outlook fundamentals drive stable outlook recovering ...€¦ · banking system outlook - united...

FINANCIAL INSTITUTIONS

OUTLOOK7 November 2018

TABLE OF CONTENTSRating Universe 2Government spending and risingoil production will drive gradualeconomic recovery 4Loan performance will stabilise 5Strong capital will provide a largeloss-absorbing buffer 8Funding and liquidity will remainstable 10Profitability will improve slightly 11Government support will remain high 14Moody's Related Research 15Rating Outlook 17Appendices 18

Contacts

Mik Kabeya [email protected]

Badis Shubailat +971.4.237.9505Associate [email protected]

Francesca Paolino +971.4.237.9568Associate [email protected]

Georgina Smartt +44.20.7772.5378Associate [email protected]

Henry MacNevin +44.20.7772.1635Associate Managing [email protected]

Sean Marion +44.20.7772.1056MD-Financial [email protected]

Frederic Drevon +44.20.7772.5356MD-Global [email protected]

» Contacts continued on last page

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Banking System Outlook - United Arab Emirates

Recovering economy and resilient financialfundamentals drive stable outlookWe have maintained our stable outlook for the United Arab Emirates (UAE)’s banking system,reflecting a gradually recovering economy combined with banks’ strong capital, resilientprofitability and solid funding. The stable outlook also incorporates our assumption of a highprobability of support from the Government of the UAE (Aa2 stable), if required.

Economic growth will recover gradually. We expect a combination of rising oilproduction, government spending on infrastructure in Dubai, Abu Dhabi's fiscal stimuluspackage and increasing activity in trade and financial services, to propel real GDP growthto 2.2% in 2018 and 2.9% in 2019, following a slowdown to 0.8% in 2017. The recoveryhas been uneven, however, because weak employment and wage growth together with ahigher cost of living have weighed on consumer confidence. The strengthening economy willstimulate credit growth of between 4% and 6% in 2018 and 2019, following a decline to1.7% in 2017.

Loan performance will progressively stabilise. We expect problem loans to stabiliseat between 5.0% and 5.5%, as the recovering economy and resilient performance of largeborrowers balance problem loan formation among small and mid-sized corporates andpersonal borrowers.

Strong capital provides a large loss-absorbing buffer. We expect strengtheningprofitability to support sector-wide tangible common equity (TCE) at 14%-15% of risk-weighted assets over the next 12 to 18 months (14.0% at June 2018).

Funding and liquidity conditions will remain solid. Higher oil prices will continue tosupport funding and liquidity. UAE banks will remain primarily deposit-funded, with onlymoderate recourse to confidence-sensitive capital markets. UAE banks have sufficientliquidity headroom to accommodate a pick-up in credit growth, given faster deposit growththan credit growth over the last 18 months.

Profitability will improve slightly. Rising interest rates will increase net interest margins.As banks raise their lending rates their higher loan yields will moderately outweigh theincreased rates they will need to pay on deposits. Operating expenses will remain broadlystable. Loan-loss provisioning will also gradually stabilise as the economy recovers.

Government support will remain high. The UAE government’s willingness and capacity tosupport local banks if needed will remain high over the next 12 to 18 months.

http://www.surveygizmo.com/s3/1133212/Rate-this-research?pubid=PBC_1142883

https://www.moodys.com/credit-ratings/United-Arab-Emirates-Government-of-credit-rating-600018601

MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

Exhibit 1

Overview of key drivers for UAE's stable banking system outlookOperating environment Stable + We expect combination of rising oil production, government spending on infrastructure in Dubai, Abu Dhabi's

fiscal stimulus package and increasing activity in trade and financial services to support a gradual recovery in

economic growth

- The recovery has been uneven, however, because weak employment and wage growth together with a

higher cost of living have weighed on consumer confidence

Asset quality Stable = Loan performance will progressively stabilise

= Recovering economy and resilient performance of large borrowers balance problem loan formation among

small and mid-sized corporates and personal borrowers

= Increasing exposure to the volatile construction and real-estate sector, a large stock of rescheduled loans and

structural exposure to government-run organisations, are credit negative Capital Stable = Strong capital provides a large loss-absorbing buffer, supported by strengthening profitability

Funding and liquidity Stable + Higher oil prices will continue to support funding and liquidity

= UAE banks will remain primarily deposit-funded, with only moderate recourse to confidence-sensitive capital

markets

= UAE banks have sufficient liquidity headroom to accommodate a pick-up in credit growth, given faster deposit

growth than credit growth over the last 18 months Profitability and efficiency Stable + Rising interest rates will increase net interest margins. As banks raise their lending rates their higher loan yields

will moderately outweigh the increased rates they will need to pay on deposits.

= Operating expenses will remain broadly stable

= Loan-loss provisioning will also gradually stabilise as the economy recovers

Systemic support Stable = The UAE government’s willingness and capacity to support local banks if needed will remain high over the next 12 to 18 months

Rating UniverseWe rate 141 banks in the UAE, which together represent approximately 91%2 of banking assets as of June 2018 (Exhibit 3). UAE banks’Baseline Credit Assessments (BCAs), our view of their standalone financial strength are distributed over a six-notch range from a3 toba3, with a weighted average BCA at baa3 and a weighted average long-term deposit rating at A2.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 7 November 2018 Banking System Outlook - United Arab Emirates: Recovering economy and resilient financial fundamentals drive stable outlook


Exhibit 2

Moody's rated banks in the UAE

Name

Total Assets

(in US$ mms, as

of June 2018) BCA Adjusted BCA

Long-term ratings /

Outlook

Notches of

uplift for

government

support

Market share -

net loans

(% as of June

2018)

Market share -

Deposits

(% as of June

2018)

