Emirates NBD Head Office at Baniyas street in Dubai. The UAE banks are expected to face a much lesser volatile operating environment in 2021 compared to last year. Image Credit: Ahmed Ramzan/ Gulf News

Dubai: The UAE banks are expected to face a much lesser volatile operating environment in 2021 compared to last year, however, the lingering impact from 2020 will continue to pressure profits and asset quality, according to analysts.

Banks are expected to report in excess of an average 20 per cent year on year decline in profits for the whole of 2020 with earnings outlook remaining modest in 2021.

The UAE banks have suffered the effects of three pronged storm in 2020 including a weak economic backdrop, the impact of the global pandemic and geo political tensions, according to a recent analysis by Bank of America Merrill Lynch (BoAML).

A host of factors such as the continuing margin compression from low interest rates, the likelihood of elevated levels of non-performing loans are expected to keep the bank profits flat in 2021.

Data for the third quarter showed 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.

Their analysis showed lower interest rate environment continued to pressure banks’ asset yield. “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 profits

Given the persistence of risk factors from 2020, market expectations remain tepid with the IMF forecasting 2021 GDP growth of just 1.3 per cent in the UAE following a contraction in excess of 6 per cent in 2021.

On the banking side, while margin compression is expected to abate, there is little scope for expansion as Fed rates are set to remain near zero per cent.

“Loan growth is expected to reach mid to low single digits and provisioning to remain elevated at about 130bps on average. As such, we (and consensus) expect aggregate banking revenues and net income to remain broadly flat year on year in 2021,” said the BoAML analysis.

Reforms to drive growth

While the backdrop remains cautious, BoAML analysts see a number of factors that provide upside to earnings via a more optimistic economic outlook, with stronger loan growth and lower provisioning costs and the recent announcement that 100 per cent foreign ownership of businesses.

Analyst believe the recent economic and social reforms s will pave the way for significant FDI, 10 year visas and Retirement visas are now being issued, which we see combatting the persistent population decline which the UAE has suffered over the past few years. The announcement of diplomatic relations with Israel is widely expected to reduce geopolitical risks in the region and spur economic activity.

Vaccine impact

The news that multiple, highly effective vaccines have been developed to protect against COVID-19 is particularly pertinent to the UAE. BoAML analysts believe the vaccine provides a realistic chance that the travel & tourism sector (including attendance at the EXPO) and trade could rebound more strongly than currently anticipated.

Strengths and weaknesses of UAE banks in 2021
The UAE banks have strong capital buffers and liquidity with an underlying state support in the event of any structural risks. However, banks continue to face challenges from asset quality pressures, shrinking coverage ratio for bad loans and concentration of exposure to real estate sector.

Capital buffers
Capital ratios in the UAE are among the highest in the region. The average CET1 [common equity tier 1] stands at 13.4 per cent while the average CAR [capital adequacy ratio] stands at 16.6 per cent. Leverage is low as well with equity to assets at 12.1 per cent in average.
In March, the central bank allowed banks to tap up to 60 per cent of their capital conservation buffer currently set at 2.5 per cent of risk-weighted assets, while the four domestic systemically important (D-SIB) banks were able to use up to 100 per cent of their D-SIB buffer.

Sound liquidity
Liquidity in the banking system remains sound and stable. As loan growth remains subdued around 5.5 per cent, the system loan to deposit (L/D) ratio has stabilized around 95 per cent for the last 2-3 years. Also, like in other GCC countries, state deposits in the system are high at 19 per cent of the total and provide some cheap funding for banks.
In addition, as part of the support measures to mitigate the impact from Covid-19, the Central Bank of UAE launched a comprehensive Targeted Economic Support Scheme (TESS) boosting liquidity in the banking system.
Strong state support
The government is expected to continue to support the major banks in the UAE. The UAE authorities provided support, in the form of additional capital and liquidity, to its banks in 2008/09. The banks’ senior ratings continue to benefit from multi-notch uplifts for support.

Asset quality
While the UAE has experienced a low growth environment since late 2014, asset quality pressures have been muted until late 2019. However, pressure have accelerated since then driven by a weak macro environment combined with the COVID-19 outbreak starting from March. As a result, non-performing loans increased by close to 60 per cent year on year as of September end.

Coverage ratio
As of September end, the average NPL ratio stand at 5.8 per cent while Stage 2 loans represent another 7.9 per cent of the loan book. NPL total coverage has deteriorated materially to 78 per cent at the end of September compared to 113 per cent a year ago. Banks’ management are guiding for more pressures to come in 2021 and for elevated cost of risks to be sustained next year.

Real estate concentration
Exposure to the construction and real-estate sectors is quite high across the banking system at about 20 per cent, but as high as 25-30 per cent at some banks.