UAE Banking: Storm Signals in ADCB's 3Q2016 Financials

AA Has the Full Range of Flags, If Needed

As promised earlier, further thoughts on ADCB’s 3Q16 financial report plus an added bonus--a typical AA “get off my lawn” rant on financial reporting and regulatory environment.  The latter in a separate section at the end.

Introductory Comments

If you know your nautical flags, you will immediately see that the “storm signals” warning is at a modest level. In other words, I am not predicting an imminent serious crisis for ADCB.

The bank has reasonably robust stand-alone financials, though note the reporting  “lapses” discussed below. 

If by some low probability event, the bank were to develop life-threatening problems, it would almost certainly receive official support as it and other UAE banks have in the past, e.g., after the Great Financial Crisis of 2008.    The Abu Dhabi Government owns more than 60% of ADCB’s equity and has a special “incentive” to step up and has the resources to do so.  ADCB is a systemically important bank. Thus, the Central Bank is also likely to provide support.

If there is no imminent danger of collapse, why this analysis and why the use of the term “storm signals”? 

Free float is generally low in GCC equities (ADCB somewhere around 30%) and generally this free float is primarily in the hands of retail and not institutional investors, the latter presumed to be less susceptible to market panic.  Note I said “less susceptible” not “not susceptible”.  

In such “markets”, the price impact of investor actions—sales or purchases--is outsized relative to other markets.  A change in market sentiment and one’s return on ADCB stock could decline.  A large enough market decline and one might lose some of the initial investment, depending on one’s entry price. 

These characteristics increase risk.  If risk is higher, then the utility of a warning is greater.  

In addition as is the case here, when an issuer’s financials are deliberately opaque, the utility of a warning increases.   

“Storm signals” like the picture of the flag above provide warnings about potential problems. 

If there is a gale force typhoon in progress, one hopefully doesn’t need to see a flag to decide to keep one’s boat in port.  But if the storm is not yet fully apparent, a warning flag can prevent the sailing of boat, a change in its planned course, or alert the crew to be on the watch for the storm if they decide to leave port on the original course. 

Financial storm signals serve the same function for investors.  Warnings can be used to trigger action to prevent losses or in some cases to gain profit. 

One final note:  warnings about potential problems are not infallible.  Sometimes no storm appears. Sometimes the storm is much different from that predicted. 

Some Technical “Notes”

I used NBAD and FGB to provide some comparisons to ADCB’s financial reporting.  NBAD’s business is different from ADCB’s in many respects so I acknowledge there are limitations to that comparison.  

Abbreviations:   3Q16 = Third Quarter 2016.  FYE15 = Fiscal Year End 31 December 2015.

Financials: 

1. ADCB:  3Q16, 2Q16, 1Q16, FYE15  
2. FGB Annual Financial Reports Access Page,  FGB Quarterly Financial Reports Access Page
3. NBAD Financial Reports Access Page

Summary

During my review of ADCB’s 3Q16 financials I noticed two significant developments which occurred primarily in a single quarter—3Q16— and which may be signs of distress in the loan portfolio. 

1. Accrued Interest Receivable (AIR) jumped some 50% from FYE15 (31 December 2015) with more than 70% of the increase during 3Q16. 
2. Overdrafts increased some 84% from FYE15 with all the change occurring in 3Q16.    

My concerns were exacerbated by a major deficiency in ADCB’s financials – a failure to report renegotiated loans.  The absence of this rather critical piece of information prevents a deeper analysis of the bank’s condition and raises questions why it isn’t provided.      

Are these 2016 “developments” and the reporting deficiency signs of problems in the loan portfolio?  Does the failure to disclose renegotiated loans indicate that the bank is “actively managing” (AA euphemism of the post) non-performing loans (NPLs)?   That is, hiding problems?  Or are there other more “innocent” explanations?  

There isn’t enough information to make a conclusive call.  On the one hand, it’s hard to build a case for a trend based on a single data point (3Q16 financials).  But the failure (which predates 2016) to disclose required information, the significant “divergence” from past financials, and the fact that these apparently occurred in a single quarter suggest that not everything is “right”.

We won’t get more financial information until FYE16 financials are released and more likely than not the same reporting or non-reporting standards will be used.  A lot can happen until then.

ADCB isn’t “going down” but its share price can.  That’s important for equity investors because by their nature share prices are more volatile than debt prices.  The limited free float and the composition of the investor base for ADCB stock exacerbate that natural characteristic for this stock.

Accrued Interest Receivable (AIR)

Problems in the loan portfolio often show up in increases in AIR before NPLs are formally acknowledged in the financials.  AIR on NPLs often turns out to be as substantial as the air we breathe.