First Abu Dhabi Bank PJSC 188,301 a3 a3 Aa3/ STA 3 23.0% 25.6%

Emirates NBD PJSC 129,999 ba1 ba1 A3/STA 4 21.1% 19.9%

Abu Dhabi Commercial Bank 73,975 baa3 baa3 A1/STA 5 11.0% 10.2%

Dubai Islamic Bank PJSC 58,710 ba2 ba2 A3/STA 5 9.5% 9.0%

HSBC Bank Middle East Limited 35,816 baa2 a3 A3/STA 0 4.9% 4.8%

MashreqBank psc 34,571 baa3 baa3 Baa1/STA 2 4.5% 4.6%

Abu Dhabi Islamic Bank 33,469 ba1 ba1 A2/STA 5 5.1% 6.0%

Union National Bank PJSC 27,380 baa3 baa3 A1/STA 5 4.5% 4.2%

Commercial Bank of Dubai PSC 18,759 ba1 ba1 Baa1/RuR DWN 3 3.1% 2.9%

The National Bank of Ras-Al-Khaimah

(P.S.C.)

13,900 baa3 baa3 Baa1/STA 2 2.2% 2.0%

Sharjah Islamic Bank PJSC 11,660 baa3 baa3 A3/STA 3 1.5% 1.5%

Al Hilal Bank PJSC 11,586 ba3 ba3 A2/STA 7 2.0% 1.9%

National Bank of Fujairah PJSC 10,370 ba1 ba1 Baa1/STA 3 1.7% 1.7%

United Arab Bank PJSC 5,494 ba2 ba2 Baa3/STA 2 0.9% 0.8%

Average (asset-weighted) baa3 baa3 A2

Note: BCA = Baseline Credit Assessment, on a scale from aaa (highest) to c (lowest). BCAs reflect banks' standalone credit strength. Adjusted BCAs incorporate any affiliate or parentalsupport assumptions. Long-term ratings incorporate our affiliate, parental and government support assumptions. NEG = Negative. NR = Not Rated.Sources: Moody's Investors Service and central bank of the UAE

Exhibit 3

Key indicators for the UAE banking system 2011 2012 2013 2014 2015 2016 2017 Q2 2018

Scorecard Ratios

Problem Loans / Gross Loans 10.6% 10.4% 9.2% 5.6% 5.0% 5.0% 5.5% 5.1%

Tangible Common Equity / Risk Weighted Assets 15.3% 16.6% 16.4% 14.3% 14.1% 14.6% 14.6% 14.0%

Net Income / Tangible Assets 1.5% 1.5% 1.7% 1.8% 1.7% 1.5% 1.5% 1.7%

Market Funds / Tangible Banking Assets 19.1% 17.4% 15.5% 15.4% 17.9% 18.5% 17.3% 16.4%

Liquid Banking Assets / Tangible Banking Assets 27.5% 30.1% 29.5% 29.6% 29.4% 30.7% 32.3% 30.8%

Other Ratios

Loan Loss Reserves / Problem Loans 43.6% 48.2% 56.5% 87.6% 94.6% 96.1% 90.8% 103.8%

Shareholders' Equity / Total Assets 12.6% 13.0% 12.9% 11.4% 11.2% 11.1% 12.1% 11.7%

Tier 1 ratio 15.1% 16.3% 16.4% 16.1% 16.2% 16.6% 16.7% 16.2%

Net Interest Margin 3.0% 2.8% 2.8% 2.8% 2.7% 2.5% 2.4% 2.5%

Interest income / average interest earning assets 4.4% 4.0% 3.7% 3.6% 3.5% 3.6% 3.5% 3.9%

interest expense / average total funding 1.6% 1.4% 1.1% 0.9% 0.9% 1.2% 1.3% 1.6%

Cost to income ratio 36.5% 36.7% 36.9% 36.3% 37.1% 36.8% 36.7% 36.1%

Loan Loss Provisions / Pre Provision Income 40.4% 34.4% 29.8% 25.9% 26.5% 31.5% 29.2% 22.6%

Net Loans / Customer Deposits 97.8% 92.8% 91.5% 91.3% 93.7% 91.7% 89.1% 89.1%

Credit Growth 8.7% 8.0% 5.8% 1.7% 2.0%

Deposit Growth 1.9% 9.2% 9.5% 11.1% 3.5% 6.2% 4.1% 3.5%

Notes: Problem Loans and Loan Loss Reserves are adjusted to include Dubai Holding exposure, if not already included. The system wide Problem Loans/ Gross Loans ratio as of Q2 2018includes a combination of figures reported under IFRS9 and figures reported under IAS39.Source: Financial statements of UAE banks



Government spending and rising oil production will drive gradual economic recoveryWe expect the UAE's oil production to increase to around 2.95 millions barrels a day in 2018, which will lead to real hydrocarbonGDP growth of 1.4% in 2018, after a 3.0% contraction in 2017. The increase will reflect the easing of compliance with the OPEC+3

production cuts agreement. These cuts have yet to be formally unwound, but oil production in the UAE increased to reach 2.9 millionbarrels a day in June this year, compared with around 2.85 million in the first quarter of 2018 and 2.9 million in 2017.

Higher oil prices will support government revenues. The rise in oil prices this year has provided the government with significantly morefiscal headroom than the budget anticipated, which will lead to higher than budgeted expenditure. We estimate that the consolidatedfiscal balance will return to a surplus of 4.3% in 2018 and 2.7% in 2019.

Non-oil economic growth will also gradually recover over the coming years, reflecting a combination of higher government spendingand increasing economic activity in the trade and financial services sectors. Government spending plans include infrastructure-relatedpublic spending in Dubai ahead of its hosting of Expo 2020, and a $13.6 billion fiscal stimulus package in Abu Dhabi that will includesocial welfare and housing projects as well as schemes to raise employment levels among nationals.

