The loan danger

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Ratings agencies Fitch and Moody’s have downgraded five UAE banks, citing concerns about the banks’ heavy exposure to assets with default potential.

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Also vulnerable are the banks that have either lent directly to the real estate sector through corporate loans and mortgages, or are indirectly exposed through personal loans that have been re-invested in property to pay rents.

“There seems to be consensus that direct exposure [for banks] is manageable,” says Kapadia. “However, there’s indirect exposure to people who have used credit cards and personal loans to plough into the sector, and banks are exposed to all the different layers of the market in terms of contractors, developers and buyers, so it does run quite deep.”

Venkatesh Srikantan, regional head of assets and liabilities at HSBC, admits that the bank’s non-performing loans portfolio has risen between the final quarter of last year and the first three months of 2009.

Non-performing loans — loans that have not been written off but are not paying the bank any interest — have mainly impacted its credit card and personal loan business rather than its mortgage division, he adds.

“In the consumer finance business you do build in some losses to the model,” says Srikantan. “We are in a turbulent economic environment globally and obviously there is economic deterioration even in this region, and I think some of these things are showing up.”

At the end of December 2008, HSBC Middle East had $323m worth of non-performing loans up from $274m the year before, and $379m of provisions to cover any losses on their loan book. Furthermore, EFG-Hermes predicts the ratio of banks’ non-performing loans to grow threefold in the UAE in 2010, to three percent.

Although a bank’s exposure to property in the UAE is officially capped at 20 percent, analysts warn that some may have chosen to ignore this limit. One Dubai-based investment bank analyst, speaking on condition of anonymity, suggested last week that some UAE banks have as much as 40 percent exposure to the real estate sector.

These concerns have found their way to the ears of credit ratings agencies, which are placing banks’ balance sheets under renewed scrutiny. On March 18 Moody’s said it was considering a downgrade for HSBC Middle East on the basis that around 70 percent of its operations are in the UAE, and that the “potential of delinquencies in the next 12 to 18 months is significantly enhanced”.

In December another ratings agency, Fitch, downgraded five banks in the UAE — Abu Dhabi Islamic Bank, Bank of Sharjah, Dubai Bank, Emirates Bank International and First Gulf Bank — citing rapid credit growth over recent years, along with high loan-deposit ratios and exposure to dented asset price bubbles.

Although the banking and real estate malaise is a countrywide phenomenon, experts say Abu Dhabi is less at risk than Dubai. Defaults will occur, says Kapadia at EFG, but because supply is so constrained, developers still have the option of renting units they can’t sell.

At UBS, Masud estimates that Dubai’s $80bn of known debt could grow to between $130bn to $150bn over the next two years, taking into account exposure to real estate, along with all on and off-balance liabilities that are tied up in project cancellations and supply payments.

Analysts agree that the debt issue could be addressed by more government bailouts. Another strategy could be to let non-core assets go under, while consolidating the state-backed players than manage 70 percent of Dubai’s real estate market.

“Dubai should let the non-strategic assets go belly up, and for government-owned ones, you orchestrate some sort of consolidation,” says Masud. “You can clean up the balance sheet so you are able to refinance that whole pool of obligations under one umbrella.

“Inflows from one unit can finance the outflows of the other, and I think [the government] might pursue forced mergers over the next couple of years.”

As the first $10bn tranche of the $20bn government bond issue filters down to developers operating under Dubai Holding and Dubai World, the market will receive firm assurances that the sector enjoys the support of federal government. For that reason, banks will also be clamouring for their share of the handouts.

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