ADCB’s AIR (included in Other Assets) was AED 1.6 billion at 3Q16, AED 1.2 billion at 2Q16, AED 1.3 billion at 1Q16, AED 1.1 billion at FYE15, and AED 1 billion at FYE14.

A couple of things jump out of those numbers.

1. The increase from FYE15 to 3Q16 was approximately 50%.  That’s larger than the 11% growth in loans. 
2. More than 70% the increase from FYE15 occurred in a single quarter--the third quarter. 

If ADCB is accruing interest on a time proportion basis, then it would seem that increase would be gradual unless loans ballooned between 2Q16 and 3Q16. 

That doesn’t appear to be the case. Net loan outstandings were AED 162 billion (3Q16), AED 155 billion (2Q16), AED 157 billion (1Q16) and AED 146 billion (FYE15).  An increase of only 11% since the beginning of the year.

If volume isn’t driving the increase, then it could be pricing.  A higher rate on newly extended loan(s) in 3Q16.  If we assume rates were higher just on the AED 7 billion increase in loans between 2Q16 and 3Q16, the rate would have to be around 23%.  That doesn’t seem likely.

It might also be an overall rate increase on the total portfolio or at least an increase on those loans that reprice quarterly. In such a case, it’s more likely that an increase of this sort would come from an increase in the base rate not an overall increase in credit margins. 

Assuming that were the case, an approximate 1% increase on the entire portfolio for three months would be required to boost AIR by AED 0.4 billion. Looking at FYE 15 Financials Note 44 “Interest Rate Risk, some 70% of ADCB’s loans are priced off base interest rates three months or less.  That would make the required base rate increase about 1.45%, assuming that the other 30% could not be repriced.   According to CBUAE data, EIBOR has not risen by that amount during this period. 

But we don’t have to look at external rates.  We can look at ADCB’s financials where an increase in the rate on loans would have to show up in gross interest revenue.  A back of the envelope analysis of quarterly interest revenue on loans to customers divided by the average of the total balance of customer loans and advances (computed using beginning and end of the period totals divided by two) shows an average 4.3% annualized yield on the loan portfolio for the three quarters of 2016 roughly consistent with full year 2015's annualized yield, though on an individual quarter basis the yield is declining:  4.44% (1Q16), 4.27% (2Q16) and 4.22% (3Q16).  2016 gross interest income on customer loans is roughly AED 1.9 billion a quarter which would put it AED 0.4 billion over 2015 but for the entire year.  However, if interest repayments are quarterly as argued above, AIR shouldn’t increase this much because clients should be paying roughly quarterly.   

A cursory inspection of other components of interest income doesn’t show any other asset types likely to be responsible for the increase –these are much more modest in amount and are fairly consistent across 2016 and comparable to the 2015 total performance (divided by four).   

So it seems an interest rate increase is unlikely for the AIR jump as well.

What are other explanations? 

1. A “catch-up” accrual – correcting a mistake(s) made earlier in 2016.  Would have been a whale of a mistake, though as we know “whales” are not that uncommon even in the Thames.  
2. A write back of previously “uncollectable” interest.  Both 1 and 2 should appear in the financials.  I didn’t see anything to indicate this. 
3. A failure by a borrower or borrowers to make an interest payment.  As noted above, Note 44 states that more than 70% of the bank’s loans were priced off interest rates three months or less at FYE15.  This probably hasn’t changed much in 2016, though we won’t know until FYE16 financials are released and then we’ll only have end of period information. Standard banking convention would be that interest is due at each repricing.  So it is possible (but not conclusively proven) that non-payment could explain a spike in the AIR.  If you’re wondering, details like those in Note 44 are not mandatory for interim financials.

Overdrafts

Increases in overdrafts are often a sign of problems. 

[AA side comment:  Another reason for looking here is historical not necessarily analytical.  Those who know their UAE banking history know that the UAE banking system floundered on “perpetual” overdrafts with capitalization of interest (to add insult to injury). ADCB was formed from the wreckage of Emirates Commercial, Federal Commercial, and Khalij Commercial Banks back some 30 or so years ago.]

At 3Q16 OD’s stood at AED 8.3 billion compared to AED 4.5 billion (FYE15) and AED 3.7 billion (FYE14), roughly an 84% increase since FYE15 and 124% since FYE14.  Note that even with the increase ODs are roughly 5% of the loan portfolio, not a large amount unless you compare them to total equity at 30 September 2016.  In that case the figure is 28%. 