Economic recovery has however been uneven. Subdued employment and wage growth, combined with higher cost of living after theintroduction of Value Added Tax (VAT) in January this year, have weakened consumer confidence. We forecast that overall real GDPgrowth will gradually recover to 2.2% in 2018 and 2.9% in 2019, following an estimated 0.8% in 2017 (2016: 3.0%).

Exhibit 4

Macroeconomic indicators* 2010 2011 2012 2013 2014 2015 2016 2017 2018F 2019F

Nominal GDP (US$ Bil.) 289.8 350.7 374.6 390.1 403.1 358.1 357.0 382.6 432.9 451.0

Population (Mil.) 8.3 8.5 8.8 9.0 9.3 9.6 9.9 10.1 10.4 10.7

GDP per capita (US$) 35,066.2 41,196.7 42,722.5 43,196.5 43,338.7 37,379.7 36,226.2 37,733.0 41,506.4 41,955.4

Real GDP (% change) 1.6 6.9 4.5 5.1 4.4 5.1 3.0 0.8 2.2 2.9

Inflation (CPI, % change Dec/Dec) 1.7 0.2 0.6 1.4 3.1 3.6 1.6 2.0 3.3 2.3

Gen. Gov. Debt/GDP[4] 21.9 17.4 17.0 15.8 15.5 18.7 20.2 19.7 20.3 20.0

Official Forex Reserves (US$ Bil.) 31.75 36.09 45.83 66.95 77.24 92.57 84.38 94.35 88.74 96.67

M2/FX reserves 6.7 6.2 5.1 4.3 4 3.5

Note: Macro indicators table – macro forecasts are based on a $74/bbl in 2018, $75/bbl in 2019, and a medium-term range of $45-65/bbl. GDP = Gross Domestic Product, CPI =ConsumerPrice Index, FX=Foreign Exchange.Source: Moody’s Investors Service

Exhibit 5

Increased hydrocarbon revenue will drive a balanced fiscal budgetin 2018 and 2019General government revenue and expenditure (in AED billion)

Exhibit 6

We expect non-oil growth to recoverContribution to real GDP growth (y/y)

-600

-400

-200

0

200

400

600

800

2010 2011 2012 2013 2014 2015 2016 2017F 2018F 2019F

Hydrocarbon revenues Non-hydrocarbon revenues

Expenditures Fiscal Balance

Sources: International Monetary Fund, Moody's Investors Service

-2

-1

0

1

2

3

4

5

6

7

8

2011 2012 2013 2014 2015 2016 2017 2018F 2019F 2020F

Mining and quarrying (Oil) Non-oil Real GDP

Sources: National Bureau of Statistics, Moody's Investors Service



Government-driven corporate activity will drive recovery in credit growthWe expect overall credit growth of between 4% and 6% in 2018 and 2019, up from 1.7% in 2017 (2016: 5.8%). Credit growth rose to2.0% in the first six months of this year.

Corporate credit demand will be fueled by government-related infrastructure projects. Credit growth over the first six months of 2018was led by increased lending to the construction, manufacturing and trade sectors. Consumer and small business credit demand willremain subdued, however, as low employment and wage growth, combined with a rising cost of living, weigh on household and smallbusiness finances.

Exhibit 7

UAE economic growth will rebound in 2018Real GDP growth by country, 2011-18F

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

UAE Saudi Arabia Kuwait Qatar Oman Bahrain

2012 2013 2014 2015 2016 2017 2018F 2019F

Sources: IMF; national authorities; Moody's Investors Service

Regional tensions pose a risk to growthRegional tensions have increased following the dispute with Qatar (Aa3 stable) in June 2017. Several countries including the UAE, SaudiArabia (A1 stable), Bahrain (B2 negative) and Egypt (B3 positive), have cut diplomatic ties with the small, gas-rich nation. In addition,Saudi Arabia, the UAE, Bahrain, and Egypt have suspended air, land, and sea transport links, banned their citizens from visiting Qatar,and gave Qatari residents two weeks to leave their respective countries.

We consider the dispute with Qatar to be credit negative for all GCC countries. However, it has had limited direct credit impact on theUAE, given the narrow trade and financial ties between the UAE and Qatar, and the lack of counter-sanctions by Qatar.

The UAE has taken steps to lower its dependence on the Strait of Hormuz, the main oil shipping passage from the Persian Gulf,reducing the potential costs of an international conflict in the Gulf region. In 2012, a pipeline was completed connecting Abu Dhabi’sonshore Habshan oil field to the port of Fujairah, located on the Gulf of Oman. The pipeline enables the UAE to continue exportingcrude oil should international shipping be disrupted in the Strait of Hormuz. Additionally, the UAE’s offshore assets provide some bufferagainst an interruption in oil exports.

Loan performance will stabiliseWe expect problem loans to stabilise over the next 12 to 18 months. Our forecasted stable problem loans/gross loans ratio reflects ourexpectation that the recovering economy and a resilient performance by large borrowers will offset problem loan formation amongsmall and mid-sized businesses and individual borrowers.

Several factors pose a tail risk to UAE banks' asset quality, including (a) the exposure to the volatile construction and real estate sector,(b) the large stock of rescheduled loans and (c) the structural large exposure to government-run organisations.

We expect problem loans to range between 5.0% and 5.5% of gross loans by the end of 2019. Problem loans declined to 5.1% inJune, from 5.5% at the end of 2017 as a result of a conservative approach adopted by the large banks upon adoption of new IFRS 9accounting standards in January 2018. Nevertheless, the problem loans ratio of UAE banks remains at the high bound of GCC peerswhose nonperforming loans (NPLs) range between 1.9% and 5.8% (Exhibit 8).



