The decongested streets of Dubai seem strangely incongruent with the message that the federal government of the United Arab Emirates (UAE) would have you to believe — that the effects of the global financial crisis haven not been severe in the UAE.

Egyptian investment bank EFG-Hermes estimates that the total population of the UAE — of which more than 80 percent is comprised of expatriates — will contract by  5.5 percent by the end of this year, propelled by Dubai which is forecasted to lose 17 percent of its inhabitants. While the well-endowed government saves its economy through multi-billion dollar bond issuances, setting up emergency funding facilities and pumping numerous liquidity injections into the banking sector, bankers can take a big sigh of relief, but not  for long. Indeed, the deep-pocketed sovereign is propping up the country’s banking system — addressing major issues such as tightened liquidity conditions and toughening up their risk management strategies. But with the ailing real estate market and soaring job cuts, banks have more to worry about than just increasing their cash flow.
In order to efficiently manage the effects of the financial crisis, the UAE sovereign entities are aiding the banking sector to positively, and briskly, move forward. With liquidity conditions finally looking up, analysts say the UAE economy — including its banking sector — is on the mend. As the world faces an indefinite period of recession and recovery, many investors are looking for safe havens to secure financial opportunities. Once the real estate sector hits rock bottom, the UAE hopes individuals and investors alike will flock back to the country, allowing Dubai to continue its reign as the region’s top trading and business hub.
With its affluent, robust government standing behind it, the UAE banking sector is well positioned to fight the crisis head on. Unfortunately, the ongoing property crisis has taken its toll on banks’ profitability and swollen their portfolios. The government has tried to jump-start recovery through various cash injections and recapitalizations, and there are hints of mergers and acquisitions among the UAE’s 52 banks. Bankers are hoping that this year will be less tumultuous than the last, aiming for conservative risk management policies and overall cautious moves.

