UAE Banks Stress-test Results
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UAE Banks Put To The Test Banks & Diversified Financials Sofia El Boury +9714 3199 716 [email protected] Ghida Obeid +9714 3199 729 [email protected] Economics Khatija Haque +9714 3199 752 [email protected] August 1st, 2010 • The slow recovery of private sector credit growth in H1 10 is one of the key factors undermining the UAE’s economic recovery. We believe much of the risk aversion on the part of banks stems from uncertainty about potential future losses and write- downs. • Our “stress test” on a sample of eight UAE banks, which account for almost 70% of FY09 banking system assets, suggests that on average, the banking sector is sufficiently capitalized to withstand significant deterioration in asset quality. Under our base case, average total CAR for our sample at 14.9% is well above the 12% UAE minimum, and average Tier 1 capital at 9.8% is above the 8% UAE minimum. Under our conservative "worst case" assumptions, average total CAR drops to 11.8% and average Tier 1 CAR falls to 6.5%; both are still above the Basel II international standards. • Additional capital injections would be required for individual banks in all our scenarios, ranging from AED 2.5bn (USD 669mn) in our base case up to AED 15.8bn (USD 4.3bn) in our worst case. We believe that the authorities have the capacity to provide this financial support, if ever required. • In our view, additional measures could be taken by the authorities to“clean up”UAE banks’balance sheets, to restore confidence and encourage banks to resume lending to households and businesses. In particular, the Irish approach of removing high-risk assets from balance sheets and replacing them with low-risk government securities should be considered in the UAE context, in our view. • However, broad structural and economic reform, including greater transparency by banks, is likely to be the most effective tool for restoring confidence and improving access to funding, as well as encouraging greater investment and economic growth over the longer-term.
description
Shuaa Capital's (SC) "stress test" on a sample of eight UAE banks, which account for almost 70% of FY09 banking system assets, suggests that on average, the banking sector is sufficiently capitalized to withstand significant deterioration in asset quality. Under SC's base case, average total CAR for our sample at 14.9% is well above the 12% UAE minimum, and average Tier 1 capital at 9.8% is above the 8% UAE minimum. Under SC's conservative "worst case" assumptions, average total CAR drops to 11.8% and average Tier 1 CAR falls to 6.5%; both are still above the Basel II international standards.
Transcript of UAE Banks Stress-test Results
UAE Banks Put To The Test
Banks & Diversified FinancialsSofia El Boury+9714 3199 [email protected]
Ghida Obeid+9714 3199 [email protected]
Economics
Khatija Haque+9714 3199 752 [email protected]
August 1st, 2010
• TheslowrecoveryofprivatesectorcreditgrowthinH110isoneofthekeyfactorsunderminingtheUAE’seconomicrecovery.Webelievemuchoftheriskaversiononthepartofbanksstemsfromuncertaintyaboutpotentialfuturelossesandwrite-downs.
• Our“stresstest”onasampleofeightUAEbanks,whichaccountforalmost70%ofFY09bankingsystemassets,suggeststhatonaverage,thebankingsectorissufficientlycapitalizedtowithstandsignificantdeteriorationinassetquality.Underourbasecase,averagetotalCARforoursampleat14.9%iswellabovethe12%UAEminimum,andaverageTier1capitalat9.8%isabovethe8%UAEminimum.Underourconservative"worstcase"assumptions,averagetotalCARdropsto11.8%andaverageTier1CARfallsto6.5%;botharestillabovetheBaselIIinternationalstandards.
• Additionalcapitalinjectionswouldberequiredforindividualbanksinallourscenarios,rangingfromAED2.5bn(USD669mn)inourbasecaseuptoAED15.8bn(USD4.3bn)inourworstcase.Webelievethattheauthoritieshavethecapacitytoprovidethisfinancialsupport,ifeverrequired.
• Inourview,additionalmeasurescouldbetakenbytheauthoritiesto“cleanup”UAEbanks’balancesheets,torestoreconfidenceandencouragebankstoresumelendingtohouseholdsandbusinesses.Inparticular,theIrishapproachofremovinghigh-riskassetsfrombalancesheetsandreplacingthemwithlow-riskgovernmentsecuritiesshouldbeconsideredintheUAEcontext,inourview.
• However,broadstructuralandeconomicreform,includinggreatertransparencybybanks,islikelytobethemosteffectivetoolforrestoringconfidenceandimprovingaccesstofunding,aswellasencouraginggreaterinvestmentandeconomicgrowthoverthelonger-term.
August1st,2010 2
UAE Banks Put To The Test
Contents
EXECUTIVE SUMMARY .................................................................................................................. 3
POST-CRISIS RECOVERY IN PRIVATE SECTOR CREDIT HAS BEEN SLOW ............................................... 5
OUTBREAK OF THE CURRENT CRISIS AND POLICY RESPONSES TO DATE ....................................................................................................................... 5WHAT HAVE UAE BANKS DONE WITH THEIR LIQUIDITY? ............................................................................................................................................... 6
IS THE UAE BANKING SECTOR SOLID ENOUGH TO WEATHER THE STORM? ........................................... 7
AIMS AND METHODOLOGY ............................................................................................................................................................................................... 7BASE CASE SCENARIO IMPACT ASSESSMENT ................................................................................................................................................................. 9FOUR ALTERNATIVE SCENARIOS .....................................................................................................................................................................................10RESULTS .............................................................................................................................................................................................................................11THE AVERAGES LOOK GOOD, BUT THE DEVIL IS IN THE DETAIL... .................................................................................................................................12
DEALING WITH THE FALLOUT OF A FINANCIAL CRISIS: DRAWING ON INTERNATIONAL EXPERIENCE ......15
DE-RISKING IRISH BANKS ...............................................................................................................................................................................................15SPANISH BANKS RESTRUCTURE AND TAKE STRICTER PROVISIONS. ...........................................................................................................................16
CONCLUSIONS AND RECOMMENDATIONS .......................................................................................17
SO WHAT COULD BE DONE TO ENCOURAGE BANKS TO RESUME LENDING ? .............................................................................................................17
APPENDIX ..................................................................................................................................18
UAE FY09 ASSET QUALITY METRICS VS. OTHER ECONOMIES ......................................................................................................................................18UAE FY09 CAR VS. OTHER ECONOMIES ..........................................................................................................................................................................18
August1st,2010 3
UAE Banks Put To The Test
Executive summary
TheUAE’seconomyandbankingsystemwerenotimmunetotheglobalfinancialcrisis.Although the worst of the recession appears to be behind us, UAE banks remain risk averse and reluctant to extend credit to the private sector. ThelatestUAECentralBankstatisticsshowthatbankloansgrewamere0.8%inH110,downfrom1.5%inH109and24%inH108.
