The year ahead is likely to be a watershed era for the UAE banking sector, which will mark both expansion and consolidation.
As the general outlook for the economy in 2008 is rosy, the banking sector stands to gain, investment bank EFG-Hermes said in its UAE Research Yearbook 2008.
“The sector is expected to see expansion and consolidation, with more domestically focused banks looking towards consolidation and larger banks engaging in expansion across the Mena region,” the Cairo-based investment bank said in its research report.
However, the turmoil in US credit markets could hamper the ability of companies and banks to raise international capital to fund acquisitive growth plans and lending.
Fee income will rise in consonance with increased M&A activity in other sectors. Fragmented sectors such as cement and insurance are the most likely candidates for consolidation and vertical integration, while companies operating in saturated sectors such as real estate and telecoms are likely to expand into related sectors and geographies.
In 2005 UAE banks benefited from the stock market boom through gains from IPOs, brokerage fees, performance fees from assets under management, investment banking fees, trading gains, revaluation gains available for sale and held to maturity equity investments. Most banks booked huge incomes from leverage offered to IPO investors. However, with the drying up of major public issues in 2007 the contribution of fee-based incomes from market have been negligible in most banks’ books.
IPO financing had a positive impact on net interest income of banks in 2006. However, 2007 witnessed fewer public issues and IPO related financing and customer deposits recorded a slower growth. A windfall is in the offing with expected increased number of public issues. At least nine major IPOs are rumoured to tap the capital market next year. Among them are Depa United Group, Abu Dhabi Vegetable Oil Company, M’Sharie, Abu Dhabi Securities Market, Dubai Aerospace Enterprise and The National Investor.
A recent change in regulations, reducing the minimum level of free float required to conduct an IPO from 55 per cent to 30 per cent, should spur the listing of family businesses. The increase in listings should provide greater sectoral breadth to the market, the report said.
Negative interest rates
Interest rates have been strongly negative, boosting credit growth of the private sector and thus overall domestic demand, both investment and private consumption. Higher government spending and the confidence factor linked with the high oil price have also helped boost domestic demand. The continued strong influx of expatriates and an increase in private wages (averaging around 10 per cent) in 2006 also supported private consumption, despite the sharp fall of the local stock market at the end of 2005 and the pick-up in prices, particularly rents and education.
Economists have forecast a large probability of a small devaluation as soon as in the first half of 2008. If the dirham is allowed to fluctuate against the dollar, there is the probability this would in turn mean higher interest rates. In terms of translational exposure, only NBAD drives a substantial portion of its business through overseas operations. However, in practice it is likely that the trade finance business, meaning primarily letters of credit and letters of guarantee, would also be affected.
The second impact of an appreciating currency would be felt on the balance sheet, which would be hit both by the appreciating currency and by rising interest rates.
Should interest rates rise, there would be a substantial maturity mismatch. However, as there is relatively little long-term lending, and there is in some cases substantial short-term borrowing, the interest rate mismatch is likely to be relatively minor. Given that any mismatch is likely to be hedged, there might be a problem, the report warned. An interest rate increase would likely lead to higher net interest income, all other things being equal.
Balance sheet growth
The year 2008 will be a year where the banks focus not only on maintaining good balance sheet growth, but also on improving the quality of balance sheet growth.
“There will be some pressure on spreads. This will to a large extent be offset by the mix effect as most banks continue to head down the path of increasing exposure to the retail segment,” the analysts at Cairo-based EFG said.
Core growth was strong in 2007 in spite of the collapse in the second half of 2006 of volatile sources of income and 2008 will be about steady progression. Loan growth held up better than expected in 2007. “There has also been significant talk of 2008 being a major year for project finance. While this is certainly a possibility, we do not necessarily believe that the banks would be best served by jumping in with their balance sheet, and so diverting funds from areas where spreads are wide and competition low,” the analysts said.
Non-interest income saw a relative decline in 2007 due to the absence of stock-market-related gains. In some cases the same can be said of the property market in 2008. Banks that show the biggest dip in non-interest income as a proportion of earnings will be those that received the strongest benefit from property-related earnings in 2007.
With few signs that the property market is stabilising at the moment, however, the shift will be from supernormal profitability to high profitability. Banks in the UAE are well placed to go into 2008 relatively free from the concerns that afflict the international sector.
“Unburdened with the higher level of volatile market-related income that we have seen in previous years, with a few exceptions we believe that steady growth can be maintained,” EFG analysts said.
EFG said in its report that the banking sector as a whole remains over-capitalised, led by First Gulf Bank and Commercial Bank of Dubai, and, as a result, most players are targeting some level of acquisitive growth.
Large cap banks, National Bank of Abu Dhabi and Emirates NBD, are focused on opportunities within the Mena region. Both First Gulf Bank and Abu Dhabi Commercial Bank have aggressive growth plans.
There is less acquisitive potential from Commercial Bank of Dubai since it is currently looking to increase its domestic franchise. Abu Dhabi Islamic Bank, which is under new management, is integrating its recent acquisition of Egypt’s National Development Bank.
M&A activity had a slow start in 2007 with the merger of Emirates Bank and National Bank of Dubai to form Emirates NBD.
There is greater focus on acquisitive growth in 2008 as both domestic and foreign competition picks up.
The report is bullish on some banks. “We favour Emirates NBD and Commercial Bank of Dubai. Emirates NBD will be successful in deriving both revenue and cost synergies while also improving cross-selling activities. Recent results indicated continued strong loan and deposit growth with a good quality balance sheet.
“Commercial Bank of Dubai has so far benefited from its strategy of segmenting its client base and has delivered results ahead of expectations,” EFG said in its outlook report.