After a torrid 2020, the pressure on banks in the UAE has eased considerably. The timing of the Covid-19 pandemic was unfortunate for lenders in the Middle East’s second-largest economy, with business sentiment weighed down by ailing construction and real estate sectors. In addition to the economic hit from local lockdowns, as well as sharp falls in oil prices, tourism and trade, local banks found themselves exposed to the collapse of two of the country’s flagship corporations.
Lenders have ridden out the pandemic on the back of high capital ratios — with a few exceptions among smaller lenders — and support measures from the Central Bank of the UAE (CBUAE), many of which are set to remain in place until at least June 2022.
Profitability saw improvement in 2021 in parallel with the wider economy, with tourist numbers recovering to around three-quarters of their pre-pandemic levels and oil trading higher than early 2019 levels.
Yet analysts remain sceptical about a significant further uptick in profitability in 2022, with sluggish credit growth predicted due to concerns about private sector confidence and asset quality.
“We do not expect higher oil prices, which have boosted credit growth in past credit cycles, to provide the same impetus this time, considering the wider coronavirus-related shock on the global economy,” says Redmond Ramsdale, head of Middle East bank ratings and Islamic banking at Fitch Ratings.
Testing times
The CBUAE acted swiftly to protect the banks and lenders from the full impact of the pandemic, unveiling its Targeted Economic Support Scheme (Tess) in mid-March 2020.
The initiative relaxed capital and liquidity requirements for local banks, enabling them to tap into selected capital conservation buffers and let liquidity ratios fall as low as 70%. The bank also made Dh50bn ($13.6bn) available to lenders to maintain liquidity in the sector, mandating lenders to provide payment deferral relief for struggling borrowers.
While the CBUAE’s loan deferral scheme ended in December 2021, relaxed liquidity and capital requirements remain in place until June 2022.
“The Tess programme has proven its effectiveness in supporting the UAE financial system and economy throughout the pandemic,” Khaled Balama, governor of the CBUAE, said in a statement in December.
“As the recovery is gaining momentum, the CBUAE has adjusted the Tess, replacing measures designed to mitigate the immediate negative effects of the pandemic with targeted steps to support the economic recovery.”
Even while measures remain in place, analysts agree that many of the largest pressures on the sector have eased since the start of the crisis.
“Most of our rating outlooks for UAE banks are now stable, with nine lenders that had been changed to negative in 2020 now back where they were before the pandemic,” says Nitish Bhojnagarwala, senior credit officer for Moody’s Investors Service in Dubai.
“The larger UAE-based banks have stable outlooks now, while two smaller banks still have negative outlooks.”
Capital buffers stood at around 13.8% across the sector as of June 2021, according to Moody’s, above the CBUAE’s requirement of 10.5%. Fitch expects capital levels to remain stable in 2022, with the common equity Tier 1 ratio remaining at around 14%, given that internal capital generation will be able to fund modest loan growth.
Recovering profitability
Just two of the country’s six largest lenders — fifth-place HSBC and sixth-place Mashreqbank — posted an annual loss for the year, according to data compiled by The Banker Database. Yet profitability suffered across the board in 2020, with aggregate return on assets (ROA) declining from 1.4% in 2019 to 0.8% in 2020, according to Moody’s.
“Banks had significant provisioning levels for 2020, but these are set to drift lower as the recovery gathers pace,” says Mr Bhojnagarwala.
“Net interest income was, of course, hit after the CBUAE followed the [US Federal Reserve (Fed)] in cutting rates during 2020, and non-interest income also declined during the year.”
Lenders’ earnings have subsequently turned a corner, with ROA recovering to 1% in the first half of 2021, and Moody’s expects further recovery in second half of 2021.
Data compiled by professional services firm Alvarez & Marsal shows that net income for the UAE’s 10 largest banks rose for each quarter of 2021, rising by 14.5% in the third quarter, driven by a 6.8% rise in higher funded income and a 25.4% rise in higher foreign exchange and investment-related income.
Crucially, net interest income saw a 6.1% rise in the third quarter — its first significant rise since the beginning of the pandemic.
Improvements in operating income have been complemented by a streamlining of costs, with average cost-to-income dropping from 33% to 31.8% during the third quarter, with Abu Dhabi Islamic Bank (ADIB), Sharjah Islamic Bank and First Abu Dhabi Bank (FAB) leading the way in improvements.
Net interest income is set to see further improvements during 2022. The Fed is widely expected to raise interest rates from around the middle of the year, with three or more rate rises predicted for the year ahead in a bid to curb rising inflation in the US. Any rate rises will be matched by CBUAE, given the dirham’s peg to the dollar.
Emirates NBD, the UAE’s second-largest lender, is set to particularly benefit from such rises, due to its solid depositor base in Dubai, according to the investment bank Arqaam Capital, with ADIB and Dubai Islamic Bank among the other main beneficiaries of such a rise.
Yet expectations that UAE banks are set for a bumper year of profits in 2022 are misplaced, according to Mr Ramsdale. “We’re forecasting a slight improvement in earnings for the year ahead, but don’t see profitability recovering to pre-pandemic levels until at least 2023,” he says. “We’re expecting lower for longer interest rates and for credit growth to remain muted in the short term, with banks also facing asset quality risks, albeit lower than before.”
Credit demand has weakened in the UAE since 2019 on the back of sluggish business conditions, particularly within the real estate and construction sector, accounting for just more than 20% of total gross loans. The UAE’s credit growth has been the weakest in the Gulf Co-operation Council (GCC) since late 2020, a scenario that is set to continue into 2022, according to Moody’s.
