A teller at a bank in Dubai
A teller at a bank in Dubai. Early indicators from the first quarter results of UAE banks point to a spike in provisions on expected credit losses from COVID-19 linked loan impairments and lower loan yields. Image Credit: Gulf News Archives

Dubai: Early indicators from the first quarter results of UAE banks point to a spike in provisions on expected credit losses from COVID-19 linked loan impairments and lower loan yields as a result of low interest rates are hurting profitability and the impact is likely to linger on for the rest of the year.

Earlier this week First Abu Dhabi Bank (FAB), the UAE’s largest bank reported a net profit of Dh2.4 billion for the first three months of 2020, down 22 per cent from Dh3.1 billion in the same period in 2019.

The bank attributed the decline in profit mainly to lower revenue due to rate cuts and unprecedented market conditions during the period, as well as the higher provisioning in light of a more challenging operating environment. Operating income at Dh4.6 billion was 8 per cent lower year-on-year.

Emirates NBD another large bank reported a net profit Dh2.1 billion for the first quarter of 2020 reflecting 24 per cent decline year on year. The bank attributed the squeeze on Q1 net profit to higher impairment charges.

Mashreq, the first among the UAE banks to report Q1, 2020 results posted a net profit of Dh450 million, down 28.3 per cent year-on-year, largely attributing to higher provisions.

Asset quality challenges

Results of all three banks point to asset quality challenges impacting their bottom-lines while maintaining robust asset growth even under difficult economic environment.

FAB reported impairment charges at Dh738 million reflecting higher provisioning. At the close of the first quarter, the non-performing loan ratio at 3.5 per cent with provision coverage ratio at 95 per cent.

Despite the uptick in provisions, the bank continued to maintain a healthy growth in balance sheet with total assets surging 14 per cent year on year to Dh835 billion at the close of the first quarter. Loans and advances at Dh382 billion was up 6 per cent year-on-year. Customer deposits at Dh497 billion was up 15 per cent.

During the quarter, ENBD’s impaired loan ratio remained stable at 5.5 per cent. The impairment charge in Q1 2020 of Dh2.55 billion was higher 349 per cent year on year and 24 per cent quarter on quarter due to higher Stage 1 and 2 expected credit loss (ECL) allowances.

“Net operating profit declined 24 per cent year on year as the Group took additional impairment allowances to increase coverage in anticipation of a deterioration in credit quality in subsequent quarters. Regional banks face multiple challenges from low interest rates, low oil prices and lower economic growth due to disruption from COVID-19,” said Patrick Sullivan, Group Chief Financial Officer.

Mashreq’s Q1 results too reflected loan impairment challenges the bank’s non-performing loans (NPLs) to gross loans ratio increased to 4.4 per cent by March end vs 3.6 per cent in December 2019. Despite the challenging operating environment, Mashreq’s total assets grew 2 per cent to Dh162.6 billion while loans and advances increased by 2.8 per cent to Dh78.3 billion as compared to December 2019.

Strong liquidity and capital levels

All three banks have reported fundamental strength of balance sheet with strong liquidity levels and capital adequacy to address the emerging challenges. At the close of the first quarter 2020, FAB reported strong liquidity and funding profile with a liquidity coverage ratio at 110 per cent. Bank’s common equity tier 1 (CET1) ratio at 12.1 per cent, in excess of regulatory requirements.

ENBD, as at 31 March 2020, reported liquidity coverage ratio of 149.7 per cent and advances to deposit ratio of 94.8 per cent. At the close of the quarter, common equity Tier 1 ratio was 14.8 per cent, tier 1 ratio is 16.8 per cent and capital adequacy ratio is 17.9 per cent. Mashreq’s liquid assets ratio stood at 31.8 per cent at the close of the first quarter with cash and due from banks at Dh46.2 billion. Capital adequacy ratio and Tier 1 capital ratio continue to be higher than the regulatory limit - at 15.9 per cent and 14.8 per cent respectively.

Prudent reporting could limit immediate impact of provisions
Dubai: In a recent move the Central Bank of UAE (CBUAE) has issued a new requirement for all banks to apply a prudential filter to International Financial Reporting Standards 9’s (IFRS 9) expected credit loss (ECL) provisions to minimize provision requirements at a time banks are hard pressed for liquidity and funding.
“The prudential filter aims to minimize the effect of IFRS 9 provisions on regulatory capital, in view of expected volatility due to the COVID-19 crisis. Any increase in the provisioning compared to 31 December 2019 will be partially added back to regulatory capital,” the CBUAE said in a recent statement.
According to the proposed transitional arrangements IFRS 9 provisions will be gradually phased-in during a five-year period, ending 31 December 2024.
Analysts said the change in approach to IFRS 9 is in sync with the dramatic economic consequences of COVID-19 outbreak on the economy and the banking sector.
“Introducing transitional arrangements for the accounting of expected credit losses at banks will delay banks’ creation of provisioning buffers to absorb potential future credit losses, a credit negative. Nonetheless, the transitional arrangements give banks greater flexibility to support borrowers facing temporary liquidity issues,” said Mik Kabeya, an analyst at credit rating agency Moody’s.
According to KPMG, concerns have been voiced about the effect of the relatively new IFRS 9 standard and expected losses (ECLs) reporting, which may force banks to take earlier provisions against bad loans.
“Several assumptions and linkages underlying the way ECLs have been implemented to date may no longer hold in the current environment; banks should not continue to apply their existing ECL methodology mechanically,” said Emilio Pera, Partner Head of Audit KPMG Lower Gulf.