Moody’s bearish on UAE banks

The outlook for the banking system of the UAE remains negative, says Moody’s Investors Service in a new Banking System Outlook published today. 

The main drivers of the outlook are asset quality challenges, especially for the Dubai-based banks, and low provisioning coverage levels. The agency said that asset quality will remain poor even in 2013, with the ratio of problem loans to gross loans in the 10-12 per cent range for 2012, and then declining marginally in 2013. 

Moody’s expects problem loan levels to remain elevated, driven by (i) exposures to large, stressed, government-related issuers (GRIs) and (ii) legacy corporate impairments, primarily real-estate-related, which are still emerging after failed attempts to restructure earlier in the crisis. 

“We expect the ongoing $10 billion distressed restructuring of Dubai Holding (a GRI), which drove the increase in problem loans to 10.7 per cent of gross loans as of year-end 2011 from 8.1 per cent as of year-end 2010, to remain unresolved in 2012 and ultimately culminate in high losses on a Net Present Value (NPV) basis,” the Moody’s report states. 

The agency expects “profitability to remain constrained by cautious loan growth and the ongoing provisioning that is required to cover elevated problem loan levels, against a background of mixed signs of a recovery and our expectation that the performance of UAE banks’ net earnings will remain uneven over the coming 12-18 months.” 

Moody’s believes that net profits of Dubai-based banks will remain particularly pressured, while Abu-Dhabi-based banks should see net profits improve in 2012 and 2013. 

It says that the negative outlook also captures specific structural weaknesses that will continue to undermine system-wide bank performance over the 12-18 month outlook period. In Moody’s view, issues such as limited transparency, sizeable related-party exposures and high loan and deposit concentrations will continue to leave UAE banks vulnerable to name-specific credit risks in the near term despite recent guidelines published by the Central Bank of the UAE. 

Over the outlook period, the diverging performance in the banking system between the two core cities will continue to grow. Abu Dhabi benefits from higher public-sector spending and Dubai’s prospects will remain overshadowed by real-estate oversupply and the legacy GRI asset-quality challenges, despite its more diversified private sector, which has shown solid signs of recovery. 

This UAE’s dependence on oil, as well as core sectors of trade, services, global logistics and tourism, continue to make the local economy sensitive to macro risks of weakened growth, global recession and low oil prices. Accordingly, although it is not Moody’s central scenario, a sustained drop in oil prices would reduce public spending and have a marked effect on overall economic confidence. 

Despite Moody’s projections of modest overall credit growth of 4-7 per cent for 2012 and 2013 real GDP growth in the 2-3 per cent (Source: Moody’s Statistical Handbook, May 2012) range for 2012 and 2013, asset quality will remain poor with the ratio of problem loans to gross loans in the 10-12 per cent range for 2012, and then declining marginally in 2013. 

Moody’s view is mainly driven by the persistently high level of exposures to large stressed GRIs and other legacy exposures, despite the recovery in core sectors, which, with commercial real estate, continue to contribute the bulk of the problem loans. 

As such, Moody’s expects associated provisioning needs and low lending confidence to continue to subdue bank profitability. Cautious loan growth and the ongoing provisioning required to cover elevated problem loan levels will be the key constraining factors for profitability. 

These trends will continue to suppress banks’ net profits for 2012 and into 2013, with the ratio of net income to average risk-weighted assets at around 2 per cent. 

However, amongst Abu Dhabi banks, Moody’s expects that stronger local economic growth and confidence will lead to higher credit growth and profitability compared with Dubai-based banks.

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