We believe much of this risk aversion on the part of banks stems from uncertainty about potential future losses and write-downs. Our analysis aims to estimate just how big these potential losses may be, and whether UAE banks would be able to absorb them if they materialize.
We have focused on what we consider to be the riskiest assets on UAE banks’ balance sheets:
• Realestateandpersonalloansextendedin2008–atthepeakofthecreditandrealestateboominthecountry;
• Potentiallossesassociatedwithbanks’exposuretoSaadandAlGosaibiandDubaiWorld;• And“renegotiatedloans”,whichappearedonmostbanks'FY09financials1.
Finally,wehavetakenintoaccountthefactthatDubai-basedbanksincurahigherriskassociatedwiththeirrealestateexposurethanAbuDhabi-basedbanks.
Our base case suggests that UAE banks are, on average, capable of absorbing the potential losses associated with more stringent default assumptions,thankslargelytotheauthorities’effortstostrengthenbanks’balancesheetssincetheonsetofthecrisis.TheimpliedNon-PerformingLoan(NPL)ratiorisesfrom3.3%to8.4%,whiletotalCapitalAdequacyRatio(CAR2)remainshealthyat14.9%andTier1capitalremainsaboveregulatoryrequirementsat9.8%.AlthoughEmiratesNBDandADCBwouldbetheonlybanksneedingacombinedAED2.5bn(USD669mn)ofadditionalTier1capitaltomeetthestringentUAErequirements,allthebanksinoursamplecomplywithBaselIIstandards.
Inour“worstcase”scenario(#4)whereweassumewhatweconsideredtobethemaximumdefaultratesonbothrealestateandpersonalloansextendedbybanksin2008,averagetotalCARismarginallybelowtheCentralBank'srequirement,whiletheaverageTier1capitalratioremainsabovetheBaselIIfloor.
Summary conclusions:Avg NPL
ratio (%)Avg Total
Capital (%)Avg Tier 1
Capital (%)Cash provision shortfall for
100% NPL coverage (AED bn)Tier 1 capital
requirements (AED bn)
Actual FY 09 3.3 19.1 14.2Base case Scenario 8.4 14.9 9.8 42.5 2.5 Scenario 1 9.1 14.4 9.2 47.8 5.4 Scenario 2 9.5 14.1 8.9 50.1 5.1 Scenario 3 10.6 13.2 8.0 58.4 9.2 Scenario 4 12.3 11.8 6.5 71.3 15.8
Source: SHUAA Capital
1 Except Abu Dhabi Commercial Bank (ADCB) and Dubai Islamic Bank (DIB) out of our eight UAE banks sample2 Total capital adequacy is Tier 1 plus Tier 2 capital. The UAE regulatory minimum was set at 12% by end-June 2010, and the Basel II minimum is 8%. For Tier 1 capital alone, the
UAE minimum requirement is currently 8% and the Basel II minimum is 6%.
August1st,2010 4
UAE Banks Put To The Test
While the banks on average are well capitalized, some individual banks would need additional capital injections to meet the central bank’s regulatory requirements in all our scenarios.
Inscenario#4forexample,theaverageNPLratiorisestoastillreasonable12.3%,butfiveoutoftheeightbankswouldthenneedcombinedcorecapitalinjectionsofAED15.8bn(USD4.3bn)tomeettheUAE'sregulatoryminimum.
However, in this (unlikely) event, we have no doubt that the UAE authorities would provide the required financial support to these banks, particularly as the government has already stepped in to recapitalize some UAE banks at the height of the financial crisis.
Followingouranalysisandbeforerecommendingstepsthatlocalauthoritiescouldtaketoencouragebankstolend,weconsideredrecentstepsthathavebeentakenbyothercountrieswhosebankshavebeenheavilyexposedtoasharplycontractingrealestatesector:IrelandandSpain. Spainhasfocusedonrestructuringandmergingitsmostexposedbanksandimplementingstricterprovisioningcriteria,whileIrelandrecapitalizeditsbanksandtransferredthetoxicrealestateassetsfromcommercialbankstoaspeciallycreatedNationalAssetManagementAgency.
Adopting the Spanish approach would mean significant up-front costs in terms of greater provisioning for UAE banks –ourbasecaseanalysissuggestsAED42.5bnwouldbeneededtoensure100%NPLcoverage,althoughthiswouldrisetoAED71.3bnunderourworstcasescenario.Thiswouldnotonlyhaveanegativeimpactonbanks’profitabilityintheshortterm,butwouldleavethebanksrelativelyvulnerableintheeventofanegativeshock.
