Banks face new headwinds

Weak loan growth and higher levels of non-performing loans (NPLs) are weighing heavily on the future prospects of the UAE’s banking sector, with official data showing that provisions for NPLs continues to swell to record numbers despite stability in the country’s overall economic situation.

According to data released by the UAE’s Central Bank, total provisioning by banks in the country rose to Dh67.3 billion in October, up 18.5 per cent in the first 10 months of 2011. Specific provisioning for NPLs is up 17.2 per cent in the first 10 months, while general provisions are up 23.2 per cent in the same period, data shows.

Year-on-year, total provisioning is up 24.4 per cent, from Dh54.1 billion in October 2010 to Dh67.3 billion in October 2011, while bank deposits are up less than 1 per cent, from Dh1,053.8bn to Dh1,062.8bn in the same period.

Meanwhile, bank lending remains erratic, with the month of October seeing lending decline by Dh2 billion, compared with a healthy growth of Dh18.4bn in the previous month. Bank lending is up 4.1 per cent in the first 10 months of the year to Dh1,073.3 billion in October 2011.

According to Exotix, an investment bank with a branch in the Dubai International Financial Centre, Dubai banks’ provisions to cover bad loans may surge further in the next two years as debt restructurings continue and a slowing global economy prevents a recovery of the emirate’s property market.

Non-performing loans will peak at 15 to 16 per cent in 2013, up from 4.8 per cent in 2009 and 11.3 per cent in 2010, Exotix said earlier this week.

According to a new report by Fitch Ratings, weak global economy and a slowdown in Abu Dhabi will represent new headwinds for the UAE banking system.

“Whilst the fragile real biz estate sector and the ongoing problems in Dubai government-related entities and several UAE corporates continue to pose significant asset quality challenges for the sector, banks will face new headwinds,” the ratings agency said on Tuesday.

Fitch is particularly expecting several key economic sectors, such as trade, tourism and services to be negatively impacted, it said. “Abu Dhabi has been cutting its spending on construction-related projects, owing to concerns about the significant oversupply in the real estate market, an increase in the Emirate’s financial commitments, and the slowdown in the global economy,” Fitch said.

“Key projects remain in the pipeline, but some contracts have been delayed or possibly cancelled, as the Abu Dhabi government has prioritised major infrastructure projects. Fitch views this as positive and to benefit the economy in the long-run. However, this sharper-than-anticipated slowdown in the construction sector in Abu Dhabi could have some implications for the banks’ asset quality in the short-term,” it added.

The agency said that the significant increase in the renegotiated private sector loans hides the true extent of the banks’ asset quality problems. “Whilst fundamental credit issues in the operating environment remain unresolved, some of these loans may re-emerge as non-performing loans,” Fitch believes.

“Ultimately, the success of the various restructuring and renegotiating plans accepted by the banks depends on recovery in both the UAE and globally,” it added.

Overall, UAE banks remain profitable to date, despite weaker asset quality and slow loan growth. Core earnings benefit from lower funding costs. However, Fitch anticipates core earnings will decline given low business volumes and the recent Central Bank of the UAE rules on retail banking.

Nevertheless, Fitch recognises the ability of pre-impairment income to continue to absorb high credit costs. Customer deposits decreased significantly in the past three months with the outflow of unstable deposits (hot money) and some large government related deposits. As a result, the system loans/deposits ratio climbed back to the 100 per cent mark in September 2011. However, Fitch believes that liquidity pressures remain manageable at a time when loan growth is slow.

The key challenge for liquidity is the banks’ ability to raise long-term funding. It is clearly more costly, especially for Dubai based banks, when global markets are less liquid. Combined with a relatively tight loans/deposits ratio, Fitch expects continuing funding constraints.

“Positively, high levels of capital and healthy core earnings provide banks with a solid cushion against a potential increase in non-performing loans. This underpins the banks’ Viability Ratings,” Fitch concluded.

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