Abu Dhabi/Dubai: The UAE's 15 largest local banks made a lot of money last quarter Dh5 billion in net earnings to be exact.

In times like these, however, banks are analysed in terms of the quality of assets they have on their books, how much they hold in non-performing loans and whether they even have enough deposits to cover their lending.

Furthermore, analysts and bankers are looking for signs of recovery. As far as the above indicators are concerned, the answer is still ‘Not yet'.

The widely-anticipated second quarter earnings season has come to an end with the majority of UAE banks announcing significant improvement in profits from the first three months of the year.

Results exceeded many analysts expectations, though the profitability levels of yesteryear more specifically 2008 are a distant memory.

Encouraging signs in the UAE economy, buoyed by significant government and central bank measures, as well as returning investor confidence in the markets, have inevitably had a positive knock-on effect on the banking sector.

Still, banks have, on the whole, increased provisioning for defaulting loans as the year progresses.

Analysts have also highlighted that banks' loans to deposit ratios, coupled with deteriorating asset quality, remain serious concerns for the remaining months of the year. For these reasons, talk of the often-cited “green shoots of recovery'' may still be premature for the country's banks.

“With the exception of the high loan-to-deposits ratio, the fundamentals of the banks appear to be sound. Although funding conditions have not returned to normal, they have improved considerably over the last six months,'' says Victor Lohle, senior credit analyst at Standard Chartered Bank.

“Our main concern relates to asset quality. Over the next six to 12 months we expect it to deteriorate and this will have knock-on effect on profits. Exposure to [the Saudi-based] Saad and [Ahmad Hamad] Algosaibi [groups] is likely to add to the asset-quality pressures of some of the banks. If current trends continue, it is possible that some of the banks will report fourth quarter losses,'' he said.

None of the local banks reported a loss last quarter. However, banks across the region have been affected by the financial troubles facing two of Saudi's largest and most renowned family business groups, Saad and Algosaibi groups. The exact extent of banks' exposures remains undisclosed.

Lending

Recently released central bank data shows a consistent increase in total loans and advances since February this year. They surpassed the Dh1 trillion mark in May.

Still, personal lending has been more constrained. Tighter lending and a waning appetite for debt led to a decline of more than 10 per cent in personal loans in the first quarter of 2009 compared with the end of 2008.

In the second quarter, personal loans actually increased between April and May before falling to Dh205.2 billion at the end of June, meaning banks are likely to remain conservative in the short term.

“We have definitely seen a slowdown in demand for personal lending in the last six months, and we will continue to be conservative in lending and pricing until the end of the year,'' Suvo Sarkar, executive vice-president and general manager for retail banking at Emirates NBD said.

Emirates NBD is the country's largest bank by assets. The bank reported Dh852 million in second quarter profits, a 41 per cent decline from last year.

While lending has tightened, banks have also encountered challenges in attracting new deposits.

The loan-to-deposit ratio is the amount of a bank's loans divided by the amount of its deposits at any given time. The higher the ratio, the more the bank is relying on borrowed finance. At the end of June, UAE bank deposits totalled Dh961.7 billion, down from Dh972.4 billion at the end of May.

According to central bank figures, UAE banks increased their total provisions allowance to Dh32.5 billion at the end of June compared to Dh25 billion in December, 2008.

“High levels of provisioning are always a good thing,'' Deepak Tolani, Al Mal Capital analyst said.

“It's like saving for a rainy day. You may not need it, but it's nice to have it.''

Economists generally view increased provisioning as an indication of the easing of recessionary activity. Tolani said that in the case of the UAE's banking sector, recovery would take time because of the sector's size and lending commitment to real estate projects and credit card customers.

“There's a lot more pain to come through,'' Tolani said. Construction, real estate and credit card loans account for 46 per cent of total lending for the UAE's five largest banks studied by Al Mal Capital.

“All of that has to get flushed through the system,'' he added.

If decreased lending and rising levels of bad debt are not enough, banks will also have to deal with concerns over their exposure to Saad and Algosaibi G=groups.

Exposure

Aside from the minimally-exposed National Bank of Abu Dhabi (Dh40 million) and non-exposed Dubai Islamic and Union National Banks, no other UAE banks have revealed their exposure.

A survey-based Standard and Poor's report released last month estimates Saad and Algosaibi, whose loan default problems surfaced in June, owe $9.6 billion (Dh35.3 billion) to 30 Gulf-based banks.

UAE Central Bank Governor Sultan Bin Nasser Al Suwaidi has admitted that the exposure of local banks to the two groups was “significant.'' He has not disclosed any exact figures.

“At this stage it is too early to quantify the impact of any losses, as the levels of exposure and the amount of any collateral held against these exposures is unknown,'' says Lohle, the Standard Chartered analyst. “The level of exposure and any expected losses for the other banks is, at this stage, guesswork.''

Last month, Mashreq Bank — which announced a second quarter profit of Dh461 million, down 38 per cent from last year said it would begin legal proceedings against Saad group.

Meanwhile, international ratings agencies have reflected concerns in the UAE banking sector in recent ratings movements.

The UAE's banking sector has been characterised by strong growth in the past five years. Fuelled partly by the government's liberalisation efforts and consistent double-digit economic growth, deposit and lending levels grew at unprecedented levels and so did the bottomlines of banks.

Looking ahead, the emphasis is likely to be on increasing profitability in the second half of 2009, to end the year on a positive note something easier said than done. “We believe that asset quality will gradually deteriorate on the back of higher corporate and consumer defaults. Banks are a reflection of the economy and this is what happens in an economic slowdown.

“From the time the economy hits the bottom to the time banks' asset quality indicators begin to improve, there can be a lag of six to nine months. We estimate the economy is going to bottom out by year end, so in 2010 bank asset quality indicators should begin to show some improvement,'' Lohle added.

A reconcentration of core business activities, including the disclosure of consistently increasing operating profits should bring some optimism to the industry. External factors such as rebounding oil prices and improving conditions in international markets will also have an impact on the country's banking sector.

Even without a global recession, economists admit the drop in profits was inevitable after last year's exceptional growth.

By Ahmed A.Namatalla and Rachna Uppal, Staff Reporters

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