The Irish approach is one that is in our view more appropriate for the UAE,particularlyconsideringtherelativelystrongfiscalpositiontheUAEbenefitsfrom,especiallycomparedwiththehighbudgetdeficitsanddebtlevelsinmanyEuropeancountries.Bytransferringbanks’riskiestassetsintoastate-managedagency,andreplacingthemwithlowerriskgovernmentsecurities,thebankswouldbeinamuchstrongerpositiontoresumelendingtokeysectorsoftheeconomyandsupportthenascenteconomicrecovery.Inourview,somecombinationofthetwoapproacheswouldmostlikelybethemostoptimalsolution.
Supply-side measures to encourage bank lending, such as government guarantees to support financing to sectors and businesses with long-term strategic importance, could also be considered.However,webelievesuchsupply-sideincentivesshouldbeusedwithcaution,toensurethatcapitalisallocatedefficiently,andtosectorsandbusinessesthatwillgeneratethegreatesteconomicvaluegoingforward.
In our view however, broad structural and economic reform to encourage private sector and foreign investment in the UAE is likely to yield greater benefit over the longer term. Structuralreforms,includinggreatertransparency,improvedcorporategovernanceandastrongerregulatoryframeworkinthefinancialsectorandbroadereconomywouldcontributetogreaterinvestorconfidenceand–ultimately–improvedaccesstofunding(bothforbanksandothercorporateentities)atbetterterms.Inapost-crisisworldwherecommercialbanksaremoreriskaverse,theirabilitytoattractlong-termfundingatgoodratesisakeyelementforsustainablecreditandeconomicgrowth.
August1st,2010 5
UAE Banks Put To The Test
Post-crisis recovery in private sector credit has been slow
Outbreak of the current crisis and policy responses to date
Private sector credit growth in the UAE declined sharply in 2009 as a result of both external and UAE specific developments. TheglobalfinancialcrisisandsubsequentliquiditycrunchwasacatalystforthesharpdeclineintheUAE’srealestatesectorfromQ408.ThetightliquidityconditionsandhighriskaversionalsocontributedtotheinabilityofUAE-basedgovernmentandcorporateentitiestorefinancedebtfallingdueatreasonablerates,triggeringseveralhighprofiledebtrestructurings.
ThesharpdeclineinUAEcreditgrowthin2009wasexpected,consideringtheweakeconomicenvironment.Theadditionalprovisionsbookedtoreflectrisksonexistingriskyexposuresaswellasinanticipationoflossesassociatedwithhigh-profiledebtdefaultsandrestructurings(especiallyrelatedtoSaad/AlGosaibiandDubaiWorld(DW))hadanundeniableimpactonbanks’willingnessandabilitytolendtotheprivatesector.
Many governments in the region, including in the UAE, took measures to strengthen banks' balance sheets and improve liquidity at the height of the financial crisis. InQatar,thegovernmentusedatwo-prongedstrategytocleanupdomesticbanks’balancesheets:theypurchasedUSD1.8bnworthofbanks’localequityportfoliosaswellasUSD4.1bnoftherealestateassetsofninelocalbanks.Inreturn,banksreceivedamixtureofbothcashandlong-termgovernmentbonds,withtheoptiontorepurchasesomeoralloftheirrealestateportfolios.3
IntheUAE,theCentralBanktackledthecrisisbyprovidingablanketguaranteeonlocalbanks’depositsandanemergencyinterbankfacilitytoalleviateshort-termliquidityneeds.TheMinistryofFinancefollowedsuitwithaAED70bnlong-termdepositfacility,AED50bnofwhichwasinjectedintoUAEbanks’balancesheetswithanoptiontoconvertthesefundsintoTier2capital,whiletheremainingAED20bnisstillavailable.Inaddition,AbuDhabi’sgovernmentsupporteditsdomesticbanksbyofferingAED16bnnon-dilutiveTier1capitaltofiveAbuDhabiplayers:NationalBankofAbuDhabi,AbuDhabiCommercialBank,UnionNationalBank,AbuDhabiIslamicBank,andFirstGulfBank.
With most of the uncertainty surrounding the DW debt restructuring being resolved following the March 25th, 2010 announcement, we had expected private sector credit in the UAE to recover during Q2 2010. However, this recovery has been slower than expected,andislaggingothercountriesintheregion,suchasQatar.AlthoughwedonothavecomprehensivedataonprivatesectorcreditbeyondApril2010,commercialbanks’overallloansandadvancesaddedamere0.4%inQ210,implyingthatprivatesectorcreditgrowthhasbeenweakduringthatperiod.
3 Source: IIF country report: Qatar; September 2009
August1st,2010 6
UAE Banks Put To The Test
Source: UAE Central Bank, SHUAA Capital
What have UAE banks done with their liquidity?
InQatar’scase,ithasbeenarguedbysomecommentatorsthatonaverage,banksweremoreconservativeintheirlendingpriortothefinancialcrisis,makingthemlessvulnerable.Moreover,thegovernment’srecapitalizationmeasuresweresufficienttoallowbankstostartlendingagainassoonaseconomicconditionsstartedtoimprove.
BanksintheUAEalsobenefitedfromsignificantcapitalandliquidityinjections.However,itseemsthattheyhavebeenmoreriskaversethantheirQataricounterparts,preferringtohoardtheircash,orimprovetheirnetforeignassetpositionbypayingdownforeigndebtandaccumulatingforeignassets.
Most of UAE banks' loans originated in FY09 appear to have been extended to the government and public sector enterprises, rather than to the private sector. Thisphenomenonofthegovernment’s“crowdingout”ofprivatesectorborrowingsuggests,inourview,eithera“flighttoquality”inthatthegovernmentisseenasasaferbetthantheprivatesector;orareflectionofthefactthatmostlocalbanksareownedbythegovernmentorprominentfamiliesandthesestakeholdershavepriorityoverwhateverfundsareavailableforlending.Wefavorthelatterexplanation.
