The outlook on the banking system of the United Arab Emirates (UAE) remains negative as a result of the country's weak operating environment and the significant challenges facing the emirate of Dubai in particular, Moody's Investors Service said in its new Banking System outlook on the UAE. The negative outlook expresses the rating agency's expectations for the fundamental credit conditions in the UAE banking system over the next 12 to 18 months. “UAE banks faced significant asset quality problems in 2009, but their capital levels and good core profitability have allowed them to absorb losses without significantly undermining their creditworthiness,” said John Tofarides, analyst at Moody's Middle East in Dubai and lead author of the report. Although systemic support provided by the UAE's federal government has eased the banks' financial challenges, asset quality pressures stemming primarily from Dubai will continue to weigh negatively on Moody's outlook for UAE banks. “Overall, the operating environment remains difficult, with low economic growth and investment, weak demand for loans, as well as investor confidence issues which are curtailing the banks' ability to access low cost, wholesale funding,” said Tofarides. This is why UAE banks did not engage in any material new lending in 2009, with the exception of some retail and infrastructure and government-related lending, mainly in Abu Dhabi, he noted. Indeed, the expected loan growth for 2010 is at a low of 4 percent-7 percent (projected to be around 6 percent-13 percent in Abu Dhabi and 0 percent-5 percent in Dubai), compared to the CAGR 37 percent recorded from 2002 -2008. Moody's new report said asset quality among UAE banks will remain under pressure this year. Dubai World's recent restructuring is central to defining problem loans that pose significant asset quality challenges to the UAE banking system. As of 2009, problem loans (excluding Dubai World) comprised around 4.9 percent of total loans. “As Moody's recently commented, problem loans could more than double by 2010 to around 9.5 percent to 12.5 percent of gross loans, taking into account the Dubai World restructuring”, Tofarides said. In this difficult environment, Moody's said UAE banks' profitability also remains under pressure. Although all UAE banks have been increasing their collective loan loss provisions in order to create satisfactory buffers, they will - for the foreseeable future - probably need to continue to provide against persistent asset quality pressures, thus depressing their bottom line. On a positive note, UAE banks have high capitalization levels by international and regional standards (the Tier 1 capital ratio of 14.5 percent at YE2009) and this is a relative strength when viewed in the context of the high risk for loan losses. Having stress-tested the capitalization levels of the rated banks for additional losses, the rating agency concludes that the rated banks are currently appropriately rated to absorb losses based on Moody's economic assumptions and expectations. Moody's considers the liquidity position of UAE banks to be satisfactory, and would expect additional funding support from the federal government, if required. In 2009, UAE banks managed their liquidity by curtailing loan growth, and they are continuing this approach in 2010 by extending new lending on a very selective basis. However, competition for domestic deposits has increased, while market funding continues to remain unattractively priced for the majority of rated banks. Overall, the over-supply of properties, particularly in Dubai, is not conducive to a quick economic recovery nor to an improvement in the operating environment that would allow for an easing of pressures on the banking sector in the near term, Moody's said. It will take time before considerable excess supply in the real estate market can be absorbed by growth in demand and for the virtuous circle of improved cash flows, wealth creation and rising collateral values to resume. Until issues in the real estate markets are resolved, investor concerns will remain and, as a result, will continue to weigh negatively on the cost of market funding for UAE banks.
