With rising write-downs on investment losses and provisions for non-performing loans, the country's banks will see their core profits come under increasing pressure. On the positive side, the absence of significant bad assets will assure that the cold snap will not be as bad as across the Atlantic and in Europe, analysts say. "If you look at it in respect to toxic assets, then, definitely, the picture is brighter here," says Mohamed Damak, a credit analyst at Standard & Poor's, the rating agency. "But there are clearly negative pressures on banks' profitability."
Most importantly, there will be less fallout because the banks were never as highly leveraged as many of their US and European peers. Also, the majority of commercial banks were barely exposed to the structured products that turned out to be so deadly for some of their western counterparts. The Achilles heel of banks in the Emirates is their heavy dependence on outside funds. The system suffered a severe shock when foreign banks suddenly withdrew US$50 billion (Dh183.65bn) last autumn. Their other headache is heavy exposure to property, the backbone of the non-oil economy.
"Above all, you did not have that severe aliquidity mismatch here in the UAE, as banking exposure to the mortgage sector is limited and many have substantial debt funding," says Raj Madha, an analyst at EFG-Hermes, a leading regional investment bank. Other analysts agree. "Banks were never as highly leveraged, they are still highly reliant on customer deposits as a main source of funding and very domestic-orientated," says Sofia el Boury, an analyst at the investment bank Shuaa Capital.
The average loan leverage, the percentage of a banks' assets it hands out as loans, is at a modest 68 per cent, according to S&P's data for the seven UAE banks rated by it. By contrast, large investment banks before the crisis were taking one dollar and leveraging it by a further 40 times. Apart from setbacks shared by banks around the world, such as equity markdowns in their books and lower fees from lending and capital markets, several peculiarities set the Emirates' banks apart.
The fact that only a couple of banks, namely ADCB and Emirates NBD, were knowingly exposed to small amounts of toxic assets, will ensure, barring large surprises, that the sector as a whole is not crippled. Nevertheless, following an oil-induced feeding frenzy leading to excessive lending and a property bubble about to burst, the fourth quarter will mark the beginning of lower core profitability this year.
The main challenges ahead are tied to the special character of the banks, further aggravated by the global financial and economic malaise. "Banks' asset quality will be one of the main challenges going forward," says John Tofarides, an analyst at Moody's, a ratings agency. "This year we will see a true test of the loan books." All banks are facing a genuine credit squeeze since the hot money from abroad left overnight and international lenders cancelled generous cross-border credit lines. In fact, many of these credit lines, nicknamed "laptop banking", were set up on the laps of foreign bankers flying in and out of Dubai, sometimes even on the same day. "What you see here is a true credit squeeze, it is unlike the economic mismanagement in the West," says Mr Madha.
That squeeze has barely abated, and lending income is expected to drop significantly for most banks this year. Following a loan growth of up 50 per cent last year, despite a dismal fourth quarter, some observers see loans growing as little as between 3 per cent and 4 per cent this year, far below the 10 per cent upper limit recently imposed by the Central Bank as part of a funding package. The large exposure to the property sector further sets the local banks apart. Although lending for property is restricted to 20 per cent of the loan book, this rule is not enforced, according to Ms el Boury. "The central bank's regulatory cap - only 20 per cent of banks deposit base can be allocated to fund the real-estate sector - is not really a cap," she says, pointing to the absence of disciplinary measures as well as an absence of clear definitions. Mr Tofarides says that even if banks do not stick to the rule, they will not tell. He laments "insufficient data" from the banks, notably on their property exposure. "The disclosures of the banks' balance sheets are not up to international standards."
The large exposure to the property market, mostly as loans to developers, will weaken the quality of banks' assets. As their assets deteriorate, they will have to take impairment charges. Property prices are falling rapidly. Shuaa Capital predicts that Dubai property prices this year may fall as much as 60 per cent from their peak in mid-2008, while a new HSBC study, based on real transaction prices, shows that Dubai property prices are already 23 per cent down from their peak in September.
As many high-profile landmark projects are cancelled or put on hold, banks may be in for a rude awakening. Although the big developers are often state-backed, banks may suffer serious hits once the first of hundreds of private-sector developers starts to fail. "The loans to these groups are most vulnerable in case of a real-estate downturn," says Mr Tofarides. As developers cancel projects or go bankrupt, banks will see higher levels of non-performing loans for which they must take provisions. That in turn forces them to either strengthen their capital base or cut down on loans they hand out.
Another threat comes from rising defaults on personal loans. As a result, banks may have to take write-downs on non-performing loans. Stories of abandoned cars, including unpaid car loans, that are left behind as their owners leave Dubai make entertaining tales at dinner parties. But for the banks, these are grim reality, forcing them to take charges. The rule that personal loans had to be secured through salary payments has served as a good backstop to weather shocks.
But with thousands of people being laid off, including many well-paid expatriates, the rule has become a paper tiger, analysts say. So far, nobody is ready to put a number on personal defaults. But as 1,500 visas get cancelled every day, that number could soon become substantial. "We don't have any data, but it is logical that a portion of the people are getting out of the country because they find themselves incapable of meeting their obligations," says Ms el Boury, referring to unpaid credit card bills, mortgages or other personal loans.
For Mr Madha, "a large mobile population that can easily default" is one of the core difficulties facing banks in the Emirates. The absence of a credit bureau makes it even harder for banks to assess an individual's creditworthiness before handing out money. Should things get even worse, banks may call for the state to play a larger role. In fact, what may once have been a distinctive feature of many local banks no longer sets them apart as European and US governments bail out their banks, take stakes and inject funds.
Likewise, when western banks showed the first signs of distress, the Central Bank moved to guarantee all deposits for three years, put in place a Dh50bn emergency credit facility and inject Dh70bn in cash directly into the banks, of which the remaining Dh20bn is expected to be handed out in the next few months. The country has historically backed its banks, many of which are state-owned or have close government ties, and it is expected to continue to do so. Mr Damak says he has "always taken into account the extraordinary support to be provided by the government". The ratings agency accounts for the probability of government support when its rates banks. All banks ranked by S&P in the Emirates are rated as "supported".
"The government will never let any bank fail here," says Ms el Boury. The banks may survive, but first they will have to endure some chilly times, and an outlook of diminished earnings. uharnischfeger@thenational.ae
