Emirati bankers arent yet shouting it from the rooftops, but the outlook for the sector in 2013 is better than it has been for five years. Many UAE banks have absorbed the significant loan loss provisions of previous years, and are booking some impressive profits as more positive economic news filters through to the bottom line.

National Bank of Abu Dhabi (NBAD), the countrys largest lender by market value, posted a 55 per cent increase in fourth-quarter 2012 net profit to Dhs1.12 billion ($305 million) on the back of higher investment income and lower impairment charges. Full-year profit was Dhs4.33 billion, up 16.8 per cent from Dhs3.71 billion in 2011, NBAD says.

Net impairment charges for the fourth quarter stood at Dhs365 million, down 24 per cent over the prior-year period. But the bank points out that growth was broad-based.

The growth came from all areas of our business, says Michael Miller, head of Investor Relations at NBAD. We experienced strong growth from our international businesses while our domestic businesses were relatively flat, reflecting tougher local conditions. The growth came from a combination of higher net interest income, net investment income and net fees and commissions.

Other major lenders showed some robust earnings. First Gulf showed a 12 per cent increase in net profits to Dhs4.15 billion, boosted by fourth quarter 2012 earnings of Dhs2 billion, the strongest quarterly revenue numbers ever recorded by the bank.

Emirates NBDs three per cent net profit increase for the year to Dhs2.6 billion was more modest, though operating profit for the year was up 82 per cent, says the bank. The Dubai-based lender says it offset loan spread compression with stronger fee income growth over the year.

In general, banks have been doing the right things. Loan-to-deposit ratios across the system stood at 95 per cent in October 2012, against 100 per cent at the start of the year.

Analysts see the improvements persisting through 2013. The banks took significant provisions against bad loans and whats happening now is that they are taking lower provisions so the result is the profitability of the banking system is gradually improving and that trend will continue, says Giyas Gokkent, NBADs chief economist.

Despite the generally better earnings news, UAE banks are not yet out of the woods. Asset quality challenges remain, particularly for Dubai-based institutions. Ratings agency Moodys expects problem loan levels to remain elevated, driven by exposures to large, stressed, government-related issuers and legacy corporate impairments - primarily real-estate-related - which are still emerging after failed attempts to restructure earlier in the crisis.

Moodys predicts that specific structural weaknesses will continue to undermine system-wide bank performance over the 12 to 18 month outlook period. In its view issues such as limited transparency, sizeable related-party exposures and high loan and deposit concentrations will continue to leave UAE banks vulnerable to name-specific credit risks. Asset quality will remain poor with the ratio of problem loans to gross loans in the 10 to 12 per cent range in 2012, declining only marginally this year.

The authorities have taken proactive measures to support the banking sector, by reducing speculation and risk exposure. Last December the UAE central bank issued a circular announcing that it would restrict mortgage lending to a loans-to-value (LTV) ratio of 50 per cent for first-time foreign property buyers, and to 40 per cent for second or subsequent real estate buyers. The mortgage cap for UAE nationals was to be set at 70 per cent LTV for first-time buyers and 60 per cent for subsequent properties.

However, the Emirates Banks Association (EBA) challenged the central banks cap plan, suggesting instead an LTV ratio of 75 per cent for initial property purchases by expatriates and 80 per cent by UAE nationals.

The central bank is reviewing the EBA proposals and an announcement is expected soon. The banks desire was that any new rules on mortgage lending should not be overly restrictive and stifle the recovery in the real estate market. And I think what was put forward by the EBA takes a reasonable, moderate stance in terms of where LTVs stand internationally, says Gokkent.

Some of the central banks steps have been well received. Last September it announced that it would create a new discount window called the marginal lending facility, a new funding facility allowing regulated UAE banks to borrow intra-day or overnight funds from the central bank by discounting eligible assets from a pre-published list.

This new monetary policy tool is designed to improve local banks liquidity management practices encouraging more banks to undertake more term funding. According to Moodys at year-end 2011 market funding above one year was only 3.2 per cent of total UAE bank liabilities.

The broader hope in 2013 is that banks, having shrugged off the worst excesses of the crisis, can start to take a longer-term view about growth prospects. One key ambition is to repay the capital that was placed with UAE banks at the height of the financial crisis, when the UAE finance ministry placed more than $19 billion with banks in late 2008 to bolster their balance sheets. This was then converted into seven-year bonds.

These bonds were priced at a higher rate than if they were to tap the fixed income market today.

Some banks have already begun addressing the bonds using their own cash resources. NBAD originally converted Dhs5.6 billion of support into bonds but repaid Dhs2.6 billion in 2012.

We are in a position to repay the capital and are committed to repayment. We have not specified the exact timing, says Miller

Repaying the crisis capital is one major challenge facing banks this year. But there are also significant lending opportunities that will come to the fore.

UAE banks continue to invest in their domestic and international platforms to ensure they are well positioned to capitalise on emerging economic opportunities.

In Abu Dhabi, some of the projects planned under the emirates 2030 economic plan are seeing real progress, which will lead to an increase in lending opportunities for the wider banking system.

In addition, with residential properties being completed, people will be looking for financing, giving support to mortgage lending activities.

Small and medium sized enterprises (SME) lending is another area that banks are targeting. However, the overall picture for this year will be one of relatively modest lending growth. That shouldnt concern Emirati bankers too much.

After the tumult of the last five years, a period of solid if unspectacular growth may be just the ticket.