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Jan. 26, 2021
Puneet TuliMohamed DamakBenjamin Young
UAE Banking Sector 2021 OutlookA Long Recovery Road Ahead
Key Takeaways
– We expect GDP growth to recover in the United Arab Emirates (UAE) this year from the sharp recession of 2020 triggered by the COVID-19 pandemic and low oilprices.
– However, we think the 2020 shock will continue to reverberate through the economy and banking sector. We expect real GDP (in dollar terms) will only return to the 2019 level by 2023. Key sectors, particularly real estate, hospitality, and retail, will likely remain under pressure for the next 12 months.
– The country’s target to vaccinate 50% of the population by end Q1 2021 is positive, but further virus waves and mutations pose significant downside risks.
– We expect banks’ asset quality to deteriorate and cost of risk to increase further as they start recognizing the impact of the 2020 shock and as the Central Bank of UAE (CBUAE) lifts its forbearance measures progressively in H2 2021. Given continued low interest rates, banks’ profitability will, therefore, remain low in 2021 with a few banks potentially showing losses.
– Strong and stable capital buffers, good funding profiles, and expected government support should continue to support banks’ creditworthiness in 2021.
We expect GDP growth to recover in the United Arab Emirates (UAE) this year from the sharp recession of 2020 triggered by the COVID-19 pandemic and low oil prices.
However, we think the 2020 shock will continue to reverberate through the economy and banking sector. We expect real GDP (in dollar terms) will only return to the 2019 level by 2023. Key sectors, particularly real estate, hospitality, and retail, will likely remain under pressure for the next 12 months.
The country’s target to vaccinate 50% of the population by end Q1 2021 is positive, but further virus waves and mutations pose significant downside risks.
We expect banks’ asset quality to deteriorate and cost of risk to increase further as they start recognizing the impact of the 2020 shock and as the Central Bank of UAE (CBUAE) lifts its forbearance measures progressively in H2 2021. Given continued low interest rates, banks’ profitability will, therefore, remain low in 2021 with a few banks potentially showing losses.
Strong and stable capital buffers, good funding profiles, and expected government support should continue to support banks’ creditworthiness in 2021.
Real GDP To Recover Only Partially In 2021
A Subdued Recovery
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f--Forecast. Source: S&P Global Ratings.
– We expect real GDP to have contracted sharply in 2020 by around 8% year on year because of low oil prices and a sharp drop in tourism and real estate activity due to the COVID-19 pandemic.
– We expect oil prices to average $50 in 2021. We also assume that the government will be able to achieve its target to vaccinate 50% of the population by the end of Q12021. Nevertheless, further virus waves pose downside risks.
– Despite the expected boost to growth from the Dubai Expo in 2021 and a recovering hydrocarbon sector, we expect GDP will only return to the 2019 level by 2023.
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Gross Lending Growth Will Remain Muted
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– In 2021, we expect gross lending growth to accelerate slightly on 2020, when banks recycled CBUAE AED50 billion liquidity support to help their clients navigate rough waters.
– Dubai Expo, now expected to take place in 2021, and borrowing by the government and its related entities (GREs) will support lending growth.
– Corporate borrowing will likely improve only slightly because some of the deferred capital expenditures in 2020 may be executed this year along with refinancing existing debt.
f--Forecast. Source: S&P Global Ratings, Central Bank of UAE.
Lending Growth To Remain Muted
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Lending growth Average lending growth since 2011
Further Increase In Non-Performing Loans Breakdown Of Loan Portfolio By Sector
Asset Quality Indicators To Weaken Further In 2021
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– We expect problem loans to increase once the CBUAE forbearance measures are lifted and banks start to account for the impact of the economic shock. However, we expect this process to be gradual to minimize the impact on the banking system.
– Real estate, construction, hospitality, consumer-related sectors, and SMEs will be the chief contributors.
Weighted average non-performing loans (Stage 3) for 10 largest UAE banks. f--Forecast. UT--Utilities. Source: S&P Global Ratings. Copyright © 2021 by Standard & Poor’s Financial Services LLC. All rights reserved.
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Coverage Ratio Will Remain Below Historic Levels Cost Of Risk To Increase Further In 2021
Asset Quality Indicators To Weaken Further In 2021
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Weighted average coverage ratio and cost of risk for 10 largest UAE banks. bps--Basis points. f--Forecast. Source: S&P Global Ratings.
– UAE banks increased their provisions in 2020 to cover for the impact of a fraud case in one of the largest corporates and the default of some construction and other companies.
– We expect additional defaults to occur in 2021 and believe that cost of risk will increase further. Coverage ratio will remain below historical levels.
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Lower Profitability Will Be A New Norm
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– After dropping in 2020, we expect UAE banks’ interest margins to stabilize at lower levels, mirroring exceptionally low interest rates globally and locally. A significant contribution of noninterest-bearing deposits to the funding profiles of UAE banks did not help.
