US policy change not to hurt UAE banks, says S&P forecast

The decision by Fed to gradually end its bond-buying programme could dampen investors’ appetite for debt in emerging markets, but it is not expected to cause a major shock for the UAE banking system because banks have solid funding profiles, said S&P analysts.

“System-wide funding improved substantially after 2008 as banks in the UAE reduced debt and deposits grew faster than lending,” S&P analysts said in its report — UAE banking sector outlook 2014: An uptick in lending and economic activity signal continued profitable growth.

The report pointed out that UAE banks’ funding profiles had improved substantially over the past four years. “Lending slowed to a trickle following the slump in local real estate and stock markets in 2008, and this led to a noticeable improvement in the banking system’s loans-to-deposits ratio.” With deposits growing faster, the ratio of net resident loans to net customer deposits declined to about 94 per cent by August 30, 2013, from 111 per cent at year-end 2008. At the same time, banks’ already limited dependence on external funds became even lower, S&P said.

“We also believe that the UAE banks are generally well placed to handle the effect of potentially higher global interest rates if the Fed changes its monetary policy. The proportion of capital market exposures on UAE banks’ balance sheets has been traditionally lower than those of their Western peers, and most of the exposures are fixed-income securities with maximum terms of five years. Therefore, mark-to-market losses following potential rate hikes would be manageable, in our view,” it said.

Banks in the UAE, underpinned by a healthy economic growth and an upbeat corporate sector, are set for a year of good prospects undeterred by the tapering of the US quantitative easing, the rating agency said.

“Real estate prices have been inching upward since late 2012, particularly in Dubai, and banks’ credit losses are gradually decreasing,” said Standard & Poor’s credit analyst Engin Timucin.

“Over the past six months, we’ve also seen signs that credit growth is picking up. We expect these trends to provide banks with another year of strong financial performance, and they support our stable rating outlooks in the sector.”

Engin said the key risk factor to watch over the next 24 months would be developments relating to certain large restructured transactions. “Potential nonpayment of these debts could increase some banks’ provisioning requirements, thereby reducing their profitability,” he said.

S&P noted that there could still be bouts of market volatility as the Fed changes its monetary policy. This could reduce the liquidity available to banks and make it more expensive. “We believe, however, that UAE banks should generally remain strong because they still have only marginal net external assets.”

Most UAE banks’ non-performing loan (NPL) ratios have been stabilising over the past 12 months, after a significant deterioration in asset quality over the past few years, it noted.

“The banks continue to generate strong pre-provision earnings and increase their coverage of reported NPLs, and the incidence of new NPLs has slowed substantially. Although, we generally expect this trend to continue over the next two years, we don’t believe it has the potential to trigger positive rating actions at the current rating levels. As such, our outlooks in the sector remain stable,” S&P said.

After four years of modest credit growth, S&P expects the pace of bank lending to quicken in 2014, with support from healthy economic activity. “We expect real GDP (gross domestic product) growth in the UAE to average about 3.7 per cent annually over 2014.”

— issacjohn@khaleejtimes.com