A teller at a bank in Dubai
A teller at a bank in Dubai. Profitability of top UAE banks declined in the third quarter of 2020 due to low interest rate environment and flat loan growth. Image Credit: Gulf News Archives

Dubai: Profitability of top UAE banks declined in the third quarter due to the low interest rate environment and flat loan growth. The Top 10 banks’ total interest income declined for a third consecutive quarter - by 7.7 per cent quarter-on-quarter - according to the consultancy Alvarez & Marsal.

The report showed lower interest rate environment continued to pressure banks’ asset yield. After a relatively stronger second quarter, net income declined by 3 per cent quarter on quarter (QoQ) due to lower interest and other operating income, which continued to impact profitability.

“After a rebound in performance in Q2 2020, profitability of the top 10 UAE banks in Q3 2020 showed signs of vulnerability with declining interest income and increased provisioning weighing on the net profit. We expect the economic conditions in the UAE and the region generally to remain challenging in the near term, which would likely limit credit and earnings growth and also result in higher non performing loans (NPLs),” said Asad Ahmed, A&M Managing Director and Head of Middle East Financial Services.

Flat loan growth

The challenging economic environment impacted credit uptake as loans and advances remained flat in Q3 2020 compared to Q2 2020. On the other hand, deposits increased 4.2 per cent QoQ, largely on the back of 16 per cent increase in FAB’s deposits. Consequently, loans to deposit ratio (LDR) decreased to 84.1 per cent compared to 87.7 per cent in Q2 2020. Top 10 banks have provided borrowers access to Dh51.1billion at the end of the third quarter under the UAE Central Bank’s Targeted Economic Support Sceheme (TESS).

We expect the economic conditions in the UAE and the region generally to remain challenging in the near term, which would likely limit credit and earnings growth and also result in higher non performing loans (NPLs).

- Asad Ahmed, A&M Managing Director and Head of Middle East Financial Services.

Operating income continued to decline for the third consecutive quarter. Persistent decline in net interest income (-6.7 per cent QoQ) weighed on the operating income, which decreased 3.4 per cent QoQ. Low interest rate environment continued to pressure asset yields among the banks and impacted net interest income. On the other hand, there was an increase in net fee income (+18% QoQ), which limited the decline in total operating income.

Margin squeeze

NIM
Contraction in UAE banks' net interest margin continued in the third quarter 2020.

Contraction in net interest margin (NIM) continued in the third quarter. Aggregate NIM fell by about 21 bps to 2.05 per cent in Q3 2020, on account of additional decline in interbank rates. NIM fell for the third consecutive quarter, as nine of the banks reported lower NIM during the period.

Rising cost-to-income

Cost-to-income (C/I) ratio of top 10 banks increased, as reduced operating income more than offset cost efficiency measures. Cost-to-income ratio increased by 0.9 per cent points to reach 34.3 per cent. C/I ratio increased despite a 0.7 per cent QoQ decline in operating expenses.

Seven of the top 10 banks reported an increase in C/I ratio. Emirates NBD, Abu Dhabi Islamic Bank and Sharjah Islamic Bank reported a decline in their CI ratios. ADIB’s C/I ratio declined as the bank was able to reduce its customer acquisition expenses, optimize branch network and introduce technologies to streamline processes.

Cost to income ratio
Seven of the top 10 UAE banks reported an increase in C/I ratio.

Asset quality

Total loan loss provisions decreased 7.2 per cent quarter-on-quarter, but they increased by about 37 per cent year-on-year. Challenging market environment on account of COVID-19 headwinds resulted in higher NPLs (+3.6% QoQ).

Cost of risk fell 11 bps YoY to 1.3 per cent, while coverage ratio increased 1.1 per cent to 90.3%. In terms of individual banks, Mashreq reported the highest increase in cost of risk (about 55 bps QoQ to 333.8 bps), with the bank’s provisions rising about 17 per cent QoQ / about 2.3 time year on year for the first nine months.

Relief extension

Banks are likely to see higher NPLs in the coming period. While the Central Bank’s recent announcement that it will extend the TESS scheme until June 30 next year should provide temporary relief to certain sectors, banks’ balance-sheets remain exposed to considerable credit risks. Once the deferral period ends, there could be a sizeable increase in NPLs for the banks, should the economy fail to recover.

“However, we remain confident that this initiative will allow the economy to gradually recover from the effects of the pandemic,” said Ahmed.

Profitability

Profitability deteriorated as lower income stream weighed on return ratios. Aggregate net income dropped 3 per cent quarter-on-quarter as lower operating income more than offset lower operating expenses and provisioning. Consequently, profitability metrics such as the return on equity - at 8.8 per cent [0.6 per cent lower QoQ] - and return on assets - 1 per cent [0.1 per cent lower QoQ]) - decreased compared to the second quarter.

“We note that RoA and RoE within the banking sector continue their downward trend; this may provide an opportunity for banks to look into further consolidation, and focus on integrating new technologies to rationalize costs,” said Ahmed.