UAE banks’ Q1 earnings will reflect continued pressure on profitability

Dubai: UAE banks reporting their first quarter results for 2021 starting this week are expected to reflect continued pressure on their profitability, largely due to margin pressures, modest loan growth and slow growth in non-interest income streams.

The aggregate net profit of the top 10 UAE banks declined by about 40 per cent year on year in 2020, on the back of lower operating income and increased provisions, according to data analysed by Alvarez & Marsal (A&M) and KPMG.

A&M expects the operating environment for the UAE’s banking sector to remain less volatile in 2021 compared to last year, although profitability isexpected to remain under stress.

“The anticipated economic recovery in 2021 should support the operating environment and the fundamentals of banks in the UAE. Profitability in the sector has shown signs of vulnerability with declining interest income and increased provisioning weighing on the net profit,” said Asad Ahmed, A&M Managing Director and Head of Middle East Financial Services.

Loan deferrals

The recent extension of loan deferral programme until the end of 2021 by the Central Bank of UAE under its Targeted Economic Support Scheme (TESS) is expected to reduce the immediate impact of loan impairments to some extent.

Analysts expect the profitability in the sector will continue to remain vulnerable although some of the loan impairments will be postponed through the loan restructurings and deferrals.

Continuing weak loan demand along with asset quality pressures are expected keep profitability under pressure. Although the immediate pressure on banks to take provisions on expected credit losses has been reduced because of the extension of the central bank forbearance measures, most banks are likely to make quarterly provisions as a matter of prudence.

Low asset yields resulting from low interest rates along with higher provisions impacted bank profitability last year. Net interest income (NII) decreased about 2 per cent year on year, as system-wide rates decreased substantially after the Central Bank of the UAE slashed rates to counter the effects of the COVID-19 pandemic. However, net interest margins improved as banks were able to reduce their funding costs further.

“With revenue pressure expected to continue in 2021, the only way banks are likely to maintain profit margins will be by strictly managing costs. Underlying this is the need to bolster back-end functions, which tend to be driven by people and paper, rather than merely focusing on what is visible to the customer,” said Abbas Basrai, Partner and Head of Financial Services, KPMG Lower Gulf.

Squeeze on income streams, profits

Growth in aggregate loans and advances increased at a marginal rate of 1.4 per cent year on year in 2020, as economic slowdown due to the outbreak of the pandemic impacted credit demand. Similarly, deposit growth slowed to 3 per cent during the period. Consequently, aggregate loans to deposits ratio fell to 86.2 per cent from 87.5 per cent.

UAE banks expect to see an increase in credit demand in the first quarter of 2021 according to the fourth quarter 2020 credit sentiment survey of the Central Bank of UAE.

The Credit Sentiment Survey is a quarterly publication of the CBUAE, which collects information from senior credit officers from all banks and financial institutions extending credit within the UAE.

The survey respondents are expecting an increase in overall credit appetite in the first quarter of 2021 with an optimistic outlook for business loan demand, expecting a notable increase across all Emirates while personal loan demand expected to remain largely unchanged.

Net interest margin improved for most of the banks in in the fourth quarter of 2020 and the trend is likely to continue in the first quarter of 2021 as banks have taken measure to reduce costs of funds by switching high cost liabilities with those with lower costs. Despite these efforts the yield on credit is expected to remain historically low because of the continuing low interest rate environment.

Last year non-interest income of leading UAE banks declined due to lower income from fee-based activities, investment securities and market trading.

“This negative trend was led by weaker trading volumes, fewer fee-generating transactions, and lower income from investment securities,” said Francesca Paolino, an analyst at Moody’s Investors Service.

Cost efficiency

Leading UAE banks’ maintained their strong cost-efficiency in 2020 and will continued to do so this year. Cost-to-income (C/I) ratio of top 10 band increased by 1 per cent year on year to 34.5 per cent, despite 1 per cent decline in operating expenses. C/I ratio increased as operating income dropped at a higher rate compared to operating expenses. The decrease in expenses can be partially attributed to cost cutting measures implemented by major banks like Abu Dhabi Commercial Bank and Emirates NBD.

Despite a challenging business environment, aggregate capital adequacy ratio of the UAE banks remained robust at 17.6 per cent at the end of December 2020, compared to 17.3 per cent at the end of December 2019.