Sheltered from on top
With the largest debt in the Gulf, the UAE’s only hope is through its sovereign entities, like Dubai Inc. Dubai Inc. is a collection of government-owned companies with an estimated $80 billion in short-term debt to date, a significant increase from the $60 billion debt it had in November of last year.
Once the global financial crisis washed over the Gulf, the federal government of the Emirates reacted “practically overnight,” according to Rajai Ayyash, country manager for UAE, Kuwait and Oman at The Bank of New York Mellon.
Central Bank of the UAE (CBUAE) started by setting up a $32.6 billion emergency funding facility in the fourth quarter of 2008. It then injected $4.4 billion into Abu Dhabi banks, and issued a $20 billion bond to the government of Dubai. Now with the most recent move taken by Abu Dhabi to raise $10 billion in bonds through international investors from Europe and North America, it is crystal clear that the affluent UAE government is willing and able to prop up its economy and banking sector.
“From a capacity point of view, the federal government is in a good position to provide support and we think that this is one of the main advantages for UAE banks, compared with other systems in the MENA region,” says Dr. Mohamed Damak, a ratings specialist in the financial services group at Standard & Poor’s in Paris.
Classifying the UAE government as “interventionist toward the banking system,” Damak says “from a willingness point of view, the willingness is apparently there and the track record is strong in terms of support.”
Without a doubt, if it weren’t for the deep-pocketed Emirati sovereign helping to fix the fight, the banking sector and the entire economy would have been dropped to the canvas in the opening rounds of global financial turmoil. Still, even with the government’s efforts, the effects of the international financial catastrophe have been rather bleak.
In mid-April, the CBUAE announced that its assets and liabilities had declined by 32 percent to $52.7 billion at the end of 2008, down from $77.8 billion in 2007. The last time the CBUAE posted any such decline in assets was in 2003, when assets shrank by a mere 1.4 percent. Currently there are no figures as to how much local banks lost last year, but so far nine of 18 listed national banks that have released results have recorded higher profits – including NBAD, National Bank of Ras Al Khaimah, Sharjah Bank, Emirates NBD, while the other nine banks — Dubai Islamic Bank, Mashreq Bank, Abu Dhabi Commercial Bank (ADCB) and Dubai Commercial Bank — have suffered noteworthy losses.
National Bank of Fujairah, for example, reported losses of $13.7 million in 2008 and $88.2 million in 2007. The largest bank in the region by assets, Emirates NBD, faced fallout in relation to the Madoff scandal in the US, says Raj Madha, director of equity research at EFG-Hermes in Dubai.
ADCB also took hits from US exposures and First Gulf Bank (FGB) had hedge fund exposure. “In all these cases they’re trying to shut down these exposures, but they shouldn’t have been in those [situations] in the first place,” Madha says. “In most ways, it’s difficult to say what they should be doing now because now we’re seeing what they should have been doing a year ago.”
An area in which the government’s efforts have made a difference in recent months is addressing the liquidity situation. Before the fateful weekend of September 13, 2008 banks in the Emirates were awash with liquidity as foreign ‘hot money’ was streaming into the country, with investors expecting a revaluation of the dirham. Cash deposits surged thereafter, and the flowing liquidity empowered banks to go on a lending binge.
As noted by a recent Moody’s report, the national banks used short-term deposits to fund long-term loans. After letting go of the idea of a currency revaluation, foreign investors were briskly withdrawing their money and thus liquidity in the Emirates began drying up. It was in late 2007 that the UAE started feeling the noose tightening on liquidity, and Moody’s estimates that liquidity fell to around four percent of total banking assets. Bankers estimate that more than $51.7 billion exited the country in 2008.
The various sovereign measures taken since the fourth quarter of 2008 have resulted in more liquidity in the banking sector in recent months. Youssef Nasr, chief executive officer of HSBC Middle East, says the amount of liquidity had “significantly improved” in the last four to five months.
Ayyash agrees with Nasr, pointing out that currently “individuals and family businesses are more confident in the local banking sector and are thus depositing more and more cash [into the banks].”
“Also, international banks are back [on] the scene again, selectively reestablishing lines, which is very important,” Nasr says.
Madha accredits the enhancement of the liquidity situation to banks yielding their offers of high deposit rates — some as high as seven percent — as well as significantly lowered inter-bank rates.
“The spread over US dollar libel has come down more into line with the rest of the GCC countries, which is obviously a positive,” says Madha.
Others agree that the liquidity situation is healthier than it was just a few months ago. But it is still not as high as it was this time last year.
“[The] liquidity situation is still under pressure compared with the situation a year ago, when the system was flush with liquidity coming from outside, betting on the revaluation of the dirham,” Standard & Poor’s Mohamed Damak says. “But, we understand the situation has eased significantly in the past few months due to the intervention that was put in place by authorities.”
But New York Mellon’s Ayyash is confident that “liquidity is no longer an issue.”
However, Moody’s Middle East analyst John Tofarides says that while liquidity has gotten much better, it is “still being financed by the government.”
“In order to assume normal deposit growth, you have to have, at the same time, economic growth, because deposits are created by a function of economic growth,” Tofarides says. “If we have a slowdown in 2009, then the deposit growth would be — under normal circumstances — negative, but here we have government support injecting money from outside the system, thus balancing it out.”

UAE bond
The first quarter of 2009 has been quite eventful for the UAE, with the federal government issuing two separate bonds just less than two months apart. The first was issued in February, announcing a $20 billion bond for Dubai’s sovereign. Luckily, half of this was automatically raised by the CBUAE, leaving the remaining $10 billion to be raised in two to three years — when the bank thought it would be needed.
As of April, Dubai had already distributed more than half of the funds from the first $10 billion tranche to several quasi-government companies in the form of loans, with an appealing interest rate of four percent.
Director general of Dubai’s Department of Finance, Nasser al-Shaikh, told DubaiEye Radio on April 22 that “all the support that we extend… is in the form of loans, the tenor of which is a bit shorter than our commitment to the central bank to ensure that we have the money paid to us before we repay it to the central bank.”
Declining to name the recipients, al-Shaikh did mention that state-affiliated real estate companies had taken some money from the funds. Al-Shaikh added that the government would not wait for the initial $10 billion to be fully used up before rolling out the second $10 billion. Exactly when the next $10 billion would be launched depends on the requirements of “more than 10” quasi-government organizations he said, adding that the government is looking at numerous options “within and beyond the country” for raising the funds.
An EFG-Hermes Research analysis released in April pointed out that, “[such] comments stand in contrast to newsflow earlier in the year, which indicated that the second tranche would not be needed for two to three years.”
Whenever the rest is used, the bond “puts confidence back into the market,” says Dr. Eckart Woertz, program manager of economics at Dubai’s Gulf Research Center. “It helps Dubai to alleviate the worse fears for 2009, to ensure refinancing; not more, not less.”
As for the $10 billion Abu Dhabi bond program announced in April, only $3 billion has actually been launched so far. Hamad Al Hurr Al Suwaidi, under-secretary at the Department of Finance, commented last month that Abu Dhabi intends to raise the remaining $7 billion for the program over the next two years.
Of the program’s $3 billion launched, al-Suwaidi noted that investors from North America and Europe bought 90 percent of the 10-year issue bonds, and 75 percent of the five-year issue bonds, on the $3 billion. Asian investors constituted around five percent of the total bond program.
Dr. Giyas Gökkent, chief economist and acting head of asset management at the National Bank of Abu Dhabi (NBAD) — the country’s second largest bank by total assets — reveals that “the purposes of the Abu Dhabi bond issue were: one, to create a sort of benchmark for other borrowers and secondly, to gauge market appetite for bond issues from the region and the UAE. The oversubscription showed that clearly there is demand for good credit, so the reason why Abu Dhabi is doing [this bond] is clearly because they have a large number of projects and from a capital use perspective, [Abu Dhabi] found it useful to go this route.”
Gökkent adds that the bond was issued to aid the funding of projects going forward in Abu Dhabi, while in Dubai the bonds are being used to finance Dubai Inc. debts.

