisis, by September 2008 the UAE’s central bank announced it would inject $19 billion, while also setting up a $13.6 billion emergency fund facility. Around 15 percent of this fund had been absorbed by UAE banks as of January. Two out of three transfers from the injection have already taken place and the third shot is expected to happen soon. “Originally, they were talking about mid-year, but that may be brought forward. [Also], although initially liquidity was injected straight into bank deposits, we now understand [this is] being renegotiated and [it is] being used as Tier 2 funding. We should get clarity on that over the next couple of months,” explains Raj Madha, director of equity research at EFG-Hermes in Dubai.
The worsening property sector in the country has left the financial market very uneasy and virtually every bank has been — or will be — affected by its outcome. According to Credit Suisse, banks in the UAE have the highest exposure to real estate among their regional peers, with a 35 percent exposure rate for the first half of 2008. Since the credit crunch began, there is no doubt that this figure has risen. With high loan-to-deposit ratios and high exposure to the real estate market, UAE banks are becoming increasingly vulnerable to loan defaults. Some banks will be affected more than others and as Thursfield puts it, “you can’t be a bank [in the UAE] and not have exposure [to real estate].” Moody’s noted the “high potential for a decline in asset quality in the likely event of a property market correction, signs of which were apparent in [fourth quarter] 2008.” In particular, Moody’s was anxious about “the loans to ‘opportunistic’ developers that have been extended over the past four to five years following Dubai’s decision to allow freehold ownership to foreigners in 2003.” As Madha remarks, “It is virtually impossible for the banks to insulate themselves adequately against a very negative scenario, as the entire economy of the UAE is linked to property and if not property then [to] finance or tourism, or retail, all of which are also suffering.”
Baton down the hatches
Due to such unpleasant market conditions, it is no surprise that banks are tightening their lending policies. Emirates NBD — the largest bank in the Middle East — for example, announced in January that it would only consider expatriate customers for home loans if they earned a minimum of $6,800 per month, up from its previous limit of a mere $2,177. Lending policies will only heighten the problem of mortgage availability in the country, thus making it even more difficult for low and middle-income earners to finance their homes. Other banks in the UAE have taken similar action, with HSBC doubling its minimum salary requirements from $2,722 to $5,444 in November 2008. Lloyds TSB also raised its loan bar in late 2008, from $3,260 to a substantial $6,805. The bank, like its peers, bases these changes on the “exceptional market conditions” taking place. Banks in the UAE will definitely suffer “from higher delinquencies, both in retail and corporate lending,” underlines Thursfield. One major difference in banks’ strategies this year will be in residential mortgage lending. “Previously, [banks] might have lent to around 90 percent loan-to-value, now they might be only lending up to 60-70 percent loan-to-value. That will be a very straightforward way of reducing risk to that kind of exposure,” notes Thursfield.
Moody’s points out that the “equity price collapse in 2008 will affect [fourth quarter] financials (although its effects are expected to stabilize in 2009).” Banks in the UAE will eventually recover from this as they have a strong association with their wealthy sovereign and are — as Moody’s conveyed — “the principal architects and drivers of infrastructure and other large-scale businesses and have traditionally helped to boost the franchises of local banks.”
Madha hopes “that the banks do not have significant exposure to third tier developers or brokers; but if they do, they should certainly be reassessing that.” Going on to highlight what UAE banks need to focus on this year, Madha believes, “Finally, it is time to overhaul credit criteria and lending standards and impose a much more cautious approach to lending and credit scoring, encouraging working capital efficiency in all its clients, and watching cash flow and counterparty risk on every loan.” Aside from liquidity, oil prices and a faulty real estate market, Thursfield believes top concerns for banks this year will be “capital, profitability, funding, staffing, franchising, etc.” Another top concern for Madha is asset liability management. Banks must “make sure they have a full understanding of their exposure to the market risk,” he comments. In 2009, banks will definitely be more prudent with their assets and overall management strategies. The major challenge will be maintaining the results of 2008, as growth will unavoidably slow down.
New year, not so new strategies
Since the global financial meltdown hit home, banks in the UAE have indeed received a reality check. “Three months ago, most people seemed in complete denial that anything would happen in the UAE; now obviously that sentiment has changed dramatically”, states Thursfield. Strategies of banks have since been reviewed and the general sentiment is that an international crisis of such a vile nature could not have been foreseen in advance. Since the banks are well capitalized and are unlikely to default — especially with the sector’s sturdy bond with their affluent government — their main concerns will be rather easy to keep an eye on. Thursfield believes that the main strategies of banks will not change, albeit they may “be more cautious and will certainly slow down their lending in corporate and retail.”
Indeed, vigilance and calculated moves are key for 2009. Madha expects banks operating in the Emirates will be focusing on “stabilizing their balance sheets and their NPLs [non-performing loans]. Once they are able to achieve this, then they will be starting to look at issues of raising growth and profitability.”
The arduous obstacles ahead for banks in the UAE are nothing to look forward to, as Moody’s and others are confident that negative market conditions will “persevere for at least 12 to 18 months.” Envisioning the worst case scenario, Madha foresees a lack of improvement in the property market and “that a major state developer could default on its loans and liabilities.” Yet it is unlikely the government would allow that to happen. Thursfield posits a similar scenario, but with banks being the ones to default. He points out, however, that this would also be “pretty unlikely.” On the bright side, says Thursfield, “it could be a good result and lead to consolidation and then you would have fewer banks going forward.” Mergers and acquisitions just might become more attractive to some of the 52 plus banks operating in the Emirates and possibly pose a long-term solution for the over-banked country. Governor of the UAE’s central bank, Sultan Nasser Al Suwaidi, in mid-January underlined that, “consolidation between banks may provide one of the most effective solutions to face the shocks of the crisis.”
In the most ideal scenario, Madha hopes to “have confidence brought back to the market by an alliance with Abu Dhabi, establishing the financial viability of all businesses in Dubai.” Thursfield claims the best case would be if banks in the UAE could “maintain profitability levels from 2008.” This will, without a doubt, be challenging.
It will take quite some time for banks to fully stabilize, as the long-term effects of the global turmoil take their final shape. Governor Al Suwaidi forecasts credit growth in the country to slow to no more than 10 percent in 2009, after surging more than 50 percent in the year to June 2008. Needless to say, 2009 presents many challenges for the banking sector and depends greatly on how well banks respond to last year’s outcomes.