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Middle EastFebruary 21 2011

UAE banks: out of the woods and heading East

Hit hard by the credit and property bubbles that were at the epicentre of the global financial crisis, the United Arab Emirates' banks have since managed to shore up their stability and start to devise strategies for future growth. 
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UAE banks: out of the woods and heading EastEmirates NBD is in a good position for growth

When state-owned holding company Dubai World announced it could not pay back $26bn to its creditors, Dubai’s future looked bleak. The announcement raised the spectre of the world's largest government default since the Argentine debt restructuring of 2001, causing markets to crash and oil prices to crumble. Just 18 months after the event, though, and the United Arab Emirates’ most flamboyant emirate is back on investors' radars, all keen to pick up where they left off in 2008, and their gradual return to Dubai has been in part thanks to Abu Dhabi’s role in rescuing its ailing neighbour.

For Dubai, 2009 and the early part of 2010 was a difficult time as balance sheets remained weighed down by the emirate's boom-led debts. All but one of the UAE's 41 banks suffered the worst losses in their history. It was First Gulf Bank that bucked the trend by posting profits of Dh3m ($815,920) in 2008, which increased to Dh3.31m in 2009. The other top 10 banks in the UAE, which include Emirates NBD, Mashreq and the Commercial Bank of Abu Dhabi, suffered an average 14.85% dip in profits between 2008 to 2009. 

Bearing the brunt 

Having been the worst hit of all the Gulf Co-operation Council (GCC) states when the credit and property bubbles burst, Dubai faced its most severe blow in 2009 as the Dubai World crisis put a huge dent in the country's global ambitions.

The Abu Dhabi government emerged as Dubai's saviour when it announced it would provide $10bn to help Dubai World avoid defaulting on a $4.1bn bond payment. Some of the money was used to cover the debt of real-estate unit Nakheel PJSC, while the rest of the money covered the investment firm's interest and operating costs until the company was able to reach an agreement with its creditors.

Banking recovery?

Though 2010 was difficult for the country's banks, they see 2011 as the beginning of the recovery for the UAE's economy and banking sector. Following the profit slides of the past two years, the UAE’s financial sector returned to growth towards the end of 2010, with Tier 1 capital increasing to about Dh70bn for the country's top 10 banks. 

Moreover, Abu Dhabi’s assistance highlighted the strength of the UAE’s federation, and convinced investors that, with a partner such as Abu Dhabi, Dubai was on a secure footing. Bankers now speak of 'cautious optimism'. The crisis forced the country's banks to clean up their balance sheets and they have steered themselves back towards health. Construction and services were at the core of Dubai’s success story and bankers in the emirate all agree this is what will drag it out of the doldrums. “Look around you,” says Paul Trowbridge, chief executive officer of United Arab Bank (UAB), “the UAE has world-class infrastructure and is extremely well positioned for the future.” Although no one talks of a full recovery just yet, positive signs are there, as bankers admit to learning lessons from the crisis.

UAB sets the standard 

UAB is one example of a UAE financial player that has successfully steered its operations towards healthy growth. Established 35 years ago in a joint venture with France’s Société Générale, UAB continues to cater to its original client base: the wealthy families of the country. 

Unlike many of its peers in the UAE, the Sharjah-based bank prides itself on keeping a low profile. “We don’t want to open a branch on every street corner,” says Mr Trowbridge. “We do what we do well and aim to continue to do so.”

Mirroring the overall finances of the global financial sector, the bank suffered a dip in its deposit and assets, with customer deposits falling from Dh4.97m in 2008 to Dh4.45m in 2009 and total assets slipping from Dh7.56m in 2008 to Dh6.99m in 2009.

However, in this challenging financial environment, UAB maintained earnings growth, posting Dh281m in net profit for 2009 up from Dh250m in 2008 (figures for 2010 are not yet available). Mr Trowbridge says the bank continued to lend to its customers. As a result, it has managed to retain its clients in what remains a difficult market. Prudent policies coupled with sound risk management cushioned the bank from the fallout of the financial crisis that crippled businesses and the banking industry across all seven emirates.

Emirates NBD meets challenges

Another UAE banking stalwart, Emirates NBD, has faced a challenging year during which it has managed to position the bank for future growth in spite of its exposure to Dubai World. The bank had set aside about $750m in the first quarter of 2010 to cover loan provisions to Dubai World, forcing analysts to estimate the size of the exposure to be well in excess of $1bn.

Emirates NBD, formed by the merger of Emirates Bank International and the National Bank of Dubai in 2007, combined the second and fourth largest banks in the UAE, creating what many see as a blueprint for consolidation in the country.

