Fitch: UAE banks face increased impairments in tough environment

"The first half of 2009 has been challenging, with a rapidly slowing economy, liquidity pressures and rising impairments restricting new lending and profitability," says Robert Thursfield, Director in Fitch's Financial Institutions team.

"While the situation has eased somewhat and with the help of some capital injections bank capitalisation has improved, the outlook remains challenging for the UAE's banks."

Results for the first six months of 2009 (H109) show the eight largest national banks reporting still adequate levels of profits (combined net income of AED8.8bn), although it will be difficult for them to repeat this level in H209, in Fitch's view. Cost growth is also likely to slow as banks become more cautious in their expansion plans, although with the average cost/income ratio of the eight banks a fairly low 33.2%, the capacity to absorb slightly higher costs remains.

Asset quality ratios are under pressure but most of the banks' non-performing loans remain around 2% of total lending at end-H109.

"However, this is a lag indicator and remains artificially low given the rapid levels of loan growth over the last few years and is likely to rise as growth has slowed significantly and as the existing portfolio loan book seasons."

Thursfield added.

Real estate related impairments are likely to rise given that the fallout from the significant real estate crash across the UAE has not yet been reflected in banks' financial statements.

Fitch has conducted a sensitivity test on asset quality and capital ratios and believes that all of the eight banks could absorb 100% and 220% increases in impaired loans over the next two years and still maintain minimum Tier 1 ratios of 12% and 8% respectively. Increases in impaired loans of this magnitude are feasible given the challenges faced by the market and as a consequence, despite recent improvements Fitch expects ongoing pressure on capital ratios. Most of the eight banks received direct injections of tier 1 capital from their respective emirates' governments.

Funding and liquidity pressures were significant for all banks during Q408 and although these have eased in H109 with the UAE Ministry of Finance (MoF) placing AED50bn of deposits into the banking system, the imbalance between loans and deposits persists. Competition for customer deposits remains high and with debt capital markets remaining unattractive to date in 2009, funding costs rose. The UAE Federal Authorities have sought to address this by issuing a guarantee on all bank deposits and planning to do the same for bank debt issuance, although no detail on either guarantee has yet been forthcoming.

The 'UAE Banks' Review and Outlook: Rising Impairments Affecting Performance, Although Higher Capitalisation Provides Support' is available on the agency's web site 'www.fitchratings.com'. The review covers Abu Dhabi Commercial Bank, Abu Dhabi Islamic Bank, Dubai Islamic Bank, Emirates NBD, First Gulf Bank, Mashreqbank, National Bank of Abu Dhabi and Union National Bank.