Overview

• The drop in oil prices and lower economic activity due to COVID-19 will lead to a rise in problem loans and the cost of risk for banks in the United Arab Emirates (UAE) in the next 12-24 months.
• The UAE Central Bank's support package is timely and provides some relief to borrowers, but certain prudential requirements have been relaxed, such as the cap on real estate exposures and higher loan-to-value limits.
• We also see the risk of a potential weakening of transparency in the recognition and disclosure of problematic assets.
• We now see negative rather than stable economic and industry risk trends in our Banking Industry Country Risk Assessment of the UAE.
• We are therefore revising our outlooks on five UAE-based banks to negative from stable due to the combination of systemic and bank-specific factors.
• The negative outlook reflects our view that the worsening operating environment could result in a significant deterioration of the banks' asset quality indicators and hamper their profitability.

DUBAI (S&P Global Ratings) March 26, 2020-- S&P Global Ratings today revised its outlooks to negative from stable on First Abu Dhabi Bank P.J.S.C., Abu Dhabi Commercial Bank PJSC, Mashreqbank, Sharjah Islamic Bank, and National Bank of Fujairah PJSC. We affirmed our long- and short-term issuer credit ratings on these entities (see the ratings list at the end).

The rating actions stem from our view that, in 2020, the sharp drop in oil prices and reduced activity due to COVID-19 will exert significant pressure on the UAE economy, especially the real estate, trade, retail, transportation, and hospitality sectors. We expect loan quality will be tested and cost of risk will increase, weighing on banks' profitability in the next 12-24 months. In 2019, banks' asset quality indicators had already started to show signs of weakness. The average ratio of stage 3 loans to total loans for the top 15 banks (representing 95% of the system's assets) reached 6.3% at year-end 2019 compared with 5.8% at year-end 2018. Moreover, the coverage ratio of these loans by provisions (including for stage 1 and stage 2) stood at 88.1% at year-end 2019 compared with 96.9% at year-end 2018.

We view favorably the UAE Central Bank's recently announced Targeted Economic Support Scheme, which should help to ease commercial enterprises' financial positions. However, alongside increased forbearance, this could potentially delay the full recognition of asset quality deterioration at UAE banks. Moreover, we note the relaxation of certain prudential requirements, for example, the cap on real estate exposures and the increase in loan to value limits, and see some risks of lower recognition and disclosure of problematic assets.

Excluding the impact of these measures and any adjustment to banks' asset-quality recognition practices, we expect the volume of stage 3 loans to increase to 7%-8% of systemwide loans in 2020-2021, and problematic assets (stage 2 and stage 3 loans) to rise to around 20% of total loans from 15% at year-end 2019. This is because the oil price shock is happening at a time when the real estate sector is already under significant stress and other UAE sectors, such as hospitality and discretionary consumer goods, would experience a significant decline in revenues. The banking system's total exposure to the real estate and construction sectors stood at 26.4% as of Dec. 31, 2019, assuming that one-third of personal loans for consumption purposes are channeled to real estate. Another 20% of total exposures comprised sectors such as trade, transport, storage, communication, and personal loans for business purposes on the same date. A material portion of these loans is at risk, in our view.

We assume the impact on banks' asset quality indicators will be moderate, since we expect oil prices will recover in 2021 to $50 per barrel from $30 in 2020, and a slight recovery in the non-oil sector in 2021. There might be a greater impact if these assumptions do not hold. In our opinion, a larger-than-expected increase in credit losses or further impairment in the disclosure of problematic assets would weigh on the creditworthiness of the UAE banking system.

We expect banks' profitability will reduce after the UAE Central Bank's cuts to interest rates, mirroring those of the U.S. Federal Reserve. On the asset side, banks' interest income will drop; while on the liabilities side, a large amount of the banking system's deposit base is noninterest bearing. At year-end 2019, the top 15 banks' average return on assets was 1.5% compared with 1.7% at year-end 2018. Ultimately, the extent of the decline depends on how the cost of risk evolves given the central bank support package. Without the latter, banks' profitability could reduce to less than 1%, similar to what we observed during the previous oil price shock. That would force banks to review their cost bases and reduce them where possible. We view as positive that the UAE's banking system does not rely on external funding and had a net external asset position at year-end 2019. Reliance on deposits from government-related entities could create risks, since some entities might use these funds over the next 12-24 months. However, we don't foresee any material impact on the banking system's funding and liquidity profile.

As a result, we now see negative rather than stable economic and industry risk trends in our Banking Industry Country Risk Assessment on the UAE, which remains in Group 5 (on a scale of 1 to 10, with the strongest banking industries being in group 1).

First Abu Dhabi Bank (FAB)

FAB is the largest bank in the UAE and we expect that it will retain its market leading position through the difficult operating environment. We expect that FAB's privileged position as the major domestic lender to a wealthy government and public sector, which provides it with a pipeline of low-risk lending opportunities, will continue to underpin our ratings. Moreover, we expect that the bank will remain supported by the government of Abu Dhabi and maintain strong fundamentals, although the systemwide challenges are pervasive throughout the UAE's economy.

