The UAE banks' outlook is not all that gloomy despite a host of challenges as there are some bright spots such as rising oil prices, falling Covid-19 infection cases as well as resumption of key strategic sectors that give reasons to be optimistic, say analysts.
"While the UAE is facing a challenged outlook, we see a number of factors that could mark a change. In particular, we highlight the improved outlook for oil prices, the encouraging pattern in Covid-19 infections, the resumption of key economic sectors including tourism and retail, forthcoming foreign ownership limits changes and attractive dividends," said Hootan Yazhari, managing director of equity research at Bank of America Merrill Lynch.
"We see this as supportive to economic growth in the UAE, which could ultimately put upward pressure on loan demand, fee income and cause impairment costs to come in below expectations," he added.
"Dubai is set to receive tourists for the first time since early March on July 7. While the process of allowing tourists into the country will be fairly stringent with only certain countries being eligible and Covid-19 tests required, we believe it could help the Dubai economy in its recovery path," he said.
The UAE follows the US Federal Reserve with regard to monetary policy. Yazhari believes that interest rates will not go into negative and unlikely to be slashed further as the US economy has staged more pronounced rebound than the market was expecting following the removal of lockdown measures.
"We believe this could provide confidence that an end is in sight for margin contraction and the UAE will not have to adopt negative interest rates. While it remains too early to consider a potential recovery in near-term interest rates, an improving rate outlook has historically been supportive of higher forward multiples in the sector," said Yazhari, the equity analyst.
Rise in NPLs
James Swanston, Mena Economist at Capital Economics, said vulnerabilities in the banking sector have been brewing for some time as subdued economic activity has led to a steady rise in the non-performing loans ratio to levels close to the highs following the 2009 crisis.
"We've argued before that the coronavirus outbreak may exacerbate problems of overcapacity in Dubai, causing bad loans to rise even further. What's more, relative to other banking sectors in the region, the UAE relies more heavily upon wholesale financing which may become more difficult to roll over during the current crisis," said Swanston.
Lower dividend forecast
Yazhari lowered forecast for the dividends by the UAE lenders on the back of cautious earning expectations, but he said the UAE banks are relatively well-capitalised with Emirates NBD, Dubai Islamic Bank and First Abu Dhabi Bank enjoying strong capital adequacy ratio, well above the statutory minimum.
"We see ENBD, DIB, FAB generating sufficient excess capital in 2020 and 2021 to service a dividend. While ADCB technically has the capacity to pay a dividend in 2020 and 2021, we believe it will leave it sufficient breathing space should the economic outlook worsens."
It also lowered expectations for asset quality deterioration in 2020-22 following higher than expected impairments in Q1 2020 and also reduced expectations for margins post Q1 2020 results with net interest margins correcting more sharply than anticipated.
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