gcc banks - done with provisions?

Kuwait Financial Centre S.A.K “Markaz” R E S E A R C H

GCC Banks Done with Provisions?

“Overexposure to real estate and highly leveraged companies has eroded asset quality. Uncertainty over the true state of balance sheets, especially in light of revealed exposures of two large Saudi conglomerates compounded by inadequate transparency, will likely persist over coming months, restraining bank funding and credit growth, although we judge the risks to be manageable”

- GCC Regional Overview, Sept 2009 Institute of International Finance

The year 2009 can truly be declared as a year of provisioning. The 61 banks in the GCC region are estimated to provide a whopping USD9.4 bn in provisions during 2009, a 40% jump from 2008 and a 5-fold increase from the modest level of USD 1.8 bn for 2007. As a percentage to loans, we forecast provisioning to hit 1.3% in 2010 as compared to 0.8% seen between 2003-2009.

The spike in some cases have been caused by specific events unrelated to the ongoing financial crisis (Gulf Bank, Kuwait and ABC, Bahrain). However, most of the story clearly points to “aggressive caution” on the part of banks to drive the bad news when the mood is gloomy. Banks are the main conduit of economic activity in the market and as such this certainly reflects the pain the overall economy is undergoing as a consequence of the global fall out. It also brings sharply into the picture the intrinsic role of credit evaluation and corporate governance standards.

A direct fallout of this can be seen in the activity levels of banks as defined by loans and deposits. Both loans and deposits enjoyed robust growth levels since 2003 (Table 1). However, the picture took a nasty turn in 2009 with overall loan growth at an anemic 4% weakly supported by a deposit growth of 3%. We expect a pick up in 2010 to 8% growth for both loans and deposits though they are still far from their historical average.

To answer the question, we may not still be done with provisioning but clearly the worst is behind us.

… Clearly, 2010 will be a year of recovery and learning.

Table 1: GCC Banking Activity (2003 – 2010f)

Source: Reuters Knowledge, Markaz Research

January 2010 Research Highlights: Examining the state of the GCC banking sector, with countryanalysis, in terms of lending,provisioning and profitability M.R. Raghu CFA, FRM Head of Research +965 2224 8280 [email protected] Layla Al-Ammar Investment Analyst [email protected] +965 2224 8000 Ext: 1205 Kuwait Financial Centre “Markaz” P.O. Box 23444, Safat 13095, Kuwait Tel: +965 2224 8000 Fax: +965 2242 5828 www.markaz.com

R E S E A R C H January 2010

Kuwait Financial Centre S.A.K. “Markaz” 2

Section A: GCC Banking in 2009 2008 was a year no one working in or out of the financial sector will soon forget; it was, in fact, catastrophic in terms of the sheer wealth destruction following the collapse of the financial bubble. Within the GCC, the focus at the end of 2008 was on a myriad of things; the UAE Real Estate sector, the Kuwait Investment sector, not to mention hemorrhaging stock markets across the board. A lesser discussed topic was the GCC banking sector, which the majority of Central Banks and Monetary Authorities deemed as healthy and stable at the onset of the crisis except for a few episodes. This diagnosis of stability was rendered for many reasons, beginning with what amounts to a bank’s security blanket; provisioning levels. Provisions against the impairments of assets and credit losses amounted to USD 6.68 bn in 2008, a nearly 4 fold increase from 2007. This was due to heightened provisions taken by many of the GCC’s largest banks in order to withstand the possibility of defaults in their loans books. This brought the GCC’s provision as a percentage of Loans ratio to 1.13% from an average of 0.58% between 2003-2007 (Figure 1). Banks made slight increases to their provisions across the board in 2008; however, pivotal in moving the overall GCC needle were provisions of over USD 1 bn from both Gulf Bank of Kuwait and Bahrain’s Arab Banking Corp, over USD 700 mn from Kuwait Finance House and nearly USD 500 mn from Emirates NBD. That was 2008, where the GCC-wide increase in provisions could be attributed to a handful of the largest GCC banks… what about 2009? 9M 2009 figures show that provisions have increased almost without exception across GCC banks, i.e. not just the “big guys”. GCC Provisions for 9M09 have already topped USD 6.41 bn, or 1.06% of loans. We expect provisions to end 2009 at 1.52% of total loans, declining in 2010 to 1.31% of loans.

Figure 1: Provisions as a % of Loans – GCC


Provisions against theimpairments of assets andcredit losses amounted to USD6.68 bn in 2008 GCC Provisions for 9M09 havealready topped USD 6.41 bn,or 1.06% of loans



The flow of provisioning has been divergent among GCC nations; in Saudi Arabia, provisions increased 7% QoQ in 2Q09 and a further 11% in 3Q09 to total USD 1.1 bn for 9M09. While in Kuwait, the level of provisions shot up 42% QoQ in the second quarter of 2009, but declined 17% in 3Q09, bringing 9M09 provisions to USD 1.8 bn. By far the most volatile has been the UAE, following the announcement of debt woes at the two Saudi conglomerates, Saad and Algosaibi Groups, which UAE banks are believed to have a significant amount of exposure to (estimated at over USD 2 bn), the central bank has charged all banks with taking provisions amounting to 50% of their exposure to the troubled groups. Additionally, news concerning the debt woes of Nakheel, and its parent firm, Dubai World, have heightened the sense that more trying times are in store for banks going forward. Consequently, UAE provisions doubled in 2Q09 to over USD 1 bn; total provisions for 9M09 stand at USD 2.57 bn and we would expect this to near the USD 4 bn mark by year end and to increase to USD 4.8 bn in 2010, especially should lending continue to be tight while banks continue to guard against defaults. Loans/Deposits The ratios of provisions to loans would not be so high if lending activity was maintaining its historical growth rates. However, the financial fallout from last year’s crisis has certainly been felt in most of the GCC’s banking sectors through dramatically decelerated loans and deposits growth rates in 2009. Both lending and deposit growth have come to a grinding halt across the GCC due to heavily decelerated growth in the largest markets, namely Saudi Arabia, the UAE, and Kuwait. GCC loans have grown at 5% YoY in 3Q09 to USD 606 bn versus a 34% annual growth rate in 2008. It is also well below the historical average growth of 29% between 2003-2008 (Figure 2), we expect GCC loans to end 2009 with a 4% growth, doubling to an expected 8% growth in 2010 to USD 667 bn. The same holds true for deposits, which have grown 3.75% YoY in 3Q09 to USD 705 bn. We expect deposit growth to match lending in 2010; growing 8% to USD 771 bn. Figure 2: Loans/Deposits Growth Trends


