S&P: Deteriorating conditions could put pressure on UAE banks

  • Mar 29, 2020
  • Zawya

“We expect loan quality will be tested and cost of risk will increase, weighing on banks' profitability in the next 12 to 24 months. In 2019, banks' asset quality indicators had already started to show signs of weakness,” S&P said in a note.

The UAE confirmed 63 new cases of coronavirus infections on Saturday, taking the total number of cases in the country to 468.

Earlier in March, the Organisation of Petroleum Exporting Countries (OPEC) failed to strike a deal with its allies, led by Russia, on oil production cuts, which effectively means that members can now pump as much as they can starting April 1.

Saudi Arabia slashed crude prices for April and planned output hikes after Russia refused to support deeper oil production cuts.

Brent Crude oil prices plunged as a reaction to the news and closed Friday’s trading session near the $25 per barrel level, down from the $51 per barrel level recorded at the beginning of March.

S&P said it views “favourably” the UAE Central Bank's recently announced targeted economic support Scheme, citing that it should help ease businesses’ financial positions.

“However, alongside increased forbearance, this could potentially delay the full recognition of asset quality deterioration at UAE banks,” it said.

The UAE Central Bank launched on March 14 a 100 billion UAE dirhams ($27.2 billion) comprehensive economic monetary package to allow banks to delay principal and interest payments for up to six months on outstanding loans for private sector companies and retail customers affected by the pandemic.

The total value of stimulus packages introduced by the UAE since the coronavirus outbreak has now amounted to 126.5 billion UAE dirhams.

“Moreover, we note the relaxation of certain prudential requirements, for example, the cap on real estate exposures and the increase in loan to value limits, and see some risks of lower recognition and disclosure of problematic assets,” the note said.

S&P said that excluding the impact of these measures and any adjustment to banks' asset quality recognition practices, the volume of stage 3 loans is expected to increase to 7 to 8 percent of systemwide loans in 2020-2021, and problematic assets (stage 2 and stage 3 loans) are forecast to rise to around 20 percent of total loans, from 15 percent at the end of 2019.

“This is because the oil price shock is happening at a time when the real estate sector is already under significant stress and other UAE sectors, such as hospitality and discretionary consumer goods, would experience a significant decline in revenues.”

The banking system's total exposure to the real estate and construction sectors stood at 26.4 percent at the end of 2019, assuming that one-third of personal loans for consumption purposes is channelled to real estate.

Another 20 percent of total exposures comprised sectors such as trade, transport, storage, communication, and personal loans for business purposes.

A portion of these loans is at risk, according to S&P.

The UAE has implemented a series of precautionary measures to stem the spread of the coronavirus. Schools, malls, cafes and restaurants have been shut, while all inbound, outbound and transit flights have been temporarily cancelled, as residents are being urged to stay indoors or observe social distancing.

“We assume the impact on banks' asset quality indicators will be moderate, since we expect oil prices will recover in 2021 to $50 per barrel from $30 in 2020, and a slight recovery in the non-oil sector in 2021,” S&P said.

“There might be a greater impact if these assumptions do not hold. In our opinion, a larger-than-expected increase in credit losses or further impairment in the disclosure of problematic assets would weigh on the creditworthiness of the UAE banking system,” the ratings agency said.

S&P expects banks' profitability to reduce following the UAE Central Bank's cuts interest rate cuts, mirroring those of the United States Federal Reserve.

On the asset side, banks' interest income will drop, while on the liabilities side, a large amount of the banking system's deposit base is non-interest bearing. As of the end of 2019, the top 15 banks' average return on assets was 1.5 percent compared with 1.7 percent in 2018.

“Ultimately, the extent of the decline depends on how the cost of risk evolves given the central bank support package. Without the latter, banks' profitability could reduce to less than 1 percent, similar to what we observed during the previous oil price shock. That would force banks to review their cost bases and reduce them where possible,” S&P said.

As for First Abu Dhabi Bank (FAB), the largest bank in the UAE, S&P said it will retain its market-leading position through the difficult operating environment.

“We expect that FAB's privileged position as the major domestic lender to a wealthy government and public sector, which provides it with a pipeline of low-risk lending opportunities, will continue to underpin our ratings.”

“Moreover, we expect that the bank will remain supported by the government of Abu Dhabi and maintain strong fundamentals, although the systemwide challenges are pervasive throughout the UAE's economy.”

However, the negative outlook reflects S&P’s view that the worsening operating environment, increasing cost of risk and lower interest rates may weaken the bank’s profitability to a level more comparable with its peer group.

With regards to ADCB, S&P said the bank will maintain strong fundamentals, citing that it has a well-established franchise, stable management and predictable earnings across different business segments.

However, the ongoing systemwide challenges are pervasive through the UAE's economy.

“The negative outlook reflects our view that the worsening operating environment could result in a significant deterioration of ADCB's asset quality indicators, given its material exposures to sectors at risk, and hamper the bank's profitability,” S&P said.

“We could lower the ratings in the next 12-24 months if we observe a significant increase in problem loans (stage 2 and stage 3) alongside increasing pressure on the bank's operating environment.”

S&P said the current operating environment could also result in the significant deterioration of SIB's asset quality indicators and hamper the bank's profitability.

“We could lower the ratings in the next 12-24 months if we observe a significant increase in problem loans (stage 2 and stage 3) or if pressure on the bank's operating environment intensifies,” said S&P.

“We could revise the outlook to stable in the next 12-24 months if SIB's asset quality deterioration does not exceed our expectation and capitalization remains strong and risks related to operating environment recede.”

The negative outlook reflects S&P’s view that the worsening operating environment could result in a significant deterioration of NBF's asset quality indicators and hamper the bank's profitability.

“We could lower the ratings in the next 12-24 months if pressure on the bank's operating environment intensifies or if we observe a significant increase in problem loans (stage 2 and stage 3),” said S&P.

“We could revise the outlook to stable in the next 12-24 months if risks related to the operating environment recede, NBF's asset quality deterioration does not exceed our expectation, and capitalization remains strong.”

Like the other banks, Mashreq’s outlook is also negative, in view of the weakening conditions.

The bank could face a “significant deterioration” of its asset quality indicators and hamper the bank's profitability.

“We could lower the ratings in the next 12-24 months if we observe a significant increase in problem loans (stage 2 and stage 3) and pressure on the bank's operating environment intensifies,” said S&P.

“We could revise the outlook to stable in the next 12-24 months if risks related to the operating environment recede or Mashreq's asset quality deterioration does not exceed our expectation and capitalization remains strong.”

(Reporting by Gerard Aoun; editing by Cleofe Maceda)

([email protected])

#RATING #UAE #BANKS #S&P #FINANCIALSERVICES

Disclaimer: This article is provided for informational purposes only. The content does not provide tax, legal or investment advice or opinion regarding the suitability, value or profitability of any particular security, portfolio or investment strategy. Read our full disclaimer policy here.