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Stable outlook for GCC banks as asset quality set to stabilize

Profitability to stagnate amid slowing loan growth

Gulf News

Dubai: Banks across the GCC are expected to see stabilisation of the financial profiles and performance after two years of significant pressure, according to S&P Global Ratings.

While analysts expect to see further easing of liquidity and funding with improvement in asset quality metrics in 2018, there is a likely spike in cost of risk across the board due to factors other than new loan impairments.

“We think that GCC banks’ cost of risk will increase in 2018 because of the adoption of IFRS 9 [International Financial Reporting Standards] and the higher amount of restructured and [loans] past due, but not impaired loans sitting on their balance sheets. However, we also think that the general provisions that GCC banks have accumulated over the years will help a smooth transition to the new accounting standard,” said Mohammad Damak, a Credit Analyst at S&P Global Ratings.

The slowdown in economic activity over the past two years only resulted in a slight increase in non-performing loans (NPLs). As on September 30, NPLs to total loans for the rated GCC banks reached 3.1 per cent, compared with 2.9 per cent at year-end 2016. However, restructured loans and past due but not impaired loans saw a higher increase, reflecting corporate entities’ longer cash flow cycles.

“We expect NPL ratios to continue to deteriorate in the next six months and then progressively stabilise, mirroring the stabilisation of the GCC countries’ real economy. Our expectation discounts any unexpected materialisation of geopolitical risk or any other shock in the commodities market. Overall, we do not expect the NPL ratio to exceed 5 per cent in the next 12-24 months,” said Damak

Last year the increase in the annualised cost of risk was contained at 1.2 per cent for rated GCC banks, compared with 1 per cent in 2016.

The first nine months of 2017 saw a slight improvement in rated GCC banks’ profitability, but analysts don’t think this situation will last. Some of the improvement is due to increasing amounts of earnings-generating assets and slightly higher interest margins. Banks have deployed their excess liquidity in government bonds, which earn more than either deposits with central banks or cash.

Improving local liquidity and the increase in the Federal Reserve’s interest rates — which local authorities (with the exception of Kuwait) mirrored — led to a slightly higher average interest margin in 2017. A more aggressive approach toward costs also helped, with the average cost-to-income ratio reducing to 36.2 per cent on Sept. 30, 2017, compared with 38.7 per cent in 2016.

Analysts from leading raging agencies think that GCC banks’ profitability will stabilise at a lower level than historically, underpinned by an increased cost of risk and the introduction of value added tax (VAT). Loan-to-deposit ratios have been on an improving trend over the past 12 months, meaning that deployment of funds rather than lack of liquidity is the new theme amid slowing credit demand.

Muted loan growth

The end of the triple-digit-oil-price era resulted in a significant slowdown of the GCC economies and reduced growth opportunities for their banking systems. We forecast that oil prices will stabilise at about $55 (Dh202) per barrel in 2018 and 2019, and anticipate unweighted average economic growth for the six GCC countries of 2.5 per cent in 2018-2019, or less than half the growth they delivered in 2012.

Growth in private-sector lending continued to drop and reached an annualised 2.6 per cent on average in the first nine months of 2017, compared with 5.7 per cent in 2016.

“In 2018-2019, we expect this situation to continue due to reduced government spending (except in Kuwait). We expect private-sector lending growth to reach 3 to 4 per cent in 2018-2019, supported by strategic initiatives such as the Dubai Expo 2020, Saudi Vision 2030, the World Cup 2022 in Qatar, and higher government spending in Kuwait led by Kuwait 2035, a long-term development plan announced in early 2017,” said Damak.

Loan demand is also negatively impacted by subsidy cuts and VAT implementation in the GCC. These measures are expected to dent consumer disposable income and demand. This will weaken the performance of consumer loans and of retail and commercial industries.