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Dubai: The UAE's banking sector, which witnessed a dramatic turn of events from the end of the first half of 2008, is headed into a tumultuous year.
The sector, which was awash with liquidity and reported more than 35 per cent annual growth in assets and an average of more than 30 per cent growth in profits over the past four years, is entering the new year in the middle of an unprecedented liquidity crunch, a drastic drop in profit growth and increasing prospects of bad debts and potential losses.
Leading international rating agencies have scaled down their outlook.
In December, Moody's Investors Service announced that it had revised downwards the outlooks on the ratings of four local banks. While Abu Dhabi Commercial Bank, First Gulf Bank, and Dubai Islamic Bank were changed to "negative" from "stable", the rating outlook on Dubai Bank was changed to "stable" from "positive".
"The rating action reflects the mounting liquidity pressures in the short to medium term; the growing downward pressures on asset prices; and the anticipated profitability pressures from rising funding costs derived from increasingly scarce liquidity and loss of confidence," says John Tofarides, an analyst in Moody's Financial Institutions Group.
Early this week, Standard & Poor's lowered its long- and short-term counter-party credit ratings on Dubai Islamic Bank to "A-/A-2" from "A/A-1" and revised its outlook on the bank to negative from stable; revised its outlook on Emirates Bank International and National Bank of Dubai to negative from stable and affirmed its "A/A-1" counter-party credit ratings on the two banks; and revised its outlook on Sharjah Islamic Bank to stable from positive and affirmed its "BBB/A-2" counterparty credit ratings on the bank.
The ratings agency has affirmed its "A/A-1" counter-party credit ratings on Mashreq. The outlook on the bank remains stable.
The agency said the changes in its outlook reflect the impact of the difficult global macroeconomic and financing environment on the local economy and the banking sector.
Rating agencies and banking sector analysts fear that UAE banks face the prospect of increasing loan defaults as the country's property boom loses steam amid the global credit crisis.
Both Moody's and S&P say a sharp real estate sector correction will have a big impact on banks as construction and real estate account for almost 50 per cent of Dubai's GDP.
"Given the scale of banking sector exposure to property developers and contractors, a problem for the property sector is substantially a problem for the banks," Raj Madha, a director responsible for equity research at EFG-Hermes Holding.
The third quarter of 2008 saw a drastic change in outlook for the banking sector, with a period of excess liquidity rapidly changing to one of extremely tight liquidity. While funding difficulties do not reflect an absolute absence of growth, it is clear that growth has slowed sharply, while funding costs have risen excessively.
Shutdown
The most significant impact of the global credit crunch on UAE banks has been a nearly total shutdown of access to international bond markets. Over the past 12 months a number of local banks had to shelve their fund-raising programmes through medium term notes (MTNs) due to high cost and virtual absence of takers for these notes.
The recent history of the UAE's banking sector has been nearly entirely driven by the influence of global factors. In the first six months of 2008, the weak US dollar and loose US monetary policy led to speculation on the dirham peg, and an environment of abundant liquidity.
With falling interest rates came faster growth, higher credit off-take and strong performance of the banks. However, as the dollar strengthened in mid-year and the credit cycle began to tighten, this situation reversed, with much of this liquidity flowing back out of the system.
The flight of speculative deposits from the country created substantial short-term liquidity pressures, which prompted the UAE Central Bank and the Federal Government to offer Dh120 billion emergency funding to the banking sector.
Some bankers and economists are optimistic that the liquidity situation will improve in the first quarter of 2009.
"Given the financial strength and the willingness of the authorities, we expect liquidity in the UAE to begin to normalise in the first quarter of 2009," said Marios Maratheftis, regional head of research, Middle East, Pakistan and North Africa, for Standard Chartered Bank.
However, analysts also think the woes of the UAE banking sector go much beyond short-term liquidity issues and are deeply rooted in the overall macroeconomic environment in the country and the region.
"Plunging oil prices, an economic slowdown, the falling stock market, and pressure on real estate prices are raising major hurdles for the banks," said S&P's credit analyst, Emmanuel Volland.
"Looking forward, these factors are expected to lead to a major slowdown in business growth and deterioration in asset quality and profitability," Volland said.
Exposure
What's worrying analysts most is the loan books of banks that have huge direct and indirect exposure to the real estate sector. Massive borrowings from private, government and government-related entities boosted the total bank borrowings in the country during the first half of 2008 by nearly 50 per cent compared to the previous year.
Although customer deposits also increased rapidly, this could not keep pace with the growth in lending. As a result, the loan-to-deposit ratio of most banks exceeds 100 per cent, forcing banks to rely on wholesale funding that is more expensive and could prove volatile.
Soaring loan growth levels and future loan commitments, in tandem with maturing external borrowings through medium term note programmes, are exacerbating the pressures on UAE banks' liquidity and overall cost of funding.
"We recognise that the excellent asset quality and profitability levels reported by all UAE banks as a result of the benign credit environment up until autumn 2008 may be negatively affected going forward," says Moody's analyst Tofarides.
Faced with tight systemic liquidity situation, depressed asset prices, both financial and real, banks in the country have started taking corrective actions on a war footing.
Over the past two months, banks have become extremely cautious in lending. Several banks have either suspended or stopped loans to construction and real estate companies and the hospitality sector, while most banks have scaled down their retail lending substantially.
"Clearly there is a sector bias against real estate, construction and the hospitality sector in our lending operations as these sectors are likely to have maximum job losses," said the chief executive of a leading bank.
Banks are also leaving no stones unturned to boost their deposit base.
Currently banks are offering up to 6.5 per cent rates on short-term local currency deposits while the central bank repo rate is 1.5 per cent and the interbank rate is around four per cent.
Earlier this month, the Central Bank said credit growth in the country would shrink to less than 10 per cent in 2009.
Focus
"Under the current market conditions the banking sector's focus is on garnering deposits. It is natural to bring down lending to sectors that have higher risks," said Yousuf Nasr, CEO of HSBC Middle East.
"Credit growth at 49 per cent was neither desirable nor sustainable. The UAE Central Bank aims to keep credit growth at around 10 per cent. If it achieves this, then the economy should begin to cool off, which should help bring inflation down to eight per cent in 2009 from 12 per cent in 2008," said Standard Chartered's Maratheftis.
Despite the mounting risk of asset quality and profitability pressures on the banking sector, the government and the central bank have assured that the banking sector is not in any danger of a systemic risk.
"The UAE banking sector remains strong with solid fundamentals including 77.4 per cent of secure financing resources," Central Bank Governor Sultan Bin Nasser Al Suwaidi said recently. The governor explained that local governments hold substantial percentages in many banks; consequently the matter was solved in the UAE a long time ago.
"The UAE banking sector remains strong with solid fundamentals, including Dh181 billion of capital and provisions," Obaid Humaid Al Tayer, Minister of State for Financial Affairs, told the Federal National Council last month. "The capital adequacy ratio in the UAE's banks is 12.6 per cent on average," he added.
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