Cracks Start to Show for U.A.E. Banks With Bad Loans on Horizon

(Bloomberg) -- Lenders in the United Arab Emirates will come under pressure this year as a property and retail slump take its toll.

One of the country’s smallest banks is being bailed out, problem loans are expected to rise this year and lenders are exploring mergers to stay competitive. Slow property sales, higher interest rates and a rise in lending amid improved economic growth could mean provisions jump as much as a quarter, according to analysts.

“We don’t expect a meaningful pickup in economic growth this year so we wouldn’t be surprised to see a deterioration in credit quality due to the SME and commercial segments,” said Shabbir Malik, a Dubai-based analyst at EFG-Hermes Holding SAE. “Recoveries from legacy loans, especially at Dubai banks, were high last year and these are likely to fade this year.”

Banks have so far largely managed to escape the impact of slowing economic growth with moderate earnings and provisions for bad loans falling to a five-year low in the third quarter. Growth in banking assets is highly correlated with that of regional GDP, which moves largely in tandem with oil prices. Since 2014, the GCC countries have been hit by a sustained period of low crude prices, which has caused governments to re-calibrate budgets and dip into state deposits.

Emirates NBD PJSC, the first U.A.E. bank to report earnings, said Wednesday it increased fourth-quarter loan loss charges by 81 percent from the third-quarter.

Cracks Start to Show for U.A.E. Banks With Bad Loans on Horizon

Average earnings at the country’s top eight banks are expected to rise about 9 percent this year, down slightly from an expected 11 percent rise in 2018, according to the average analyst forecast compiled by Bloomberg.

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“We expect higher default rates in real estate -- mortgages, commercial and residential real estate,” said Aarthi Chandrasekaran, a Dubai-based banking analyst at Shuaa Capital PSC. “Small and medium enterprises which account for close to 47 percent of Dubai’s GDP, are likely to get impacted by a higher financing cost along with higher cost of operations due to additional taxes.”

Chandrasekaran expects bad loan provisions as a percentage of total loans, or the cost of risk, to rise by 20 basis points this year, compared with an average of 82 basis points in the third quarter of 2018 for the country’s 17 listed banks, according to data compiled by Bloomberg.

Hopes of a property rebound in Dubai have missed the mark again and again over the last three years, putting increased pressure on lenders. Property prices and rents have declined as supply outpaced demand and given way to quiet resignation that the slump may persist for two to three years.

Chiradeep Ghosh, an analyst at investment bank SICO BSC in Bahrain expects provisions to rise by 10 to 20 basis points this year. Bloomberg Intelligence analyst Edmond Christou expects the cost of risk to rise by as much as 15 basis points as banks boost lending and interest rates rise. A drop in recoveries from existing bad loans are also likely to increase provisions, Dubai-based Christou said.

Invest Bank PSC, the second-smallest of 17 listed U.A.E. lenders, is in the process of getting a 1.9 billion dirham ($520 million) capital injection from the government of Sharjah. It was forced to take a similar amount in provisions to cover losses from real-estate and construction loans, which would have wiped out its entire capital base.

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