OD’s increased rather dramatically in 3Q.  ODs were AED 8.3 billion (3Q16), AED 4.5 billion (2Q16), and AED 5.0 billion (1Q16).  Like AIR, the increase was concentrated in 3Q16.  Unlike AIR, the entire increase took place in the third quarter.   

By contrast NBAD’s comparative figures are AED 10 billion (3Q16), AED 12 billion (FYE15), and AED 14 billion (FYE14).   A 17% decrease since FYE15 and 29% since FYE14.   

FGB doesn’t provide this information, probably based on “materiality” compared to the aggregate amount of the loan portfolio.  ODs at both NBAD and ADCB were about 5% of total loans well under the traditional 10% materiality standard.  A similar level is likely at FGB.

So why is AA making a “federal” case (pun intended) on this issue? 

ODs are one of the trickier forms of credit for banks to manage. 

When extending loans with a defined drawdown period and defined repayments (triggered off the end of that drawdown period and specified by date and amount), banks perform a detailed analysis or should. Monitoring of the status of the loan has well defined milestones in the form of amount and date certain contractual repayments. 

Overdrafts don’t have the same clearly defined signposts as these other loans do.  Typically, the test for non-performance of an OD is an absence of adequate turnover (drawdown and repayment transactions) which has led to a persistent level of debt.  This test is based on the concept that ODs are revolving facilities that should track the borrower’s business/cashflow cycle, increasing when expenditures exceed cash collections and then reversing as collections exceed expenditures. 

This test makes monitoring more difficult and allows more discretion in the timing of classifying a loan as non-performing.  What is an adequate “turnover” of transactions in the account?  What time period should be used to determine that a persistent level of debt has been reached? Does a slowdown in economic activity justify new norms and how should these be calibrated?  Beyond conceptual issues like these, there is also the practical matter of conducting effective monitoring, keeping one’s eye on the ball.

Non-Disclosure of Renegotiated Loans

ADCB does NOT disclose data on renegotiated loans.

AA understands that IFRS #7 (I believe paras 36 and 44, though I am not a hafiz of IFRS) require that this information be disclosed.  Both FGB and NBAD disclose this information. NBAD takes the prize for disclosure.  Let’s hope the merged entity follows NBAD reporting standards. 

NBAD’s FYE 2015 Annual Report Note 4a provides aggregate totals and a reconciliation of the movement in renegotiated loans.  As per that information, during 2015 NBAD’s renegotiated loans doubled to AED 2.6 billion.

By contrast ADCB has a “bland”  “philosophical rumination” defining renegotiated loans but no numbers.  Not really of much analytic utility.  

But it could be worse, here’s a quote from ENBD’s 2015 Annual Report.

Loans with renegotiated terms are loans, the repayment plan of which have been revised as part of ongoing customer relationship to align with the changed cash flows of the borrower with no other concessions by way of reduction in the amount or interest, but in some instances with improved security. These loans are treated as standard loans and continue to be reported as normal loans.

ADCB almost certainly has renegotiated loans.  See the Fitch quote below. 

The bank also has a concentrated portfolio with large individual and aggregate exposures to government related enterprises (GREs) and “private” companies connected to the shaykhly but hopefully not shaky elite.  By some estimates (see Fitch report linked to below) the latter is twice the GRE related exposure.  Ample “opportunities” for problem loans.   

Failure to disclose renegotiated loan data--amounts and other IFRS required information--indicate to AA  that the bank thinks it needs to hide this information.  Why?  Presumably not because it has so few but rather because it has so many.  IFRS-required disclosures would enable a reader to determine when renegotiation took place –giving an indication of whether NPL problems were increasing or decreasing.  That is precisely one of the reasons that IFRS #7 imposes this requirement.

What could be another reason for not reporting this information?

Renegotiating loans typically gives the borrower less onerous terms – lower interest rates, a revised repayment schedule, a longer average life of the loan.  In some cases payments can be reprofiled to push substantial amounts of principal payments well into the future – “ballooning” as one banker I know calls it. 

Take an extreme example: a loan maturity is extended from 5 to 20 years with 80% of principal due during the last three years.  For the first 17 years of the renegotiated loan period, maintaining a “performing” status is much easier than if the loan were extended for a shorter tenor with equal semi-annual principal installments.    

If a bank takes pre-emptive action (before a loan has missed a payment) it can avoid declaring the loan non-performing, thus, “hiding” NPLs and making the bank’s loan portfolio look more robust than it actually is.   If it doesn’t report renegotiated loan data, pre-emptive NPL management might not be noticed by the market.

