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Gulf banks' ratings and asset quality comes under scrutiny

In its latest report on the prospects for banks' ratings in the Gulf region, the international rating agency Moody's has said that any upward revision in the ratings of region's banks looks unlikely in the context of concerns relating to asset bubbles.

“The rating uplift has typically been constrained by Moody's concerns about certain risk pockets relating to the rapid growth in lending and the possible build-up of asset bubbles. Nevertheless, the otherwise favourable Gulf economic and banking environment is reflected in the stable or positive outlooks on all rated banks' financial strength ratings (FSRs),” Moody's Investors Service says in a new special comment "Arabian Gulf banking: Stable to positive rating outlooks — amid concerns over rapid loan growth and possible asset bubbles".

According to the yet to be released report from the rating agency, banks operating in the Arabian Gulf have achieved material improvements in recent years, however, they have to date enjoyed only selective, rather than broad upgrades in their FSRs.

The warnings from Moody's comes at a time when the region's central banks and regulators are taking a close look at the quality of assets held by banks and the extent of banking sector's exposure to the regional stock markets which have been in a free fall from Mid-October 2005.

On May 7, the Central Bank of UAE issued a circular addressed to all banks operating in the country to report their exposure to the stock market. The Central Bank is understood to have issued the circular in the context of the deep correction the UAE markets have been going through during the past few months. While the DFM Index has lost more than 60 per cent since the beginning of this year, many regional markets have slipped 50 to 75 per cent during the past six months.

“A number of banks, financial institutions and brokers have lost money during the recent crash as many were offering unofficial margin trading and leverage to speculators. In the falling market, the margin calls added to the steep decline,” said the General Manager of a Dubai-based broking company.

Although the Saudi Central Bank recently clarified that no banks in the Kingdom were in trouble from the recent stock market turmoil, there were strong rumours of a leading private bank getting into serious trouble and was being quietly bailed out by its shareholders.

“Gulf banks have been benefiting from the strong economic cycle underpinned by the substantially increased oil and gas prices. In particular, over the past two to four years, most institutions have been reporting strong business growth and material improvements in their financial performance, which now compares favourably with that of higher-rated institutions in emerging markets," said Mardig Haladjian, a General Manager in Moody's Financial Institutions Group and author of the report.

“Nonetheless, Moody's maintains a cautious approach as we believe that the surge in economic and banking activity has also led to a build-up of new risks, which are largely of a systemic nature.”

Moody's is concerned, based on the experience of other markets, that the rapid growth in lending to corporates, consumers and small- and medium-sized enterprises may hide both individual and systemic risks. The currently impressive loan quality indicators do not, in the rating agency's view, fully capture the normalised loss content of such loans, which could become more apparent when the books mature and repayment ability is tested under adverse economic conditions.

In a recent interview with Khaleej Times Pierre Cailleteau, Senior Vice-President and Senior Credit Officer, Sovereign Risk Unit, Moody's Investors Services expressed his concern about the overall credit quality in the region.

“Although there isn't anything alarming about the growth in the region, there are too many things happening too fast. Banks and financial institutions need to be sure about the quality of assets they are acquiring,” he said.

The latest note of caution comes from Moody's at a time regulators and key industry players have already taken note of the potential risks. "Gulf banks' direct and indirect exposure to local capital markets has not only inflated their business volumes and earning levels, but also exposed them to a possible asset bubble, especially in Saudi Arabia and Qatar. In this context, Moody's main concern relates to lending secured by equity holdings and indirect exposure to the capital markets in the form of personal and corporate loans that were diverted to the capital markets.” said Haladjian.

The rating agency has also expressed its concern over the increasing level of exposure to the construction, contracting and property markets, especially given the short-term funding profiles of most Gulf banks, with a possible reversal in real estate values potentially placing some institutions under financial strain.

Reacting to the Moody's views on the regional banking sector, a leading Dubai based banking sector analyst said: “Moody's has not discovered anything new as the local media including Khaleej Times have been very vocal in questioning the overall asset quality of banks in the context of their exposure to the stock markets and the property markets.”

On the overall economic environment in the region, Moody's said it believes that strengthened economic conditions are likely to prevail over the medium term and to continue to benefit Gulf banks.

"In our view, the markets will enter a phase of more moderate growth and excessive risks in the capital markets will be reduced, while necessary changes will also take place at the level of individual banks including a lengthening of funding profiles to match the longer-term lending practices. As these changes occur, Moody's expects that more, though still selective, rating upgrades in the Arabian Gulf will occur," said Haladjian.