Exhibit 8

UAE banks' problem loans remain higher than many GCC peersProblem loans/ gross loans and loan-loss reserves/problem loans by banking sector, Q2 2018

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

0.0% 50.0% 100.0% 150.0% 200.0% 250.0%

Pro

ble

m L

oa

ns / G

ross L

oa

ns

Loan Loss Reserves / Problem Loans

UAE OMAN QATAR BAHRAIN KUWAIT SAUDI ARABIA

Note: Data for Bahrain and Kuwait as of year-end 2017. Data for Qatar and Saudi Arabia as of Q1 2018. The system wide Problem loans/ gross loans ratio as of Q2 2018 includes acombination of figures reported under IFRS9 and figures reported under IAS39Sources: Rated banks' financial statements, Moody's Banking Financial Metrics

Solid corporate loan performance will balance delinquencies among small businesses and consumersLoan performance at large corporate borrowers will remain resilient. Ongoing resolution of legacy impairments, including from Dubai-based public-sector bodies and large corporates, will limit problem-loan formation in this segment.

Household loan performance will continue to weaken, however, as subdued employment and wage growth combined with a highercost of living constrain borrowers' repayment capacity. Job cuts at government-owned companies and in the private sector this yearand last have reflected an adjustment to expected relatively lower economic growth. Household loans accounted for 22% of sector-wide lending as of June 2018.

The quality of loans to small businesses and mid-sized corporates will also weaken. Delinquencies in these segments will reflect thelagging effect of weak economic growth in 2017 and the soft consumer confidence, which is disproportionately hitting this morevulnerable sector. UAE banks do not report their small business exposure but we estimate that it is limited.

In addition, several factors pose a tail risk to UAE banks' asset quality, including (a) the exposure to the volatile construction and realestate sector, (b) the large stock of rescheduled loans and (c) the structural large exposure to government-run organisations.

Increasing exposure to the volatile construction and real-estate sector is credit negativeUAE banks' large direct and indirect exposure to the construction and real-estate sector poses a sizeable risk to their asset quality, giventhe higher-than-average delinquency levels of these sectors. UAE banks’ direct lending to the construction and real-estate sectors ishigh, representing 21% of the sector-wide loan book at June 2018 (Exhibit 9). Moreover, personal loans for business purposes extendedby banks (6% of their total loans at June 2018) include financing to high net worth individuals, a material portion of which we estimateto involve real estate as either end-use or collateral. In addition, the banks are financing fast-growing real-estate developers, raisingtheir indirect exposure to the country's volatile real estate market.

In addition, the increase in the banks' exposure to construction and real estate also constrains our view of their asset quality. Loansextended to the commercial properties segment, to the residential properties segment and to real-estate developers expanded at a fastpace in 2017. The growth in exposure to commercial properties primarily reflects increased lending to the hotel segment. Real-estatetransactions have also increased materially in Dubai, with off-plan sales, where the properties concerned are still under construction,accounting for 59% of sale transactions. A material increase in the supply of residential and commercial properties, combined withsubdued demand, has driven a decline in rents and sale prices over recent years.

Nonetheless, stronger regulation and tightened underwriting practices introduced after the 2008 financial crisis, will help to moderatethe risks. New real-estate regulation has reduced the scope for speculation-induced asset bubbles by lowering loan-to-value caps,increasing real-estate transaction fees and requiring larger down-payments by buyers for properties under construction, before they cansell the property on.



Exhibit 9

Construction and real-estate exposure has increased to 21% of the sector loan bookUAE banks; loan book breakdown by economic activity, June 2018

Personal Loans for Consumption 22%

Construction & Real Estate21%

Government12%

Trade11%

Financial Institutions 9%

Personal Loans for Business 6%

Manufacturing5%

Transport, Storage & Communication4%

Mining & Quarrying1%

Electricity, Gas & Water1% Others

10%

Source: UAE central bank statistical bulletin

A large stock of rescheduled loans poses further riskUAE banks have large stocks of rescheduled loans in their lending portfolios that pose a further asset quality risk. The size of thestock of rescheduled loans provides an indication of the risk to the system's asset quality, although some rescheduled loans willhave been partially provisioned for and classified as nonperforming. Moreover, the portion of the rescheduled loans stock that isclassified as performing has a higher propensity to become nonperforming than other performing loans. According to central bank data,rescheduled loans accounted for around 6% of the sector loan book at the end of 2016 (latest publicly available data).

Structural exposure to government-run organisations also presents riskThe UAE economy is dominated by a limited number of large government-owned companies and bodies and family-ownedconglomerates, and UAE banks have large concentrations of loans to them. This creates significant risk, especially given the debtappetite of government organisations in Dubai.

Nonetheless, the UAE central bank's stricter rules on borrower concentrations set following the financial crisis will partly moderate therisk. A new regulation caps banks’ exposure to local governments and to government-related commercial entities at 100% of totalequity each. In addition, new lending to government bodies and large corporates has been better structured - in secured and amortisingform - with a focus on entities with solid operating cash flows, rather than investment-driven businesses.

Large distressed restructurings of debt from Dubai-based conglomerates Dubai World and Dubai Holding in 2009 contributedto a material increase in the system’s problem loan ratio, which peaked at 10.4% in 2012. Dubai government-owned companiesrestructured approximately $25 billion of bank and capital market debt because of financial problems during 2009-11.

Leading non-oil economy indicators suggest this remains sluggishThe oil price is a key leading indicator of loan performance in the oil-producing UAE, given its impact on government spending,business confidence and economic growth. Given the UAE's broader economic diversification than GCC peers, however, other non-hydrocarbon indicators also provide insight into the future evolution of borrower creditworthiness.