However, there is no evidence in ADCB’s financials of a massive increase in loan maturity as per Note 45 “Liquidity Risk” in FYE15 financials.  The relative percentages in less than one year and the other two maturity “buckets” for 2015 are almost spot on with 2014. 

But the bank’s reporting is also opaque here as well.  

ADCB uses a maximum maturity “bucket” of “over three years”.  FGB and NBAD use maximum maturity “buckets” of periods of “over five years”.    ADCB therefore has more room to maneuver. If a loan with a three year maturity were extended two years, this would not show up in the Maturity Risk note at ADCB.  It would at FGB or NBAD.    

Dramatically lengthening maturities is one but not the only way to avoid NPL status.  One could back end principal payments (making later repayments higher than nearer repayments) with much shorter extensions of maturity.  If a bank were pro-actively managing problem loans to prevent the appearance of NPLs and did not disclose renegotiations, it could use future renegotiations to manage the problem on a rolling basis. 

But we can’t tell from ADCB’s financials what , if anything, might be going on.

With no evidence in the financials, let’s turn to a quote from Fitch’s August 2016 ratings report (which by the way confirmed an A+ rating for the bank).  Boldface courtesy of AA.

ADCB does not disclose the volume of renegotiated loans, but Fitch understands that it has done a lot of corporate loan renegotiations since the crisis and has reclassified most of these exposures back to performing over this time as they demonstrated normal performance.  ADCB renegotiated some of its 20 largest exposures during 2015.  Fitch understands that these loans would be overdue if they had not been renegotiated.

We don’t know for certain if ADCB is pre-emptively renegotiating troubled loans to avoid having to declare them non-performing, but that’s clearly one way to read the Fitch quote.  Non-disclosure of renegotiated loan information certainly provides cover for such activities, if they are occurring.  AA can’t think of a single “benign” reason why ADCB would withhold this information. One final comment on the Fitch quote: if the terms of the renegotiated loan are generous enough, the bar for “normal performance” may be set low indeed.

AA was also troubled by ADCB’s new external auditor signing off on the financials as being in compliance with IFRS.   As AA understands it, IFRS compliance is all or nothing.  One can’t be partially compliant.

Troubled as well by the CBUAE’s apparent acquiescence.  That being said, though there is both historic precedent elsewhere in the GCC, what wags refer to as IRS (Investcorp Reporting Standards), and closer to home and time, CBUAE “Dubai Inc” renegotiated loan treatment rules.   

Another Warning But This Time About Something That Definitely Will Happen

Accounting and Regulatory “Rant”

Cashflow Statements: 

Accrued but uncollected interest is not a “use of funds” that “increases” Other Assets as seems to be common reporting practice for ADCB, FGB, and NBAD.  Until interest is paid by the borrower, it is uncollected revenue and not cash. 

There are two consequences. 

1. Since it wasn't collected, it is properly a deduction from net income on the cashflow statement. 
2. Since it isn't cash, it can't be used to fund an increase in Other Assets. 

If one insists on treating AIR as a “use” of funds, then the statement issuer and its auditor have the duty to disclose the components of Other Assets so that financial statement users can determine what is happening with collection of AIR.  Financial statement users should not have to wait for annual reports to get this information.

Investors/Creditors: 

When issuers shy away from disclosure, it’s usually because they have or think they have something to hide. 

1. Lack of disclosure limits an investor’s ability to monitor and thus protect its investment. 
2. More importantly it offers an important insight into the business ethics of an issuer. 

Should you invest with an issuer that withholds basic information from you? And may be withholding that information so it can “manage” its financials?  

Standard financial theory holds that when risk is higher, investors should demand a higher risk premium.  But a key wrinkle to the successful implementation of this theory is that realized returns are often much lower than earlier anticipated or promised returns.  A problem more acute with equity than debt because with equity there are no contractual “promises” and equity prices are more volatile.  

Dubai World to Meet With Local Creditors - No or Low Interest Repayment Option?

The National reports that DW is planning meetings with local creditors - Abu Dhabi Commercial Bank and Emirates National Bank.  These meetings follow ones held earlier this week in London with "international" banks.

The goal of this series of meetings is probably twofold.

First to test some restructuring ideas with these major banks to get feedback.   Second as a way of managing the process - trying to influence future negotiations by framing the bankers' expectations.  

One of the options that apparently is being considered is a low or no interest repayment of 100% of the principal over some extended period.

Let's look at some examples to see what sort of discounts one can achieve through this device.