The flow of provisioning hasbeen divergent among GCCnations Both lending and depositgrowth have come to agrinding halt across the GCC due to heavily deceleratedgrowth in the largest markets,namely Saudi Arabia, the UAE,and Kuwait



The Loans to Deposits ratios (LDR) vary across GCC markets, from 100% in the UAE and Qatar to a low of 71% in Bahrain (Table 2). These levels are comparable to other Emerging Markets like Brazil and China where the L/D ratio is in the mid-to-high 70% range. It’s worth noting that within the MENA region, Lebanon has one of the lowest L/D ratios, in the low 30% range as deposits are the main driver of the banking sector while lending has traditionally been tight and cautious in addition to being targeted to government institutions. If claims on the public sector were included, the ratio would be more comparable, in the low to mid 70% range.1 Table 2: Loans to Deposit Ratios

Note: L/D ratios for GCC countries as of September 2009 Source: Institute of International Finance (IIF), Banque du Liban, Markaz Research The majority of GCC countries maintain a loan to deposit rate (LDR) under the ceiling stipulated by their respective central banks (Table 3). However, Qatar, Bahrain and Oman, are expected to run an LDR slightly above their ceilings in 2009. Table 3: Loans/Deposits Ratios

2009e 2010f Central Bank Cap

Saudi Arabia 79% 81% 85% Kuwait 75% 77% 85% UAE 99% 96% 100% Qatar 94% 90% 90% Bahrain 76% 76% 75% Oman 90% 98% 88% Source: IIF, Central Banks

2009/2010 Expectations We expect GCC provisions to end 2010 at USD 8.76 bn (Table 4), representing a 7% decline over our full year 2009 estimated provisions of USD 9.4 bn. Concurrently, lending activity stagnated across the GCC in 2009, with growth rates falling well below historical averages, as banks have hoarded cash and been hesitant to extend financing in a tenuous economic environment. GCC loans have amounted to roughly USD 606 bn in 9M09, a 5% growth from the same period in 2008. Saudi Arabia has been the main drag on loans growth, growing just 1% in 3Q09 compared to 3Q08, in stark contrast to the 25% average growth in loans seen in the last five years. We expect GCC loans to show an overall growth of 4% in 2009, a far cry from the historical average of 29% between 2003-2008. This

1 Lebanon Country Report, Institute of International Finance (IIF), February 2009

GCC loans have amounted toroughly USD 606 bn in 9M09, a5% growth from the sameperiod in 2008 Kuwait and the UAE areexpected to contribute 70% oftotal GCC provisions in 2009and 2010



would bring the provision to loans ratio to 1.52% in 2009 as compared to 1.13% in 2008. While we expect to see some recovery in lending in the GCC, we still expect Saudi Arabia and the UAE to be a drag on overall GCC loans growth. Hence, we have a forecasted 2010 loans growth of 8% for the GCC to USD 667 bn. The catalyst for the boost in GCC provisions in 2009 has come from Kuwait and the UAE, which we expect to contribute a combined USD 6.6 bn (or 70%) of total 2009 GCC provisions. We expect the UAE to top the charts with full year provisions of USD 3.9 bn, representing 1.72% of loans, on account of heightened prudence among UAE banks in the face of exposure to the troubled debt books of Saudi conglomerates, Saad and Algosaibi groups, in addition to Dubai World and its entities. We expect this ratio to near 2% in 2010 with UAE provisions of USD 4.8 bn (Table 4). As for Kuwait, we expect it to rack up the second highest level of provisioning, with an estimated USD 2.65 bn or 2.97% of loans booked by the end of 2009. This is led by a few of the State’s largest banks, namely Kuwait Finance House (KFH), Gulf Bank, and Commercial Bank of Kuwait. We expect provisioning in Kuwait’s banking sector to ease by about half in 2010 to USD 1.4 bn given the heightened prudence shown in 2009. Deposit growth across the GCC has kept pace with loans growth, increasing 3.7% in 9M09 to USD 705 bn, boosted by a 10% growth in UAE deposits. Annual deposit growth across the GCC has average 23% over the last five years fueled by high levels of economic growth. We expect 2010 GCC deposits to come in at USD 771 bn, an 8% growth over our 2009 estimate. As for the bottom line, weak forecasted performance in Saudi Arabia and the UAE would mitigate GCC bank net income growth. We expect the bottom line in 2010 to be USD 20 bn, a 21% growth over our 2009 estimate of USD 16.65 bn, and a turnaround from the 16% decline in net income across the GCC banking sector in 2008.

