The reputation of the United Arab Emirates’ banking sector has undoubtedly been tarnished in recent years by the bursting of the local real estate bubble and the notorious $25bn restructuring of the Dubai government-owned global holding company, Dubai World.
Banks have been confronted with a weakened operating environment, record levels of non-performing loans (NPLs) and subdued investor appetite. However, sentiment among industry professionals is changing, with many believing that the country, and more specifically Dubai, has turned a corner in 2011.
The successful completion of the $25bn debt restructuring of Dubai World in March this year was a major milestone in the economic rehabilitation of the emirate, and lifted a shadow that had been cast across the whole of the UAE’s banking sector.
Dubai’s credit default swap rates – a measure of the probability of a sovereign default – are currently trading at about 370. This is roughly 40 basis points short of their lowest figure since the emirate announced the six-month debt standstill on state-owned conglomerate Dubai World in November 2009.
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Liquidity flow
“We have had a reasonable business year so far and our revenue line has been maintained,” says Rick Pudner, chief executive of
Emirates NBD, the largest Arab bank with assets of $78.44bn at the end of June 2011. “We grew our deposits quite substantially over the past two years so liquidity has now
significantly improved in the UAE market and there is a renewed appetite for borrowing. Volumes of credit applications have increased significantly – we are forecasting loan book growth of 3% this year.”
Dubai has also benefited from being perceived as a safe haven in the Middle East, following a series of political uprisings and violent crackdowns across the region as a result of the Arab spring.
“There has been a flight to quality,” says Mark Yassin, senior general manager of the corporate and investment banking division at National Bank of Abu Dhabi (NBAD). “Our bank and other institutions have recorded an increase in deposits as investors from across the region have relocated funds.”
After a period of being perceived as the risky market in the Gulf, Dubai has been capitalising on this relative stability through a wave of new bond issuances. In early June, state-owned airline Emirates tapped markets with a $1bn five-year bond, which received offers of more than $6bn from investors. In mid-June, the Dubai Department of Finance issued a 10-year, $500m bond, which generated a large order book with more than 90 investors placing orders of over $1.8bn. Orders were made by a wide range of high-quality fixed-income investors, including fund managers, insurance companies and banks.
Vote of confidence
Such levels of demand are a strong vote of confidence in Dubai’s economic recovery. Several other companies, including the local retail group Majid al-Futtaim, are now looking to tap the bond market.
“We bank most of the top corporates in the UAE and we are starting to do more advisory work on debt arranging deals,” says Emirates NBD’s Mr Pudner. “The authorities here have been talking about establishing a more defined government debt market as well so we hope to see a bigger growth in the capital markets over the next few years.”
NBAD’s Mr Yassin adds: “Our debt capital markets business has seen some notable activities this year and in the previous years, which will definitely carry through into the years to come.”
Our debt capital markets business has seen some notable activities this year and in the previous years, which will definitely carry through into the years to come
Indeed, the Gulf’s debt markets are currently seen as one of the few bright spots in the global finance industry. Investors from across the world are buying up Abu Dhabi and Qatari government debt as a safe bet against tumbling stock markets in the West.
The yields on Gulf bonds are currently higher than those on US or UK government debt, giving them the added prospect of higher returns. For example, while 10-year US Treasury bonds are yielding about 2%, comparable bonds in Qatar and Abu Dhabi are putting up 3% yields.
Feeling the strain
The events of the past few years have dispelled any decoupling beliefs held prior to the current financial crisis, however, and UAE banks are once again feeling the pinch of the US and Europe’s economic woes.
“As we all know, with what’s happening in the US and Europe, bank liquidity has seen some strains and mid-term to long-term funding is coming at a cost for many banks,” says Mr Yassin. “Real estate used to be a concern to many lenders, but for most banks, exposure to this sector is now largely accounted for.”
