S&P Global Ratings said it expects the UAE banking sector to remain resilient in 2020, with mid-single-digit credit growth supported by government spending on key investment projects.

In the report, UAE banking Sector 2020 Outlook: Resilience In A Difficult Operating Environment, issued Monday,  the agency said resilient financial performance will enable rated UAE banks to maintain stable credit profiles in 2020, barring any unexpected increase in geopolitical risk or a major fall in oil prices.

“Although in our base-case assumptions we exclude a fully-fledged direct military confrontation between Iran and the US, we do expect tensions to intensify and recede periodically. This will mainly affect the UAE through lower consumer sentiment and delays in leveraged finance investments, which are accentuating price declines in the already-depressed real estate sector.”

The ratings agency expects the UAE economy will expand at a slightly higher pace this year compared with 2019. This is due to Abu Dhabi's $13.6 billion stimulus package and the Dubai government's planned investments for the 2020 World Expo (Expo 2020), which should support investments in the non-oil economy and increase tourism-related activities.

“Although lending growth slowed slightly to 4.5 percent annualized, in the first nine months of 2019, we expect a slight acceleration to 5-6 percent in 2020.”

It said that while the banks’ stock of problem assets and loans should remain stable, there could be some migration between the two categories and a slightly higher cost of risk at about 120 basis points (bps) in 2020 (versus 110 bps in 2019).

However, banks are expected to maintain healthy coverage ratios, which will help them navigate asset-quality challenges. Their nonperforming loan coverage ratio increased to 124 percent at Sept. 30, 2019, from 62 percent at year-end 2010.

On the real estate front, despite a more than 35 percent decline in prices since mid-year 2014 and UAE-based banks' somewhat large real estate exposure (about 20 percent of total lending or 333 billion dirhams as of Sept. 30, 2019), asset-quality indicators have remained resilient, the report said.

This is because:

-The market remains dominated by cash buyers. Mortgages contributed about a quarter of transactions by value in 2019.

-The major construction companies are government-related, which means that, ultimately, the government could be obliged to step in should the correction continue.

-Banks seem have to have taken a relatively conservative approach in their recognition of Stage 2 loans with the transition to IFRS9. “If the real estate correction is not followed by a stabilization of prices in the next 24 months, we might see a bigger effect on banks' asset quality.”

The report also noted that UAE banks' capitalization was strong with unweighted-average S&P Global Ratings risk-adjusted capital ratio of 12.3 percent at year-end 2018.

“We believe this ratio will increase to 13.0-13.5 percent in 2020-2021, thanks to the issuance of hybrid instruments by some rated banks in2019.”

UAE banks saw a slight decline in profitability in the first nine months of 2019, and this is set to continue. The lenders’ three interest-rate cuts, mirroring the loosening in US Federal Reserve monetary policy, will hit the bank’s margins.

S&P Global Ratings expects expect low-single-digit annual deposit growth over the next two years. Growth in customer deposits slowed to 2.7 percent in the first nine months of 2019, compared with 7.9 percent in 2018.

“This was mainly due to stagnation in government and GRE deposits, linked to increased investment activity and infrastructure spending, as well as a decline in nonresident deposits.”

Nevertheless, public-sector and government depositors provide more than 25 percent of resident deposits, and that is expected to continue.

(Writing by Brinda Darasha, editing by Seban Scaria seban.scaria@refinitiv.com)

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