1. A bullet repayment 10 years from now of 100% of principal equals a present value of 61% of face at a 5% annual discount rate.  Changing just the repayment to 5 years from now raises the present value to 78%.
2. Using the same two scenarios above but applying a 10% discount rate, the 10 year bullet has a present value of 39% of face and the 5 year bullet is worth 62%.
3. Amortizing the loan in 5 equal yearly installments gives present value of 87% at 5% and 76% at 10%.
4. If there is unequal amortization of 0%, 10%, 15%, 25%, and 50%, then the present value of at 5% discount rate is 82% and 68% with a 10% discount rate.

What's the bottom line?  One can achieve quite a hefty "haircut" through this tool.

The Nation suggests that banks might want the zero interest or low interest option as a way of avoiding taking the "hit" to income up front.  I think it is highly likely that any reputable accounting firm is going to let a client who uses IFRS as the basis for financial reporting "get away" with carrying the loan at its nominal value.  This is clearly a restructured loan. 

The relevant Chapter and Verse are IAS #39 Paragraphs 58 and 59 which deal with impairments in value.  Haircuts, no interest or below market interest rates,  tenor extensions, other concessions that a lender would not normally agree to along with several other items are cited as evidence of  potential "impairment" in Paragraph 59.  

Paragraphs 63-65 deal with calculating impairments for assets held "at cost".   Present value the projected cash flows at the original interest rate on the instrument.  Any shortfall between original cost and present value is an impairment loss which must be taken immediately to the income statement.

Paragraph 66 deals with impairments on assets "held as available for sale".  There the discount rate is the "market" rate for that asset at present. Since this is an impairment not a fair value adjustment, it also goes through the income statement.

Retail Loan Exposure and NPLs: Emirates NBD Bank

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Almost all of the media coverage of loan problems in the GCC is focused on the commercial market. Scarcely a day goes by without an article on AlGosaibi, Saad, TIBC, Awal, Investment Dar or Dubai World.  It's not just the paid media but also blogs like this.  There's a natural fascination. The story of the average Joe or Abdullah is harder to follow.  The amounts are smaller.  Therefore, the drama seems less.

The major corporates give us exciting amounts with larger than life villains, once proud tycoons now humbled, disconcerted and angry bankers.  The plot lines and therefore the excuses are even more elaborate.  One doesn't excuse a mistake on granting a credit card by recounting the legend of "Big Foot" and the "implicit guarantee".  The BBA doesn't write a letter to the Shaykh to complain that Abdullah is behind on his personal loan.  Sadly, financial journals do not thunder about the irresponsibility of Sanjay in Dubai who skipped a payment or two on his car loan.  Or call on the Shaykh up the road for a bailout.

Yet, all these small loans can add up to one big headache. And the usual pattern of transmission of financial distress is that large commercial firms are hit first with the shockwaves being transmitted to smaller commercial firms and then the public.  

If this pattern repeats itself,  Gulf banks are in for a second wave of NPLs.  What's perhaps more to the point is that since much of the consumer lending in the GCC was done with manifestly weak underwriting standards, this wave may be quite high.  Since I've posted before on this topic, I think I'll just hum the first few bars. You already know this song.

Yesterday again I posted a similar comment.

Today let's look at some data.

60 second summary:   EmiratesNBD's retail NPLs have jumped to 11% of the retail portfolio from approximately half that the year before.

While EmiratesNBD has yet to release its 2009 financials (pending CB UAE approval) it has released a 26 page presentation on 2009.  Though my intent is to focus on retail loans, I will discuss commercial and "Islamic" loans as well to provide a context.

The key pages are 13 and 14.

Slide 13 Asset Quality Loans Receivables and Islamic Financing 

Absolute amounts of NPLs:

1. Aggregate NPLs have increased from AED1.976 billion to AED5.041 billion (155%).
2. Corporate NPLs from AED0.464 billion to AED1.674 billion (261%)
3. Retail NPLs from AED1.305 billion to AED2.685 billion (106%). Note that the retail portfolio is 20% of the corporate portfolio.  Yet, the absolute NPL increase here is larger than the increase in the corporate portfolio NPLs.  That is both a distressing sign and a sign of distress to come.
4. "Islamic" NPLs from AED0.207 billion to AED0.682 billion (229%).

Relative percentages NPLs/Portfolio 2009 and (2008):

1. Corporate 1.3% (0.37%)  This level seems low given the existing level of problems.  I'd guess that 5.0% might be a more realistic absolute minimum for the corporate sector.   And that is likely to be low  unless there are cosmetic "extend and pretend" adjustments or a financial miracle.
2. Retail 11% (5.3%)  - A very large jump.  Admittedly, there is some "noise" here.  During 2009 ENBD made a long overdue switch in definition of a retail NPL from an unrealistic/unbelievable 180 days past due to a more conventional 90 days.  Regardless of how much of the year on year increase is due to the accounting change, the key point is that 11% of the retail loan portfolio is non performing.
3. Islamic 3% (0.94%)

Note 2008 percentages are estimated using 2009 loan data and relative percentages as these do not appear to have materially changed from 2008.  Thus, this should give a rough approximation of the change.

