At the start of the year, analysts expected a binary scenario for UAE banks in 2010 on the back of a slow but steady risk crystallisation of ‘Dubai Inc.’ risks. At this stage , it looks like the recent Dubai World proposal to creditors is a constructive first step in a gradual resolution and avoids a worst case scenario for the banks. The banks are by no means out of the woods yet – with NPLs still to peak in 2011 – however , things are moving in the right direction and higher quality UAE banks are set to benefit from receding risks while valuations remain attractive.
Dubai World restructuring impact on banks
The restructuring of Dubai World’s debt will still have a negative impact on the UAE banks but is far away from a worst case scenario that would have seen the banks take significant hair cuts and provisions on their exposures testing their capital strength. Investors will most likely continue to have some lingering doubts about the sustainability of the deal – given still sizeable operating issues at the entities and substantial Dubai Inc. debts – and this will cap the extent of the banks’ rerating potential.
A central bank guideline for provisioning charges on Dubai World restructuring are also expected. BofA Merrill Lynch Global Research expects UAE central bank to offer leeway for local banks to factor in minimal provisioning charges – likely in the 15% to 20% range – given no direct haircuts on the debt.
Stick to quality names post initial DW rally
Post the initial early reaction favouring the highly exposed/high beta names to – ADCB and DIB – it is expected better quality names such as FGB, NBAD, and UNB to outperform as investors shift their focus beyond Dubai World. ADCB and DIB can continue trade at distressed levels given a much weaker core T1 capital position and other toxic exposures.
Go for Buy rated FGB and UNB…
On a long term view, UNB remains the most compelling risk/reward among the banks given deep value (at 0.8x current book) and more conservative balance sheet which could also benefit from the return of liquidity as investor appetite moves to smaller names.
BofA Merrill Lynch Global Research also favour Buy rated FGB given (1) strong government and Abu Dhabi ruling family support, (2) a more limited loan book exposure to Dubai (C.15%), and (3) a stronger relative NIM and loan growth delivery versus local peers, and (4) an attractive valuation at 1x and 6x 2011 PBV and PE, respectively, with sustainable ROEs of 18%.
UAE banks base case outlook
Subdued loan growth:Â 7% system wide loan growth in 2010 is expected, propped up by extended maturities of restructured loans and public sector linked spending in Abu Dhabi. FGB and NBAD are set to substantially outperform the sector on Abu Dhabi based lending opportunities and given healthier balance sheets.
Interest margin expansion no longer a theme: expanding NIMs where highly supportive in 2009 as loan books where reprised and banks benefited from the gap between EIBOR and LIBOR rates. However, for 2010 BofA Merrill Lynch Global Research expects marginal NIM contraction for the banks as lower rates reduce liability spreads and the gap between EIBOR and LIBOR. This will impact ADCB most negatively given its sizeable wholesale funding and current deposit mix while UNB would be least impact and could see some margin expansion post its underperformance in 2009 due to high liquidity levels.
Cost rationally to remain a theme: banks will continue to ration their cost base with cuts taken place in 2009 to have a full impact in 2010. More pain on the asset quality front: NPLs are set to peak in 2011 in our view with similar provisioning charges to pre-provision profits in 2010 as in 2009. While Dubai World restructuring has improved visibility and limited the risk of a worst case scenario the banks will still have to face the underlying deterioration in the local corporate and retail sectors.
Diversions in profitability: Overall, the diversion in profitability is set to remain stark with an ROE range between 2% at ADCB and 19% at NBAD. We believe NBAD, FGB, and UNB will be able to maintain strong capital strength if in a worst case scenario given better profitability than ADCB and stronger CAR levels.
