UAE’s credit demand seen picking up in the third quarter
The net profit of top 10 UAE banks declined by 22.4 per cent quarter on quarter in Q1 2020 on account of a 3.6 per cent drop in operating income and a 35 per cent increase in provisioning. Image Credit: Supplied

Dubai: The UAE’s banking sector is facing challenges on its asset quality and profitability from COVID-19 and low interest rate environment, according to an analysis of the first quarter 2020 financial results of top 10 banks by Alvarez & Marsal (A&M).

The report said that the top 10 UAE banks reported a combined 6.3 per cent quarter-on-quarter drop in interest income, largely due to the low interest rate environment.

The net profit declined by 22.4 per cent quarter on quarter on account of a 3.6 per cent drop in operating income and a 35 per cent increase in provisioning. Consequently, the average return on equity (RoE) for the universe was impacted by the reduced operating income due to a series of rate cuts and increased provisioning.

Dr. Saeeda Jaffar

“The Covid-19 pandemic has negatively affected the real estate market in the UAE with banks’ exposure reduced by about 100 bps compared to the last quarter. The subsequent pressure on the real estate sector is imminent, underpinned by economic slowdown and persistent oversupply,” said Dr. Saeeda Jaffar, co-author of the report and Managing Director and Head of Middle East A&M.

Slow growth

When compared to Q1 2019, banks’ loans and advances and deposit growth was the slowest amid tight market conditions.

Operating income
Operating income Image Credit: Alvarez & Marsal

Total loans, advances, and deposits increased 0.9 per cent and 0.5 per cent, respectively. Despite the completion of Dubai Islamic Bank’s (DIB’s) acquisition of Noor Bank, the loans and advances and deposit growth for the top 10 banks increased at a marginal pace only. Consequently, loans to deposit ratio (LDR) increased to 87.8 per cent from 87.4 per cent in Q4 2019.

At the aggregate level, operating income of top 10 UAE banks declined after increasing for two consecutive quarters. The operating income sank by 3.6 per cent from Q4 2019 as major income streams reported reduced contributions. Net interest income (NII) dropped by 3.1 per cent as low interest rates fully offset a marginal increase in loans and advances and non-interest income dropped by 4.9 per cent, which impacted total operating income.

Margin squeeze

Net interest margin (NIM) witnessed sizeable contraction by about 15 bps to 2.54 per cent in the first quarter of 2020, on account of a sharp decline in interest rates. NIM decreased after rising for two consecutive quarters. Seven of the top 10 banks reported a decline in NIM.

NIMs Image Credit: Alvarez & Marsal

Cost-to-income (C/I) remained one of the few areas where some progress was seen. After rising throughout 2019, C/I ratio fell by about 1.1 per cent points to reach 34 per cent. C/I ratio declined largely on the back of a 6.8 per cent quarter on quarter decline in operating expenses. Cost-cutting measures adopted by the banks resulted in some improvement as eight of the 10 banks had reduced their operating expenses.

Asset quality & profitability

Total loan loss provisions of top 10 banks saw a sharp increase by 35 per cent from Q4 2019, while non-performing loans (NPL) to net loans ratio increased substantially to 5.2 per cent. Tough market conditions due to COVID-19 headwinds was the primary factor that led to increased provisioning. Cost of Risk (CoR) increased to 1.8 per cent as banks took increased provisioning because the challenging operating environment weighed on asset quality.

Return on equity (RoE) continues to exacerbate in Q1 2020 with 9 per cent, compared to 15.4 per cent in Q1 2019.

“A low interest environment and increased provisioning impacted the net profit of the top 10 UAE banks. Profitability metrics (RoE and RoA) declined to multi-period low levels on the back of lower operating income and increased provisioning, which weighed on the net income,” said Asad Ahmed, Co-author of the report and Managing Director, Head of ME Financial Services at A&M

Asad Ahmed

The country’s 10 largest listed banks by assets analysed in A&M’s UAE Banking Pulse are First Abu Dhabi Bank , Emirates NBD, Abu Dhabi Commercial Bank, Dubai Islamic Bank, Mashreq Bank, Abu Dhabi Islamic Bank, Commercial Bank of Dubai, Emirates Islamic Bank, National Bank of Ras Al-Khaimah and Sharjah Islamic Bank.