UAE banks to focus on building up NPL provisions

The UAE's banks are still heavily exposed to the volatile real estate and construction sector, while an ongoing drive to build up loan loss provisions could again stifle their profits this year, according to analysts.

Despite an improvement in their asset quality, the country's 24 national banks and 28 foreign units are more vulnerable to real estate downturns than those in other oil-producing Gulf Co-operation Council (GCC) states after having lavished massive funds on the sector during its booming years before being jolted by the 2008 global fiscal distress.

But banks in the other GCC countries have also been caught in the quagmire of the highly speculative property sector, with their combined weighted average non-performing loans (NPLs) to total loans nearly doubling from around two per cent at the end of 2008 to four per cent at the end of 2009.

The downturn in the real estate sector has emerged as one of the key factors responsible for the lower profitability of many banks in 2009, along with higher provisioning requirements related to the exposure to Saudi Arabia's two family-affiliated conglomerates, some deterioration in corporate loan portfolios, and defaults in personal loan and credit card portfolios.

"I think the UAE banks are heavily exposed to the real estate sector following the sharp increase in their loans to this sector when it was growing very fast during the four to five years before the crisis," said Ziad Dabbas, Financial Advisor at the government-controlled National Bank of Abu Dhabi.

"I expect the banks to continue building up NPL provisions this year because the downturn in the real estate and construction sector means a decline in their asset value in that sector. Perhaps the provisions this year will be lower than the record allocations in 2009 but I believe they will affect their full year net profits, so, I expect their income to be slightly lower than in 2009," he said. 

Eroding asset quality

According to the Institute of International Finance (IIF), overexposure to real estate and Saudi business families has eroded GCC banks' asset quality. "In the UAE, the banking sector is significantly exposed to the construction sector and the highly speculative real estate sector. Several banks in the UAE are exposed to high levels of credit risk in connection with the family-affiliated conglomerates in Saudi Arabia and government-related entities in Dubai."

Its figures showed the NPL ratio of UAE banks rose from 2.5 per cent at the end of 2008 to 4.3 per cent at the end of 2009, and is expected to grow to about nine per cent at the end of this year. The report said the increase is partly due to the Central Bank's tightening of regulatory standards via a reduction in the loan classification period from 180 days to 90 days.

Central Bank figures showed UAE banks, which control the largest asset base in the Arab World, had extended a staggering Dh145.7 billion in real estate mortgage loans by the end of March 2010. Credit to the construction sector totalled Dh124.8bn by the end of that period.

Total loans to the two sectors stood at Dh270.5bn at the end of March, accounting for nearly 28 per cent of the overall credit provided by banks.

The bulk of the real estate and construction loans were extended through 2008 and in the previous four years, when both sectors were leaping by at least 10 per cent because of a business upswing in the region spurred on by high oil prices. 

Tighter credit policies

The trend was reversed after the global economic crisis as banks tightened their credit lines because of their exposure to regional defaults and market contractions.

Official data showed mortgage loans in the UAE, the second largest Arab economy, slowed down sharply in 2009 as banks maintained their tight credit policies and chopped a large portion off their balance sheets for NPL provisions.

Poor investor confidence because of a general downturn in the real estate sector and bank liquidity shortages also contributed to the plunge in mortgage credit growth as part of an overall slowdown in domestic loans.

After soaring by around Dh74bn through 2008, the total mortgage loans extended by the UAE's 24 national banks and 28 foreign units grew by nearly Dh15 billion in the first 11 months of 2009, Central Bank figures showed.

This means growth in domestic mortgage credit dived from around 123 per cent during 2008 to only about 12 per cent during January to November 2009.

"There are several reasons for this slowdown in mortgage loans. Banks are still maintaining a cautious approach in general lending, including mortgage loans," said Mohammed Al Asumi, a UAE-based economist.

"The banking sector also faces liquidity shortages while most banks have commitments, for which they have made large provisions. This has made them even more careful. Another factor is the real estate downturn, which has made investors reluctant to invest in property."

From around Dh56.4bn at the end of 2007, mortgage loans provided by the UAE's 52 banks leaped to nearly Dh125.8bn at the end of 2008, the largest annual increase in the country's banking history. During the first quarter of 2010, such loans grew by only around Dh4bn, the Central Bank figures showed.