Leading indicators suggest that the rebound in the non-oil economy has yet to gain traction. Employment growth in particularremains subdued. The employment component of the UAE Purchasing Managers Index (PMI), an indicator of economic health formanufacturing and services, fell to 494 given job losses, the first contraction since the beginning of this data series in August 2009.PMI output costs have failed to rise with input costs after the implementation of Value Added Tax (VAT) in January, suggesting thatbusinesses have not been able to pass on VAT and other costs due to subdued demand.

Tourism performance has also been mixed as illustrated by a contraction in both passenger arrivals and cargo traffic in Dubai so farthis year, the former for the first time since 2011 (Exhibit 10). Dubai accounts for around two thirds of UAE tourist arrivals. Growth inthroughput at Dubai's Jebel Ali port, an indicator of trade activity, recovered partially in 2017 after slowing in 2016 (Exhibit 11). The



number of business licenses issued by the Department of Economic Development (excluding free zones)5 decreased by 4% in 2017,following a 6% decline in 2016 and 3.3% growth in 2015.

Exhibit 10

Air passenger and cargo volumes growth has slowedDubai airport passenger traffic and freight volumes

Exhibit 11

Trade activity recovered somewhat in 2017DP World throughput at Jebel Ali port; gross volumes in TEU millions

-5,000

-3,000

-1,000

1,000

3,000

5,000

7,000

9,000

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

Ja

n-1

1

May-1

1

Sep

-11

Ja

n-1

2

May-1

2

Se

p-1

2

Ja

n-1

3

May-1

3

Se

p-1

3

Ja

n-1

4

May-1

4

Sep

-14

Ja

n-1

5

May-1

5

Sep

-15

Ja

n-1

6

May-1

6

Se

p-1

6

Ja

n-1

7

May-1

7

Se

p-1

7

Ja

n-1

8

May-1

8

Passenger ('000 - right axis) Passenger growth (left axis)

Cargo traffic growth (left axis)

Source: Dubai Airports statistics

11.5

12.0

12.5

13.0

13.5

14.0

14.5

15.0

15.5

16.0

2011 2012 2013 2014 2015 2016 2017

Note: TEU=Twenty-foot equivalent unitSource: DP World

Strong capital will provide a large loss-absorbing bufferCapital will remain strong over the next 12 to 18 months, with system-wide Tangible Common Equity (TCE)6 at between 14% and 16%of risk-weighted assets (RWAs). This reflects the resilience of UAE banks’ internal capital generation. UAE banks' capital buffers are atthe mid-range of GCC peer banking systems, which span from 12.3% to 17.4% (Exhibit 12). UAE banks fully comply with Basel III capitalstandards introduced by the central bank in February 2017, for gradual phase-in until 2019. The central bank has also developed a BaselIII-compliant framework for Domestic Systematically Important Banks (D-SIBs) (Exhibit 13).

Exhibit 12

Capital buffers compare well against regional peersTCE/RWA and shareholders' equity/total assets, June 2018

Exhibit 13

Implementation of Basel III capital requirements is in progressReported capital versus phased-in Basel III requirements

UAE data as of Q2 2018. SE / TA data UAE and

8.0%

9.5%

11.0%

12.5%

14.0%

15.5%

10.0% 11.5% 13.0% 14.5% 16.0% 17.5%

Sh

are

ho

lde

rrs' e

qu

ity /T

ota

l Asse

ts

Tangible Common Equity / Risk Weighted Assets

UAE OMAN QATAR BAHRAIN KUWAIT SAUDI ARABIA

Note: TCE/RWA data for Bahrain and Kuwait as of YE 2017; Saudi Arabia as of Q1 2018.SE/TA data for Bahrain, Kuwait, Saudi Arabia and Qatar as of Q1 2018.Sources: Rated banks' financial statements; Moody's Banking Financials Metrics

7.0% 7.0% 7.0%

1.5% 1.5% 1.5%16.8%

1.7%

2.0% 2.0% 2.0%

1.25% 1.875% 2.5%0.50%0.75%

1.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

UAE Banks(YE17)

2017 2018 2019

Common Equity Tier 1 Additional Tier 1

Tier 1 Tier 2 Capital

Capital conservation Buffer D-SIB

UAE Central Bank

Banks' Basel III

Sources: Banks' annual reports; UAE Central Bank Financial Stability Report 2017



In our stress test, UAE banks outperform the global medianWe conduct a scenario analysis to gauge the solvency of banks under both a base case and a low probability, highly stressed scenariothat is roughly equivalent to a 1-in-25-year event. The base case is based on Moody's current macroeconomic forecasts. The stressedscenario is designed to be globally comparable and is based on a common approach to derive loan and security losses and stressedincome, and looks at how these factors will impact capital.

Base expectations: Stable capital

Under our baseline (or most likely) scenario7, UAE banks' capital (tangible common equity/RWA) would remain stable over a two yearperiod, with a TCE ratio of 14.7% in 2019 (14.7% in 2017). This is driven by loan losses, risk-weighted assets and dividend payouts(respectively reducing capital by 190, 200 and 210 basis points), partially mitigated by pre-provision income (adding 600 basis pointsto the capital ratio) (Exhibit 14). The banks would remain profitable under this scenario, with a 1.4% net income to tangible bankingassets ratio.

Exhibit 14

United Arab Emirates: evolution of capital under our baseline scenario

14.7%

14.7%

-1.9%

0.0% 0.0%

6.0%

0.0% 0.00% -2.1%

-2.0%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

TCE 2017 Loan Losses Deductible LLR Security Losses PPI Change in impacton cap of DTA

Taxes paid Dividends Change in RWA TCE 2019

Source: Moody's Investors Service

Stress scenario: moderate impact under stressed conditions

We also consider an alternative stress scenario8. This is not our baseline expectation but a measure of the capacity of banks towithstand highly stressed conditions. It therefore informs our opinion on the creditworthiness of the system as a whole. In our stresstest scenario for the UAE banking system, the capital ratio would fall by 3.1 percentage points to around 11.6% of risk-weighted assetsover the two-year period.