Source: UAE Central Bank, SHUAA Capital* October and November 09 data is not available
UAE private sector credit growth
0
10
20
30
40
50
60
Dec-0
8
Jan-
09
Feb-
09
Mar-
09
Apr-0
9
May
-09
Jun-
09
Jul-0
9
Aug-
09
Sep-
09
Oct-0
9
Nov-
09
Dec-0
9
Jan-
10
Feb-
10
Mar-
10
Apr-1
0
% Y
oY
Public sector credit growth crowds out the private sector
0
10
20
30
40
50
60
Dec-
08
Jan-
09
Feb-
09
Mar-0
9
Apr-0
9
May-
09
Jun-
09
Jul-0
9
Aug-
09
Sep-
09
Oct-0
9
Nov-
09
Dec-
09
Jan-
10
Feb-
10
Mar-1
0
Apr-1
0
% Yo
Y
Public sector credit
Private sector credit
August1st,2010 7
UAE Banks Put To The Test
Is the UAE banking sector solid enough to weather the storm?
Aims and Methodology
Based on reported banking statistics, the UAE banking sector appears to be well capitalized, and with manageable NPL ratios. Our paper considers how UAE banks would fare under stringent default assumptions.
We selected a pool of eight leading UAE banks as a sample for our analysis. Theseeightplayers,whichaccountedforalmost70%ofUAEbankingsystemtotalassetsasof2009,arethefollowing:EmiratesNBD(ENBD),NationalBankofAbuDhabi(NBAD),AbuDhabiCommercialBank(ADCB),Mashreqbank(Mashreq),FirstGulfBank(FGB),DubaiIslamicBank(DIB),UnionNationalBank(UNB)andCommercialBankofDubai(CBD).Withinthisuniverse,wemadethedistinctionbetweenAbuDhabiandDubaibanksasthelatterareexposedtogreaterrisks,specificallyduetotheirexposuretoDubai’srealestatesector.
Our starting point is to identify the key risks threatening UAE banks’ solvency today. Onthebalancesheet,realestate(RE)financingandpersonalloansareunsurprisinglytheprimarysuspects.Inourview,propertyandpersonalloansoriginatedin2008aretheriskiestexposuresonbanks’balancesheets.Thoseloanswereextendedinafranticeconomicclimatemarkedbylowinterestratesandstretchedliquiditypositions.2008alsomarkedthepeakofthepropertyboomintheUAE(asshowninthegraphbelow).Finally,wenotethatlendingpracticesinpre-crisis2008weremuchmorerelaxed,withrelativelyweakcreditworthinessassessmentproceduresinplaceand"namelending"verycommon;makingmostloansextendedin2008riskierthanthoseextendedpost-crisis.
Source: Colliers International
Dubai housing price index: quarterly
100117 120 125
178
206216
199
117107 114 115 119 114
0
50
100
150
200
250
Inde
x Poi
nts
2008 real estate loans have lost on average 33-50% and are currently in negative equity
2007 real estate loans remain in positive equity hence were not incoporated in NPL additions
Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Q2 10
Index points 100 117 120 125 178 206 216 199 117 107 114 115 119 114
% change 17% 3% 4% 42% 16% 5% -8% -41% -9% 7% 1% 3% -4%
August1st,2010 8
UAE Banks Put To The Test
Interestinglyandasshowninthegraphbelow,55% of our pool's FY08 loan additions were extended to the real estate sector (23%) and to the consumer segment (31%).FGBdisplayedthehighestsharewith72%,followedbyUNBandADCBwith63%.Ontheotherhand,only27%ofMashreq'sFY08loanadditionswereintendedforrealestateandpersonalloanfinancing.These statistics are important as the outcome of our "stress test" is directly linked to the lending patterns of each of these banks during 2008.
Source: Banks' financials, SHUAA Capital
We also considered other selected risks in our retrospective. DoubtfulexposurestoSaadandAlGosaibigroupsandtoDWentitieshavebeentakenintoconsideration,aswellastheblackboxrepresentedby"renegotiatedloans",significantonbanks’balancesheetsbytheendof2009.
WeestimatedalltheseriskyassetsatAED148bn,thatis20.4%ofourpool'saggregatedloanbookasofFY09.
Source: Banks' financials, SHUAA Capital
RE & Personal loans as % of FY08 total loan additions
7%
24% 23%
33%
13%
20%
35%
22% 23%20%
10%
26%
18%
45% 43%
29%
49%
31%27%
34%
49% 50%
57%
63% 63%
72%
55%
0%
10%
20%
30%
40%
50%
60%
70%
80%
Mashreq DIB ENBD NBAD CBD ADCB UNB FGB Total
FY08 RE additionsFY08 Personal Loan additionsTotal
.
FY 09 aggregated gross loan book of our pool
Estimated DW exposure
2.9%
Estimated Saad/ AHAB exp
0.5%
RE & Personal loans FY 08 additions
14.1%
Reported FY 09 renegotiated loans
2.9%
Other loans79.6%
August1st,2010 9
UAE Banks Put To The Test
Ourbasecasescenarioassumesthefollowing:
Renegotiated loans FY08 RE loan additions
FY08 personal loan additions
DW est. exposure
Dubai banks est. default rate (%) 25 50 50 20
Abu Dhabi banks est. default rate (%) 25 50 30 20 Source: SHUAA Capital
The next step in our methodology was to consider various scenarios where the above key risks were assigned different rates of default translatingtofurtherprovisioningchargesanddirectlosses.Inthecaseswhereadditionalprovisioningwasnecessary,wemeasuredtheimpactthiswouldhaveonbanks’assetqualityratios(NPLsandprovisioncoverage),capitaladequacylevels(Tier1andtotalcapital)andprofitability.