What the bonds mean for the banks
Logic would lead one to believe that people will begin depositing money into local banks as confidence creeps back into the market. Moody’s Middle East analyst John Tofarides says the bonds “will help [the banks] indirectly because this money will eventually be directed to the corporates; it will be fed through the banking system so at some point it will sit as deposits in the banks and then move to the uses of the corporates and pay contractors.”
Shayne Nelson, regional CEO of Standard Chartered Bank for Middle East and North Africa, echoes this sentiment, stating the bond “indirectly helps the banks and gets the economy moving.”
NBAD’s Gökkent believes that these bond programs “[lessen] the pressure on the banking system,” as the federal sovereign is giving “a fresh $10 billion to the Dubai government to inject in various companies, which means that the money did not come from the banking sector itself.”
“It’s complementary to the banking sector resources and it therefore does not put further pressure on the banking system, as the banking [sector] in the UAE had a somewhat high loan-to-deposit ratio [and] the balance sheets were already somewhat stretched,” Gökkent says.
HSBC Middle East CEO Youssef Nasr says the Dubai bond is “very positive,” adding that “the amount is sufficient for meeting all of Dubai’s current maturities of debt in 2009 and it allows the Dubai government to proceed with its budget plans.”
All in all, the bonds “seem to be achieving what [they were] designed to achieve,” states EFG-Hermes’ Madha.