While economic sentiment has shown some signs of improvement — the average Purchasing Managers’ Index for the fourth quarter of 2021 was the highest since the second quarter of 2019 — banks are likely to remain cautious with regard to lending until further improvements are registered.
“We’re expecting relatively weak demand in the private sector in the coming year,” says Mr Ramsdale. “We’re still seeing reasonably tight underwriting standards from local banks, who are waiting for clearer signs of recovery before they’re willing to really increase lending.”
Fitch forecasts credit growth to improve from 2% in 2021 to 3% in 2022. What’s more, growth is expected to be driven by lower-yielding government and related exposures, constraining revenue generation for lenders.
After rising in the fourth quarter of 2020, the loan-to-deposit ratio has decreased for three consecutive quarters at the country’s 10 largest lenders due to slow loan growth, according to Alvarez & Marsal.
This slower growth, together with higher oil revenues in 2022 and the extension of the CBUAE’s Tess measures, are set to see liquidity remaining at reasonable levels, though lower than before oil prices fell from their historic highs in 2014, according to Fitch.
NPL blues
Asset quality is set to remain the key challenge for UAE banks into 2022, above and beyond their regional peers. In addition to issues emanating from the pandemic, loan books came under pressure in 2020 from the collapse of Abu Dhabi-based healthcare provider NMC Health in April, amid widespread claims of fraud by its founder Bavaguthu Raghuram Shetty, and construction giant Arabtec in October.
Non-performing loans (NPLs) as a percentage of gross loans rose from just below 5% in 2019 — the second-highest level in the GCC after Bahrain — to around 6.1% in 2020, according to Moody’s.
With UAE banks lending more to small businesses than their GCC counterparts, uncertain economic conditions are set to see the NPL-to-gross-loan ratio rise further in the coming years, reaching 7% by 2023, Moody’s predicts.
“The extension of the [CBUAE’s] loan deferral scheme until [the end of the first half of 2022] will continue to cloud transparency of asset-quality reporting and leaves uncertainties around the trajectory of loan quality metrics once debt-relief measures end,” says Mr Ramsdale. “Nevertheless, actual loan deferrals in banks books is now modest at about 2%.”
Even as NPLs continue to rise, banks’ strong positioning during 2020 and 2021 means that such increases are likely to be well contained, according to Fitch.
Digital dawn
Already one of the most digitally advanced economies in the Middle East ahead of the pandemic, UAE lenders have seen a surge in the take up of digital financial services and cashless payments in particular in the past two years
Suvo Sarkar, Emirates NBD’s group head of retail banking and wealth management, told The Banker that 90% of retail-counter transactions for the bank in the UAE are now contactless, up from around 50% before the pandemic. Mobile wallet-based payments at the bank have more than tripled during the period and now make up around a third of all point-of-sale transactions as of early 2022, with the number of tap-and-go based payments doubling since the start of the pandemic.
“The average ticket size of contactless payments has also increased by half, illustrating growing customer comfort with using these options for larger purchases as well,” he says.
Several local lenders have introduced their own digital-only offerings in recent years. Emirates NBD’s Liv, launched in 2017, now has a user base of more than 500,000 people in the UAE, with the service launching in Saudi Arabia in early 2020.
The increased uptake of digital banking has had an inevitable impact on banks’ physical presence, with around one in five physical branches nationwide (excluding electronic banking service units and cash offices) closing during the past two years, according to the CBUAE.
Yet the launch of digital-only banks by entities without prior banking operations in the country is a relatively recent phenomenon. ADQ — an Abu Dhabi state-owned holding company for assets including Abu Dhabi Airports and the Abu Dhabi Securities Exchange — announced plans in October 2020 to launch a digital-only bank, with Zand and Al Maryah Community Bank following suit with their own announcements in March 2021.
Al Maryah Community Bank began offering services in mid-2021, while Zand is preparing to launch services during the first quarter of 2022 (see interview page 69). ADQ did not respond to requests for comment on its launch timetable.
While new digital banks are unlikely to put a significant dent in the operations of the country’s larger players, they may put pressure on smaller banks with weaker digital offerings, according to Mr Ramsdale.
“Banks like Emirates NBD and FAB have been able to spend reasonable amounts of money on their digital strategies,” he says. “The big question is what happens to smaller incumbents that can’t dedicate those kinds of resources to their own basic digitisation, let alone set up a standalone digital bank.”
Consolidation calling
Mounting pressures on smaller lenders once again raise the spectre of further consolidation in the UAE banking market, which consists of 21 national banks and 37 foreign lenders serving a population of just more than 10 million.
Since the merger of National Bank of Abu Dhabi and First Gulf Bank to create FAB in 2017, the sector has seen several major deals creating a new category of regional super lenders that dominate the local market. FAB, Emirates NBD, Abu Dhabi Commercial Bank and Dubai Islamic Bank — all of which have undergone mergers and acquisition (M&As) since 2017 — accounted for around 85% of total banking assets in the UAE at end-2020.
“We believe that economic and credit conditions are optimal for further M&A, as banks are trying to fight profitability pressures from a lower interest rate environment, strong competition and elevated impairment charges,” says Mr Ramsdale. “Smaller banks with limited franchises are the most vulnerable to the economic downturn and constitute potential targets who have suffered more from asset quality and profitability pressures, with thinner capital buffers and weaker revenue generation and diversification.”