In 2010, Emirates NBD made good progress, growing customer deposits by 10% over 2009, to Dh200bn, and strengthening its capital adequacy ratio to 20.1% when compared with 2009 figures. However, total income for 2010 fell by 10% from 2009 to Dh9.7bn, and net profits fell from 2009’s Dh3.2bn to Dh2.3bn in 2010.

Rick Pudner, the chief executive officer of Emirates NBD, is confident, however, that 2011 will see the bank perform better as the situation across global markets gradually improves. “We’ve done good work enhancing profitability over the past two years, now we are looking to drive profitability further in 2011 and 2012,” he says. Mr Pudner points to the signs of stability and improving economic activity that are leading to an increase in confidence and credit appetite in the UAE. “The financial sector is now showing signs of emerging from the deleveraging process that commenced at the end of 2008; we will see improvements in 2011.”

Dubai's resurgence 

Analysts point to Abu Dhabi’s strong economic outlook as a driver for growing investor confidence and a major contributor to a healthier future for UAE’s banks. According to the Abu Dhabi Chamber of Commerce and Industry, strong oil prices will boost the region’s nominal gross domestic product by 8%, while international investment will grow by 15% in 2011, as investors begin to look at placing funds in UAE again. Private equity firms are also eyeing investment opportunities in the resurgent construction industry.

Mohammad Al Tuwaijri, regional head of global banking for the Middle East and north Africa (MENA) for HSBC, is satisfied with the steady pace of the recovery. “The quality of work being done in the region is productive and things are happening. We expect opportunities to arise as a result,” he says. 

Mr Al Tuwaijri points to successful bonds from the Dubai government and Emaar Properties. In September 2010, Dubai launched a $1.25bn government bond, beginning its first round of fundraising since the financial crisis deepened in late 2009 as a result of Dubai World. The book was four times oversubscribed at $5bn.

HSBC acted as joint lead manager and bookrunner with Standard Chartered bank and RBS on the dual-tranche $1.25bn, $500m five-year and $750m ten-year bond, acting through the Department of Finance of the Government of Dubai. This was the first sovereign issuance out of the GCC region in 2010.

Dubai's return to international capital markets was followed by construction company Emaar Properties, which issued a $500m bond to settle debts and fund projects outside the emirate. HSBC was also involved along with Deutsche Bank and Standard Chartered in Emaar Properties' inaugural public sukuk issue of $500m. The transaction was subsequently rated B1 by Moody’s and BB by Standard & Poor's. The final orderbook of 145 accounts closed at $1.7bn. It proved to be  geographically diverse, with 38% of the deal placed in the Middle East, 52% in Europe, 7% in Asia and 3% in US offshore.

Bond issuance is gaining traction in the Gulf on the back of increased investor appetite. Qatar has issued three bonds in the second half of 2010 alone. Qatari Diar Finance issued a $350m bond, with the Qatar Investment Authority as the issuer parent. This was followed by telecommunications provider Qtel’s $150m bond followed by another $150m bond for Qatar National Bank.

Bankers regard the success of these and others – such as Abu Dhabi investment company Ipic’s $250m bond issued in November 2010 or Waha Aerospace’s $150m bond sales – as a litmus test for Dubai's recovery, and a sign that investors are looking for higher-yielding debt after a long refuge in safer assets.

Long-term obstacles 

Mr Tuwaijri is realistic about the challenges that remain, however. First and foremost, there is the size of Dubai's debt, currently about $110bn. Weighing down the region's bank balance sheets, it continues to hamper economic growth by muting risk appetite and lending activity.

There are signs, however, that debt restructuring initiatives are becoming more common. Many hope that these initiatives will begin to free-up bank activity. In January 2011, Dubai Group, another investment company controlled by the Dubai government, announced it was in separate talks with two sets of international lenders in an effort to hammer out a $6bn debt restructuring. Analysts say this could spur on other state-owned entities to enter debt restructuring talks with lenders.

Energy boost

With exports from Abu Dhabi's oil and gas sector expected to grow by 9.5%, most analysts think the region will see sustained recovery, offering good scope for investors keen to return to a region that still offers opportunities of high returns in infrastructure as well as financial services.

HSBC Middle East aims to be at the forefront of the recovery process. With its core risk management capabilities, the bank is well placed, says Mr Tuwaijri. “These have gained in importance in the post-crisis banking environment.”