Credit to the construction sector also largely slackened through 2009 after several projects were delayed or cancelled. After soaring by nearly Dh65bn through 2008, construction loans edged up by only around 600 million in 2009 before slumping by about Dh2bn in the first quarter of 2010. 

High NPL provisions

Banks' exposure to real estate, construction and regional defaults has prompted them to allocate record high provisions of around Dh12.9bn during 2009. Provisions remained relatively high during the first four months of 2010, standing at around Dh3.4bn, according to the Central Bank.

Analysts expect the banks to keep up their provisioning drive this year in line with Central Bank instructions to strengthen their financial positions and build a good cushion against defaults and other problems.

"2009 was a year of provisions and I don't think this year will be different for UAE banks," said Humam Al Shamaa, financial analyst at Abu Dhabi-based Al Fajer Securities, a key UAE stock brokerage and investment firm.

"Banks need to take provisions because of the Dubai debt, strict regulations by the Central Bank and risks besetting the real estate sector. As you know, banks have been very tight in terms of lending to the real estate sector and this will lead to a further decline in the sector. This will consequently prompt the banks to allocate more provisions against mortgage loans."

"I believe the banks will continue making provisions during 2010 in compliance with Central Bank regulations and as long as they feel their assets are at risk. They could be lower this year but they are needed so the banks will show that their assets are real," Dabbas said.

Lower profits in Q1 2010

High provisions have allied with a steep fall in credit to adversely affect the banks' performance, with the net earnings of national banks dipping by about 1.14 per cent in the first quarter of 2010 and more than 20 per cent in 2009.

From around Dh5.566bn in the first quarter of 2009, the consolidated net profits of the 19 listed banks slumped to Dh5.502bn in the first quarter of 2010, their balance sheets showed.

Analysts considered the results in the first quarter of 2010 as good on the grounds they were far higher than the profits in the fourth quarter of 2009 and slightly lower than their level in the first quarter of 2009, which was better than the Q1 results in 2008 despite the oil boom that year.

Balance sheets of 16 listed national banks also showed their net profits plunged by around 20.6 per cent to Dh14.87bn in 2009 from Dh18.71bn in 2008. In the first quarter of 2009, their earnings edged up by nearly 0.07 per cent to Dh5.41 bn from Dh5.406bn in the first quarter of 2008.

The performance of UAE banks since the eruption of the global crisis is in sharp contrast with their strong operating income in the preceding period, when they recorded growth of more than 100 per cent in some years.

Official figures showed 2004 was one of the best years for the UAE banking sector, with net earnings rising to Dh7.14bn from Dh4.9bn in 2003. The following year was equally strong as their net profits leaped by nearly 112 per cent to Dh15.2bn.

In 2006, profits edged up by only around 1.9 per cent to Dh15.5bn before jumping by nearly 28 per cent to Dh19.9bn in 2007. Profits swelled by about 4.5 per cent to a record high of Dh20.8bn in 2008 despite losses by some banks and a sharp fall in the profits of others in the fourth quarter.

Dabbas said low credit is also putting downward pressure on the net income of banks although it is partly offset by income from other investments. 

Favouring the public sector

Dabbas noted that banks have remained reluctant to extend large or long-term loans to the private sector, opting instead to lend to the government and other public institutions. But other analysts said they saw what they described as slackening appetite by the public sector for credit following the surge in oil prices.

After soaring by around 27 per cent from Dh72.2bn at the end of 2008 to Dh91.8bn at the end of 2009, banks' credit to the government grew by just 0.7 per cent in the first quarter of 2010 to around Dh92.5bn.

Loans to the private sector declined from around Dh630.7bn at the end of 2008 to Dh607.09bn at the end of 2009. They continued their descent to reach Dh604.7bn at the end of March 2010, the Central Bank showed.

Private business and industrial sector establishments were the main beneficiaries of banks' credit through 2009, with loans to them soaring from around Dh341.3bn at the end of 2008 to Dh355.2bn at the end of 2009. But they tumbled to about Dh333.07bn at the end of March.

Central Bank figures showed UAE banks were tapping other sectors to offset the weak domestic credit demand, with their foreign assets growing from Dh203.3bn at the end of 2008 to Dh208.1bn at the end of 2009 and around Dh220.4bn at the end of March 2010. Domestic investments also grew from Dh66.6bn to Dh70.5bn and Dh73.3bn in the same period.

Follow Emirates 24|7 on Google News.