Heightened risk of asset quality deterioration is the main threat to UAE banks’ Viability Ratings in 2021-2022, Fitch Ratings says in a new report. Asset quality will weaken as borrowers face pressure from continuing pandemic-related economic disruption, lower oil prices and the ending of payment holidays.
But we expect liquidity to remain sound and capital buffers adequate for the risks. UAE banks’ Long-Term Issuer Default Ratings, which are all driven by sovereign or institutional support, are mostly on Stable Outlook, reflecting either the Outlook on the sovereign rating or that of their parent.
Asset quality metrics had deteriorated moderately by end-3Q20. The average Stage 3 loans ratio was 5.6% (end-2019: 4.4%) for the UAE’s six largest banks excluding HSBC Bank Middle East. Stage 2 loans ratios also typically increased slightly.
However, these ratios do not yet signal the likely extent of asset quality deterioration as they are benefiting from loan deferral programmes and forbearance measures, giving banks some flexibility in loan classification.
We expect potential problem loans (Stage 3 and Stage 2 loans) to increase in 2021-2022 after borrower support and forbearance measures expire at end-June 2021. We also expect an increase in restructured loans.
Cyclical sectors, including real estate, construction, trade and manufacturing, represent a key risk to asset quality, accounting for about 33% of sector loans at end-3Q20. Retail loans (19% of total sector loans) also face pressure in a weaker labour market.
Capital buffers should remain adequate in 2021-22, supported by still reasonable internal capital generation, muted loan growth and some flexibility in dividend payments. Funding is generally stable and mostly from deposits, including a high proportion of government and government-related entity deposits, supported by sovereign debt issuance.