Table 4: Summary 2010 forecasted Performance of GCC Banking Sector Net Income Loans Provisions Provisions % Loans Deposits

USD mn

YoY % USD mn YoY %

USD mn

YoY % 2009e 2010f USD mn YoY %

Saudi Arabia 7,656 20% 190,803 7% 1,118 -30% 0.90% 0.59% 236,362 5% Kuwait 3,019 117% 95,390 7% 1,426 -46% 2.97% 1.49% 123,525 4% UAE 4,128 -16% 242,650 6% 4,830 23% 1.72% 1.99% 253,907 10% Qatar 3,930 33% 78,636 20% 382 12% 0.52% 0.49% 87,520 25% Bahrain 807 59% 32,040 0% 618 12% 1.72% 1.93% 42,025 0% Oman 681 33% 27,571 20% 389 31% 1.29% 1.41% 28,089 10% GCC 20,221 21% 667,091 8% 8,763 -7% 1.52% 1.31% 771,428 8%




Section B: Country Analysis

1. Saudi Arabia

The Saudi Arabian Monetary Authority (SAMA) has kept strict tabs on its local banks, tightly monitoring capital adequacy ratios, lending and provisioning. As a result, provisions have steadily increased throughout the year, growing 7% QoQ in 2Q09 and a further 11% in the third quarter. 9M09 provisions in the Kingdom stand at over USD 1 bn, 125% higher than the same time last year. Al Rajhi Bank, the largest bank in the Kingdom, took USD 332 mn in provisions in 9M09 (Table 5), representing 0.87% of loans and a 90% increase over the same period in 2008.

Table 5: Top Bank Provisioning in 2009

Source: Reuters Knowledge

Increasing provisions coupled with decelerating loans growth has pushed up the Kingdom’s overall provisions to loans ratio to 0.63% in 9M09 versus 0.28% in the same period of last year. This is higher than the 0.47% seen in 2008, but on par with the historical average (Figure 3). Based on decelerating loans growth and additional 4Q09 provisions, we expect this ratio to jump to 0.90% by end of year 2009 before reverting to mean in 2010, amounting to 0.59% of total loans.

Figure 3: Saudi Banking Sector Provisions to Loans


Meanwhile lending activity in the Kingdom came to a grinding halt in the third quarter of 2009. After achieving a 31% growth in 2008, loans growth has flattened in 2009; registering 0% quarterly growth in the first half of the year before declining 0.57% in 3Q09 to USD 176 bn (Figure 4). A main drag on the Kingdom’s loans growth has been Samba Financial Group, the third largest lender, whose loans have declined 11% in 3Q09 as compared to 3Q08, thereby offsetting the 5% growth in Al Rajhi Bank’s loan book in the same period.

9M09 provisions in theKingdom stand at over USD 1bn, 125% higher than thesame time last year The Kingdom’s overallprovisions to loans ratio is at0.63% in 9M09 versus 0.28%in the same period of last year.This is higher than the 0.47%seen in 2008, but on par withthe historical average



Figure 4: Loans/Deposits Quarterly Trend


As for deposits, these have slowed along with loans and have shown a flat 1% YoY growth in 3Q09 to USD 228 bn. Samba’s deposits, which account for roughly 18% of total deposits in the Kingdom, have declined 3% while Al Rajhi’s have grown 3%; the strongest growth has been in Riyad Bank, where deposits have surged 25% in 3Q09 versus the same period of 2008.

In terms of earnings (Figure 5), the banking sector’s top line has taken a hit as lending has decelerated with Interest Income for 9M09 at almost USD 9 bn, a 10% decline from the same period in 2008. All banks have shown declining top line figures except Al Rajhi Bank, whose interest income has grown 9% YoY in 9M09 while Samba’s top line is down 21% in the same period. Net Interest Income for the Kingdom is down 1% YoY in 9M09 to USD 6.15 bn, on account of a mere 2% growth in the same for Al Rajhi to USD 2.13 bn.

Net Income figures show a 3% decline for the Saudi banking sector to USD 5 bn in 9M09, due to flat bottom line growth in some of the Kingdom’s biggest banks. Al Rajhi Bank and Samba have managed YoY net income growths of 4% and 3%, respectively, in 9M09, while Riyad Bank has been flat and the Saudi British Bank has seen an 11% YoY decline in its bottom line for the first nine months of the year.

Figure 5: Quarterly Income Trends for the Kingdom


After achieving a 31% growthin 2008, loans growth hasflattened in 2009 Both Interest Income and NetIncome have shown quarterlydeclines in 2009



2009/2010 Banking Sector Forecast

The banking sector’s Capital Adequacy Ratio (CAR) was reported at 16% in June 2009 (Table 6), well above the 8% minimum set by SAMA. NPL’s to total loans declined to 1.40% in 2008 as lending grew by 31%, however, tighter lending plus higher provisioning has pushed the ratio up to 1.60% by mid-2009 and we would expect it to stabilize in 2010 as credit conditions remain tight and NPL provisioning increases.

Table 6: Saudi Arabia Banking Sector Indicators

Source: The Institute of International Finance, SAMA, Markaz Research

We expect the banking sector to show a net profit of USD 7.65 bn in 2010 (Table 7), representing a 20% growth over 2009e. Interest Income is expected to show a yearly growth of 22% while we expect 2010 Interest Expense to grow 38%, which would result in a 16% growth in Net Interest Income to USD 9.2 bn. However, as with most of the GCC, we anticipate that increased provisions will be the main squeeze on the sector’s bottom line. We expect provisions for the Kingdom to come in at USD 1.6 bn in 2009, a 92% increase over 2008, before declining by 30% in 2010 to USD 1.2 bn, or 0.59% of total loans.

We do not foresee a pickup in lending in 4Q09 and expect the sector’s Loan’s to show a scant 1% yearly growth in 2009, while we expect Deposits to decline 0.20%. We see a slight pickup in lending activity in 2010, with loans growing 7% to USD 190 bn coupled with a 5% growth in deposits, bringing the loans to deposits ratio to 81%.

Table 7: Forecasted 2009/10 Performance of the Saudi Arabian Banking Sector


We expect the Saudi Arabianbanking sector to show a netprofit of USD 7.65 bn in 2010, a 20% growth over 2009e



Scenario Analysis

Our 2010 analysis is predicated on three scenarios (Bull, Base, and Bear), each of which is assigned a weighting based on our convinction in its ultimate occurrence. For Saudi Arabia, we have the highest convinction in the Base Case scenario (65%) with a slight Bull Case bias (20%).

