Weathering the storm

The UAE's banking sector remained well protected right from the beginning of the global financial crisis as the UAE Central Bank and the Federal Government extended unconditional support to maintain the integrity of the nation's financial system.

The UAE Central Bank Governor Sultan Bin Nasser Al Suwaidi said recently that the Central Bank is working on a plan to regulate the credit and mortgage markets to improve lending.

At the height of the liquidity boom between 2004 and 2008, the country experienced average credit expansion in excess of 30 per cent. This fell to single-digit growth following the global liquidity crisis. "We need to control this kind of fluctuation in the credit markets," Al Suwaidi said.

The amount of loans disbursed by banks during 2009 grew by 4 per cent. The Central Bank governor said the growth will remain around the same level this year.

He said the Central Bank is looking at reforming the mortgage business in the country in view of the severe crunch following the financial crisis. "There has been significant slowdown in the mortgage sector and the cost of mortgage financing is excessively high. This needs to be rectified in the interest of investors and the economy at large," Al Suwaidi said.

Commenting on banking sector liquidity, the Central Bank governor said there has been significant improvement in deposits and there has been an increase in the flow of external deposits to the banking system.

In response to the liquidity squeeze that began in the third quarter of 2008, the Central Bank of the UAE responded by guaranteeing deposits for three years and provided a Dh50 billion liquidity support. The Ministry of Finance injected Dh70 billion of deposits, which it later agreed to be converted into subordinated debt, and Abu Dhabi injected Dh16 billion of Tier 1 capital into its five largest banks.

While the government and the Central Bank made timely capital injections, additional liquidity support and deposit guarantee to the banks, the UAE banks on their own made prudent provisions to protect their balance sheets against the significant surge in bad loans.

Various analysts and rating agencies who have stress tested the UAE's banking system have concluded that the local institutions are well capitalised to withstand the deterioration of asset quality it faces.

"UAE banking sector's strong capitalisation should make its current challenges manageable despite rising impairments and difficult operating conditions. As such, Fitch believes that fresh government support for the sector is less likely to be required," said Robert Thursfield, a Dubai-based director in Fitch's Financial Institutions team.

UAE banks faced significant asset quality problems in 2009, but their capital levels and strong core profitability have allowed them to absorb losses without significantly undermining their creditworthiness. Systemic support provided by the UAE's Federal Government has also helped banks better confront their financial challenges. Nevertheless, asset quality pressures stemming primarily from Dubai-based entities and significant exposure to real estate sector continue to weigh heavily on their balance sheets.

Loan growth has been negligible across UAE banks in 2009 and in the first half of 2010, as fear of mounting non-performing loans kept banks risk-averse and earnings took a beating as provisions climbed.

"The operating environment remains difficult, with low economic growth and investment, weak demand for loans, as well as investor confidence issues which are curtailing the banks' ability to access low cost, wholesale funding. As a result, in 2009, the UAE banks did not engage in any significant new lending," said John Tofarides, an analyst with Moody's.

The overall loan growth across the banking sector was 0.8 per cent in the first half of this year compared to an average growth of 1.5 per cent in the first half of 2009 and 24 per cent in the same period in 2008. Analysts and bankers expect loan growth to remain low as banks are focusing more on balance sheet repair.

Al Suwaidi said the UAE's banking sector didn't shrink during the financial crisis but has instead grown at a slower rate. "As of June 30, total assets and liabilities were Dh1.59 trillion, total deposits at Dh985 billion, loans and advances at Dh1.096 trillion," he said.

"We expect loan growth to remain under pressure for the rest of the year. We believe much of the risk aversion on the part of banks stems from uncertainty about potential future losses and write-downs," said Sofia Al Boury, a banking analyst at Shuaa Capital.

Most leading banks reported declines in profit growth in the first half of this year. The earnings were impacted by the virtual stagnation of balance sheet growth and substantial write-downs on loans and investment impairments.

Shuaa Capital recently conducted a stress test on a sample of eight UAE banks such as Emirates NBD, National Bank of Abu Dhabi, Abu Dhabi Commercial Bank, Mashreqbank, First Gulf Bank, Dubai Islamic Bank, Union National Bank and Commercial Bank of Dubai, which account for almost 70 per cent of banking system assets last year.

"Our tests found the banking sector is sufficiently capitalised to withstand the significant deterioration in asset quality. Under our base case, average total capital adequacy ratio for our sample at 14.9 per cent is well above the 12 per cent UAE minimum, and average Tier 1 capital at 9.8 per cent above the 8 per cent UAE minimum," said Al Boury.

Analysts said under the current economic environment of extreme risk aversion among banks, additional capital injections could help in easing the situation.

Moody's considers the liquidity position of UAE banks to be satisfactory, and would expect additional funding support from the Federal Government, if required. In 2009, UAE banks managed their liquidity by curtailing loan growth, and they are continuing this approach in 2010 by extending new lending on a very selective basis.

Provisions set to surge

 Leading UAE banks have reported substantially lower provisions in the first two quarters than widely anticipated and this could have implications for bank profits in the two quarters ahead, according to banking analysts.

"Provisioning caused the main surprises. Across the sector, provisioning was significantly lower than we expected and, in general, the proportion of write-offs remained low," Raj Madha, an analyst wrote in a report published under Rasmala Investment Bank and Royal Bank of Scotland brand.

Among the leading UAE banks, the main exception was Abu Dhabi Commercial Bank (ADCB), which decided to provide for its Dubai World exposure early and disclosed significantly higher exposure than it had suggested earlier. At the other end of the spectrum, NBAD and ADIB continued to record low provisioning.

ADCB took a Dh1.035 billion impairment amounting to 15.7 per cent of its total exposure of Dh6.6 billion. Mashreq has suggested the impairment it will take will amount to a 5-10 per cent haircut, and Emirates NBD has indicated that its total impairment is likely to be no greater than Dh745 million, suggesting no more than a 10 per cent impairment rate.

Shuaa Capital, a Dubai-based investment bank, said in a recent report that all of the UAE banks have not come clear on their exposure to Dubai World provisions, which could range between Dh2 billion to Dh3 billion in the second half considering the latest data.

"Taking into account the latest public data on the restructuring proposal terms as well as the additional general provisions taken by banks in the first half of 2010, we estimated that they could require up to Dh3 billion on top of the Dh3.5 billion in first half provisions, Dh1.7 billion of which are known to be related to Dubai World," said Sofia Al Boury, a banking analyst with Shuaa Capital.