GCC banks face risk of increased loan write-downs in 2021

The Central Bank of Kuwait. The Kuwaiti and Saudi Arabian banking sectors are the least vulnerable in the GCC to increased asset quality risk, given their healthy credit fundamentals before the pandemic and low levels of bad loans.
Image Credit: Provided

Dubai: GCC banks are expected to face persistent asset quality risks, leading to increased loan write-downs and high provisions, putting pressure on profitability in 2021, analysts and agencies say rampant.

Rating agency Fitch says deteriorating asset quality is the main risk for GCC banks following the economic shock from the coronavirus pandemic and low oil prices.

The rating agency believes that the extended loan deferral programs have only pushed back asset quality issues.

“Extending borrower support measures will limit short-term pressure on asset quality, delaying recognition of Phase 3 loans until 2021. Nonetheless, asset quality measures could weaken significantly. in 2021-2022 once the support measures are withdrawn, “said Redmond Ramsdale, Middle East bank ratings manager at Fitch.

Rating agency Standard & Poor’s predicts that the recovery of the region’s banking sector from the impact of the pandemic will be gradual in 2021. Analysts said the asset quality of UAE banks is likely to deteriorate and that the cost of risk would increase further as the Central Bank of the United Arab Emirates (CBUAE) gradually lifts its forbearance measures in the second half of 2021.

Loan restructuring and potential problem loans (the sum of phase 2 and phase 3 loans under IFRS 9) began to increase soon after the onset of the pandemic and borrowers could face lasting pressure from the crisis. economic weakness and low oil prices.

Impairments on GCC Loans

Impairments on GCC Loans
Image Credit: Fitch

Extended support for borrowers

Several GCC countries have extended their loan deferral programs and other support measures to ease pressure on household and business cash flows.

Oman and Saudi Arabia have extended their programs until the end of March 2021, Qatar until mid-June 2021 and Bahrain and the United Arab Emirates until the end of June 2021. Kuwait is therefore the only GCC country where the payment holidays have not been extended beyond September 2020.

Advanced provisions

Many banks in GCC countries, particularly in the United Arab Emirates, have taken advance provisions for expected credit losses, rushing their provisions in anticipation of significantly weaker credit conditions. This has hurt their profitability in 1H20, still at an early stage of the pandemic and well ahead of most of the deterioration in asset quality that they are likely to experience.

“We expect the average cost of risk (average gross loan / loan impairment charges) to almost double in 2020, mainly reflecting forward-looking allowances recorded by banks,” Ramsdale said.

Deferred loan exposures

Deferred loan exposures vary between and within GCC banking sectors, as do the associated risks.

According to Fitch, in the United Arab Emirates, the deferred exposures of the four largest banks averaged 2.9% of total loans at the end of the third quarter of 2020. The inclusion of all linked balances would bring the ratio to 20% of the total loans. . These exposures mainly concerned the real estate, construction, services and retail segments. On average, 13% of deferred loans and associated balances (2.6% of total loans) have been classified as stage 2 and could move to stage 3 if the capacity of these borrowers to cope with the pandemic weakens further.

The extension of the UAE loan deferral program until the end of the first half of 2021 is expected to temporarily limit loan migration to Stages 2 and 3. However, more migration is likely in the second half of 2021-2022 to unless there is a strong recovery in economic activity, particularly in the real estate and construction sectors.

In Saudi Arabia, loans under payment leave amounted to SAR 77 billion in November 2020 according to the Saudi Central Bank. This equates to only 4.4 percent of total banking sector credit at the end of the third quarter of 2020. The low proportion reflects the fact that only micro, small and medium enterprises are eligible for payment holidays.

Lower risks in Kuwait

Kuwait’s loan deferral program was largely aimed at the retail segment, with businesses being looked at on a case-by-case basis.

Fitch sees the Kuwaiti and Saudi banking sectors as the least vulnerable in the GCC to increased asset quality risk, given their healthy credit fundamentals before the pandemic and low levels of bad loans.

Qatari banks also have relatively strong credit indicators due to a high proportion of exposure to the national government and lower Stage 3 loan ratios before the pandemic. However, they could be under pressure on asset quality due to weakness in the real estate and construction segments as well as high levels of Phase 2 lending.

Impact of the recognition of loan losses under IFRS 9

As part of expected credit losses (ECL), loan impairments are recognized in three stages.
The general approach requires an entity to determine whether the financial asset is in one of three stages in determining both the amount of ECL to recognize as well as how the interest income is to be recognized.
Stage 1 corresponds to the stage where the credit risk has not increased significantly since initial recognition. For phase 1 financial assets, entities are required to recognize 12-month ECL and recognize interest income on a gross basis – this means that interest will be calculated on the gross carrying amount of the financial asset before adjustment for ECL.
Stage 2 is when the credit risk has increased significantly since initial recognition. When a financial asset is transferred to phase 2 entities, it is necessary to recognize lifetime ECL, but interest income will continue to be recognized on a gross basis.
Stage 3 is when the financial asset is impaired. This is indeed the moment when there was a loss incurred. For financial assets in step 3, entities will continue to recognize lifetime ECL but will now recognize interest income on a net basis. This means that interest income will be calculated on the basis of the gross book value of the financial asset less ECL.
Rating agency Fitch expects the asset quality of UAE banks to deteriorate as payment holidays expire and not all borrowers are able to weather the downturn. This is especially true in the real estate, construction, retail, aviation and hospitality industries.
The agency expects an increase in phase 3 loans according to the IFRS 9 reporting classification. “Phase 3 loans could reach 6.5% of gross loans by the end of 2021 against 4.9% at the end of 2019, which would be well above levels reached during the last oil shock in 2014-16, said Redmond Ramsdale, Middle East Bank Ratings Manager at Fitch.
“In addition, the increase in restructuring and the extension of support measures until the end of H1-21 mask the real increase in Phase 3 loans.”
Phase 2 loan ratios vary among UAE banks and are not yet fully comparable. But some have reached 20% and more, indicating a potential for high pressure on asset quality.

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