Table 8: 2010f Scenario Analysis

Source: Markaz Research

2. Kuwait

Kuwait’s banking sector was put under a microscope in late 2008 as Gulf Bank of Kuwait announced a derivitives loss of over KD 300 mn (USD 1 bn), causing widespread panic. This prompted an immediate response from the Central Bank of Kuwait, where it announced a blanket guarantee of all deposits in all local banks, which brought a modicum of stability to the sector. Gulf Bank’s USD 1.25 bn loss for 2008 dragged the sector’s overall 2008 net income to just over USD 1 bn, a 70% decline from 2007.

As for provisioning in Kuwait’s banking sector in 2008, these amounted to USD 2.84 bn, largely due to Gulf Bank; however, Kuwait Finance House (KFH) increased provisions by over 5 times to USD 737 mn while National Bank of Kuwait (NBK) increased provisions by over 3 times to USD 283 mn by year end 2008.

The striking increase in provisions coupled with decelerating loans growth (17% in 2008 versus 37% in 2007) resulted in the Provision to loans ratio surging to 3.33% from an average of 0.78% between 2003-2007. Provisioning has continued into 2009, with the 9M09 figure for the sector standing at USD 1.82 bn (Table 9), a 207% increase over the same period in 2008. Leading the way is KFH, with provisions of USD 480 mn for 9M09, an 8 fold increase over 9M08. Gulf Bank and Commercial Bank of Kuwait have also dramatically increased provisions in 2009, with 9M09 totals of approximately USD 350 mn each. By comparison, NBK, the state’s largest bank, has increased provisions by just 67% YoY to USD 123 mn in 9M09.

Table 9: Provisioning in 9M09


Provisions in 9M09 for thesector stand at USD 1.82 bn, a207% increase over the sameperiod in 2008



As a result, the provision to loans ratio is at 2.08% in 9M09 versus 0.73% in 9M08. This is below the 3.33% seen in 2008 (on account of Gulf Bank), but significantly higher than the average 0.78% seen between 2003-2007. We expect 2009 provisions to be 2.97% of total loans given the constricted lending and increased prudence among banks in the latter half of 2009. We expect a slight pick up in lending in 2010, along with an easing of provisions by roughly half to push the ratio down to 1.5% of total loans in 2010.

Figure 6: Provisions to Loans Ratio of Kuwait Banking Sector


Lending activity has slowed markedly across the State as banks remain hesitant to extend financing in the face of a tenuous economic and political environment with many of the sectors that banks have exposure to, namely Investment and Real Estate, remaining under duress. Loans have grown 9% YoY in 3Q09 to USD 89 bn (Figure 7), however, on a quarterly basis, loans growth has flattened, from 2% QoQ in 2Q09 to 1.1% QoQ in 3Q09.



Deposits have flattened in 2009, amounting to USD 119 bn in 3Q09, a growth of just 1% from the corresponding period in 2008, but have been

We expect 2009 provisions to be 2.97% of total loans, declining to 1.5% in 2010 Loans have grown 9% YoY in3Q09 to USD 89 bn



flattening on a quarterly basis since the beginning of the year, before declining 1% QoQ in 3Q09. NBK’s deposits have decreased 2% YoY in 3Q09 while Gulf Bank and Commercial Bank of Kuwait have seen their deposits fall by 10% and 15%, respectively, in the same period. Conversely, KFH’s deposits have grown 11% in the same period.

Kuwait’s banking sector made a net income of USD 1.08 bn in 2008, down 70% from 2007, largely on account of a USD 1.25 bn loss for Gulf Bank. In 9M09, the sector has made a net income of USD 1 bn, down 62% from 9M08, with 5 of the 9 banks reporting losses for the period. Heavyweight NBK has seen its bottom line decline by 17% YoY in 9M09 while KFH’s net income was reported at USD 371 mn, i.e. half of that reported in 9M08.

Interest income for the banking sector is down 13% YoY in 9M09 to USD 5.53 bn. NBK’s interest income is down 19% to USD 1.47 bn while the same for KFH’s has declined 4% YoY in 9M09. As for Net Interest Income, this has amounted to USD 2.1 bn for the sector in 9M09, a 27% decline from the same period in 2008.


In 2009, we expect the Kuwait banking sector to show a net profit of USD 1.39 bn, a 28% growth over 2008 (Table 10). This level of growth is not the positive outlook it would at first appear to be given that the decimation done to the sector’s bottom line in 2008 was on account of a unique incident at Gulf Bank; had the bank reported a normal net profit figure, our 2009 forecast would show a significant decline as all Kuwait banks are experiencing the same trends, i.e. higher provisioning and declining top line figures. The main squeeze on the bottom line in 2009 will be the provisioning seen throughout the year; although we expect the total figure to be 6% lower than 2008 at USD 2.65 bn, however, this has been spread across the entire banking sector rather than just one bank.

We expect some reversal in fortunes in 2010, as healthier spreads and lesser provisioning led to a net profit of USD 3 bn in 2010.

We expect Interest Income to grow 20% in 2010 as lending activity grows by 7%. Moreover, we expect Interest Expense to grow 13% in 2010, bringing Net Interest Income to USD 3.5 bn, a 32% growth from 2009e.

The majority of Kuwaiti banks have announced their non-exposure to Dubai World and its subsidiary Nakheel, except for Al Ahli Bank of Kuwait (ABK) and Gulf Bank, which have exposures of USD 20 mn and under USD 100 mn, respectively, to the Dubai entities2. Consequently, we expect provisioning to halve in 2010, declining 46% to USD 1.4 bn or 1.5% of total loans. Having said that, the investment sector accounts for approximately 12% of bank lending while exposure to real estate is roughly 24% of bank loans3, and these will continue to be watched vigilantly for any possible adverse effects on bank’s bottom lines in 2010.

