UAE banking and the oil price shock of 2015

Crude's fall will have an effect on lenders, writes Matein Khalid

UAE bank shares were slammed by a bear market amid an epic fall in oil prices, a rise in the US dollar and an exodus of global capital from emerging/frontier markets. The scale of selling on the Dubai Financial Market and the Abu Dhabi Securities Exchange has eerie echoes with the autumn of 2008, when Lehman's failure led to a seizure in the global interbank and wholesale funding markets, a $100 a barrel drop in Brent crude, panic flows into the US dollar and a free fall in Gulf property markets. Yet the autumn of 2015 is not the autumn of 2008 for UAE banks. Why?
One, UAE banks have vastly boosted their capital cushions since 2008 and Basel Tier One capital for the banking sector is now 16.7 per cent, at least 500 basis points higher than on the eve of Lehman's failure.
Two, six years of frenetic loan growth had made loan/deposit ratios in UAE banking excessive at 108 per cent in fall 2008. This is not the case now as UAE banking's loan-to-deposit ratio has fallen to 97 per cent, higher than Saudi Arabia's 79 per cent but lower than Qatar's 108 per cent. Banking sector leverage has also fallen to 7.6, 100 basis points lower than in 2008.
Three, UAE banks have also successfully raised the non-performing loan coverage ratios in the banking system to 113 per cent, far higher than the coverage ratio during the 2008 global credit crisis.
Four, the UAE banking sector was dependent on fickle global wholesale funding markets, which froze after Lehman's failure triggered an epic crisis of confidence in the international interbank market. The depositor run on Gulf Bank, the $24 billion Saad/Al Gosaibi bank loan-loss scandal in Saudi Arabia and the US Treasury's bailouts of Citigroup, AIG, Lloyds and RBS all contributed to excessive risk premia for Arab bank borrowers in the nervous, unsettled euromarkets.
However, with lower leverage and higher loan/deposit ratios, UAE banks have reduced their dependence on offshore funding vehicles like Euro-Medium Term Notes and Eurocommercial paper. There is also no sign of systemic risk in the international interbank market, though successive sovereign credit downgrades could see emerging markets bank borrowers blackballed from the euromarkets, as in 2008.
Five, UAE banks have reduced their exposure to volatile sectors such as real estate development/construction since 2008, boosted their credit underwriting cultures, increased provisions on stress loans.
Six, the UAE is the strongest sovereign credit in the Arab world, thanks to the sheer scale of Abu Dhabi's state reserves. Given the government majority shareholding in all UAE money-centre banks except Mashreq, there is no real liquidity or funding risk as the diversified, networked, globalist UAE economy will grow at least three per cent and bank asset growth targets are reasonable.
In any case, the Central Bank of the UAE has established mortgage caps, mandated a higher proportion of liquid assets on bank balance sheets and frowned on speculative loans to property "offplan flippers". For instance, Union National Bank has 30 per cent of its balance sheet in liquid assets, a tribute to one of the best-managed bank treasuries I know in the Arab world. National Bank of Abu Dhabi, the government's flagship bank, has a 38 per cent liquid asset ratio, making it the most liquid bank in the GCC.
I see two macro headwinds for UAE banks in the next six months. First, UAE bank exposure to real estate, construction and home mortgages is far too high at almost 30 per cent of all loans. The property market has fallen significantly since spring 2014 and transaction volumes have halved. Second, the Dh600 million loan Atlas Jewellery scandal makes me nervous about corporate loan asset quality.
I get nervous whenever mortgage bankers try to sell me "innovative loans". As a debt trader who once represented Bear Stearns in the UAE, I agree with former Fed chairman Paul Volcker that the only real useful financial innovation in the last century was the bank ATM. I am also worried about property/construction exposure at some UAE Islamic banks, which is 65-70 per cent of the loan book.
Despite the horrors of 2009-10, almost one-third of UAE mortgage finance is for offplan properties, though this risk is mitigated by higher provisioning and collateral. The oil shock means the UAE government will recycle lower petrodollar revenues and generate lower trade/project finance fee income. This could mean liquidity pressures in the interbank market, lower bank net interest rate margins and EPS growth. I will not bottom-fish in UAE bank shares.

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