UAE banking sector to enjoy 'robust' growth

Record high oil prices, the government's continued investment in infrastructure development, ongoing corporate loan growth and strong retail loan growth spurred by real estate mortgage demand and personal loans will continue to prop up the prospects of the UAE's banking sector in the medium term, says a report received yesterday.

The UAE's banking sector should continue to enjoy robust top and bottom line growth. "Barring external influences, we expect the positive operating environment should continue in the medium term," noted the report issued by Al Mal Capital.

The report lists record high oil prices (more than twice the budget estimates) as one of the primary drivers of this growth, coupled with the extraordinary expenditure being made by the country's government to upgrade physical infrastructure.

Although the country is believed to be overbanked – there are 49 banks (with 667 branches across the country) catering to a population of just 4.6 million people – analysts at Al Mal Capital are bullish about the growth prospects of the UAE's banking sector as a whole.

"The advanced nature of the UAE banking industry is evident from the relatively high banking penetration ratios as of year-end 2007 – Loans to GDP and Loans to Deposit ratio at 102 and 100 per cent, respectively," notes the report. "Although the Loans/GDP ratio is higher than other countries in the GCC, we believe there is ample room for growth when compared to other developed markets," it adds.

While the UAE's financial budget estimates oil at $35-$45 a barrel, spot crude was trading near $133 yesterday amid supply concerns worsened after a militant attack in Nigeria disrupted supplies from Africa's largest producer. "As global oil prices have increased, the UAE has benefited from a budget surplus that has been directed into various infrastructure projects, real estate developments and expanding the economy beyond the hydrocarbon sector.

"The increased government spending has had a bootstrap effect on investment growth in various sectors, resultant population growth, and in turn, investment in other businesses to cater to the increasing population," the report points out.

Banks in the UAE have seen spectacular growth in their loan books over the past three years, with a CAGR of 38 per cent between 2005 and 2007, the report reckons. "Deposits also have grown at a spectacular rate with a CAGR of 29.9 per cent over the same period," it says. Despite the huge number of banks operating in the country vis-à-vis the population, the top nine banks account for 78 per cent of loans, 74 per cent of the deposits and 71 per cent of assets owned by the country's banking sector.

Analysts believe local banks will continue to maintain their market share in the medium term, benefiting from entrenched business lines, large coverage area, government support and the interconnected nature of corporate and business relationships in the country.

Nevertheless, as the report points out, "Future consolidation may be determined by players in the market merging to benefit from the increased heft in the marketplace." Even though the recent boom in oil prices, along with a desire to invest capital closer to home (post 9-11) has spurred the growth of regional economies at breakneck speed, there remain concerns, with inflation and skills shortages being some of the largest challenges facing the sector.

"Increased investment in the local economies, resultant demand for knowledge workers, shortage in real estate supply, and the consequence of being pegged to loose US monetary policy have caused inflation to rise and pushed real interest rates into negative territory thus feeding the vicious cycle of asset price increases," the report says. With effective changes in property ownership laws, visa regulations and incorporation laws, the emirates have spurred growth in the real estate, tourism and finance sectors. In addition, the local governments have diverted funds into major infrastructure and real estate development projects (estimated to be $300 billion through 2012).

This investment has spurred piggyback investments from corporations trying to take advantage of the investment boom in the region. While the different emirates of the UAE have made efforts to diversify their revenue bases away from the oil and gas sector, a slowdown in government spending – if it were to happen – will negatively impact the fortunes of the country's banks. "To this effect, a significant drop in oil prices could affect the amount of excess liquidity and the level of government and corporate investment in the system. However, current crude prices are approximately twice the budget estimates, creating a substantial buffer."

On the other hand, the UAE's banks have a significant exposure to the country's real estate sector, with construction and real estate sector loans representing between 7.3 and 31.4 per cent of the outstanding loan book across Al Mal Capital's coverage universe.

The next step in this evolution is for the banks to cater to the expectant increase in real estate mortgages. Currently, mortgages (Dh50.1 billion in the third quarter of 2007) represent only seven per cent of the UAE's GDP, compared to 130 per cent in the US, 70 per cent in the UK, and 10 per cent in Mexico.

On the retail side, with potentially loosened regulation and rising population trends, the UAE banks are positioning to make the retail sector a bigger piece of their net income. To take advantage of the nascent growth in the sector (auto, credit card, mortgage and personal loans) and buoyed by higher margins, the banks are extending themselves further to the consumer via branch openings and by extending terms and credit to their customers.

Deposit growth, although healthy, has been unable to keep pace with loan growth. The lowering of nominal interest rates to match US Fed moves is feeding asset price inflation, which in turn is causing real interest rates to move deeper into negative territory, thus making deposits expensive.

This has resulted in the banks needing to tap the capital markets to meet the funding gap. Currently, there is an increased reliance on convertible bond issues (Tier II capital) in the market, with NBAD, ADCB and FGB all announcing issuances in the last month.
Analysts believe this provides a temporary relief in the funding gap, but could further impact stock dilution. Although interest rates have fallen recently, wholesale funding could come at a higher cost on an absolute basis – due to the recent credit tightening and on a relative basis – as compared to customer deposits. However, the banks' increased reliance on wholesale funding should help them to better match the asset-liability duration gap.

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