As for lending, we expect activity to slow further in 4Q09, resulting in a 2009 loans growth of 5% to just under USD 90 bn. We expect some pickup in lending in 2010, growing 7% to over USD 95 bn. As for deposits, we expect these to grow 4% in 2010 to USD 123 bn, bringing the loans to deposits ratio to 77% in 2010 from 75% in 2009e, well below the 85% stipulated by the Central Bank of Kuwait.

2 Central Bank of Kuwait 3 IMF Country Report, International Monetary Fund, May 2009

Kuwait’s banking sector madea net income of USD 1.08 bn in2008, down 70% from 2007, largely on account of a USD1.25 bn loss for Gulf Bank In 2010, we expect the Kuwaitbanking sector to show a netprofit of USD 3 bn



Table 10: 2009/10 Performance Forecast for Kuwait Banking Sector


Recapitalization Needs

Kuwait banks’ balance sheets are in a relatively healthier position than their GCC peers, maintaining Capital Adequacy Ratios (CARs) well over the 12% minimum stipulated by the Central Bank in accordance with Basel II standards. However, it must be noted that the Kuwait banking sector CAR has been on a declining trend (Table 11), from 21% in 2005 to approximately 15% in 20084.

That being said, an increase in provisions (to combat non-performing loans “NPLs”), in addition to depreciation in investment and asset values in the Investment and Real Estate sectors are of concern going forward. The ratio of NPLs to loans fell from 5% in 2005 to 3.2% in 2007 mainly on account of high loans growth, however, the ratio has surged to roughly 5.3% in 2008 as lending slowed and NPLs increased.

It must be noted that most banks in Kuwait segregate their loans into Pre-invasion and Post-invasion loans, discounting the NPL’s accordingly; however, in our analysis, we have taken aggregate loans.

Table 11: Kuwait Banking Sector Indicators

Source: The Institute of International Finance, August 2009

A stress test conducted by the IMF in May 2009 indicated that should defaults/loss of asset value be in the 5%-10% range, the banking sector

4 Kuwait Country Report, The Institute of International Finance, August 2009

Kuwait banks’ balance sheetsare in a relatively healthierposition than their GCC peers,maintaining Capital AdequacyRatios (CARs) well over the12% minimum stipulated bythe Central Bank



would remain well capitalized, however, should the default rate hike to the 15%-20% range, the banking sector would become undercapitalized whereby returning the system to a CAR of 12% would require a capital injection of USD 2.6 bn – USD 4.8 bn or roughly 5% of GDP5.

Capital Increases

• Burgan Bank recently received Central Bank approval for a USD 123.8 mn capital increase, bringing total capital to roughly USD 350 mn,

• Kuwait International Bank (KIB) plans to increase its capital by 45% through a rights issue at 170 fils per share6. The bank’s current paid up capital is roughly USD 360 mn.

• Anecdotal evidence suggests that National Bank of Kuwait (NBK) is considering a capital increase of 20% at KD 0.700 a share7.

Our 2010 forecast is based on an 80% conviction that the Base Case scenario will materialize, while we have a slight (15%) negative bias.



3. UAE As 2009 winds down, UAE banks have come up for scrutiny. In addition to the UAE suffering an economic recession in 2009 due to distressed pillars of its economy, namely Real Estate and Financial Services, there has been an out flux of the expatriate community which is so pivotal to the economy, specifically in Dubai. The reduced economic activity and weak retail segment will undoubtedly have an effect on the banking sector’s bottom line for the year. The announcement in late November 2009 from Dubai World, the investment arm of the Dubai government, requesting a six month standstill on debt repayment and the rescheduling of roughly USD 26 bn of debt briefly threw regional and international markets into turmoil. This came on the heels of an announcement from the UAE Central Bank concerning bank exposure to the troubled Saudi conglomerates, Saad and Algosaibi, which reportedly totals nearly USD 3 bn. Furthermore, the Central Bank has charged all UAE banks with taking provisions worth 50% of their exposure

5 IMF Country Report, International Monetary Fund, May 2009 6 KSE 7 KSE

The reduced economic activityand weak retail segment willundoubtedly have an effect onthe banking sector’s bottomline for the year



to the aforementioned groups by the end of 20098; no such announcement has been made regarding provisions against Dubai World and its entities. In the first nine months of 2009, UAE banks have taken provisions of USD 2.57 bn, over 3 times the amount for the comparable period in 2008, and equaling 1.13% of loans. This is significantly higher than the 0.48% historical average (Figure 8). We expect further 4Q09 provisioning to lead to a 1.72% provisions to loans ratio by year end 2009. We also anticipate additional provisioning in 2010, which coupled with further credit tightening, would bring the provisions to loans ratio to almost 2%.

Figure 8: UAE Banking Sector Provisions to Loans

Source: Reuters Knowledge, Markaz Research The highest provisions have been in Emirates NBD and Abu Dhabi Commercial Bank of USD 772 mn and USD 463 mn, respectively (Table 13). Mashreqbank, First Gulf Bank and National Bank of Abu Dhabi have also drastically increased provisions during the year. Table 13: Top Bank Provisions for UAE Banking Sector

Source: Reuters Knowledge As for loans, these have grown by 8% in 9M09 to USD 227 bn driven by growth in UAE heavyweights, however, this is dramatically lower than the average loans growth of over 40% that the sector has seen in the last 5 years (Figure 9) with a peak growth of 54% in 2007 spurred by the merging of Emirates Bank International and National Bank of Dubai (to form Emirates NBD) in mid-2007.

