There has been no shortage of headlines written about the United Arab Emirates’ banking sector since Dubai rattled credit markets the world over in 2009 when it announced it was close to defaulting on $25bn of debt.
Four years ago, Dubai was at the height of an unparalleled economic boom that quickly turned to bust at the onset of the global financial crisis. Years of runaway credit growth had spurred a sizeable real-estate bubble in the Gulf state that quickly burst, causing over-inflated property prices to tumble by as much as 50%, in turn triggering a corporate debt crisis.
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As businesses struggled to service their loans and asset quality deteriorated sharply, a large spike in non-performing loans across the banking sector weighed heavily on growth as banks set aside extensive provisions.
The UAE’s 23 national banks and 28 foreign lenders made record high provisions in 2009, leaping by 62% to Dh32bn ($8.7bn) from Dh19.7bn at the end of 2008, according to data from the UAE central bank.
This sharp rise in provisions was the main reason for the 16% decline in net profits of the national banks in the first nine months of 2009 to Dh15.7bn compared with Dh18.7bn in the first nine months of 2008. Compounded by a reluctance to extend credit in an uncertain environment, banks in the country experienced a severe slowdown in both asset and profit growth.
On the comeback trail
But after years of licking its wounds and being preoccupied with several high-profile debt restructurings, the UAE banking sector staged a lively comeback in 2012 on the back of a resurgence in the economy. Growth in gross domestic product (GDP) accelerated to 4.4% in 2012 from 3.9% in 2011, as activity picked up across all sectors.
“The general mood is noticeably upbeat and people are confident that the worst is behind them,” says Paul Trowbridge, chief executive of United Arab Bank. “Overall, when you look at the landscape of the global economy, the UAE is performing very strongly. We were one of the first sovereign countries to go into a recession, but we have also been one of the first to emerge.”
Often regarded as the barometer of an economy’s overall health, the leading UAE banking institutions all posted positive results in the first half of 2013 amid a renewed appetite for lending and the improved business climate. Emirates NBD, the UAE’s largest bank with assets of Dh334.8bn as of June 2013, recorded a substantial 40% profits increase in the first half of 2013 to Dh1.81bn, from Dh1.29bn in the same period in 2012. Customer loans grew by 6% to Dh231.8bn over this same period, while deposits increased by 8% to Dh230.4bn.
Meanwhile, the UAE’s second largest bank, National Bank of Abu Dhabi, saw its net profit rise by 25.6% year on year to reach Dh2.62bn in the first half of 2013, while total assets reached Dh327bn, up 8.7% compared with the first half of 2012, driven mainly by increased lending and liquidity. Loans grew by 5.4% year on year to reach Dh173.5bn, with growth coming from both domestic and international demand, while customer deposits increased by 15.3% to Dh219.4bn.
Record revenues
Another Abu Dhabi-based lender, First Gulf Bank’s second-quarter net profit rose 15% year on year to Dh1.17bn and it achieved record revenues of Dh2018m in the same quarter. Its loan book has grown by 11% in the past 12 months.
“Recent result announcements at the conclusion of the second quarter of 2013 showed outstanding performance for the majority of banks,” says Andre Sayegh, chief executive of First Gulf Bank. “Comfortable liquidity levels were shown by all, as well as healthy balance sheet growth and higher profitability.”
With the Emirates three-month Interbank Offered Rate at 1.3% since September 2012, its lowest point in more than two years, there has been ample liquidity in the market. Meanwhile, with inflation under control, the Central Bank of the United Arab Emirates is expected to keep interest rates low from 2013 to support lending growth in the economy.
Following the Dubai debt crisis in 2009, the central bank has focused on managing liquidity and strengthening the banking sector through new regulation. In February 2011, it approved a new multiple-of-earnings law that stipulates a loan cap of 20 times a customer’s monthly income. Banks were previously free to extend large loans to consumers because of relaxed borrowing rules, which capped personal loans at Dh250,000.
Regulation concerns
However, concerns have been expressed by the central bank about how closely these rules are being followed in light of figures that show that loans granted in the first five months of 2013 are already equal to the total for 2012.
In July 2012, a UAE central bank official accused banks in the country of violating the personal loan regulations it enacted in February 2011, while also noting there are no provisions in the regulations for imposing penalties against banks that violate them.
“The central bank has discovered many violations by banks regarding its rules about personal loans, mainly regulations stipulating that such loans must not exceed 20 times the client’s monthly salary,” says Khaled Al Kharji, head of the banks’ control division at the central bank. “The central bank can only draw the bank’s attention to summon its senior management for a meeting on the issue.”
A study published by research group Strategic Analysis in July 2013 shows that consumer debt in the UAE alone has reached $95,000 per household, or $114bn in total, with the UAE representing 67% of the entire Gulf’s household debt.
Mortgage caps
In separate efforts, the central bank also announced plans to impose tighter controls over banks’ real-estate exposure by issuing a circular in December 2012 informing all UAE banks that it had decided to cap mortgage lending. According to the circular, mortgages for expatriates were limited to 50% of the property’s value for their first property and 40% for the second. Caps for UAE nationals were set at a respective 70% and 60%.