Exhibit 15

Solvency metrics under Moody's stress test - United Arab Emirates versus median banking system

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

Capital ratio (TCE) Problem loans (% of gross loans) Net income ratio (% of adjusted tangible assets)

Data 2017 System result (Stress test) All-system median result (stress test)

Source: Moody's Investors Service



Funding and liquidity will remain stableWe expect the deposit funding base and liquid resources of UAE banks to remain stable over the outlook horizon. Higher oil prices willcontinue to support funding and liquidity in the country, as the level of oil prices drives the revenue of large bank depositors in thecountry. Oil prices averaged $71 during the first six months of this year compared with $54 in 2017 and $44 in 2016.

UAE banks have sufficient liquidity headroom to accommodate a pick-up in credit growth, given faster deposit growth than creditgrowth over the last 18 months. Healthy deposit growth has resulted from both higher oil prices and lower lending growth in 2017amid reduced business activity and confidence. Lending comprised a healthy 89% of sector-wide deposits in June 2018. Lending slowedto 1.7% in 2017 (Exhibit 16) but has picked up so far this year, standing at 2.0% during the six months ending June 2018.

Exhibit 16

Credit growth picked up somewhat this year, after slowing during 2017

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

2014 2015 2016 2017 2018

Credit Growth Deposit Growth

Source: Central Bank of the UAE quarterly statistical bulletins (year on year data)

UAE banks will remain mainly deposit funded, with only modest recourse to market fundingWe expect UAE banks to remain primarily deposit-funded, with moderate reliance on more volatile market funding. Deposits comprisearound 70% of total non-equity funding at UAE banks. Government deposits accounted for 28% of total deposits as of September2018 (25% as of December 2017).

UAE banks' funding is solid, reflecting reliance on stable sources (mainly deposits and equity) combined with solid capital market accessfor the largest banks. However, funding strengths are moderated by high depositor concentrations (from large public sector entities andcorporates), along with term structure challenges given the short term nature of banks' deposits and longer maturities of most of theirlending.

Market funding reliance will remain broadly stable, at 16.4% of tangible banking assets in June 2018, compared to 17.3% in December2017. Liquid resources will also remain stable, at 30.8% of tangible banking assets at June 2018, compared to 32.3% in December 2017.These metrics are at the mid-range of GCC peers (Exhibit 17).



Exhibit 17

Liquid resources will remain stable and adequate

84%

86%

88%

90%

92%

94%

96%

98%

100%

0%

5%

10%

15%

20%

25%

30%

35%

2011 2012 2013 2014 2015 2016 2017 H1 2018

Liquid Assets / Tangible Banking Assets (left axis) Market Funds / Tangible Banking Assets (left axis) Net Loans / Deposits (right axis)

Source: Financial statements of Moody's rated banks

Profitability will improve slightlyWe expect profitability to improve slightly over our outlook horizon, with net income at around 1.6% - 1.8% of tangible banking assets.

Rising interest rates will increase banks’ gross yields as they gradually re-price their loan books. Loans to the corporate and governmentsectors, which typically carry floating rates that reset at pre-determined intervals, account for the bulk of UAE banks’ loan books(74% as of June 2018). We expect increased government spending in the country to support both economic growth and lendingopportunities. This will make it easier for banks to re-price their lending in the competitive local environment after constrained pricingincreases in 2017 when credit growth was muted and lenders were focused on high-quality, price-sensitive large borrowers.

Rising US interest rates will also increase banks’ funding costs. Given the currency peg of the UAE’s local currency, the dirham, to theUS dollar, rising US interest rates have historically translated into higher local currency interest rates in the UAE. However, improvedlocal liquidity resulting from higher oil prices will moderate competition for deposits and so ease funding cost pressure. The level of oilprices drives the revenues of large bank depositors in the country (including government related issuers and large corporates), therebyaffecting the cost of wholesale deposits. Oil prices averaged $71 during the first six months of this year compared with $54 in 2017 and$44 in 2016.

Exhibit 18

UAE banks' net interest margins are improving graduallyExhibit 19

Repo rates

3.0% 2.8% 2.8% 2.8% 2.7%2.5%

2.4%

2.5%

1.6%1.4%

1.1%

0.9%0.9%

1.2%1.3%

1.6%

4.4%

4.0%

3.7%3.6%

3.5%

3.6%

3.5%

3.9%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

2011 2012 2013 2014 2015 2016 2017 H1 2018

NIMs Cost of Funds Gross Yields

Note: Net interest margins for Bahrain and Kuwait are as of YE 2016Source: Financial statements of Moody's rated banks

0

0.5

1

1.5

2

2.5

3

EIBO3M Index EIBO1M Index

CUAE1-7 Index FEDL01 Index

Note: EIBO3M = Emirates Interbank Offer Rate 3 Month Ask, EIBO1M = EmiratesInterbank Offer Rate 1 Month Ask, CUAE1-7 = Central Bank of the UAE Repo Rate Index,FEDL01 = US Federal Funds Effective Rate (continuous series)Source: Bloomberg



We expect that the improvement in net interest margin will vary by bank, with those that have the highest proportion of corporateloans and the highest proportion of current account and savings (CASA) deposits benefiting the most. This is because corporateloans tend to be easier to reprice owing to their floating rates, while CASA deposits tend to be less price sensitive because of theirtransactional and operational nature.

Operating expenses will remain stable, while provisioning charges gradually stabiliseWe expect UAE banks’ efficiency to remain stable, reflecting the balance of rising digital investments and compliance costs, againstdigitalisation benefits and other cost optimisation in anticipation of lower non-oil economic growth. The sector-wide cost-to-incomeratio stood at an efficient 36% for the first six months of 2018 compared with 37% in 2017.

