Dubai: GCC banks are expected to face continued asset quality risks resulting in higher loan impairments and elevated provisions leading to strain on profitability in 2021, according to analysts and raging agencies.
Rating agency Fitch says that asset-quality deterioration is the main risk for GCC banks following the economic shock due to the coronavirus pandemic and low oil prices.
The rating agency believes the prolonged loan deferral schemes have only postponed the asset quality issues.
“The extension of support measures for borrowers will limit short-term pressure on asset quality, delaying the recognition of Stage 3 loans well into 2021. Nevertheless, asset-quality metrics could weaken materially in 2021-2022 once support measures are withdrawn,” said Redmond Ramsdale, Head of Middle East Bank Ratings at Fitch.
Rating agency Standard & Poor’s sees the region’s banking sector recovery from the impact of the pandemic to be gradual in 2021. Analysts said UAE banks’ asset quality will likely deteriorate and the cost-of-risk to increase further as the Central Bank of UAE (CBUAE) will lift its forbearance measures gradually in the second half of 2021.
Loan restructuring and potential problem loans (the sum of Stage 2 and Stage 3 loans under IFRS 9) started increasing soon after the onset of the pandemic and borrowers could face lasting pressure from economic weakness and low oil prices.
Prolonged borrower support
Several GCC countries have prolonged their loan deferral schemes and other support measures to alleviate cash flow pressure on households and corporates.
Oman and Saudi Arabia have extended their schemes to end-March 2021, Qatar to mid-June 2021, and Bahrain and the UAE to end-June 2021. Kuwait is accordingly the only GCC country where payment holidays have not been extended beyond September 2020.
Many banks across the GCC, particularly in the UAE have taken advanced provisioning for expected credit losses, front-loading their provisions in anticipation of severely weaker credit conditions. This dented their profitability in 1H20, still at an early stage of the pandemic and well in advance of most of the asset-quality deterioration that they are likely to experience.
“We expect the average cost of risk (loan impairment charges/average gross loans) to have almost doubled in 2020, reflecting mainly forward-looking provisions booked by the banks,” said Ramsdale.
Deferred loan exposures
Exposures to deferred loans vary between and within GCC banking sectors, as do the associated risks.
According to Fitch, in the UAE, the four largest banks’ deferred exposures accounted for 2.9 per cent of total loans on average at the end of the third quarter of 2020. Including all related balances would push the ratio to 20 per cent of total loans. These exposures were mostly in the real estate, construction, services and retail segments. On average, 13 per cent of deferred loans and related balances (2.6 per cent of total loans) were classified as Stage 2 and could migrate to Stage 3 if these borrowers’ ability to face the pandemic weakens further.
The extension of the UAE’s loan deferral scheme until end the end of first half of 2021 should limit loan migration to Stage 2 and Stage 3 temporarily. However, a more significant migration is likely in in the second half of 2021-2022 unless there is a strong recovery in economic activity and particularly in the real estate and construction sectors.
In Saudi Arabia, loans under payment holidays amounted to SAR77 billion in November 2020 according to the Saudi Central Bank. This equates to only 4.4 per cent of total banking sector credit at end of the third quarter of 2020. The small proportion reflects the fact that only micro, small and medium-sized enterprises are eligible for payment holidays.
Risks lower in Kuwait
Kuwait’s loan deferral scheme was largely targeted at the retail segment, with corporates considered on a case-by-case basis.
Fitch views the Kuwaiti and Saudi banking sectors as the least vulnerable in the GCC to increasing asset-quality risk given their healthy pre-pandemic credit fundamentals and their low levels of impaired loans.
Qatari banks also have relatively strong credit metrics owing to a high proportion of domestic government exposure and lower Stage 3 loans ratios pre-pandemic. However, they could face pressure on asset quality from weakness in the real estate and construction segments as well as from high levels of Stage 2 loans.
Under the expected credit loss (ECL) framework, impairment of loans are recognised under three stages.
Under the general approach, an entity must determine whether the financial asset is in one of three stages to determine both the amount of ECL to recognise as well as how interest income should be recognised.
Stage 1 is where credit risk has not increased significantly since initial recognition. For financial assets in stage 1, entities are required to recognise 12-month ECL and recognise interest income on a gross basis – this means that interest will be calculated on the gross carrying amount of the financial asset before adjusting for ECL.
Stage 2 is where credit risk has increased significantly since initial recognition. When a financial asset transfers to stage 2 entities are required to recognise lifetime ECL but interest income will continue to be recognised on a gross basis.
Stage 3 is where the financial asset is credit impaired. This is effectively the point at which there has been an incurred loss. For financial assets in stage 3, entities will continue to recognise lifetime ECL but they will now recognise interest income on a net basis. This means that interest income will be calculated based on the gross carrying amount of the financial asset less ECL.
Rating agency Fitch expects asset quality of UAE banks to deteriorate as payment holidays expire and not all borrowers are able to weather the downturn. This is particularly true in real estate, contracting, retail, aviation and hospitality sectors.
The agency expects a spike in Stage 3 loans under the IFRS 9 reporting classification. “Stage 3 loans could rise to 6.5 per cent of gross loans by end-2021 from 4.9 per cent at end-2019, which would be well above levels reached during the last oil price shock in 2014-2016, said Redmond Ramsdale, Head of Middle East Bank Ratings at Fitch.
"In addition, increasing restructuring and extension of support measures until end-H1-21 masks the true increase in Stage 3 loans.”
Stage 2 loans ratios vary across UAE banks and are not yet fully comparable. But some have reached 20 per cent and above, indicating potential for high asset quality pressure.