Risky business
Presently, the real estate market is still a chief concern throughout the banking sector. Bank of New York Mellon’s Ayyash asserts that “the real estate sector is the most significant sector in the UAE economy and it has been hit the most.”
Woertz believes that the property market in Dubai is “pretty much a mess.” Gökkent mentions that “some banks got ahead of themselves, offering credit [to real estate developers and investors] without looking at the risk” involved. Woertz trusts that Dubai will remain a trading hub, and that more people will move to the UAE once the property market hits rock bottom.
“Investors will come back,” he says. “Many investors will go bankrupt, new investors will come in and buy it cheaper […] that’s capitalism, basically. It’s the end of many real estate investors over here, but not the end of the Dubai model.”
The situation is changing so fast in Dubai it’s hard to tell exactly what is happening. The lack of transparency doesn’t help one to get a clear picture either. What is known is that the population grew exponentially over the last 10 years, with expats coming to make up an estimated 80 percent of the population. That growth helped fuel construction and real estate prices. Now, the UAE’s growth is slowing.
As the end of the school year creeps up, the UAE is waiting to see how many more expatriates leave once they can take their children back home. With Dubai canceling 54,684 residency visas in January 2009 alone — around 1,764 per day, according to EFG-Hermes — foreign laborers losing their jobs create a ‘skip risk’ for national banks.
The law in the UAE does not permit unemployed expatriates to reside in the country for more than one month after being terminated; it forces them to leave the country and thus puts them at higher risk of defaulting on all sorts of loans taken from local banks. Woertz illustrates this concern, saying “there is a larger risk for banks here than elsewhere, because the expatriate incentive to walk away is pretty significant. Even the obligation to walk away — you’re not allowed to stay here if you don’t have a job here.”
Nasr explains that the reason the law is so strict on expatriates being forced to leave after only four weeks of unemployment is an “old philosophy… If you don’t have a job, you might become a burden on the state,” Nasr says. “It’s being offset by the fact that if the person has to leave it means he has an empty house, he won’t pay his debt, he’ll turn back his car.”
Nasr says the government is trying to find middle ground with the law, and allowing people to stay six months is being considered. But Nasr says until the law is amended and people start staying in the country, “skip risk is something we’re all going to have to deal with.”
Woertz says that even if the UAE extends the residency law to six months, “why should you stay?”
“You don’t get any unemployment benefits, it’s still pretty expensive although the rents have come down. So if you’re fired now, just forget it.”
Whether the law is altered or not, banks will definitely need to watch out for foreign borrowers skipping town and defaulting on their loans.
Dealing with this hangover in the banking sector has created room for some bankers to reach some  rather obvious epiphanies. Robert Thursfield, a director in equity research at Fitch Ratings in Dubai, asserts that national banks’ approaches to risk management “have become more cautious, although given the rapid growth of the last few years, this was inevitable once liquidity tightened significantly.”
Woertz says he thinks banks will be more risk-averse this year, while cutting lending to implement stricter rules on mortgages and credit card limits. What banks need to do this year, insists Nasr, is have capital and “get deposits first and then lend, not the other way around,” which is what was happening in 2008.
Due to numerous ill-calculated moves prior to the global meltdown, this year banks will naturally witness a significant slowdown in growth and profitability. Woertz is pessimistic, and doesn’t “see any growth potential at all — growth potential was yesterday.”
With such rapid growth over the last few years, the UAE will unavoidably experience a slowdown in bank profitability, albeit most banks will still manage to profit while a few others could break even in 2009.

‘After the drunkenness’
Referencing the Arabic expression, ‘After the drunkenness, there is an awakening,’ Nasr notes that, “we went through a period of drunkenness. But it’s back to basics [now].”
Unfortunately, he says, many of bankers forgot what banking was all about “for a few years.” Investors went a little crazy in recent years, diving first into stocks and then irrationally investing in the real estate market, with banks taking the brunt as they gave out loans at an excessive pace, disproportionate to their actual lending capabilities. Woertz says the loan-to-deposit ratio is over 100 percent in the UAE, “so it’s not as conservative as the 85 percent in Saudi Arabia.”
“Banks in the UAE grew their loans by more than 70 to 90 percent in 2008,” notes Gökkent, suggesting that the number is quite excessive.
“People tend to prefer shorter-term deposits and longer-term loans,” Nasr says. “The banking system plays a useful role in terms of bridging this gap between deposits and lenders, [especially] when they have different liquidity preferences.”
He adds that “we started getting into situations where banks were using overnight money or one month money and making 10-year loans. That’s irrational because you’re assuming that it’s going to roll over for the next 10 years, but it doesn’t happen [that way].”
Now, banks in the UAE — and around the globe, for that matter — will be focusing on reprioritizing their domestic agendas. The primary concern for national banks is to reassess and beef-up their risk management strategies, which can be done through more conservative lending policies and basic, cautious banking.

What to do?
Outsiders might find it strange as to why there have been no big mergers and acquisitions (M&A) in the UAE since the crisis took hold. But “under normal circumstances,” explains Gökkent, “[M&A] should have already happened because there was stress in the system… but because the UAE is so well endowed in terms of large accumulation of assets over the years, so far they haven’t had the need to do that.” This leads back to the eminent benefit of having an ultra-wealthy government backing you up.
This year, Madha believes that banks should be “sticking to the knitting.” While the UAE government has laid the foundation for recovery, banks can now focus on their core business and best practices. After the drunken hangover fully passes, banks and the economy of the UAE will have an opportunity to realign their agendas. Ayyash says the “only thing we can do is not to fall into the same trap and have all your portfolio concentrated in one sector; maybe they need to diversify and redefine their portfolios.”
Nasr predicts that “some banks will become more focused on retail or commercial business [and] become more specialized.”
In 2009 UAE banks will have to either sink or swim. Banks should keep in mind that, “The banking system is not an end, it’s just a means,” says Woertz.