UAE banks' 2021 outlook blunted by sector exposure – S&P

Lenders in the United Arab Emirates face a "long road to recovery" as the recession caused by the "one-two punch" of the health crisis and low oil prices in 2020 continues to "reverberate" through a banking sector with relatively high exposure to pandemic-affected sectors, according to S&P Global Ratings.

As the government progressively lifts its forbearance measure from the second half of 2020, asset quality is expected to deteriorate, the agency said. However, the process will likely be gradual to minimize the impact on the banking sector.

Sectors including real estate, hospitality and retail will likely remain under pressure for the next 12 months, and Ratings does not expect real GDP in dollar terms to return to 2019 levels until 2023.

The banking sector's exposure to those sectors will result in weaker asset quality and higher credit losses, Ratings said.

Nonperforming loans are expected to rise to about 7% in 2021 as forbearance measures come to an end, with the chief contributors being loans to the retail sector and the construction and real estate sector, which make up a combined 41% of UAE banks' total loan exposure.

Gross lending growth will likely remain muted overall and is forecast to be around 4% in 2021 despite government entities borrowing more during the year due to the Dubai Expo. Corporate borrowing will improve slightly as they look to refinance existing debt and execute deferred capital expenditures from 2020.

Asset quality

The agency expects banks' asset quality to fall and cost of risk to rise once they begin to recognize the impact of the recession.

Although government support is expected to remain strong, additional defaults are likely in 2021, with the weighted average cost of risk of the 10 biggest banks in the UAE forecast to rise to 180 basis points. Meanwhile, the weighted average coverage ratio is expected to remain below historic levels at around 84%.

Higher provisioning due to high-profile defaults in 2020 and the additional defaults expected in 2021 will likely cause a sharper drop in profitability for UAE banks versus their peers. UAE banks have the worst forecast for return on assets in 2021.

Capitalization is expected to remain strong despite the drop in profitability. Quality of capital remains good, with the contribution of hybrid instruments on the rise. Liquidity also remains at healthy levels mainly due to state support and is not an issue for now. Roughly one-quarter of UAE banks' assets were in liquid form as of September 2020.