However, the proposed caps were dropped in response to fierce lobbying by banks, which complained that their business would suffer and that it could slow the UAE real-estate market's recovery from the crash of 2008 to 2010. The industry lobby group is seeking a 75% loan-to-value limit for expatriates and an 80% limit for UAE nationals, and the UAE central bank is now negotiating revised caps with the banks.
“Banks have shown a willingness to abide by this regulation, but have provided their recommendations for further defining and refining the details of it. Since the UAE property market is showing healthy recovery signs, a more measured approach to regulation is needed,” says Mr Sayegh.
“We believe that several factors need to be taken into consideration before providing loans, such as whether customers are first-time home end-users or investors, and also, a differentiation needs to occur between completed properties and those under construction. The UAE Banks Federation has provided its feedback to the central bank and expressed its members’ desire for self-regulation as well.”
Real-estate concerns
However, there are concerns that the heady days of the pre-2008 real-estate boom are returning. Dubai’s largest property developer, Emaar, which has announced several new projects this year, says total sales of real estate in Dubai for the first half of the year stood at Dh6.3bn, four times the figure during the same period in 2012. To date in 2013, Emaar alone has handled more than 36,600 units including some 20,900 apartments and about 15,700 villas.
After plunging by as much as 50% in the wake of the crisis, Dubai has seen average residential rentals grow by more than 30% over the past 12 months, consultancy CBRE said in a report published in July.
“The government has already taken some steps to prevent history repeating itself, but I think more particularly, banks are now much more cautious and are becoming better at self-regulating,” says Mr Trowbridge. “The banks have learnt some very tough lessons over the past five years and so I don’t think they’ll repeat their mistakes very easily. It’s about striking a balance between promoting lending again to help the economic recovery while also keeping an eye on their loan-to-value ratios.
United Arab Bank’s mortgage portfolio grew from Dh6m in 2010 to Dh1.87bn in the first half of 2013, making the bank one of the largest mortgage underwriters in the UAE. However, despite this huge growth, Mr Trowbridge concedes: “I’m surprised by the number of people who are paying for apartments in cash – many aren’t using any debt at all.”
Cash is king
Indeed, industry observers note that whatever the outcome of the decision, the mortgage rules will need to be complemented by other measures, given that much of the home buying taking place in the UAE today is being done with cash rather than mortgages.
In fact, the International Monetary Fund (IMF) drew attention to this in its UAE consultation paper published in June 2013. “Regulation related to mortgage lending, including caps on loan-to-value and debt-service-to-income ratios, will help mitigate real-estate-related risks, though the imminent effect on the residential real-estate market, currently largely a cash market, will be limited,” it notes. “Looking ahead, the [central bank] should carefully monitor the interaction of mortgage lending and the real-estate sector, and tighten the mortgage regulation or introduce new measures as needed.”
Interlinked to the central bank’s desire to prevent banks from becoming over-exposed to the real-estate sector was its announcement in April 2012 that by the end of September that year, banks would also have to limit their exposure to the UAE government or government-related entities (GREs), given that many GREs hold sizeable stakes in most of Dubai’s big real-estate developers.
Under the rules, banks’ loan exposure to the UAE government or GREs was to be capped at 100% of its capital base, while lending to a single borrower was limited to 25%. There was previously no limit. These rules were aimed at preventing any repeat of Dubai’s corporate debt crisis, which erupted in 2009 as the real-estate market crashed owing to banks’ extremely high exposure to GREs.
Regulatory climb-downs
However, this proposed regulation was also met with extreme hostility from the banks and, in December, the central bank announced it was suspending the rules while it consulted banks. In fact, it is worth pointing out that there were three separate incidents during 2012 in which the central bank announced regulations designed to reduce risk, before retracting any plans to introduce them due to fierce protests from the banking community. Requirements for banks to hold a certain proportion of their assets in liquid instruments were mooted last year and then suspended.
These three regulatory climb-downs have raised questions over authorities’ regulation of banks as the UAE recovers. According to a research note published by Deutsche Bank on April 9 this year, the exposures to the UAE government and GREs by Emirates NBD and National Bank of Abu Dhabi stood at 192% and 199% of capital, respectively, while Abu Dhabi Commercial Bank, another state-owned lender, stood at 108%.
Bankers generally expect the central bank to extend the deadline, given that many of the largest UAE banks exceed the 100% limit and it could be damaging to them and the economy if they tried to sell off their GRE loans too quickly. In July 2013, the UAE Banks Federation asked for five years to comply with the proposed central bank regulations but the central bank has yet to respond.
“As of now, it is unclear as to when a final decision on this issue will be issued. However, there are discussions being held between the UAE Banks Federation and the central bank on this matter,” says Mr Sayegh. “In general, government risk in the UAE has generally been acceptable and different banks will need different deadlines for complying with the regulation. This is based on many factors, including their size, availability of capital, sophistication of credit risk management and other indicators. We are hoping for a more broad-based regulation in the near future, which will make compliance easy and more pragmatic.”
