Bankers facing earnings squeeze

Profits for the third quarter at UAE lenders will be pressured by slow growth in lending, hindered by lingering financial uncertainty, an increase in non-performing loans as well as provisions for bad debts, analysts project. UAE banks are likely to struggle with slow loan growth and a rise in provisions that will put a dent in profits until at least the middle of next year, analysts say.

With the banks' third-quarter earnings on the way, analysts project that lenders will continue to see a rise in non-performing loans and will retain cash on their balance sheets in the form of provisions to account for them. "The trend now is weaker, and we expect bottom-line growth to be lower," says Deepak Tolani, a banking analyst at Al Mal Capital in Dubai. The three main factors weighing on bank earnings are: slowing loan growth brought on by the financial crisis; a rise in non-performing loans; and the need to set aside provisions for more bad debts.

Provisioning has become an especially hot topic in the past six months because of the large exposures some banks have to Ahmad Hamad Al Gosaibi and Brothers and the Saad Group, a pair of Saudi conglomerates that are restructuring their debts. Meanwhile, banks also face an increase in loan defaults from other retail and commercial customers who have found making regular payments increasingly difficult during the global economic downturn.

In the first half of the year, banks in the UAE put aside almost Dh5 billion (US$1.36bn) in provisions that would otherwise have been booked as profits. This trend led to a decline of 27 per cent in second-quarter profits at listed banks compared with the same period last year. As banks continue to set aside provisions, the toxin of soured loans will eventually work its way through the system, analysts say, helping financial institutions to return to increased profits.

Yet that process is likely to take many months. Banks must report non-performing loans, or loans on which payments are late, only when they are more than 180 days overdue. Lenders can also reclassify a loan as healthy if they renegotiate its terms with the borrower before the 180-day window closes, restarting the six-month period before the loan is accounted for as non-performing. These factors allow banks time to contend with a rash of bad loans. But they also mean that the full extent of loan write-offs is not likely to be reflected in financial results until next year.

"I think provisions will be higher [in the third quarter]," says Suleman Soorani, a banking analyst at SICO, an investment bank in Bahrain. "We are in a down cycle, and we've seen provisions increase in the first and second quarters. I think the trend is largely going to continue in the third and fourth quarters." Janany Vamadeva, a banking analyst at HC Securities in Dubai, says she is looking for non-performing loans and provisions to reach a peak next year before tapering off.

"It takes about six months for bad loans to be reflected in the books because of the 180-day cut-off," she says. "We expect them to peak some time in the middle of next year, but it hinges on the economic environment globally. 'We would expect it to take some time. But it's very hard to say exactly how long." Stagnant loan growth is another factor analysts are looking at as they piece together profit projections.

Loans and advances at most lenders have declined or risen only moderately in recent quarters as they curtail lending to comply with stricter capital adequacy requirements from the Central Bank. Finding money on international markets has also become more difficult because of the global credit crunch, further cramping lending. Fees and commissions from new loans, a long-time profit source for banks, have gradually diminished in importance. The emphasis, analysts say, has changed to interest income, which has seen a boost as spreads - the difference between what it costs a bank to borrow money and how much it charges its own borrowers - have widened.

"Net interest margins have increased sharply due to an increase in credit spreads, which UAE banks have been able to pass on to customers," Mr Soorani says. These increased interest rates have not fully offset increases in provisioning and bad loans at most banks. But they have been a welcome respite during an otherwise harsh period for lenders. Some banks may also get a profit boost from investment income as global capital markets turn upwards. Many banks across the region have large investments in western stock and fixed-income markets, which faltered during the early part of the year but have since recovered.

"Banks that were heavily invested in capital markets might see benefits as global asset prices increase," Mr Soorani says. "Emirates NBD had a significant portfolio of bonds and other fixed-income assets in regional and international markets, and they might book gains from that." Banks that do a brisk business with government entities - especially those in Abu Dhabi - also stand to do well in the coming quarters, analysts say. Lenders in Abu Dhabi have benefited from financing the emirate's aggressive expansion, which has continued in spite of the global downturn. This has led to strong loan growth at Abu Dhabi's biggest banks, including First Gulf Bank and National Bank of Abu Dhabi.

Overall, though, analysts expect the next few quarters to be rough for the region's banks. While healthy interest income and investment performance - coupled with continued government spending on infrastructure and property projects - help offset bad loans and slow loan growth somewhat, analysts do not expect to see a major rise in profits any time soon. As third-quarter bank results start to trickle in - Banque Saudi Fransi is the only bank in the GCC to have reported results so far, notching a 1.9 per cent decline in profits - analysts are looking keenly at trends in provisioning and loan growth. Generally speaking, they do not expect losses, but they also do not foresee major gains.

"We expect that the third quarter is not going to be that great," Ms Vamadeva says. "There's not much loan growth and they're having to take on more [provisioning] charges." Analysts are also looking carefully at banks' exposures to the Saad and Al Gosaibi groups, which are involved in a series of legal disputes including allegations of a $10bn fraud by Maan al Sanea, a Saudi billionaire who owns the Saad Group, against Al Gosaibi.

Listed banks in the UAE were recently required to disclose their exposures to the groups and Saudi lenders reportedly reached an agreement with the Saad Group to settle debts. But with legal disputes still being thrashed out in London, New York and the Cayman Islands, much remains unclear about how or when lenders will be repaid. Another unknown facing UAE banks is the fate of loans to property developers and the construction sector. Banks became deeply involved in project financing during Dubai's property boom, which ground to a halt late last year amid major price declines. That has left many lenders with large loans to a struggling sector, and many analysts consequently see its future as inextricably linked with the banks.

"I think higher provisions could continue for two to four more quarters," Mr Soorani says. "In mid-2010 we might see the situation stabilising, but that depends on the overall performance of the real estate market." @Email:afitch@thenational.ae