We expect loan-loss provisioning charges to gradually stabilise from an upwards trend over recent years. This will reflect the balance ofhigh problem loan formation among mid-corporates, small businesses and individual borrowers, with continued recoveries and write-backs of legacy bad loans from corporates and government bodies. These recoveries relate to delinquencies dating from the 2008global financial crisis, given the relatively long recovery period in the region. Furthermore, the adoption of IFRS 9 accounting standardswill continue to drive lower loan-loss provisioning charges for large banks given their conservative approach upon adoption in Q1 2018,but higher provisioning needs for several small and mid-sized banks given their exposure to more vulnerable segments.

Exhibit 20

Efficiency will remain stableCost-to-income, 2011-17 and H1 2018

Exhibit 21

Provisioning charges will stabilise graduallyLoan loss provisions/Pre-provision income, 2011-17 and H1 2018

32.0%

33.0%

34.0%

35.0%

36.0%

37.0%

38.0%

2011 2012 2013 2014 2015 2016 2017 H1 2018

Source: Financial statements of Moody's rated banks in UAE

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2011 2012 2013 2014 2015 2016 2017 H1 2018

Source: Financial statements of Moody's rated banks



Fintech in Focus

The widening application of digital innovations in financial services is placing a premium on efficiency and opening up competition that isdisrupting the banking sector (see our report on the Bank of the Future).

We expect UAE banks to remain amongst the most digitally advanced in the Gulf Cooperation Council, given the conducive environmentin which they operate. Digital innovations will drive an evolution in the UAE banking landscape, primarily through the growth of digital onlybanks and through partnerships of incumbent banks with fintech companies. UAE banks will continue to introduce innovative digital productand services, with the largest banks in the country benefiting the most from digitalisation benefits.

UAE banks benefit from a conducive environment for digital innovations. The country has a high smartphone penetration and a relativelyyoung, tech-savvy population that is open to new technology. Government initiatives also support new technologies; Dubai government isaiming to rollout the extensive use of block-chain technology for administrative purposes by 2020. All these factors will be conducive for thebanks’ digital initiatives.

Over our outlook horizon, we expect the banking system to remain the primary provider of financial intermediation (including lending, depositcollection, payment and settlement) in the country. However, the composition of the banking landscape will continue to evolve, as digital-only banks launched by incumbent conventional banks gain market share. Three conventional banks have launched digital-only platformsover the last 18 months. The largest among these is Emirates NBD’s Liv, a smartphone app which collects deposits and offers a debit cardand discounts on consumer goods. The Liv app has attracted more than 100,000 clients in the first year of operation. Mashreq bank and CBDhave also launched mobile banking apps. We also expect banks to engage in external strategic partnership with Fintechs and other technologycompanies, in order to develop new products.

UAE banks have shifted a significant portion of customer transactions from branches to mobile banking. Transactions have continued toincrease as more and more customers use mobile apps for payment transfers. As an example, First Abu Dhabi Bank, the country's largestbank, launched “payit” in 2018, a fully featured digital wallet allowing to send and receive money instantly, 24/7, and make payments throughmerchant partner apps and websites.

As in some other GCC countries, UAE banks have started to regain control of expat remittances from exchange houses. Expats make up a largeportion of the UAE population and transfer sizeable amounts to home countries annually. Over the past 18 months, the banks have loweredtheir fees, offered competitive foreign-exchange rates and sharpened their customer service.

We expect the largest banks in the country to benefit the most from the digitalisation benefits, reflecting their larger financial resources andtherefore access to state-of-the art expertise to support their digital initiatives. As an example, Emirates NBD, the country’s second-largestbank, has allocated AED1 billion ($272 million) over three years to 2020 in its digital transformation program.


https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1116770


Government support will remain highWe assess the willingness of the UAE government to support the country's banks in the event of need as strong, reflecting thedominance of local banks in the domestic financial system, the concentrated nature of the banking system (the top four banks hold65% of deposits) and significant government shareholdings in several banks.

The government will maintain very strong capacity to provide support, as indicated by its Aa2/stable credit rating. Our supportassumptions reflect the government's financial strength, with a low debt to GDP ratio (20% in 2017) and large offshore assets. TheInstitute of International Finance estimates the assets of ADIA, Abu Dhabi’s sovereign-wealth fund, at $585 billion, which is equivalentto 178% of the country's GDP, or more than five years of general government expenditure. In addition, the size of the banking system ismanageable, at 184% of nominal GDP at the end of 2017 (Exhibit 21).

This high willingness and capacity of government support translates into an average of three to four notches of government supportuplift for the debt and deposit ratings of UAE banks. This level of government support uplift is similar to uplift for some banks in theGCC region (Qatar and Kuwait), but noticeably higher than for most international peers.

Exhibit 22

The UAE government benefits from large reserves and relatively low debt levelsGovernment debt/resources to GDP and banking sector size/GDP, year-end 2017

Note: The size of the circles indicate the banking sector size to GDP.

Government resources are a government's reserves (including the sovereign wealth funds)

-100%

0%

100%

200%

300%

400%

500%

600%

700%

0% 20% 40% 60% 80% 100% 120%

Go

ve

rnm

en

t R

eso

urc

es / G

DP

General Government Debt / GDP

Kuwait UAE Qatar Oman Saudi Arabia Bahrain

Note: The size of the circles indicates the banking sector size to GDP. Government resources are government reserves (including Sovereign Wealth Funds).Sources: Moody’s Investors Service; GCC central banks; International Monetary Fund



Moody's Related ResearchCredit Opinions:

» United Arab Emirates, Government of

» First Abu Dhabi Bank PJSC

» Emirates NBD PJSC

» Abu Dhabi Commercial Bank

» Dubai Islamic Bank PJSC

» Abu Dhabi Islamic Bank

» Union National Bank

» HSBC Bank Middle East Limited

» MashreqBank psc

» Commercial Bank of Dubai PSC

» National Bank of Ras-Al Khaimah (P.S.C.)