The negative outlook reflects our view that the worsening operating environment, increasing cost of risk, and lower interest rates may weaken FAB's profitability to a level more comparable with its peer group. FAB's superior earnings metrics have been a stand-out characteristic of its credit profile, allowing it to more easily cover unexpected losses than peers. We would lower the rating in the next 12-24 months, if this strength diminished materially.

Absent the scenario relating to peer relativities envisaged above, any deterioration in FAB's stand-alone credit characteristics such as asset quality or capitalization, or of the UAE banking system would be compensated by higher support from the government of Abu Dhabi, given the bank's status as a government-related entity. We would revise the outlook to stable in the next 12-24 months if FAB continues to demonstrate strong profitability while keeping risks in check, all other factors remaining unchanged.

Abu Dhabi Commercial Bank (ADCB)

ADCB has a well-established franchise, stable management, and predictable earnings across different business segments. While we expect the ongoing economic strains will lead to a deterioration in some metrics, we still expect ADCB to maintain strong fundamentals. However, the ongoing systemwide challenges are pervasive through the UAE's economy.

The negative outlook reflects our view that the worsening operating environment could result in a significant deterioration of ADCB's asset quality indicators, given its material exposures to sectors at risk, and hamper the bank's profitability.

We could lower the ratings in the next 12-24 months if we observe a significant increase in problem loans (stage 2 and stage 3) alongside increasing pressure on the bank's operating environment.

We could revise the outlook to stable in the next 12-24 months if ADCB's asset quality deterioration does not exceed our expectation and capitalization remains strong or risks related to the operating environment recede.

Sharjah Islamic Bank (SIB)

The negative outlook reflects our view that the worsening operating environment could result in a significant deterioration of SIB's asset quality indicators and hamper the bank's profitability.

We could lower the ratings in the next 12-24 months if we observe a significant increase in problem loans (stage 2 and stage 3) or if pressure on the bank's operating environment intensifies.

We could revise the outlook to stable in the next 12-24 months if SIB's asset quality deterioration does not exceed our expectation and capitalization remains strong and risks related to operating environment recede.

National Bank of Fujairah (NBF)

The negative outlook reflects our view that the worsening operating environment could result in a significant deterioration of NBF's asset quality indicators and hamper the bank's profitability.

We could lower the ratings in the next 12-24 months if pressure on the bank's operating environment intensifies or if we observe a significant increase in problem loans (stage 2 and stage 3).

We could revise the outlook to stable in the next 12-24 months if risks related to the operating environment recede, NBF's asset quality deterioration does not exceed our expectation, and capitalization remains strong.

Mashreqbank

The negative outlook reflects our view that the worsening operating environment could result in a significant deterioration of Mashreqbank's asset quality indicators and hamper the bank's profitability.

We could lower the ratings in the next 12-24 months if we observe a significant increase in problem loans (stage 2 and stage 3) and pressure on the bank's operating environment intensifies.

We could revise the outlook to stable in the next 12-24 months if risks related to the operating environment recede or Mashreq's asset quality deterioration does not exceed our expectation and capitalization remains strong.

BICRA Score Snapshot*

United Arab Emirates

Related Criteria

• General Criteria: Group Rating Methodology, July 1, 2019
• General Criteria: Hybrid Capital: Methodology And Assumptions, July 1, 2019
• Criteria | Financial Institutions | General: Risk-Adjusted Capital Framework Methodology, July 20, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Guarantee Criteria, Oct. 21, 2016
• General Criteria: Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015
• General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions, Nov. 19, 2013
• Criteria | Financial Institutions | Banks: Assessing Bank Branch Creditworthiness, Oct. 14, 2013
• Criteria | Financial Institutions | Banks: Quantitative Metrics For Rating Banks Globally: Methodology And Assumptions, July 17, 2013
• Criteria | Financial Institutions | Banks: Banks: Rating Methodology And Assumptions, Nov. 9, 2011
• Criteria | Financial Institutions | Banks: Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011
• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009
• Criteria | Financial Institutions | Banks: Commercial Paper I: Banks, March 23, 2004

Related Research

• S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure, March 19, 2020
• Prolonged COVID-19 Disruption Could Expose The GCC's Weaker Borrowers, March 11, 2020
• Banking Industry Country Risk Assessment Update: March 2020
• Abu Dhabi Commercial Bank, Dec. 31, 2019
• First Abu Dhabi bank, Dec. 30, 2019
• Mashreqbank, July 23, 2019
• Sharjah Islamic Bank, July 4, 2019
• National Bank of Fujairah, May 29, 2019
• Banking Industry Country Risk Assessment: United Arab Emirates, April 17, 2019

Ratings List