Slide 14 Asset Quality Retail and Corporate Loans and Receivables

Corporate and Sovereigns

1. 96% of exposure is to UAE to "top tier" names with whom the Bank has long standing relationships.  Not sure what that means in terms of creditworthiness measured by the old fashioned yardstick of ability to pay.  I rather doubt that ENBD has a lot of exposure in Abu Dhabi.  Concentrations to obligor groups (Dubai Inc and Dubai Government for example) may be problematical.
2. Loan renegotiations in 2009 did not involve any sacrifice of interest or principal.  Apparently, only extension of payment terms.   Sometimes this is all that is required.   A bit of breathing room for the borrower and then one gets repaid.  Other times it is the first step in "extend and pretend" scenario that turns out less rosy in the end.
3. Real estate "selective financing".  With the existing exposure to Dubai World, this must refer to a  break from past underwriting standards.  Financing  is now restricted to Dubai and Abu Dhabi.  Presumably, with limits suitably scaled for risk.  
4. 55% of the real estate portfolio is due for repayment in next three years.  Given the depressed state of the real estate market, this may not be a particularly robust season for loan repayments.

 Retail Loans

1. Delinquencies are stabilizing across categories and only trending downwards on 33% of portfolio (personal loans).  While it's good they are not increasing, the issue is whether they are stabilizing at high levels.  I suspect this is the case as typically distress in the consumer sector lags that in the corporate sector.  If a business recovery is protracted in Dubai (my  view), then  consumer difficulties are likely to persist and may not yet have hit bottom.  If so, the retail NPLs will continue to increase in absolute and percentage terms.
2. 44% of value of retail loans to UAE nationals and greater than 60% to government employees.  It would be interesting to see the breakdown of NPLs between these categories and "all other" to see if the problem is concentrated in one customer segment.  If government employees (which presumably includes almost all of the nationals) are having financial problems, that would be a sign of very wide distress.
3. The bank is controlling unutilized limits on credit cards.  Not sure I follow this.  Isn't the point of a credit card to have an unused limit?  Is this a reduction in limits not frequently used?  That is,  underutilized limits?  If so, then it would seem the bank is expecting more consumer distress as it is trying to prevent cash strapped consumers from using their credit cards as "last resort" financing.   Though to be fair bankers are usually pretty good at figuring out they should close the corral gate after the horses have bolted.  So it may be a bit of retroactive underwriting - which usually hits largely the good customers.  It would also be interesting to see how many cards were either max-ed out or nearly so.  That could be a sign of more potential bad loans.
4. Like firms who "downsize" instead of 'fire" workers, ENBD has "de-grown" its car loan portfolio.  A good de-offensive move.
5. Mortgages have an average 75% loan to original value.  With the decline real estate prices, it would seem highly likely there are a lot of "under water" mortgages on the books.  Offsetting this ENBD claims that  90% of its customers are "high income"  though I wonder if US$82,000 or thereabouts is really high income in high cost Dubai.  Expect more mortgage problems.

  Other Information

1. Slide 10 with an analysis of the net interest margin.  An 89 basis increase in loan spreads (primarily corporate) and a 25 basis point increase in treasury profits (I'm guessing primarily from loan  benchmark pricing definitions and some gapping) offset partially by an increased cost of funding -  roughly 50 basis points. 
2. Slide 16 with some funding data.  Debt maturity profile: over the next three years the bank has to refinance 79% of its AED24.1 billion debt with 30% due this year.  Offsetting that the bank states it has AED18.5 billion in unused liquidity facilities.
3. Slide 36 has a quarterly review of 2008 and 2009 with asset quality credit metrics. Here you can track the quarterly movements.

There's probably no ultimate credit worry here.  The UAE is not going to let a bank the size or importance of ENBD fail (Oh, did I just glimpse the shadow of an "implicit guarantee"?  Perhaps just an imagined "keepwell").  Probably the major concern is stock performance.  And for term lenders, credit re-rating risk.  It would be unfortunate to prematurely lock in a margin which suddenly becomes too low for the risk.  

Major UAE Banks Have Rengotiated AED15 Billion (US$4.1 Bn) in Loans - Signs of Writeoffs to Come?