Base Case Scenario Impact Assessment
Underourbasecasescenario,theNPLratioofourpoolofUAEbanksjumpsto8.4%fromactual3.3%asofFY09.
Source: Banks' financials, SHUAA Capital
Oncapitaladequacy,sevenoutofeightbanksremainwellcapitalizedwithaveragetotalCARgoingdowntoastillcomfortablelevelof14.9%fromanactual19.1%.OnlyADCB'stotalcapitalratiostandsmarginallybelowtheCentralBank's12%minimumandwouldneedjustAED190mn(USD52mn)inadditionalcapitaltomeetthisrequirement.
Source: Banks' financials, SHUAA Capital
NPL ratio impact assessment
7.2%
6.7%
11.5%
7.7%
10.7%
7.9%
7.9%
9.7%
8.4%
2.4%
1.2%
3.5%
7.3%
5.2%
6.0%
1.5%
2.2%
3.3%
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0%
Emirates NBD
National Bank of Abu Dhabi
First Gulf Bank
MashreqBank
Abu Dhabi Commercial Bank
Dubai Islamic Bank
Union National Bank
Commercial Bank of Dubai
Average
Esti matedActual FY09
Total CAR impact assessment
14.9%
13.4%
16.7%
18.3%
11.9%
14.9%
16.7%
15.2%
14.9%
18.7%
17.6%
22.6%
20.2%
17.4%
17.5%
20.7%
20.2%
19.1%
5.0% 10.0% 15.0% 20.0% 25.0%
Emirates NBD
National Bank of Abu Dhabi
First Gulf Bank
MashreqBank
Abu Dhabi Commercial Bank
Dubai Islamic Bank
Union National Bank
Commercial Bank of Dubai
AverageEsti matedActual FY09
August1st,2010 10
UAE Banks Put To The Test
Similarly,averageTier1capitalwouldstillbeabovetheCentralBank'sminimumrequirementat9.8%downfromanactuallevelof14.2%.ADCBandEmiratesNBDwouldrequireAED2.0bn(USD535mn)andAED492mn(USD134mn)ofcorecapitalrespectively.
Source: Banks' financials, SHUAA Capital
However, it is important to note that in our base case scenario, all the banks in our pool comply with Basel II international standards on both core and total capital.
Four alternative scenarios
We derived four alternative scenarios from our base case picture by increasing the default rate on each of the key-risk factors(renegotiatedloans,realestate,personalloans).Asweassumerenegotiatedloansincludeaportionofrealestateandpersonalfinancing,wesetthemaximumdefaultrateonthatcategoryat50%.WealsodistinguishDubaifromAbuDhabibanksforrealestatefinancing,astheDubairealestateslumpputsDubai-basedlendersmoreatriskonthatfront.Scenario#4isour“worstcase”,wherewehavesetmaximumdefaultratesonrealestateandpersonalloansextendedin2008at100%forDubaibanks,andat70%and60%respectivelyforAbuDhabibanks.WehaveconservativelymaintainedtheassumedhaircutonDWat20%inallscenariosastheproposeddebtrestructuringagreementsuggestslossesofthatmagnitudeatworst.
Table of assumptions:Renegotiated loans FY08 RE loan
additionsFY08 personal loan
additions DW est.
exposure Dubai banks - Estimated default rate (%) Base Case Scenario 25 50 50 20 Scenario #1 50 50 50 20 Scenario #2 - 100 50 20 Scenario #3 - 50 100 20 Scenario #4 - 100 100 20 Abu Dhabi banks - Estimated default rate (%) Base Case Scenario 25 50 30 20 Scenario #1 50 50 30 20 Scenario #2 - 70 30 20 Scenario #3 - 50 60 20 Scenario #4 - 70 60 20
Source: SHUAA Capital
Tier 1 Capital impact assessment
7.8%
11.8%
13.1%
12.0%
6.5%
9.7%
11.2%
8.7%
9.8%
11.9%
16.0%
19.2%
14.0%
12.4%
12.4%
15.5%
14.1%
14.2%
5.0% 10.0% 15.0% 20.0% 25.0%
Emirates NBD
National Bank of Abu Dhabi
First Gulf Bank
MashreqBank
Abu Dhabi Commercial Bank
Dubai Islamic Bank
Union National Bank
Commercial Bank of Dubai
Average
Esti matedActual FY09
August1st,2010 11
UAE Banks Put To The Test
Results
The results of our analysis show that from the base case scenario to scenario #4, the average NPL ratio for the eight UAE banks gradually increases from 8.4% to a maximum of 12.3%.
Source: IMF, SHUAA Capital
IntermsofsolvencyanddespiteallthestressonNPLsandprovisioningunderourdifferentscenarios,theUAEbankingsystemeffectivelyprovesitscapacitytoabsorbsignificantlosses.In fact, average total CAR ranges between 14.9% and 11.8% and remains well above the regulatory minimum set by Basel II (8%), although the 12% UAE floor is marginally breached in scenario #4.
Source: SHUAA Capital
NPL ratio impact assessment
3.3%
8.4%9.1% 9.5%
10.6%
12.3%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
Actual FY 09 Base caseScenario
Scenario 1 Scenario 2 Scenario 3 Scenario 4
Commonwealth of Independent States
Developing Asia
Western HemisphereAdvanced EconomiesUAE
Sub-Saharan AfricaMENACCE
12.1
FY 09 Actual NPL ratio (%)
2.2
3.744.6
6.56.67.5
Total Capital impact assessment
11.8%13.2%14.1%14.4%
14.9%
19.1%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
Actual FY 09 Base case Scenario Scenario 1 Scenario 2 Scenario 3 Scenario 4
CB min. requirement
Basel II min. requirement
August1st,2010 12
UAE Banks Put To The Test
Average Tier 1 capital for our sample remains well above Basel II requirements (6%), and would only be below the UAE minimum in scenario #4.