8 Central Bank of UAE

Loans have grown by 8% in9M09 to USD 227 bn driven bygrowth in UAE heavyweights

In the first nine months of2009, UAE banks have takenprovisions of USD 2.57 bn,over 3 times the amount forthe comparable period in 2008 As for loans, these have grownby 8% in 9M09 to USD 227 bndriven by growth in UAEheavyweights



Figure 9: UAE Banking Sector Loans Growth (2003 – 9M09)

Source: Reuters Knowledge As for deposits, these have marginally outpaced lending, growing at 10.5% in 9M09 versus 9M08 to USD 228 bn. The majority of UAE banks have seen positive deposit growth rates thus far in 2009 excepting Mashreqbank and Dubai Islamic Bank whose deposits have declined 2.53% and 2.78%, respectively, in the first nine months of 2009. On a quarterly basis, loans growth has decelerated sharply, from a 9% QoQ growth in 3Q08, loans across UAE banks have only averaged a 1.7% quarterly growth in the first three quarters of 2009 to USD 228 bn by the end of September 2009 (Figure 10). Deposits have slowed as well, showing an average quarterly growth of 2.4% in the first three quarters of 2009 after growing 5% and 3% in 3Q08 and 4Q08, respectively.



UAE loans have grown by 8%in 9M09 to USD 227 bn drivenby growth in UAEheavyweights On a quarterly basis, loansgrowth has decelerated sharply



In terms of earnings, increased provisions have led to a decline in the UAE banking sector’s bottom line; net income was down 8% in 9M09 to USD 4.6 bn. Nearly half of UAE banks have reported declining bottom line figures in 9M09, however, growth in some heavyweights have helped mitigate the decline. Emirates NBD’s net income has grown 21% YoY in 9M09. The top line figures for the sector are healthier by comparison; Interest Income for the sector has grown at 29% YoY in 9M09 to USD 13 bn driven by positive results in nearly all UAE banks. 2009/2010 Banking Sector Forecast

The UAE banking sector’s exposure to the distressed real estate sector has been on an increase since 2006, and has continued into 2009, with real estate loans accounting for 13.4% of total loans in the UAE as of March 2009. The banking sector’s Capital Adequacy Ratio (CAR) has been declining from nearly 17% in 2006 to 13.3% in 2008, still well above the 11% minimum set by the Central Bank. However, for banks receiving government assistance, the minimum CAR has been raised to 12% effective June 2010. September 2009 CAR was reported at 18% by the Central Bank.

The NPL to loans ratio declined dramatically in 2007/2008 as loans growth was high, however, tightened lending in 2009/2010 is likely to push the ratio higher. September 2009 NPL/loans was reported at 2.72%.

Table 14: UAE Banking Sector Indicators

Source: The Institute of International Finance, UAE Central Bank, Markaz Research

Capital Increases

• Dubai Islamic Bank (DIB) received approval for a AED 3.75 bn (USD 1.02 bn) capital increase over a 5 year period.

Earnings Forecast We expect the UAE banking sector to post an 8% decline in its bottom line to USD 4.9 bn in 2009 due almost unilaterally to provisions (Table 15). The UAE Central Bank announced an expected net profit of USD 5.5 bn for the sector9 when it made the announcement concerning provisions for the Saudi conglomerates; however, we expect that the recent announcements concerning Dubai World will push UAE banks to take additional provisions in 4Q09, pushing full year provisions to nearly USD 4 bn for 2009. This jump in provisioning would eat away more than half of the top line figure, resulting in a net income of just under USD 5 bn. We would expect this heightened prudence and tight credit growth to continue to affect bank profitability in 2010. Therefore, we expect to see a

9 UAE Central Bank, 18 November 2009

Nearly half of UAE banks havereported declining bottom linefigures in 9M09 We expect the UAE bankingsector to post a 16% decline inits bottom line to USD 4.13 bnin 2010



further 16% decline in the UAE banking sectors bottom line in 2010 to USD 4.13 bn. We expect lending to remain stagnant in 2010, with full year growth coming in at 6% to USD 242 bn while we expect deposits to grow 10% to USD 254 bn, bringing the loans to deposits ratio to down to 96% from nearly 100% in 2009e.

Table 15: UAE Banking Sector 2009/2010f Performance


Our 2010 forecast is based on an 80% conviction that the Base Case scenario will materialize, while we have a slight (15%) negative bias.





4. Qatar In 9M09, Qatar banking sector provisions have increased by 7 times their 9M08 levels to USD 229 mn, or 0.37% of loans (Table 17). Provisions have been increasing throughout the year, surging 3.5 fold in 2Q09 to USD 93 mn before increasing by 18%, or USD 110 mn, in 3Q09. The largest Qatari bank by loans, Qatar National Bank, has taken provisions of USD 60 mn in 9M09 while the second largest bank, Commercial Bank of Qatar, has made provisions of USD 79 mn. Table 17: Top Bank Provisions in 9M09

Source: Reuters Knowledge Loans have grown at 11% YoY in 3Q09 to USD 60.7 bn while deposits have outpaced lending, growing at 21% YoY to USD 60.64 bn in 3Q09. This brings the Loans/Deposits ratio down to 1.00 versus 1.09 in 9M08. On a quarterly basis (Figure 11), Qatar loans showed fairly healthy growth towards the end of 2008; however, the same declined 6% QoQ in 1Q09, showed flat growth in 2Q09, before growing 8% QoQ in 3Q09. Deposits, meanwhile, declined 4% in 1Q09 before expanding 9% in 2Q09 and ending with a flat third quarter performance. Figure 11: Loans/Deposits Quarterly Trend


As for earnings, the Qatar banking sector’s net income has grown 21% YoY in 9M09 to USD 2.4 bn due to a strong showing in Qatar National Bank. This has been due to healthy top line growth; Interest Income has grown by 33% in 9M09 to USD 3.86 bn led again by Qatar National Bank. 2009/2010 Banking Sector Forecast

Qatar loans declined 6% QoQ in 1Q09, showed flat growth in 2Q09, before growing 8% QoQ in 3Q09 We expect the sector to post a12% increase net profits toroughly USD 3.3 bn in 2010



There have not, as yet, been any shocks to the Qatari banking sector; despite the increases in provision levels in 2009, top line figures remain healthy. As a result, we expect the sector to post an 8% increase net profits to roughly USD 3 bn in 2009 (Table 18), with a 2010 forecasted growth of 33% to USD 3.9 bn. Capital Increases

• Qatar Investment Authority (QIA) will purchase an additional 5% stake in local listed banks (totaling roughly USD 1 bn) in the second stage of a previously announced support program aimed at boosting confidence.