Furthermore, bankers talk of an improvement in perception of UAE risk; this, combined with what they say are "enticingly" low trading multiples, makes foreign direct investment in infrastructure in and around the Gulf more attractive, and means there is greater scope for more cross-border deals between large companies in the region. Many cite the upcoming merger of telecommunications giants Zain and Etisalat as an obvious sign of renewed appetite for mergers and acquisitions.

Construction growth 

Specific sectors expected to see growth include cement and financial services such as building insurance - both driven by renewed growth in the construction industry. Despite the UAE's impressive construction record, many buildings have very basic insurance cover, and bankers have high hopes for the sector's development as domestic and international banks tailor new products.

The crisis that engulfed the region was rooted in a real-estate sector that had experienced a construction boom like no other. And yet mammoth projects are still being built. “Buildings that were started before the crisis have to be finished,” says Sameer Al Ansari, chief executive officer of Dubai’s Shuaa Capital.

Like other firms in the region, Shuaa Capital was hit by the crisis, and profit fell sharply to Dh145.7m in 2009 from Dh400.5 in 2008. Post-crisis, the bank has cleaned up its balance sheet and reduced costs. The firm has “gone back to basics”, says Mr Al Ansari. It is focused on core business lines – investment banking, asset management, brokerage, private equity and financing - and has put any desire to expand into new territories or into new sectors of activity on hold. For now, it has reduced its risk appetite. “[We will] stick to what [we] know best, which is the five main activities the bank is renowned for,” he says.

Based on earnings growth expectations for the broader economy as well as falling risk perception, analysts maintain a bullish stance on the UAE's banking sector. However, there are areas of concern for institutional investors, such as the lack of formal segregation between custody and trading accounts, and the foreign ownership limits imposed by UAE-based companies. Mr Al Ansari says some of these issues are already being addressed by regulators. For example, market participants expect new rules related to custody/trading account segregation to be implemented some time in 2011.

Dealing with unrest

Recent political turmoil in Tunisia, Bahrain, Libya and Egypt will no doubt have a material effect on the economies of the MENA region, and the UAE's banks are unlikely to escape, particularly as many Abu Dhabi banks own stakes in or work in close collaboration with Egyptian banks.

Union National Bank of Abu Dhabi (UNB) is among those heavily involved in Egypt, although Mohammad Nasr Abdeen, its chief executive officer, is confident the turbulence will be short-lived and should have little or no impact on the bank’s activities in the north African country. “The unrest is a temporary phase and Egyptians are keen to return to normality and as a people are efficient in dealing with crisis,” he says, adding that once the dust has settled, business will resume and new scope for opportunities can arise as a result of the new political landscape that will emerge.

The rolling protests, however, have practical, day-to-day effects on banks. With regards to Egypt, Georges El Hedery, global head of rates at HSBC, says the prolonged effects of the stand-off between Egyptian protestors and the country’s authorities are making day-to-day operations impossible in the Arab world’s most populous country.

“Banks are closed and people are running out of money,” says Mr El Hedery. "We can’t even access the banks to supply the customers, which makes for a tense situation that is difficult to sustain."

Analysts believe that other MENA countries are unlikely to see major negative economic effects, but believe markets will remain jittery in the near term. The impact of continued unrest on oil prices has a knock-on effect for the region's banks, much of whose business and client relationships are so closely linked to the hydrocarbon sector.

Looking East  

A notable trend in the GCC region is its ever-greater focus on Asia. Trade with Europe and the US remain very much part of the business agenda, but most industry players talk of looking eastward. “It’s where the future is and where the region already enjoys strong relationships,” says Omar Mehanaa, head of advisory at HSBC.

Dubai also sees its recovery as likely to be linked to its future business with Asia; in light of this growing trend, many large banks such as HSBC now include certain Asian countries within their MENA coverage. Mr El Hedery explained that the bank now includes central Asian countries such as Pakistan in its MENA section.

Mr Mehanaa believes that the UAE's ambition to become a regional financial and services hub can only be strengthened by looking east. “Thanks to its infrastructure, Dubai’s future [lies] in linking the European and Asian markets and becoming the regional hub,” he says.

The emirate, part of a GCC block that aims to become one of the next BRIC nations (Brazil, Russia, India, China) - or ‘GRIC’ nation (Gulf, Russia, India and China) as UAB's Mr Trowbridge likes to call it - has in Dubai an ideal asset that joins together the countries specifics that make the GCC block so attractive. With Bahrain as its Islamic banking hub, Qatar the liquefied natural gas giant looking to develop renewable energy and Dubai able to cater to all the various market participants that will need to visit or work in the region as a result, the UAE's prospects look bright. 

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Read more about:  Middle East , United Arab Emirates