The National reports that three of the UAE's largest banks have renegotiated some AED15 billion in loans.  To be clear this is the stock of renegotiated loans as of 31 December 2009.

1. EmiratesNBD - AED7.8 billion in 2009 on top of an existing AED2.5 billion.
2. NBAD - AED3.2 billion
3. First Gulf Bank - AED2.5 billion

Some comments.

1. It's common practice for a bank to renegotiate a loan with a client if the client cannot fulfill the original terms.  This is often the smartest thing to do.  Court windups are costly - both in terms of time and ultimate recovery.  No more so that in the UAE which has one of the worst insolvency regimes in the region.  The goal of any banker is to get back as much of the contractual amount due as is possible.
2. Under IFRS loans are included in the "renegotiated" category if a material change has been made that is a concession the Bank would normally not make or terms of the loan have been amended.  So for example if the interest rate has been reduced.  Or if changes have been made in repayment schedules - extension of maturities.   So some changes may not reflect fundamental credit weakness in terms of ultimate repayment but a bit of slack - a lower interest rate, an extra six months for repayment.
3. That being said, can renegotiations be used to push problems into the future?  Yes.  Do banks sometimes do this?  Yes.   
4. Looking at NBAD's 2009 financials (Note 4), they have classified roughly AED557 million of the AED3.183 billion of renegotiated loans as "OLEM"  which means weak  or watch credits.  Those monitoring  the health of NBAD would want to keep an eye on the OLEM category which has gone from AED454 million at FYE08 to AED3.3 billion.  "Non Pass" loans were AED3.0 billion at FYE 2008 and AED2.3 billion at FYE 2009.  An improvement not only in amount but as well in allocation among the classifications.
5. Looking at FGB's financials (Note 32.2), renegotiated loans were AED836 million at FYE08 increasing to AED2.456 billion at FYE 09.  FGB's watch loans increased to AED1.2 billion from AED0.8billion.  There has also been a fairly dramatic rise in the amount of "non pass" loans (= weaker credits) from roughly AED3.5 billion to AED6.3 billion. 
6. Therefore, I think that when looking for potential future problems, the OLEM or "Watch" category  is probably the best early warning indicator, followed by a close eye on the movement in renegotiated credits.

S&P Final Rating on Emirates Bank International and National Bank of Dubai

Earlier this week, Emirates National Bank NBD announced that it was terminating S&P's rating services.  The market assumption is that this was in response to S&P's downgrade of DHCOG and the rather negative comments S&P made about DHCOG and transparency in the local market.

Whenever a rating agency stops rating an obligor or an issue, it updates its view on the ratings of that entity so that it leaves the market with an accurate read of its credit opinion.

Today S&P reaffirmed its ratings of BBB/A-2 (long term and short term respectively) for Emirates Bank International and National Bank of Dubai with negative outlooks on both  At this point both EBI (which was formed from the rescue of several failed or near failed banks in Dubai) and NBD (which was the previous Ruler of Dubai's personal bank and which was run very conservatively but a canny old Scot at one time) have merged to form a new bank, Emirates NBD.  

The ratings of the two banks benefit substantially (three notches to be precise) based on the assumption that as a systematically important bank, ENBD would receive extraordinary support from the UAE authorities (meaning the Federal Government and the Central Bank of the UAE). Other positive factors were the bank's leading commercial position and its adequate preprovision earnings capacity.  On the negative side were depressed financial conditions in Dubai and high exposure to weakened Dubai government related entities.

ENBD has some AED 7 billion (US$1.9 billion) of debt maturing in 2010. 

As of 30 September 2009, the bank had total assets of AED291 billion (US$79.3 billion), equity of AED 32.2 billion (US$8.8 billion) and medium term debt (bonds and syndicated loans) of AED25.7 billion (US$7 billion).  When adjusted for debt payments due in 4Q09, the adjusted medium term debt total is AED23.4 billion (US$6.4 billion). 78% of that amount matures in the period 2010-2012 as follows:  AED7 billion  (US$1.9 billion) in 2010, AED3.5 billion (US$1 billion) in 2012 and AED7.8 (US$ 2.1billion) in 2013.

The Emirate Strikes Back: Emirates Bank NBD Drops S&P

"What is thy bidding, my master?"
"There is a great disturbance in the Ratings".
"I have felt it".
"We have a new enemy, the rating agency who downgraded DHCOG."

Here's the press release.  I trust the Death Star is ready.

UAE Market Volatility Continues

Contrary to reports this week that everything was just fine in local stock markets, there's been a reversal today.

Frankly, there's nothing surprising about this. 

