Stock DFM Dubai stock market traders
Watch out for the banking stocks... Conservative accounting practices will pay off for them and investors in the medium-term. Image Credit: Antonin Kelian Kallouche/Gulf News

The DFM gained 1.66 per cent and ADX closed higher by 1.15 per cent in the week ended March 4.

The top performers are Abu Dhabi Aviation (17.41 per cent), Emirates Driving Company (14.88 per cent), Al Dhafra Insurance (14.87 per cent), RAK National Insurance (13.98 per cent) and Dubai Refreshments Co. (13.64 per cent).

Among banks, National Bank of Umm Al Qaiwain (NBQ) recently announced its earnings report for 2020. Predictably, the bank, which derives 84 per cent of its revenue from retail and corporate services, suffered a setback on account of the pandemic.

Almost 31 per cent of the loan book was advanced to the real estate sector, while 69 per cent went to the wholesale and retail trade, personal loans, manufacturing, transport and and other financial institutions. So, this is a bank that is very much correlated to the performance of the UAE economy.

Despite the challenges, the bank could post a profit of Dh211 million on revenues of 417 million. In 2019, NBQ had a profit of Dh424 million from revenues of Dh608 million. Profit last year was impacted by a net impairment of Dh112 million. Nevertheless, things could turn out to be better due to the way banks do their accounting.

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Cautious with reserves

Banks' loan provisions are amplified because since they operate under 'Current Expected Credit Losses (CECL), which are guidelines developed in the aftermath of the 2008-09 recession. These laws require banks to make provision for possible losses on the entire life of their loan book.

This conservative accounting stance means banks are preparing for loss that they anticipate occurring in the future... even if there is no reason to believe specific borrowers will go into default.

The net result is banks front-load loan reserves more heavily than ever before. And they prepare for loan damages by reserving capital in advance. This capital is deducted from profits every quarter through a provision and added to a total loss bucket known as the allowance for credit losses.

Nevertheless, the worst-case scenario might not happen as mass vaccinations lead to a rapid bounce back in economic activity. Europe has vaccinated 4 per cent of its population; the US has covered 11 per cent, while the UK leads by inoculating 21 per cent.

Fast tracking jabs

The UAE is on track to vaccinate half its population by March. This should boost activity and reduce potential loses. The macroeconomic scenario is improving. According to the Central Bank, the non-oil economy is projected to grow by 3.6 per cent in 2021, in contrast to the contraction of 4.5 per cent in 2020.

We can expect NBQ to write back some of the provisions in 2021, boosting profits substantially. Some of the loan loses projected earlier might not happen at all.

This bodes well for NBQ as it had reduced staff costs for 2020 to Dh75 million from Dh83 million in the previous year. Many of the tailwinds in 2021 is true for other UAE banking stocks also.

But with almost 69 per cent of the business anticipated to benefit from the reopening of the economy, NBQ could deliver good returns for investors. To top it, the bank also has almost a 5 per cent yield.

- Vijay Valecha is Chief Investment Officer at Century Financial.