However, given that many of the largest UAE banks are assisting GREs in their debt restructurings, obtaining clarity on the issue in the near future is important for the economy. Indeed, while GRE debt restructurings related to the 2009 crisis are nearing completion, several major maturities are now drawing closer, most notably the Dubai government’s $20bn debt to the Abu Dhabi government, which matures in 2014.
Dubai’s total debt continues to be substantial at $142bn (about 102% of GDP) and it is estimated that about $60bn of GRE debt will fall due between 2013 and 2017, according to the IMF’s June consultation paper.
The impending GRE regulation, combined with the partial retrenchment of Western banks from the region, has led many to question how the raft of new real-estate projects announced in the past nine months – currently totalling $180bn – are going to be financed. Judging by the words and actions of some Dubai property companies, the answer is simple: tap the bond market.
Rise of the bond market
Dubai firm Arabtec Construction has said it might raise as much as $450m from the bond market at the end of 2013 or in 2014. This would be its first bond issue. Meanwhile, Dubai Investments, which has interests in property and manufacturing, has hired banks for a $300m sukuk (Islamic bond) sale. Indeed, while in the past most property companies relied almost exclusively on bank finance, there is now growing talk that the bond market will play a key role in financing upcoming real-estate projects.
The UAE’s bond market is much deeper and more liquid than it was during Dubai’s last real-estate boom in the mid to late 2000s and foreign investors are now much more familiar with it. Furthermore, with interest rates at historically low levels, many bond issuers have been able to borrow at ever-lower costs.
“Gulf banks have been capitalising on investors' global search for higher yields and the resulting improvement in bond markets that saw long-term debt issued at low prices in 2012,” noted a report issued by international rating agency Standard & Poor’s in March 2013. “Banks in the UAE remained the largest issuers last year and we forecast robust issuance levels again in 2013 as banks continue efforts to optimise their funding costs. The UAE has the largest banking system in the region and the amount of debt UAE banks issued increased by 53% in 2012 to reach $8bn or about 54% of total issuance reported in the Gulf region.”
Mr Sayegh says: “Bonds are an important tool for obtaining funds in a manner that minimises negative effects to the banking sector. It is important to obtain high rates of liquidity to finance projects and those include real-estate projects. We have seen a big appetite by investors worldwide for bond and sukuk issued by UAE corporates and GREs due to the relatively higher returns offered in comparison with those issued by other countries, and due to the investment-grade rating.”
Fatca implications
Another recent development that UAE banks are going to have to contend with in the near future is the US Foreign Account Tax Compliance Act (Fatca), which comes into force on July 1, 2014 and is aimed at clamping down on tax evasion. Fatca requires all foreign (non-US) financial institutions to disclose all US account holders to the US Internal Revenue Services. Failure to do so could result in a withholding tax of 30% on a firm’s US transactions, as well as the risk of withdrawal of US dollar clearing rights. Current estimates indicate that there are 40,000 to 50,000 American citizens living in the UAE.
To date, 85 countries have signed intergovernmental agreements with Washington, whereby they will oversee the compliance of financial firms. The UAE’s central bank governor, Sultan Al Suwaidi, said in March 2013 that the government was considering signing such a deal with the US, but no further update has been provided.
“My expectation is that the UAE will enter into an [intergovernmental agreement] with the [Internal Revenue Services] towards the end of the year. The UAE banks and the Middle Eastern banks more generally were slower to pick up on Fatca than a lot of other countries, but it will have a big impact on them,” says Sean Finn, a partner at global law firm Latham & Watkins' London office. “The difficulty for the UAE banking sector in dealing with this is that it doesn’t have the necessary infrastructure to collect tax information because it is a low or zero-tax environment. This makes the task harder for them and is causing some stickiness for the wheels to go round.”
Several factors have enabled the UAE banking sector to overcome many of the challenges associated with the global financial crisis. The UAE’s status as a safe haven during the Arab Spring combined with its important role as a trading and logistics hub have allowed the financial sector to restore investor confidence and stage a strong recovery.
In light of the slowdown in oil expansion, the IMF is forecasting a slowdown in GDP growth to 3.6% in 2013, but the country's economy will be buoyed by healthy growth in investments, trade, tourism and logistics support. This growth is expected to rise to 3.7 % in 2014 and 3.8% in 2015.
“There is no doubt that the UAE is very well placed to take advantage of a first-past-the-post recovery position,” says Mr Trowbridge. “But the key challenge is the obvious one of not being over-confident.”
While many lessons have been learnt in the past few years, it is clear that the UAE still needs tougher banking regulation to control risk in the system and help mitigate future financial problems. But as always with regulation, its efficacy depends on how rigorously it is enforced and followed. That will remain the key test for both the banks themselves and the central bank in the coming years, and will ultimately determine the sustainability of the economic recovery.