Until there is more clarity on the restructuring and some progress has been made with creditors, market volatility should remain high.  Especially since this market and other GCC markets are largely dominated by retail trade.  

UK Bank Exposure to Dubai Inc

The Financial Times today carried a story that UK banks held US$5 billion or so out of the US$40 billion or so at Dubai World.   That gives them the dubious distinction of being the largest foreign creditor group.

US$ 2 billion at Royal Bank of Scotland, and US$ 1 billion a piece at HSBC, Lloyds, and Standard Chartered.  The article also identifies BNP Paribas, Societe Generale, and Calyon as large creditors.

The article goes on to say that their exposure is focused on the "still functioning" parts of Dubai World e.g.,  Jebel Ali Free Zone and Dubai Ports World.

Thus, of the Dubai World debt which the government has to date announced will be rescheduled, their exposures are a more modest US$700 million (RBS) and US$350 million for Stan Chart.

Some thoughts:

1. It would be natural for big foreign banks to lend to what they perceived to be major companies.
2. It is usually the tenderfoots in the market as opposed to the grizzled veterans who are most likely to see Bigfoot or its financial equivalent the "implicit guarantee".   As I noted earlier the implicit guarantee is not worth the paper it isn't written on.
3. That being said some of the grizzled veterans in the market sometimes make mistakes.  It looks like the market and S&P are pretty much convinced that Abu Dhabi Commercial Bank, Emirates NBD have massive exposures.   Local banks especially those owned by governments often step up to lend government entities, especially when in cases like Emirates NBD the same government owns both the lender and the borrower.
   

EmiratesNBD Exposure to AlGosaibi and Saad - Around US$350 Million

Khaleej Times reports.

And not a big deal for EmiratesNBD in terms of any real harm.

At 30 September 2009, the Bank had AED 32. 3 billion (US$8.8 billion) in shareholders' funds.  And had earned AED 3.2 billion (US$897 million) for the first nine months of 2009 - even after increasing loan loss provisions 163% to AED 2.0 billion from AED 0.7 billion in the corresponding period in 2008 (Note 7).

Arab and GCC Banks: Financial Position and Capacity

Earlier this week at the Kuwait Financial Forum, H.E. Hamood Bin Sangour  Al-Zadjali Executive President of the Oman Central Bank advocated bank mergers as a way of strengthening the GCC financial sector.  As a first step, he called for active GCC central bank promotion of domestic bank mergers to be followed by regional cross-border mergers and expansion. 

A very worthy goal.

The GCC has too many banks.

As a result, limited financial capital and human talent are dispersed preventing the development of the scale and muscle necessary for local banks to truly compete on the global stage and to fully  serve regional markets.

Perhaps, that last comment about limited capital seems strange.  After all, the GCC states are major oil exporters.  It seems intuitive that their banks would be major players in the world.

Let's drill down into the details to see that this is not the case.

Each year The Banker prepares a list and analysis of the "Top 1,000 World Banks".  Note that this is based on financials from the close of the previous financial year: the 2009 list is based on 2008 fiscal year end financials.

The 2009 Top 100 Arab Banks had Tier 1 Capital of US$138 billion, roughly 3.2% of the total Tier 1 Capital for  the Top 1,000 banks. The GCC Banks' share was US$110 billion or 2.6% of the Top 1,000. 

To put this into an even starker perspective, the Tier 1 Capital of just JPMorgan Chase was $136 billion - roughly equal to all of the Top 100 Arab Banks.  The market capitalization of  ICBC (PRC)  US$248 billion.

Looking at assets, the Top 100 Arab Banks had total assets of US$1.3 trillion and the GCC Banks' share of that amount was just short of US$1 trillion.

By contrast one bank, Wells Fargo (ranked #18 in assets among the Top 1,000) had US$1.3 trillion in assets.  Dexia Bank Belgium (#25 in the list) had total assets equivalent to all the GCC banks in the Top 100 Arab Banks.

What's even more striking is the Emirates Bank-NBD (UAE), the largest of the Top 100 Arab Banks,  had total assets of US$76.9 billion - roughly 57% of JP Morgan's Tier 1 Capital!  When compared to US banks, Emirates Bank-NBD would be slightly larger than Country Wide (the 16th largest US bank) and slightly larger than JP Morgan's Delaware Bank (the issuer of JPMC's credit cards).

National Commercial Bank (Saudi Arabia) had the largest Tier 1 capital among the Top 100 Arab Banks at US$6.68 billion.

For those interested in pursuing this topic further, additional information on The Banker's 2009 List is here and on the Top 100 Arab Banks here.  You'll find links to detailed charts on the Top 100 Arab Banks at end of the second link.