Source: SHUAA Capital
The averages look good, but the devil is in the detail...
Ourfindingsaresummarizedinthetablebelow.
Table of resultsAvg NPL
ratio (%)
Avg Total Capital
(%)
Avg Total Capital
excl. injections in 08/09 (%)
Avg Tier 1 Capital
(%)
Cash provision shortfall for 100%
NPL coverage (AED bn)
Capital injections required to meet
8% Tier 1 minimum (AED bn)
Actual FY 09 3.3 19.1 11.8 14.2
Base case Scenario 8.4 14.9 6.6 9.8 42.5 2.5
Scenario 1 9.1 14.4 6.0 9.2 47.8 5.4
Scenario 2 9.5 14.1 5.7 8.9 50.1 5.1
Scenario 3 10.6 13.2 4.8 8.0 58.4 9.2
Scenario 4 12.3 11.8 3.3 6.5 71.3 15.8 Source: SHUAA Capital
Even though the average CARs remain above the regulatory floors in our base case, some of the banks in our sample would need further core capital injections in all our scenarios. TheamountsrangebetweenAED2.5bn(USD669mn)inthebasecasetoAED15.8bn(USD4.3bn)underourmostconservativescenario#4.
However, column 3 in the table above illustrates the importance of the authorities' capital injections to the banking system at the height of the liquidity crisis intheformofcoreTier1capital(AED16bn)andTier2MoFlong-termfunds(AED50bn).Withoutthesecapitalinjections,averagetotalCARwouldalreadybebelowthe12%UAEregulatoryminimum,andwouldbebelowtheBaselIIfloorof8%inallourscenarios.
Tier 1 capital impact assessment
14.2%
9.8%9.2% 8.9%
8.0%
6.5%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
Actual FY 09 Base case Scenario Scenario 1 Scenario 2 Scenario 3 Scenario 4
CB min. requirement
Basel II min. requirement
August1st,2010 13
UAE Banks Put To The Test
AccordingtothevariousscenariosandimpliedNPLratios,our pool of UAE banks would need to recognise between AED 42.5bn (USD 11.6bn) and AED 71.3bn (USD 19.4bn) in additional provisions to achieve 100% NPL coverage.
Fully writing-off banks’ riskiest exposures would have a significant negative impact on their short-term profitability,whichwouldnotbewell-receivedbyshareholders.Ontheotherhand,itmaybearguedthatthethoroughimmediateclean-upofUAEbankswouldsendahighlypositivesignaltotheinternationalinvestorcommunity,asitwouldcontributetoimprovedtransparencyandhelptorestoreconfidenceintheUAEbankingsystem.
Source: SHUAA Capital
The chart above illustrates which banks would need additional Tier 1 capital, based on our set of assumptions, to meet the Central Bank's requirements.EmiratesNBDandADCBwouldrequirenegligiblecombinedcorecapitalinjectionsofAED2.5bn(USD669mn)inthebasecase,increasingtoAED5.4bn(USD1.5bn)inscenario#1.
Inscenario#2,EmiratesNBD,ADCB,DIB,andCBDwouldfallAED5.1bn(USD1.4bn)short,whileinscenario#3,thesamebanksexcludingDIBwouldneedcombinedcorecapitalinjectionsofAED9.2bn(USD2.5bn).
Inscenario#4(theunlikelyscenariowhereweassumedourmaximumdefaultratesonrealestateandpersonalloansextendedin2008),MashreqandUNBaretheonlyonescomplyingwithboththeTier1(8%)andtotalcapital(12%)requirementssetbytheCentralBank.WhileUNB'scapitalbaseprovesresilienttoourseriesoftests,,Mashreqbenefitsfromitsrelativelylimitedexposureto2008realestateandpersonalloanfinancing.Asmentionedearlier,only27%ofthebank'snewloanswereextendedtobothsegments,comparedwithanaverageof58%fortheothersevenbanks.
Inthisscenario,NBADmeetstheTier1requirementsbutneedsanadditionalAED900mninTier2capitaltomeetthe12%minimumfortotalCAR.AndwhileFGBwouldneedamereAED95mnofcorecapitaltomeetCentralBankstandards,theotherfourbanksrequireAED15.7bn(USD4.3bn)ofextraTier1capital.
Tier 1 capital requirements based on UAE Central Bank �oor of 8%
0.5
2.0
3.4
2.01.6
3.2
0.2 0.1
2.0
6.0 6.0
1.2
0.10.7
7.3
1.7
-
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
Emira
tes
NBD
ADCB
Emira
tes
NBD
ADCB
Emira
tes
NBD
ADCB DI
B
CBD
Emira
tes
NBD
ADCB CB
D
Emira
tes
NBD FG
B
ADCB DI
B
CBD
Base casescenario
Scenario 1 Scenario 2 Scenario 3 Scenario 4
AED
bn
August1st,2010 14
UAE Banks Put To The Test
We note that the UAE's minimum CAR requirements (both for Tier 1 and total capital) are much stricter than Basel II international standards, which the European Central Bank (ECB) has used as the benchmark in its recent stress tests on European banks.
BasedonBaselIITier1capitalrequirementof6%,onlyADCBwouldrequireadditionalfunds,estimatedatamereAED654mn(USD178mn)underscenario#2risingtoAED3.5bn(USD955mn)inscenario#3,alongwithAED578mn(USD157mn)forCBD.Our“worstcase”scenariowouldfindthreelendersinourpoolfallingshort:EmiratesNBD(AED1.9bn),ADCB(AED4.8bn),andCBD(AED1.1bn)wouldrequirecorecapitaladditionsestimatedatAED7.7bn(USD2.1bn).
