After a surge in profits in 2023, UAE lenders have a positive outlook for this year. Strong capital buffers are expected to move even higher, while robust liquidity conditions provide a solid base for growing loan books.

The UAE economy’s revival, meanwhile, continues. That will support lenders’ loan quality, with borrowers’ ability to repay loans steadily improving – albeit from a high level of problem loans, which account for an estimated 4-5% of total loans.

The key factor in borrowers’ improved repayment ability is the UAE’s impressive non-oil performance, which has resulted in diminishing corporate problem loans.

With legacy Covid-era challenges now substantially reduced for the UAE private sector, banks’ non-performing loan (NPL) ratios have declined across the board.

Exposure to the property sector, considered a strategic vulnerability for lenders, is not proving problematic. Those developers with indebtedness issues are in the process of settling those.

For example, in December 2023, Dubai-based developer Union Properties announced an AED875m ($238.3m) debt repayment to a local lender, as part of a restructuring of its loans.

According to Moody’s Investors Service, the UAE banks’ coverage ratio, defined as loan-loss reserves as a proportion of problem loans, reached 103% in 2023 – meaning the existing stock of property-related loans is now fully covered.

The ratings agency said this level is comparable to other highly rated GCC banking systems, providing a healthy extra layer of protection to core equity against expected losses and strengthening total loss absorption capacity. 

However, there is a limit to the level at which NPLs will decline because of large legacy exposures and large restructurings emanating from previous cycles, where there was volatility in the non-oil space.

Last year, non-oil growth in the UAE was around 5%. That drove greater, repayment capacity from borrowers, which was very visible in the headline NPL ratios of the banks that pretty much declined on average, says Badis Shubailat, a bank analyst at Moody’s Investors Service.

“Still, there is some form of floor level to this decline because of the legacy exposures, and large restructurings that emanated from the previous credit cycles, during which we saw volatility in the non-oil space.”

This structural feature keeps the UAE at a disadvantage from a comparison standpoint to the other markets regarding asset quality indicators.

The broader profit picture in the UAE underscores the benign conditions confronting banks. The combined net income of all UAE banks increased by 54.1% in year-on-year terms in 2023, to AED76.9bn ($20.9bn).

High interest rates and supportive operating conditions ensured that asset yields (at 6.0% according to Moody’s) outpaced the cost of funding (3.7%). Banks managed to preserve low-cost current and savings accounts (CASA) and supported wider margins at 2.6% (compared to 2.2% in 2022). 

Profit boost

Results from the largest UAE lenders show a massive profitability boost last year. The country’s largest lender by assets, First Abu Dhabi Bank (FAB), saw 2023 net profit reach $4.5bn, an increase of 56% on an underlying basis compared to 2022.

Total assets increased 5% to $318bn. Dubai’s largest bank, Emirates NBD, reported a 65% increase in profit last year to AED21.5bn ($5.9bn), with a 16% increase in its asset base propelled by strong CASA increases.

According to Moody’s, the four largest banks – FAB, ENBD, Abu Dhabi Commercial Bank and Dubai Islamic Bank, which together accounted for around 74% of total UAE banking assets as of December 2023 – reported a combined net profit of $14.3bn in 2023, up from $9.6bn in 2022.

Analysts expect sustained profitability in 2024, given widening net interest margins and improving credit growth. Even anticipated interest rate cuts from the US Federal Reserve are unlikely to hit UAE banks hard, especially as these are only due to kick in in the second half of this year. Moreover, any interest rate reductions will likely be gradual. 

These improving metrics prompted Moody’s in mid-March to change the outlook for the UAE banking sector in 2024 to positive from stable.

The profitability improvement will also support banks’ capital ratios. Fitch Ratings expects the average CET1 ratio (post-dividend payments) to remain in the 13.5%–14% range, as the impact of lending growth will be broadly compensated by internal capital generation. Operating profits provide a solid cushion against any increase in the cost of risk, said the ratings agency.

That UAE banks are mainly funded by low-cost CASA deposits – considered ‘sticky’ – is a positive for the sector’s liquidity position. Last year, noted Moody’s, customer deposits made up 78% of UAE banks’ funding base. In contrast, the reliance on market funding is a moderate 17.7% of tangible banking assets.

Funding positions are supported by higher deposits from government-related entities (GREs), whose revenue performance has been sufficiently strong to allow them to deleverage to a greater degree.

Last year’s aggregate deposit performances from the top 10 banks, as reported by consultancy Alvarez and Marsal, showed that deposits grew 13.4% in 2023, while aggregate loans and advances increased by only 9%. Consequently, the loan-to-deposit ratio for these banks slipped 3.1 percentage points to 74.9%.

Some banks’ bottom lines face challenges. In March of this year, Dubai announced a 20% annual tax on foreign banks operating there, excluding those based in the Dubai International Financial Centre (DIFC). However, the Dubai authorities said the corporate tax rate will be deducted from the annual tax that foreign banks pay.

Volatile sectors

There remain vulnerabilities related to the construction and contracting sectors, which Moody’s notes are more volatile. It expects pockets of risks in the small- to medium-sized business segments because of high interest rates, particularly for smaller banks.

Exposure to foreign economies such as Turkiye and Egypt is more of a risk for the larger UAE banks.

“There is a foreign exposure story with large UAE banks, mainly in markets that have strong trade ties with the region, namely Egypt and Turkiye,” says Shubailat. “Those open avenues for growth and profitability diversification, but also present relatively less benign and more challenging environments.”

Such risks should easily be absorbed in the grand scheme of things. With overall conditions remaining supportive and healthy profits being generated, the UAE’s banks will look to expand loan books and capture the full growth potential of a vibrant domestic market.

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