Earnings As for provisions, we expect fourth quarter provisions to match those in the third quarter, bringing full year 2009 provisioning to USD 340 mn, a nearly 3 fold increase from those seen in 2008. This would result in a provision to loan ratio of 0.52% up from the historical average of 0.15% (Figure 12). We expect the ratio to remain at nearly 0.50% in 2010. Figure 12: Qatar Banking Sector Provisions to Loans Ratio

Source: Reuters Knowledge, Markaz Research We expect loans to grow at 20% in 2010 to USD 78.6 bn with deposits growth outpacing lending to grow at 25% to nearly USD 87.5 bn; this would bring the loans to deposit ratio down to 0.90 from an expected 0.94 in 2009, i.e. in line with Central Bank stipulations. As for RoA, we expect it to remain relatively stable at 3% while we expect RoE to increase to 20% in 2010 after declining to 18% in 2009e.

Table 18: Qatar Banking Sector 2009/2010 Performance

We expect the ratio to remainat nearly 0.50% in 2010




Given that our Base Case scenario for growth in the Qatari banking sector is optimistic, we maintain a 70% conviction in this scenario, while taking a balanced Bull/Bear view. Table 19: 2010f Scenario Analysis


5. Bahrain Bahrain’s banking sector took a beating in 2008, due to the Arab Banking Corp. (ABC) which sustained heavy losses. ABC’s provisions of USD 974 mn in 2008 pushed the overall banking sectors provisions to over USD 1 bn. In 2009, total provisions across the Kingdom have come to USD 386 mn in 9M09 (Table 20), the majority of which is from Ahli United Bank and ABC with USD 196 mn and USD 98 mn, respectively. The provision to loans ratio is at 1.20% in 9M09, down from 3% in 9M08 on account of ABC. Table 20: Top Bank Provisions 9M09

Bahrain’s banking sector took abeating in 2008, due to theArab Banking Corp. (ABC)which sustained heavy losses



Source: Reuters Knowledge Lending activity across Bahrain has come down, declining 11% YoY to USD 32 bn in 3Q09. Nearly all banks have seen their loans decline in the period. ABC’s loans are down 21% YoY in 3Q09. Declines in deposits have been more pronounced, dropping 18% YoY in the third quarter of 2009 to USD 45 bn (Figure 13) as Ahli United Bank and ABC saw their deposits fall 32% and 10.6%, respectively, in the period. Figure 13: Bahrain Banking Sector Loans & Deposits

Source: Reuters Knowledge As for earnings, the banking sector reported a net profit of USD 541 mn in 9M09, a 10 fold increase over 9M08 (the cause of which was a USD 852 mn loss in ABC). Ahli United Bank saw its bottom line decline 34% in 9M09 while National Bank of Bahrain (NBB) reported a 45% growth in its bottom line in the same period. Interest Income for the sector is down 25% in 9M09 to USD 2.5 bn. Both Ahli United Bank and ABC have seen their interest income decline in 9M09 by 36% and 41% YoY, respectively, while the same for NBB is up 64% YoY in the same period. Recapitalization Needs Bahrain’s Arab Banking Corp (ABC) recently announced plans for a capital increase of USD 1.11 bn for expansion purposes. The capital injection (from existing shareholders) would bring the bank’s capital to USD 3.11 bn. Following severe sub-prime related losses in 2008, the bank increased capital through a USD 1 bn rights issue in June 200810.


10 Reuters

We expect lending to remainflat in 2010 as the Bahrainb ki t i d



2009 will be a turnaround story for the Bahrain banking sector given the USD 23 mn loss sustained in 2008 due to the USD 880 mn loss reported by ABC. We expect the sector to report a net profit of USD 506 mn in 2009, which remains a poor performance on a historical basis (Table 21), we expect to see further growth in 2010 of 59% to USD 807 mn. We expect the sector’s Interest Income to grow 1% in 2010 to USD 3.2 bn with Interest Expense growing at 19%, which would bring the Net Interest Income to USD 1.1 bn, a 21% decline from 2009e. We expect provisions for the sector to amount to USD 550 mn for 2009, 58% lower than 2008; however the provisions are now spread across the sector rather than being attributed to one bank. This brings the provision to loans ratio down to 1.72% in 2009 from 3.66% in 2008 (Figure 14), which is significantly higher than the historical average of 1.05%. We expect to see further provisioning in 2010 of USD 618 mn, or 1.93% of total loans. Figure 14: Bahrain Banking Sector Provisions

Source: Reuters Knowledge, Markaz Research After declining by an expected 10% in 2009, we expect lending to flatten in 2010 as the banking sector remains under duress. Likewise, we expect deposits to remain flat after declining by an expected 20% in 2009. This would bring the 2009/10 loans to deposit ratio to 76% up from the 68% seen in 2008.