– As cost of risk continues to increase, we think UAE banks’ profitability will keep declining, with limited prospect of returning to historical performance over the medium term.
– Cost-reduction initiatives will therefore be on top of banks’ management agenda. Reducing real estate footprints, relocating staff to lower-cost areas, and leveraging the opportunities offered by digitalization will be among their action plans.
– Lower profitability, or even losses for some players with high-risk exposures, could provide the impetus for further consolidation of the banking system.
Source: S&P Global Ratings.
UAE Banks’ Profitability To Remain Low For Longer
UAE Banks Have Strong Capital Position
Capitalization Remains Strong
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Q--Quarter. Sources: S&P Global Ratings, Central Bank of UAE.
– Despite the likelihood of lower profitability in 2020-2021, we expect banks to maintain strong capital buffers, with reduced dividend payout ratios. Some banks may raise additional capital in the form of Tier 1 or Tier 2 instruments to benefit from supportive market conditions.
– Quality of capital is still good, with a modest--but increasing--contribution of hybrid instruments.
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Weak Deposit Growth Will Continue
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– UAE banks’ funding structure benefits from a strong core-customer deposit base and limited reliance on external funding.
– Overall deposit growth dropped in 2020, as some corporates had to use their deposits to cover operating costs while their revenues contracted.
– At the same time, government and cash-rich public sector entities deposited their extra cash in the banking system. We expect some of these deposits to be withdrawn in 2021.
– Retail deposits continued to increase despite significant job losses, as individuals prioritized saving over spending.
Data until October 2020, annualized for full year. f--Forecast. GRE—Government-related entity. Source: S&P Global Ratings, Central Bank of UAE.
Deposit Growth Remained Weak in 2020
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UAE Banks Have Ample Liquidity On Their Balance Sheet
Liquidity Is Not An Issue For Now
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Liquid assets include cash and balances with central bank and interbank deposits. Calculated for 10 largest banks in UAE. f--Forecast. Source: S&P Global Ratings.
– UAE banks benefited from a AED 50 billion free liquidity injected by the CBUAE and a relaxation of regulatory liquidity ratios in 2020.
– As of Sept. 2020, almost one-quarter of UAE banks’ assets were in liquid form.
– This picture could change if oil prices declined significantly or in the case of an unexpected increase in geopolitical risks, neither of which are our base-case scenario for 2021.
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Our UAE Bank Ratings
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Ratings as of Jan. 25, 2021.
– All rated UAE banks carry a negative outlook, owing to the current weak operating environment.
– Outlooks could be revised to stable if we perceive that asset quality deterioration will remain within our base-line expectation, banks maintain strong capital buffers, and risks related to the operating environment recede.
– By contrast, we could lower the ratings if asset quality deteriorated significantly alongside increasing pressure on the operating environment.
Issuer Credit Rating
First Abu Dhabi Bank AA-/ Negative/ A-1+
Abu Dhabi Commercial Bank A/ Negative/ A-1
Mashreq Bank A-/ Negative/ A-2
Sharjah Islamic Bank A-/ Negative/ A-2
National Bank of Fujairah BBB+/ Negative/ A-2
Weaker Asset Quality For UAE Banks
More Pain For UAE Banks Than GCC Peers
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bps--Basis points. f--Forecast. NPL--Nonperforming loans. Source: S&P Global Ratings.
– Relatively higher exposure to sectors affected by the pandemic--including real estate, construction, hospitality, and retail--will result in weaker asset quality and higher credit losses for UAE banks.
– In the UAE, we might observe variances in the extent and timeliness of government support for corporates between the smaller vs. larger and richer emirates. This factor could influence UAE banks’ asset quality outcomes.
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Sharper Drop In Profitability For UAE Banks
More Pain For UAE Banks Than GCC Peers
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Source: S&P Global Ratings.
– Higher provisioning requirements for UAE banks will lead to a sharper drop in profitability compared with regional peers.
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Related Research
– GCC Economic Activity Held Back By Its Hydrocarbon-Heavy Economic Structure And OPEC-Related Production Cuts, Dec. 7, 2020
– GCC Banks: Lower Profitability Is Here To Stay, Oct. 13, 2020
– Credit FAQ: Dubai's Already High Debt Burden Set To Worsen Amid A Deep Pandemic-Related Macroeconomic Shock, Sept. 30, 2020
– Banking Industry Country Risk Assessment, United Arab Emirates, May 20, 2020
– Outlook On Five UAE Banks Revised To Negative On Deteriorating Operating Environment, March 3, 2020
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Analytical Contacts
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Puneet TuliAssociate
Dubai
+971 4 372 7157
Mohamed DamakSenior Director
Dubai
+971 4 372 7153
Benjamin YoungDirector
Dubai
+ 971 4 372 7191
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