UAE banks’ solid pipeline encounters margin, credit-cost test | Insights


This analysis is by Bloomberg Intelligence Senior Analyst Edmond Christou. It appeared first on the Bloomberg Terminal.

Higher borrowing costs, economic angst and corporate tax menace United Arab Emirates banks’ 2024 credit quality, with extra 2H provisions likely. A five-year $225 billion construction pipeline and liquidity buffer see banks well-capitalized for asset growth. Yet low pass-through and rising funding costs suggest limited scope for margin gains.

UAE banks entered 2023 with healthy balance sheets — after reducing financial risk in real estate, hospitality and services — as well as an acceleration in recoveries and bad-loan writeoffs. Central bank support measures, strong economic activity and a property rebound are key valuation-rating catalysts. UAE banks have been on an upward trajectory since late 2020, aided by a robust property market and private-sector activity. Though domestic property prices may continue to rise, albeit at a decelerating mid-single-digit pace, upside risk comes from high borrowing costs, corporate taxes and global economic uncertainties.

Qatari banks are trading below their UAE peers for first time since May on a price-to-book valuation, while Kuwaiti lenders are trading below them for first time since July 21.

Loan increases of 4% see slow 2H threatening consensus

Credit at all UAE banks expanded 3.5% (4% excluding foreign loans) in the year to June, fueled by an equal rate of public- and private-sector gains, based on central bank data. The latter was driven by growth of almost 6% in personal lending (largely mortgages) and 3.5% in corporate finance. Aggregate consensus for the top eight banks suggest a similar pace of gains is likely in 2H, supported by the UAE’s healthy construction pipeline. However, we still see risks to estimates from a slowdown in 2H — from the retail segment in particular — given elevated borrowing costs.

Emirates NBD (ENBD), First Abu Dhbai Bank (FAB), Abu Dhabi Commercial Bank (ADCB) and Commercial Bank of Dubai (CBD) advanced their lending-market share in the year to June, but sequentially in 2Q only CBD, ADCB and RakBank registered increases.

Cost of funding catch-up a risk to margin trajectory

The top 14 UAE banks’ annualized net interest margin contracted 5 bps on average sequentially in 2Q (4-bp decline in 1Q). That’s with the cost of funding (CoF) continuing to rise at a rate of 50 bps in each of the past two quarters, despite the smaller pace of increase in banks’ cost of interest-bearing funds in 2Q. Still CoF is masked by a stable share of low-cost deposits “CASA” at a 43% median (51% peer average) in 2Q. The risk is CASA falls in 2H amid high interest rates, pushing CoF higher. Asset yields expanded 45 bps on average in 2Q (on annualized basis), unchanged vs. 1Q. Loans — corporate loans in particular — are still repricing rate increases as the average interbank rate is still 53 bps above 1Q.

ENBD’s margin fell less in 2Q than in 1Q, but those of DIB, Ajman Bank, CBI, CBD, SIB and NBQ started to contract.

Greater demand-deposits rivalry amid rising rates

Abu Dhabi Commercial Bank (ADCB), Dubai Islamic Bank (DIB) and National Bank of Fujairah (NBF) lost market share in demand deposits or current accounts this year, while other peers lost share during 2Q (except for First Abu Dhabi Bank (FAB) and Mashreqbank). Emirates NBD (ENBD) doesn’t disclose its demand-deposits size, but its share of low-cost “CASA” deposits — largely driven by demand accounts — was reached 61% in 2Q vs. 60% in 1Q. The rest of the peer group saw demand deposits drop during 2Q (except FAB and Mashreq).

UAE banks’ 2Q deposits rose 3.3% sequentially, totaling 7% in the year to June after a strong 1Q. That outpaced credit expansion, driving a better 74.8% simple loan-to-deposit ratio in June (86% 10-year average). Sector liquidity is healthy, with interbank rate spreads (including US SOFR) still negative.

Bank cost of risk may normalize higher sequentially

UAE banks’ 2Q earnings found support in lower cost of risk (credit charges). This was helped by improved asset quality, higher recoveries and writebacks. The lenders were able to recover some of their legacy loans due to better economic activity and a strong property market. The latter helped better valuations for collateralized exposure and encouraged companies to seek resolutions. However, risks are mounting due to elevated borrowing costs, corporate taxation beginning in 2024 and global economic uncertainty. That suggests there will be precautionary provisioning toward 2H and a rising cost of risk for banks sequentially.

The compiled consensus of the top eight banks suggests cost of risk of about 88 bps (net basis) this year vs. about 107 bps in 2022.



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