Property woes weigh on banks' outlook: Moody's

UAE banks show strong profitability indicators due to the relatively stable net interest margins and good fee and commission levels, Moody's said in a report yesterday, while continuing to maintain a negative outlook for the country's banks.

"UAE banks faced significant asset quality problems in 2009, but their capital levels and good core profitability have allowed them to absorb losses without significantly undermining their creditworthiness," says John Tofarides, Analyst at Moody's Middle East in Dubai and the lead author of this new report. However, the agency says that real estate woes will continue to drag bank profitability. "Moody's believes that the over-supply of properties is not conducive to a quick economic recovery nor to an improvement in the operating environment that would allow for an easing of pressures on the banking sector in the near term," it said.

"Moody's outlook for the property industry in the Gulf and particularly the UAE remains negative. We have concluded that the supply-demand imbalance in commercial property and to some degree in residential units, depending on the city or country, is likely to grow worse as vast supply meets slack demand," the report said.

"However, from among GCC emirates/countries, the Dubai real estate market has suffered the greatest deterioration – indeed, house prices in Dubai have declined by as much as 50 per cent and rental income has also deteriorated. The real estate exposures of the banking sector are capped by the CBUAE limit of 20 per cent of customer deposits.

"Including construction loans, we believe that these exposures will be around 18 per cent of the loan book, although official CBUAE estimates [which exclude construction loans] place the exposures at 13 per cent."

Efficiency levels among UAE banks remain robust despite the economic slowdown, the agency noted, maintaining that efficiency levels benefited from the faster pace of increase in operating earnings than in operating expenses.

"The vast majority of UAE banks continue to operate on cost-to-income ratios well below 40 per cent due to strong core profitability and a cost-conscious approach," it said. However, higher loan loss impairments, said the global ratings agency, are denting net profitability.

Of the banks under the agency's coverage, only two – ADCB and Dubai Bank – reported negative profits in 2009 as a result of specific impairments, while HSBC ME reported almost zero profits in 2009 for similar reasons.

ADIB, DIB, ENBD, Mashreq and UNB reported declines in net profits, while FGB, NBAD, RakBank and NBQ showed positive net profit growth.

Moody' pointed out that capitalisation levels among UAE banks improved considerably in 2009. According to UAE Central Bank figures, the total capital adequacy ratio increased to 19.2 per cent at year-end 2009 from 13.3 per cent at year-end 2008, while the Tier 1 ratio is estimated to have grown to 14.5 per cent on average from 11.7 per cent for the same period. The improvements were mainly due to additional government support (in the form of both Tier 1 and Tier 2 capital) and internal profit generation.

In response to the unprecedented asset quality and liquidity challenges, the CBUAE, in association with the UAE's Federal Ministry of Finance, jointly provided sufficient and timely funding in excess of Dh70bn ($19bn) in the following ways:

n Direct deposits to the banks worth a total of Dh50bn ($13.6bn), which the banks are in the process of converting into Tier 2 capital notes based on an agreement with the Ministry of Finance. According to the agreement, these notes can be converted into Tier 1 securities in case the Tier 1 capital ratio of the bank falls below 11 per cent and if there is evidence that it could deteriorate to below 8 per cent (a new regulatory minimum as of June 30, 2010).

- In February 2009, Tier 1 capital notes from the government of Abu Dhabi have also injected Dh16bn into the five largest Abu Dhabi government-owned banks: ADCB, ADIB, FGB, NBAD and UNB.

- Tier 1 capital notes issued to the Investment Corporation of Dubai (Government of Dubai) from ENBD totalling Dh4bn.

- Internal capital generation. Total net profits for the rated universe (13 banks) was in the range of Dh14.3bn for 2009. However, following expected dividend payouts, internal capital generation would fall further by an estimated 20-30 per cent.

Deposit rating drivers

Moody's views the UAE as a high support country. There have been several occasions when local authorities have stepped in to assist banks and the banking system in times of crisis, irrespective of the bank's size or systemic importance, the agency noted in its report. Government support has often taken the form of orchestrated mergers and capital injections.

"To our knowledge, no depositor has lost money as a result of any UAE bank failing to meet its obligations, with the exception of the Bank of Credit and Commerce International (BCCI), which went bankrupt in 1991," Moody's said.

"However, this was a case of fraud and we understand that depositors were able to recover more than 70 per cent of their deposits after more than a decade," it added.

"As Moody's continues to believe that banks are special institutions that are pivotal to a well-functioning economy, we have not changed our traditional support assumptions as far as banks are concerned. The banks that are regulated by the CBUAE receive support directly from the federal government. Moody's also continues to believe that the financially stronger local government of the emirate of Abu Dhabi continues to stand fully behind the federation," the report said.

"Our strong belief that the UAE authorities would provide support to failing banks is reflected in the local banks' deposit ratings, which are often much higher than would be implied by their standalone bank financial strength ratings [BFSRs]. This support is reflected in the current global local currency deposit ratings of the banks."

Outlook

The outlook on the banking system of the UAE remains negative as a result of the country's weak operating environment and the significant challenges facing the emirate of Dubai in particular, says Moody's Investors Service in a new Banking System outlook on the UAE.

The negative outlook expresses the rating agency's expectations for the fundamental credit conditions in the UAE banking system over the next 12 to 18 months.

Although systemic support provided by the UAE's federal government has eased the banks' financial challenges, asset quality pressures stemming primarily from Dubai will continue to weigh negatively on Moody's outlook for UAE banks.

"Overall, the operating environment remains difficult, with low economic growth and investment, weak demand for loans, as well as investor confidence issues which are curtailing the banks' ability to access low cost, wholesale funding," says Tofarides.

This is why UAE banks did not engage in any material new lending in 2009, with the exception of some retail and infrastructure and government-related lending, mainly in Abu Dhabi.

Indeed, the expected loan growth for 2010 is at a low of 4-7 per cent (projected to be around 6-13 per cent in Abu Dhabi and 0-5 per cent in Dubai), compared to the CAGR 37 per cent recorded from 2002 -2008.

Moody's new report says that asset quality among UAE banks will remain under pressure this year. "As Moody's recently commented, problem loans could more than double by year-end 2010 to around 9.5-12.5 per cent of gross loans, taking into account the Dubai World restructuring," says Tofarides.

In this difficult environment, Moody's says that UAE banks' profitability also remains under pressure. Although all UAE banks have been increasing their collective loan loss provisions in order to create satisfactory buffers, they will – for the foreseeable future – probably need to continue to provide against persistent asset quality pressures, thus depressing their bottom line.

On a positive note, UAE banks have high capitalisation levels by international and regional standards (the Tier 1 capital ratio of 14.5 per cent at YE2009) and this is a relative strength when viewed in the context of the high risk for loan losses.

Having stress-tested the capitalisation levels of the rated banks for additional losses, the rating agency concludes that the rated banks are currently appropriately rated to absorb losses based on Moody's economic assumptions and expectations.

Moody's considers the liquidity position of UAE banks to be satisfactory, and would expect additional funding support from the federal government, if required. In 2009, UAE banks managed their liquidity by curtailing loan growth, and they are continuing this approach in 2010 by extending new lending on a very selective basis. However, competition for domestic deposits has increased, while market funding continues to remain unattractively priced for the majority of rated banks.

Overall, Moody's believes that the over-supply of properties, particularly in Dubai, is not conducive to a quick economic recovery nor to an improvement in the operating environment that would allow for an easing of pressures on the banking sector in the near term.

Follow Emirates 24|7 on Google News.