Banks in the Gulf have generally fared quite well, benefitting from a much stronger set of economic drivers than their United States and European counterparts.
The earnings prospects for the region's banks remain bright through rapid credit expansion, which has been sustained by strong economic growth and buoyant oil prices. Negative real interest rates, a strong pipeline of projects and surplus liquidity keep the earnings outlook for the banks strong, said a JPMorgan report.
Excessive liquidity due to high oil prices has delivered a substantial dividend to GCC economies. Expectations are that oil and gas revenues will remain elevated, boosting domestic oil, gas and chemicals industries, in addition to the overall balance of payments and government revenues. Inflow of revenues will continue to contribute to increased liquidity in the region, which will be to the benefit of the banking sector, as it continues to profit from strong deposit growth that can in turn be recycled into credit expansion.
The banking sector will also benefit from the growing pipeline of large-scale public- and private-sector projects, which make project finance a very attractive growth area for the GCC banks, said the report. Another factor for the strong performance of GCC banks is their strong shareholder support, which has mitigated sub-prime and structured credit losses.
However, some non-retail banks did report losses. Gulf International Bank (GIB) took a $965.7 million (Dh3.54 billion) provisioning in financial year 2007, and Arab Banking Corporation took a $603m provision in quarter one of 2008. These banks have been realigning their strategies and with the strong support of shareholders they have been able to pull through. GIB was swiftly recapitalised with a $1bn capital injection from its shareholders, and Arab Banking Corp is now pursuing a rights issue.
The report said: "We also note that the downside risk for the affected institutions has been greatly mitigated by the unconditional level of support made available by core shareholders, which include sovereign or quasi-sovereign institutions. The immediate response in terms of capital raising initiatives for the affected institutions is in our opinion very positive from a credit perspective."
Analysts at JPMorgan warn that rapid economic and credit expansion leads to inflationary pressures, which is plaguing the GCC economies and could have a mixed effect on the banks.
"The combined impact of increasing inflation rates together with decreasing nominal interest rates is that effectively real interest rates are negative, which would be a very strong incentive for credit expansion.
"This credit expansion would in turn fuel increased inflation and this could potentially lead to an upward spiral in prices that would be difficult to break. The impact on the region's banks is mixed. While we have noted the beneficial impact of credit expansion, we would also point out that the decline in interest rates will effectively be a support for the banks in the region given that assets (loans) will tend to re-price more quickly than liabilities (deposits)," the report said.
"The downside risk for the banks is that rising inflation will feed through to the cost base of these institutions and will impact profitability. In addition, if inflationary pressures increase to the extent that the currency peg becomes less of a priority, then the resulting corrective action by the monetary authorities in the form of interest rate hikes would likely have a negative impact on asset quality, as borrowers would then face a potentially steep hike in rates. An economic environment with high inflation would tend to discourage deposit growth, with investors/savers likely to opt for assets offering better protection against inflation."
Experts are also upbeat about the booming real estate market in the region. Most banks are encashing on this boom but there could be a flip-side as well. "Some banks are growing their loan books at rates close to 40 per cent year-on-year, which suggests that the there could be problems caused by over-investment in the future. The speed of the current boom is unsustainable over the longer term, and is likely to cause some risks to the regional banks when it slows or reverses, however, there are no signs of an imminent slowdown," the experts said.
In fact, domestic property markets and banks could even receive another upward fillip if the expansion of residential mortgages accelerates. "In the medium-to-long term, the outlook for the property market will continue to be supported by very supportive demographics and with a considerable change in terms of the perception of mortgage debt. This is a product area with very strong potential, particularly among markets where the degree of mortgage penetration has been low by global standards," it said.
Consolidation will also play a big role in the sector and the trend has been set by the merger of Emirates and National Bank of Dubai.
"The trend towards greater consolidation would be motivated by the cost pressures, which the region's institutions might be experiencing, with the potential cost synergies being an important potential benefit," the JPMorgan report said.
Abu Dhabi Commercial Bank received an overweight recommendation from JPMorgan because of its solid performance in terms of core revenues. Despite some earnings volatility driven by losses on structured finance portfolios, the performance of the core franchise has been sufficiently robust to absorb these writedowns without compromising earnings growth.
Emirates NBD has also been given overweight status. Cost savings will be a potentially important value driver for the bank. In addition, the larger scale of the institution will allow it to participate in larger ticket deals, with the larger combined balance sheet being a relatively important competitive advantage.
Arab National Bank also received an overweight recommendation. Saudi Arabia's sixth largest bank has a market share of about 10 per cent. Its year-on-year growth in special commission income outstripped loan book growth, reflecting growth in margins, and more than offsetting the slight decline in fee income. The NPL ratio and provisions for credit losses continues to fall from already very low levels.