Source: SHUAA Capital
We have no doubt that the UAE government stands ready to provide any additional capital that may be required to ensure that these individual banks remain sufficiently capitalized.Indeed,theauthoritieshavealreadyinjectedAED16bninnon-dilutiveTier1capitalintoAbuDhabibanksattheheightofthefinancialcrisis.Theestimatedcorecapitalshortfallsare,eveninourworstcasescenario,undoubtedlymanageable,especiallywhenweconsiderthattheMinistryofFinancestillholdsAED20bn(USD5.5bn)outoftheoriginalAED70bnemergencyfacility.
Tier 1 capital requirements based on Basel II oor of 6%
0.7
3.5
0.6
1.9
4.8
1.1
-
1.0
2.0
3.0
4.0
5.0
6.0
ADCB ADCB CBD ENBD ADCB CBD
Scenario 2 Scenario 3 Scenario 4
AED
bn
August1st,2010 15
UAE Banks Put To The Test
Dealing with the fallout of a financial crisis: drawing on international experience
UAEbanksarenotaloneinfacingtheconsequencesoftheglobalfinancialcrisis.Authoritiesaroundtheworldhaverespondedindifferentwaystostabilizeandlimittheimpactofthecrisisontheirownbankingsystemsandeconomies.WebelievethecasesofIrelandandSpainareworthexamininginparticular,asliketheUAE,theIrishandSpanishbankswerehighlyexposedtocollapsingdomesticrealestatemarkets.
De-risking Irish banks
Ireland’sfinancialsectorwasheavilyexposedtotherealestatesector,whichhadfuelledtheCelticTiger’sgrowthinthedecadeprecedingthefinancialcrisis.Morethan75%ofthesixIrishbanks’totalloanswerereportedlysecuredagainstproperty4.Somebanks,suchasAngloIrishBankhadmostoftheirloanportfolioextendedtodevelopersandbuilders,theriskiestgroupofrealestateborrowers.TheIrishgovernmentusedtwokeymeasurestopreventthecountry’slargestbanksfromgoinginsolvent:
1/Theycapitalizedthebanksinreturnforequity,insomecases(suchasAngloIrish)nationalizingthebanksoutright,2/TheycreatedaNationalAssetManagementAgency(NAMA),totakeontheriskiestassetsofthebanks,mainlyrealestatebackedloans,inreturnforgovernmentsecurities.Theseloans,withanestimatedfacevalueofEUR80bnasofMarch2010,werepurchasedatadiscountbyNAMA,andwillbemanagedovera7-10yearperiodtomaximizethereturnforthetaxpayer.TheloanstakenonbyNAMAwerenotallnon-performing;theyweresimplythehighestriskloansonthebanks’balancesheets.
Theaimofthesemeasureswasnottoliquidateorwriteoffthebanks’portfolios,buttoremovethesehighriskassetsfrombanks'balancesheetsandreplacethemwithlowriskgovernmentsecurities.Indoingso,bankswouldbeencouragedtoresume"normal"lendingtobusinessesandhouseholds,thussupportinganoveralleconomicrecoveryinIreland.AstheprocessoftransferringtheloanstoNAMAwasonlystartedinMarch2010,andwilltakeseveralmonthstocomplete,itisstilltoosoontosayhoweffectivethismeasurehasbeenincontributingtoprivatesectorcreditgrowthinIreland.
ItisimportanttonotethatthefinancialcrisisandcollapseintheIrishreal-estatesectoralsohadasignificantanddirectimpactonthecountry’sfiscalposition.Duringtheboomyears,theIrishbudgetbecameoverly-reliantonrevenuesfromrealestatetaxesandfees,whichwereusedtofinanceincreasedexpenditureinothersectors(health,educationandsocialspending).Asaresult,whenthefinancialcrisishit,Irelandhadtodealwiththe“doublewhammy”ofbailingoutitsinsolventbanksaswellasfinancingagapingholeinitsbudgetrevenues.TheIrishgovernmentbudgetbalanceconsequentlymovedfromasmallsurplusin2007to14.3%ofGDPdeficitin2009.
Source: NAMA, Eurostat, Wikipedia4 Irish Independent, January 16, 2009
August1st,2010 16
UAE Banks Put To The Test
Spanish banks restructure and take stricter provisions.
Spain’sbankingsystemwasrelativelyimmunefromtheUSsubprimecrisis,andhasonlystartedtacklingtheissuesfacingitsbankingsectorinthelastfewmonths.About45%ofSpain’sfinancialsectorismadeupofsmall,regional,unlistedsavingsbanksknownascajas.ManyofthesehavelargeexposurestoSpain’srealestatesector,whichhasalsoexperiencedasharpcontractionsinceQ42008,andhavefounditverydifficulttorollovertheirmaturingdebtinthewakeoftheGreekcrisis.
TheSpanishauthoritiesareencouragingthecajastorestructureandmergewitheachotherandwiththelargercommercialbanks,toreduceinefficienciesandimprovetheirbalancesheets.Inaddition,thecentralbankhasintroducedstricterprovisioningrules:lendersnowhavetosetasideprovisionsforthefullvalueofeachbadloanwithinoneyearofdefault,ratherthantheprevious2-6yearprovisionperiod.However,thevalueofunderlyingassetscanbetakenintoaccountwhencalculatingtheprovisions,albeitatadiscountwhichdependsonthetypeofassetonwhichtheloanissecured.Provisioningrequirementsonrealestateassetsthathavebeenheldforover2yearshavealsobeenincreased,whichhashadabigimpactonthecajas.