Table 21: Bahrain Banking Sector

Source: Reuters Knowledge, Markaz research

6. Oman Omani banks have taken provisions of USD 216 mn in 9M09, a 4 fold increase over the same period in 2008 and representing 1.03% of total loans in the sector. This is higher than the 0.54% average seen between 2004-2008 (Figure 15), indicating a heightened level of prudence among Omani banks, specifically BankMuscat and National Bank of Oman. We expect 2009 provisions to come to 1.29% of total loans, rising to 1.41% of total loans in 2010. Figure 15: Oman Banking Sector Provisions to Loans


BankMuscat tops the chart, increasing its provisions almost 7 fold to USD 157 mn (Table 22). The banking sectors’ provision to loans ratio is at 1.03%

We expect 2009 provisions tocome to 1.29% of total loans,rising to 1.41% of total loansin 2010



for 9M09, significantly higher than the 0.28% seen at the same time last year. Table 22: Top Bank Provisions 9M09

Source: Reuters Knowledge Meanwhile, lending activity has grown 13% YoY in 3Q09 to USD 21 bn while deposits have grown 9% YoY in 3Q09 to USD 23.6 bn. However, when seen on a quarterly basis (Figure 16), loans and deposits have stagnated throughout 2009. Figure 16: Oman Banking Sector Loans & Deposits

Source: Reuters Knowledge The banking sector’s bottom line is down 15% YoY in 9M09 to USD 381 on account of an 11% decline in BankMuscat net profits in the same period. The sectors top line, though, remains relatively healthy all things considered, showing a growth of 20% YoY in 9M09 to USD 1.15 bn. In the wake of the Dubai World announcement, Oman’s top banks announced a total exposure of around USD 77 mn to Dubai World, USD 50 mn of which is held by BankMuscat. Other Omani banks with exposure are National Bank of Oman and Bank Sohar, with USD 22.6 mn and USD 4.3 mn, respectively11.

2009/2010 Expectations We expect the Omani banking sector to show a net profit of USD 681 mn in 2010, a 33% growth over 2009e (Table 23). We expect increased provisions to put a squeeze on bottom line figures in the coming year, with provisions increasing 31% in 2010 to roughly USD 390 mn, or 1.41% of total loans.

11 Bank Press Releases, 6 December 2009

We expect the Omani bankingsector to show a net profit ofUSD 681 mn in 2010, a 33%growth over 2009e



We expect loans to grow by 20% in 2010 to USD 27.5 bn with deposits growing at 10% to USD 28 bn, bringing the loans to deposit ratio to 0.98 from an expected 0.90 in 2009.

Table 23: Oman Banking Sector


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Strategic Research What is left for 2009? (Sept-09) Kuwait Investment Sector (Jun-09) Missing The Rally (Jun-09) Shelter in a Storm (Mar-09) Diworsification: The GCC Oil Stranglehold (Jan-09) This Too Shall Pass (Jan-09) Fishing in Troubled Waters(Dec-08) Down and Out: Saudi Stock Outlook (Oct-08) Mr. GCC Market-Manic Depressive (Sept-08) Global Investment Themes (June-08) To Yield or Not To Yield (May-08) The Golden Portfolio (Apr-08) Banking Sweet spots (Apr-08) The “Vicious Square” Monetary Policy options for Kuwait (Feb-08) China and India: Too Much Too Fast (Oct-07) A Potential USD 140b Industry: Review of Asset Management Industry in Kuwait (Sep-07) A Gulf Emerging Portfolio: And Why Not? (Jun-07) To Leap or To Lag: Choices before GCC Regulators (Apr-07) Derivatives Market in GCC (Mar-07) Managing GCC Volatility (Feb-07) GCC for Fundamentalists (Dec-06) GCC Leverage Risk (Nov-06)

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Bahrain • Gulf Finance House (Oct-08) • Esterad Investment Company

(Aug-08) • Bahrain Islamic Bank (Aug-08) • Ithmaar Bank (July-08) • Tameer (July-08) • Batelco (July-08)

Research Coverage Market Cap as % of total Market cap 29%

Qatar • Qatar Telecom (Jun-09) • Industries Qatar (Apr-09) • Qatar National Bank (Feb-09) • United Development Co. (Feb-09) • Qatar Fuel Co. (Dec-08) • Qatar Shipping Co (Dec-08) • Barwa Real Estate Co. (Nov-08) • Qatar Int’l Islamic bank (Nov-08) • Qatar Insurance Co. (Nov-08) • Qatar Gas Transport Co. (Oct-08) • Doha Bank (Aug-08) • QEWC (July-08) • QISB (July-08) • Masraf Al-Rayan (Jun-08) • Commercial Bank of Qatar (Jun-08) Research Coverage Market Cap as % of total Market cap 95%

UAE • Dubai Financial Market (Sept-09) • ADCB (Jun-09) • DP World (Jun-09) • NBAD (Feb-09) • Sorouh Real Estate (Feb-09) • Aldar Properties (Feb-09) • Gulf Cement Company (Jan-09) • Abu Dhabi National Hotels (Dec-08) • Dubai Investments (Dec-08) • Arabtec Holding (Dec-08) • Air Arabia ( Nov-08) • Union Properties (Nov-08) • Dubai Islamic bank (Oct-08) • Union National Bank (Aug-08) • Emaar Properties (July-08) • Dana Gas (July-08) • FGB (July-08) • Etisalat (Jun-08) Research Coverage Market Cap as % of total Market cap 48%

Oman • Galfar Engineering & Cont. (Nov-08) • Oman Telecommunications (Sept-08) • Bank Muscat(Sept-08) • Oman cement (Sept-08) • Raysut Cement Company (Aug-08) • National Bank of Oman (Aug-08) • OIB (July-08)


Egypt • Commercial Int’l Bank (Oct-08) • Orascom Telecom (Sep-08) • Mobinil (Sep-08) • Telecom Egypt (Aug-08) • EFG-Hermes (Jun-08)


Jordan • Arab Bank (Sept-08) • Cairo Amman Bank (Oct-08) Research Coverage Market Cap as % of total Market cap 39%

Saudi Arabia • Arab National Bank (Oct-09) • SAFCO (Oct-09) • Al Rajhi Bank (Aug-09) • Riyad Bank (Jul-09) • Saudi Telecom Co. (May-09) • Sabic (Mar-09) • Samba Financial Group (Feb-09) • Saudi Investment Bank (Jan-09) • Savola Group (Dec-08) • Kingdom Holding Co (Dec-08) • Al Marai Company (Nov-08) • Saudi Kayan Petro Co. (Aug-08) • Banque Saudi Fransi (Jun-08) Research Coverage Market Cap as % of total Market cap 60%

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