UAE financial institutions saw a spike in NPLs after the bursting of the property bubble in late 2008, which caused values to plummet by as much as 50%. Loans extended to real estate averaged 30% across the country’s banking sector. In June 2011, in an effort to reignite demand, the UAE government announced that it was extending residency visas granted to foreign property owners from six months to three years.
After several years of being skirted by banks, the property market is being viewed with renewed interest by UAE lenders, which have begun rolling out new mortgage products to lure potential homebuyers. In June this year, the Sharjah-headquartered United Arab Bank (UAB) recently unveiled the lowest mortgage interest rate in the UAE at 4.99%.
“We believe we are helping lay the foundations for the next generation of mortgage banking in the emirates,” says Paul Trowbridge, chief executive of UAB. “There might be some further softening in the market but we saw an opportunity as values are either reaching or have reached the bottom.”
Since the start of 2011, several major foreign banks have cut interest rates in a bid to outdo each other in their mortgage loan offerings. HSBC revised its rate to 5.49% for UAE buyers looking to buy completed residential property, while Standard Chartered has plans to bundle UAE mortgages with pre-approved personal loans of up to Dh250,000 ($68,000) and credit cards with no annual fees.
Such moves are reminiscent of the price wars of the 2005 to 2007 credit boom years where banks were extending loans to customers at a multiple of 60 to 80 times their monthly salary. With an estimated 3.7 million credit cards in the UAE racking up a combined bill of $3bn, the country’s credit-card debt accounts for just under half of the Gulf’s total balance of $6.8bn, outpacing even Saudi Arabia, which has a bill that stands at $2.3bn.
Limits on lending
In February this year, the UAE’s central bank approved a new multiple of earnings law that stipulates a loan cap of 20 times a customer’s monthly income. The repayment period is set at 48 months and repayment instalments should not exceed 50% of the borrower’s gross salary.
However, industry professionals insist that banks have already implemented tougher lending procedures after having learnt their lesson the hard way.
“Most banks are becoming more cautious in assessing credit risk and no one wants to get burnt again so all banks are asking for more credit information and undertaking greater due diligence,” says Mr Yassin. “The central bank is overseeing all of this, especially in the retail sector.”
Mr Pudner adds: “It caused some consternation among banks when it was introduced but people recognise that it’s a healthy move and will no doubt lead to more innovation in retail banking. However, stronger credit checks have permeated through to all aspects of banking, including looking for value deals that are well structured.”
Buying time
Meanwhile, UAE banks remain preoccupied with several big debt restructurings coming through on state-owned conglomerates. In July 2011, Dubai World’s transportation subsidiary, Ports & Free Zone World, approached banks for a $850m five-year loan deal to be used to refinance a $1bn dual currency loan that matures in September 2011.
In August 2011, Dubai Holding reached an agreement with lenders to extend a $1.16bn syndicated loan due that month until December 2016. Meanwhile, Dubai Group, the unit mainly comprising financial services assets, is currently in talks to restructure about $10bn in debt.
After the credit boom years of 2005 to 2007, the banking community is welcoming the chance to sit back, pick the customers they want and plan ahead
“There are a number of deals still on the table that are going through a restructuring process by the banks here, but of course that is true of most economies in the world,” says Mr Yassin. “The big Dubai borrowers all have strong business models so I don’t envisage them having any problems in closing these restructurings.”
Too much debt?
Concerns remain, however, about the ability of the emirate to pay off, rather than keep refinancing, its debt pile which is estimated at $115bn or 140% of its economic output. The banking sector’s focus on deleveraging balance sheets along with tightened central bank requirements for provisions are expected to hamper growth across the UAE banking sector in the immediate future.
With another financial crisis brewing in Europe and fears of a deepening recession, there are also growing concerns of a repeat of the 2008 to 2009 burst of the global
asset bubble, which is depressing investor sentiment.
“I think we will experience very moderate growth for the next few years,” says UAB’s Mr Trowbridge, “But after the credit boom years of 2005 to 2007, the banking community is welcoming the chance to sit back, pick the customers they want and plan ahead.”