Evenwiththerestructuringofthebankingsystem,itisexpectedthatsomebanksandcajaswillneedtoberecapitalized,althoughestimatesvarydependingontheassumptionsmade.InitsApril2010GlobalFinancialStabilityReport,theIMFestimatedthecajaswouldneedaboutEUR17bnofcapitalunderan“adversecasescenario”;theseestimatesweremadeundertheoldprovisioningrulessounderthenewprovisioningrules,wewouldexpectthisfiguretobehigher.However,initsrecentlyreleasedstresstestonEuropeanbanks,theECBindicatedthatsevenEuropeanbanks(fiveofthemSpanish)wouldneedonlyEUR3.5bnofadditionalcapital.ThisdifferenceinestimatesreflectstheverydifferentunderlyingassumptionsmadebytheIMFandtheECB.
Source: IMF, Financial Times
August1st,2010 17
UAE Banks Put To The Test
Conclusions and recommendations
Based on our stress test, we believe UAE banks are overall sufficiently capitalized to face significant deterioration in their asset quality. Even inour“worstcase”scenario,theaveragetotalcapitalratioisonlymarginallybelowthe12%UAEminimum;andaverageTier1capitalofourpoolremainsabovethe6%BaselIIfloor.Thisisabetterthanexpectedresult,andshouldhelpalleviatesomeconcernsabouttherobustnessoftheUAEbankingsystem.
Nevertheless,underourmostconservativedefaultassumptions,theaverageNPLratioforoursamplerisesto12.3%fromthecurrent3.3%andfiveoutofoureightbankswouldrequireuptoAED15.8bn(USD4.3bn)ofadditionalTier1capitalinordertocomplywithCentralBank'sregulation.Weareconfidentthatinthisunlikelyevent,therequiredfinancialsupportwillbeprovidedbytheauthorities.
As private sector credit growth is critical for a sustained economic recovery in the UAE, the current situation should be addressed directly. Uncertainty about the extent of future provisions and questions over banks’ ability to absorb potential losses will otherwise linger, undermining confidence and making it more difficult for banks to attract much needed funding to grow their loan books.
So what could be done to encourage banks to resume lending ?
We believe the Irish solution is one that should be seriously considered. Indeed,theUAEenjoysarelativelystrongfiscalpositionthatshouldenableittofundthecreationofagovernment-backed"badbank"tohostlocallenders'mosttoxicassets.Qatarhasimplementedasimilarsolutionforbanks'localequityandrealestateexposures,whichappearstohavebeenrelativelysuccessful.ByremovingsomeoftheriskiestassetsfromUAEbanks’balancesheetsandreplacingthemwithlowerriskgovernmentpaper,orcash,bankswillbeinamuchstrongerpositiontoattractfundingandresumelendingtohouseholdsandbusinesses.
On the other hand, Spain’s conservative, immediate provisioning route would severely impact banks’ earnings and profits should it be adopted in the UAE. OuranalysissuggestsanadditionalAED42.5bn(USD11.6bn)–AED71.3bn(USD19.4bn)wouldallowbankstoensure100%NPLcoverageunderourfivescenarios.Thiswouldalsoleavethebanksvulnerableintheeventofnew,unexpectednegativecreditevents.However,thisdoesnotmeanthattheUAEauthoritiesshouldruleoutthisoptionaltogether-perhapsacombinationofmorerigorousprovisioningrequirementstogetherwithisolatingbanks'"toxic"assetswouldbeafeasiblealternative.
Other measures the government could implement to boost bank lending could include offering incentives, such as government guarantees, tosupportlendingtosectorsandbusinesseswithlong-termstrategicimportance.However,webelievesuchsupply-sideincentivesshouldbeusedwithcaution,toensurethatcapitalisallocatedefficiently,andtosectorsandbusinessesthatwillgeneratethegreatesteconomicvaluegoingforward.
In our view, broad structural and economic reform to encourage private and foreign investment in the UAE is likely to yield greater benefit over the longer term. Structuralreforms,includinggreatertransparency,improvedcorporategovernanceandastrongerregulatoryframeworkinthefinancialsectorandbroadereconomywouldcontributetogreaterinvestorconfidenceand–ultimately–improvedaccesstofunding(bothforbanksandothercorporateentities)atbetterterms.Inapost-crisisworldwherecommercialbanksaremoreriskaverse,theirabilitytoattractlong-termfundingatgoodrateswillbeakeyelementforsustainablecreditandeconomicgrowth.
August1st,2010 18
UAE Banks Put To The Test
APPENDIX
UAE FY09 asset quality metrics vs. other economies
Source: SHUAA Capital, IMF
UAE FY09 CAR vs. other economies
Source: SHUAA Capital, IMF
NPL ratio (%)
1.12.1
1.52.5
6.0
7.5
4.2
5.7
1.3
2.83.3
4.65.5
6.06.4
9.7
14.8
5.6
14.7
6.6
0
2
4
6
8
10
12
14
16
Qatar Oman KSA UAE Morocco Lebanon Jordan Average Kuwait Egypt
2008 2009
Provision cover (%)
63 61
89
75
102
88
144
92
49
6468
7479 80
9095
83
127
94
114
0
20
40
60
80
100
120
140
160
Jordan Lebanon Kuwait Morocco UAE Average Saudi Arabia Qatar Egypt Oman
2008 2009
Total Capital Adequacy Ratio (%)
11.6
12.7
14.3
14.6
17.0
16.1
13.7
10.9
10.9
13.0
16.6
16.7
16.7
19.2
16.719.1
- 5 10 15 20 25
Advanced Economies
Developing Asia
Middle East and North Africa
Central and Eastern Europe
Sub-Saharan Africa
Western Hemisphere
Commonwealth of Independent States
UAE
2008 2009
August1st,2010 19
UAE Banks Put To The Test
Research
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