Dubai: Job losses across the private sector following the outbreak of COVID-19 pandemic and a contraction in economic activity resulting from oil price decline are hurting the profitability and asset quality of UAE banks.
The financial results of banks for the first half of 2020 revealed that top ten banks in the country have reported an average of 20 to 30 per cent decline in net profits resulting from sharp decline in their interest incomes and a spike in loan loss provisions.
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Bankers admit in private that new retail banking customer on-boardings have declined substantially in the second quarter resulting in contraction in the sales of retail loan products such as personal loans, mortgages, auto finance and card products.
“Recent job losses and the fear of further retrenchments have impacted demand for retail loan products. A decline in the number of new retail customers has reduced cross selling opportunities across our product portfolios,” said the retail banking head of a local bank.
The UAE’s PMI [Purchasing Managers’ Index] data for June and July showed rising new businesses drove a solid upturn in business activity. However, firms continued to lower employment in an effort to reduce payroll costs.
While output and new orders rose further in July, hiring intentions among UAE businesses remained weak as employment declined for the seventh month in a row. Firms were reportedly able to cover the rise in new work with existing workforces, as signalled by a stable level of backlogs. At the same time, company requirements to offset business costs led several respondents to cut payroll numbers.
“Employment fell for the seventh month in a row amid weak capacity pressures and efforts by companies to lower workforce costs. This acted as a drag on overall business conditions, as the headline PMI reading of 50.8 indicated just a marginal improvement,” said David Owen, Economist at IHS Markit.
Slowing loan demand
The UAE witnessed a decline in credit appetite for both business and personal loans during the second quarter of 2020, according to the second quarter 2020 Credit Sentiment Survey by the Central Bank of UAE.
The survey results showed credit demand from corporates and small businesses showed a decline, with over half of respondents, (53 per cent), assessing that demand has decreased either substantially or moderately. Almost a quarter of respondents saw no change in demand, while 22 per cent saw a moderate or substantial increase in demand.
COVID-19 and job losses in the privates sector was seen as the key reasons for decline in demand for personal loans and tightening of credit standards. The trend is broadly similar for all product categories of personal lending such as personal loans, auto loans, mortgages and credit cards. The main explanation for the reduced demand in the second quarter was the adverse change of income largely driven by private sector job losses, but the housing market and financial market outlook also contributed.
Decline in NII & NIM
Banks are experiencing net interest income (NII) and net interest margins as a result of both decline in the volume of lending and the yield on loans compared to the cost of funds.
“Retail and SME loan products are relatively higher yielding compared the corporate loans. A decline in their volumes and growth outlook is worrying from a profitability perspective,” said a banker.
The Central Bank of UAE implemented substantial cuts in interest rates following Federal Reserve rate cuts which in effect has started reflecting on the net interest margins and ultimately the profitability of banks.
“The sizable cut in interest rate will reduce UAE banks’ net interest margins (NIMs) because gross yields earned on loans will decline more than the funding cost paid on deposits, and because the rate cut is unlikely to materially increase credit volumes in the current difficult operating environment,” said Mik Kabeya, an analyst at Moody’s in a recent note.
The interest rate on certificates of deposit is down by a large 125 basis points since March 4, 2020.
“Weaker profitability from lower interest rates and NIMs will compound existing pressure on profitability from our expectation of low credit demand and higher provisioning requirements for UAE banks this year, amid challenging operating conditions,” said Kabeya.
Moody’s said lower interest rates will decrease UAE banks’ gross yields as they gradually reprice their loans, around 81 per cent of which were corporate, government and public sector loans at yearend 2019, which typically have floating rates that reset at intervals of around three to six months.
“We expect the weakening capacity of borrowers to repay their loans to trigger a migration of loans downwards to Stage 2 from Stage 1 under IFRS 9 and an increase in non-performing loans (migration to Stage 3 from Stage 2). Both migrations will bring about higher provisioning charges,” said Nitish Bhojnagarwala, Vice President and Senior Credit Officer at Moody’s in a recent note.
The latest credit sentiment survey of the CBUAE showed most of the banking sector loan growth was from government related entities higher rated large corporates. “This clearly reflects the lower risk appetite of banks for small and medium size enterprises that under pressure from the impact of COVID-19 and riskier retail customer whose job security is an important factor in banks’ asset quality,” said a banker.
Even in the corporate lending, bankers admit there is cherry picking happening. “Many banks are quietly deleveraging from some of their SME exposures are switching these with stronger corporates or GREs even at the cost of lower loan yields,” said a banker.