The increased domestic banking sector support to Dubai Inc has brought exposure to the public sector as percent of capital to the highest level since the late 1970s. Vulnerability to foreign bank funding has however moderated somewhat, providing some comfort at the onset of GRE refinancing challenges of 2014-15, according to BofA most recent investors recommendations. This reflects the economic recovery, increased foreign assets, perception of a potential Abu Dhabi put, as well as continuing business ties to regional entities. Still, GRE deleveraging and asset sales would be needed to contain banking sector exposure and address refinancing challenges going forward, particularly for restructured debt, according to the bank’s report.
Banking sector on a stronger footing
Following strategic official support during the global financial crisis and progress on the deleveraging front thereafter, the banking sector appears in a more solid position at the onset of the GRE refinancing challenges of 2014-15. The loan-todeposit ratio stood at 92% in July, from a peak of 112 in September 2008, and the capital adequacy ratio stood at 19% in 2Q13, from 13% in 3Q08. Liquidity has improved as cash, bank deposits and CDs held at the central bank increased to AED198bn in April, from a low of AED92bn in January 2009. The latter remains very much cyclical in the absence of adequate tools to manage banking sector liquidity. Lastly, the EIBOR-LIBOR spread compressed markedly, reflecting an improvement in counterparty risk, with, for instance, the differential at the one-month tenor now at 35bp, versus 390bp in September 2008.
Modest credit growth on liquidity and economic recovery
M2 growth increased markedly in July to 11.9% yoy, broadly likely still supported by government and public sector deposits (which represent a combined 26% of total deposits). In counterpart, growth in loans and advances accelerated in July to 6.4% yoy, the fastest pace since mid 2009. This comes largely on the back of lending to the government and to the public sector, which has grown by an average of 13% yoy this year, and represent a combined 30% of total loans. Private sector loans are now expanding by a modest 2-3% yoy in 1H13 on a stronger non-oil economic activity, after contracting for 40 consecutive months. Credit to the manufacturing, construction sectors has had a noted rebound.
Deleveraging turns corner; GRE exposure highest since 70s
After government-supported recapitalization during the global financial crisis, deleveraging appears to have turned a corner as total claims have been increasing as percent of bank capital in 1H13. According to IFS data, exposure to the government and non-financial public enterprises as percent of bank capital has been increasing since mid 2010, and currently is 104%, the highest level since the late 1970s. This is consistent with sustained domestic banking support to GRE restructurings and refinancings since the global financial crisis, which was partly accommodated through lower credit to the private sector. Since the Lehman crisis, the domestic banking sector has extended a whopping US$42bn in credit to the government and GREs, an annual increase of 2.6% of GDP. This fully compensated for the foreign outflows but increased the banking sector’s exposure as percentage of capital by 26ppt. The credit stock also suggests very roughly that about 50% of Dubai Inc debt is owned domestically.
Central bank regulations not a spanner in the works
BofA’s analysts continue to see little chance of a timely implementation of the UAE central bank circular setting large exposure limits, and see this as a tool for coordination and consultation rather than to force a disorderly GRE deleveraging process. The UAE Banks Federation’s final feedback proposal to the central bank has been to exclude bonds, to apply means and purpose tests in order to determine whether the circular applies to an entity, and to allow five years to comply with the regulations. With the banking sector holding AED55bn in government and official entities bonds (20% of claims on central government and non-financial public enterprises), the exclusion of the latter would bring total exposure as % of capital down by 20ppt, leaving some breathing space. That being said, GRE deleveraging and asset sales would still be needed to contain domestic banking sector GRE exposure going forward.
Foreign money watchful, but still committed for now
Despite lingering vulnerabilities, the better-than-expected behavior of foreign bank funding reflects the following factors 1) broadly better than expected restructuring terms for creditors; 2) economic recovery; 3) perception of a potential Abu Dhabi put; and, 4) the lack of a full pullout from the region and the consequent need to maintain business relationships with sovereign and quasi-sovereign entities.
According to central bank data, elevated oil prices and some foreign deleveraging allowed the banking sector net foreign position to turn positive in January, for the first time since mid 2006. That being said, foreign liabilities have been growing again moderately since the trough in February 2010 to close to their 2008 peak.
Still, in the absence of more robust deposit formation, a sustained acceleration of credit growth is likely to require additional foreign borrowing. The rapid acceleration of credit growth in boom years and the subsequent depositlending funding gap was partly financed by foreign borrowing. Non-resident deposits have been broadly resilient throughout global and regional woes, reflecting the UAE’s relative safe haven in the region, in our view.
UAE vulnerability to foreign bank funding moderates
BIS locational statistics corroborate the above and suggest the UAE’s net external position vs BIS banks turned positive in 1Q13, which helps moderate the vulnerability to withdrawal of foreign bank funding. In FX-adjusted terms, the cumulative drop from 3Q08 in BIS banks’ UAE exposure was US$18bn, with the bulk of the retreat occurring over the first year but remaining broadly stable thereafter. In terms of consolidated statistics, incorporating the domestic subsidiaries of foreign banks, on an ultimate risk basis, exposure to banks and non-financial corporates was reduced the most. This largely took the form of lower cross-border lending, though claims of domestic subsidiaries of BIS banks appear to have increased their lending to UAE entities meanwhile.
There appears to be a modest increase in exposure of non-European banks at the expense of European, but the largest foreign claims are still owned by UK-based banks (52% of total BIS consolidated claims on UAE entities). BIS consolidated claims on UAE entities are now at 20% of total banking sector liabilities, from a peak of 33% in 3Q08. This is the highest in the MENA region, but still well below levels in CEE countries. Since 3Q08, outstanding claims’ maturities lengthened modestly, but the bulk of consolidated exposure is still short-dated (56% of total in the 1-year or less bracket, and 40% of total in the over 2-years bracket), which points to still lingering rollover risk, in our view.