Thursday, December 31, 2009

Banking Report: Analyzed

The EFG Hermes report on some of the banks is interesting by all means, while not aimed at a credit assessment but more at stock performance, it nevertheless presents a balanced view. While there are some notable exceptions in the report I have seen, like Mashreq and Union National Bank (my former bank), it does make the point that the current financial woes are not as bad as they sound. The 3rd quarter performance of the banks was better than expected and judging by the analysis the banks that appear as laggards in their analysis are not on account of credit issues but more management style and focus in terms of the economic segmentation they pursue for earnings. While I am a traditionalist who would not rely on inter bank borrowing to fund the loan book, I concede in the ten years I have been out of managing a bank a great deal has changed. While back in the 1990's international banks panicked at the slightest political trouble in the region, the trend since then has been more mature and banks do not cut lines at the slightest of whims as they used to back then. Thus inter bank funding is more stable and can be seen as a factor in funding the loan books of banks, even though I was surprised that some banks from the sub continent got over cautious through the recent Dubai World crisis and while not cutting exposures to the country did have a 'wait and see' policy.

Indeed it was interesting that their analysis of the Dubai Inc (a loose word to describe all the debt of Dubai Government and the GRI's) is spot on in mentioning that while the numbers seem significant, even to GDP, there are two aspects that need consideration, a) the surplus cash flow of the good companies can be used through the parent structure mechanisms to help the weaker ones. and b) there are a number of assets that are eventually available for a sell off or privatization, (though they don't make these two points-that is how I read it). The current restructuring is a major element of this conundrum that needs to be solved and for this I would urge the Dubai World and the government to set a much faster pace to come to a settlement with the banks on this issue.

While the financial press have made a big deal, even today, about the support that has come from Abu Dhabi and hinted about it not being available in all circumstances (see today's FT) they forget that no support can be a carte blanche and has to be discussed on the merits. Interestingly yesterday an Abu Dhabi official spoke to Moody's Investors, as they have reported, and discussed that they have more than twice the reserves of the whole UAE public sector debt (assuming even the GRI's) in just one entity, to which if you add the Central Bank reserves and the other assets held by UAE entities the situation is more than comfortable. This is where I get so frustrated with reporters than they miss the big picture. Abu Dhabi thinks of the country as a whole, and eventually will be there to stitch things up, perhaps at a cost but it will be done.

The analysis of the banks in each of the cases is interesting. It is heartening to note that banks like EmiratesNBD and National Bank of Abu Dhabi still figure out as the strongest and the impact of either one of them of the current situation is minuscule. EmiratesNBD with a captial adequacy of near 20% and a provision of 95.5% of loans actually stands out better than Moody's would have us believe just two weeks back. None of the banks in terms of their capital adequacy numbers or coverage for non performing loans seem to be a problem. It is highly likely that into the mid of 2010 we may find over provisions on most of the balance sheets, which I strongly advise the bankers not to move back into profits. This will offset some of the need for higher provisioning on the general commercial and personal lending portoflios that may have suffered through the slow down.

In the end the macro economic scenario will play an important part. Higher liquidity, small to medium sector finance availability, and better respositioning of the asset-liability mismatch, which plagues all banks in the region, will ensure a stable to better year ahead. Significant in this process will be the following factors:

a. Better GDP performance.
b. Stability on the issue of the debt restructuring.
c. Middle market performance being better, i.e. trading, retail and services.
d. A steady real estate market, which while overburdened with supply will still gradually get over the panic stage.
e. A greater awareness of UAE position as a regional hub for business.

While I am not predicting major new avenues of business income for the banks in the year ahead, i.e. IPOs etc, I do feel that they will protect their market share better, hoping a better corporate and government sector performance will offset a weaker personal debt performance in the year ahead. Banks who manage to address the asset-liability mismatch early into the year will find themselves lighter on their feet and more nimble to take advantage of a recovery.

In terms of safety of the banking system I have the least of worries. No Bank incorporated within the UAE has ever been allowed to go under. (BCCI was not UAE incorporated and interestingly according the Sept 2009 Liquidators report of that failed bank 81% of all creditors have been paid, which must be some sort of a record as normally failed banks struggle to pay off 40-50%). I am positive of this that the UAE cannot and will not let a bank fail, to which is added a better regime of regulatory control and a more mature management in most banks.

How do I see the year ahead for the banks? In a nutshell: stable to better performance, dealing with the recent past bringing cheer with each successful settlement or restructuring and in terms of safety pretty much at the top of the definition of 'prime quality'.


Andrew said...

One aspect to be considered is the incubation of toxic debt as many attempted to remain afloat during 2009 but fell increasingly behind as business income receded during the course of the year. This has in many sectors fostered a new raft of potentially defaulting indebtedness due to non-settlement of aged receivables.

There are, if you scour the grass roots of small to medium business, many instances where the end of the line has been reached at the conclusion of a torrid twelve months not part way through.I refer to those who have tried to weather the economic storm to the final hurdle but without access to additional funds have finally faltered.

This collective liability will undoubtedly begin to plague the banking balance sheets as the number of cases begins to rise.

Yes indeed on the face of it the banking fraternity will be in a far better integral position in 2010, but unless financial assistance trickles out to the bottom of the heap a whole new set damaging fundamentals will emerge. Banks are getting stronger,many businesses are not.

Great hopes are pinned on 2010 but if the new commercial year flat-lines, I believe the popular term is 'stabilises' then the whole cycle may start again. The private sector also needs a cash injection and soon.

Andy McT

Blake Goud said...

That was an informative post. I wonder what your opinion is of the prospects for the banks in the UAE (conventional and Islamic) if the Federal Reserve in the US starts tightening rates later this year. With the dirham linked to the US dollar, this will transmit the effects of the monetary policy to the UAE, particularly with regards to aspects of the economy dependent on international trade. Do you think this will change the outlook for the banks in the UAE or is their concern more focused on a probably-still-developing deleveraging following the bursting of the property bubble primarily in Dubai?

Anwer Sher said...


A very valid point on the Fed tightening rates. First I think that the rate tightening in the US will be nominal, secondly, UAE rates have been higher than the US rates through this period anyways, so there is room for the UAE Central Bank not to tighten rates.
As for the prospects of the banks, in terms of liquidity the UAE Central Bank has provided closed to $33 billion on a tap to them and this has not been used as extensively as I would have thought. I do believe higher provisions will hurt them in terms of profitability but 2010 the trend will stabilize and feel Q3 2010 will see the reversal setting in for the banks. Ofcourse I am assuming there will be no more surprises!

Blake Goud said...


I agree with your assessment and the UAE will have some flexibility about monetary policy. However, it will be only a short-term fix with the fixed exchange rate. If (and a big if) the US economy begins a sustained growth, the rate hikes won't be one-off and there will begin to be pressure on the exchange rate peg without a domestic interest rate increase. This could be the 'surprise' you did not mention and if the Dubai economy is still undergoing the effects of the property bust, there could be pressure from businesses for a revaluation of the dollar peg to revalue the AED w.r.t. USD that would have resulted from a US rate hike without corresponding hikes in the UAE rates. There appear to be sufficient reserves to defend that peg, but that isn't always enough (e.g. when the GBP was forced to break the Euro ERM in 1992).

I understand that this is speculation based on multiple 'ifs', but if banks have foreign-currency-denominated debts or if short term rates rise and the funding costs for those banks rises as well, it could be a big negative for banks profitability outside any further surprises in the local economy.

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