» United Arab Bank PJSC

» Sharjah Islamic Bank PJSC

» National Bank of Fujairah

» Al Hilal Bank PJSC

Issuer In-depth:

» UAE's four biggest banks - Higher interest income and lower provisions push Q2 net profits higher

» UAE - Large banks Q4 earnings update Net profit rises despite higher provisioning and operating costs

Issuer Comment:

» Emirates NBD PJSC - Emirates NBD’s digital-only bank rapid growth is credit positive

» Emirates NBD PJSC - Emirates NBD's planned rights issuance would be credit positive

» Dubai Islamic Bank PJSC - Dubai Islamic Bank's rights issue improves Tier 1 capital and liquidity

Sector In-depth:

» Banking GCC - Stabilising Oil Prices and International Debt Issuances Will Ease Funding Pressures

» Banking - Gulf Cooperation Council - Islamic banks' fundamentals converging with conventional peers

» Banking - Gulf Cooperation Council - Funding pressures have lifted for GCC banks and margins resilient to rising rates



http://moodys.com/#




https://www.moodys.com/research/Abu-Dhabi-Islamic-Bank-Update-to-credit-analysis-Credit-Opinion--PBC_1124372


https://www.moodys.com/research/HSBC-Bank-Middle-East-Limited-Update-to-credit-analysis-Credit-Opinion--PBC_1142867

https://www.moodys.com/research/MashreqBank-psc-Update-of-credit-analysis-Credit-Opinion--PBC_1124451


https://www.moodys.com/research/The-National-Bank-of-Ras-Al-Khaimah-PSC-Update-to-Credit-Opinion--PBC_1125515

https://www.moodys.com/research/United-Arab-Bank-PJSC-Update-following-recent-downgrade-to-Baa3-Credit-Opinion--PBC_1136212

https://www.moodys.com/research/Sharjah-Islamic-Bank-PJSC-Update-to-credit-analysis-Credit-Opinion--PBC_1131939












Sector Comment:

» Stress Testing Banks: A Globally Comparable Approach

» Financial Institutions - United Arab Emirates banks' three-way merger is credit positive for the banking system

» Financial Institutions - United Arab Emirates’ banks will benefit from increasing interest rates

Rating Methodology:

» Banks

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of thisreport and that more recent reports may be available. All research may not be available to all clients.


https://www.moodys.com/research/Banks-Global-Stress-Testing-Banks-A-Globally-Comparable-Approach--PBC_1044659





Banking System Outlook Definition

Banking system outlooks represent our forward-looking assessment of fundamental credit conditions that will affect the creditworthiness ofbanks in a given system over the next 12-18 months. As such, banking system outlooks provide our view of how the operating environmentfor banks, including macroeconomic, competitive and regulatory trends, will affect asset quality, capital, funding, liquidity and profitability.Banking system outlooks also consider our forward-looking view of the systemic support environment for bank creditors.

Since banking system outlooks represent our forward-looking view on credit conditions that factor into our bank ratings, a negative (positive)outlook suggests that negative (positive) rating actions are more likely on average.

Rating OutlookOverview of Banking System Outlooks

Exhibit 23

Banking System Outlook TableAs of 23 October 2018

Banking System Positive Stable Negative Banking System Positive Stable Negative

Argentina Stable Lebanon Stable

Armenia Stable Malaysia Stable

Australia Stable Mexico Stable

Austria Stable Mongolia Stable

Azerbaijan Stable Morocco Positive

Bahrain Negative Netherlands Stable

Baltic Countries Positive New Zealand Stable

Belarus Stable Nigeria Stable

Belgium Stable Norway Stable

Bermuda Stable Oman Negative

Bolivia Stable Pakistan Stable

Brazil Stable Paraguay Stable

Canada Stable Peru Positive

Chile Stable Philippines Stable

China Stable Poland Stable

Colombia Negative Portugal Stable

Cyprus Positive Qatar Stable

Czech Republic Stable Russia Positive

Denmark Stable Saudi Arabia Stable

Egypt Positive Singapore Stable

Finland Stable Slovakia Stable

France Stable South Africa Stable

Germany Stable Spain Positive

Greece Positive Sri Lanka Negative

Hong Kong Stable Sweden Stable

Hungary Positive Switzerland Stable

India Stable Taiwan Stable

Indonesia Stable Thailand Stable

Ireland Positive Turkey Negative

Israel Stable Ukraine Positive

Italy Negative United Arab Emirates Stable

Japan Stable United Kingdom Stable

Kazakhstan Stable United States Stable

Korea Stable Uruguay Stable

Kuwait Stable Uzbekistan Stable

Vietnam Positive



AppendicesUnited Arab Emirates Macro Profile: Strong -Banks in the United Arab Emirates (UAE, Aa2 stable) benefit from operating in an environment with a very high degree of economicstrength, combined with a high degree of institutional strength and a moderate degree of susceptibility to event risk. Our view of theUAE operating environment also considers the credit conditions for the banking system, with structural challenges including limitedtransparency of large corporate borrowers and high lending concentrations.

Read the full report, United Arab Emirates Macro Profile: Strong -. For more information about Moody’s Macro Profiles, please seeMoody's Macro Profiles: A Compendium and consult Moody's Bank Rating Methodology.

Exhibit 24

Arriving at UAE's Macro9

Source: Moody’s Investors Service


https://www.moodys.com/credit-ratings/United-Arab-Emirates-Government-of-credit-rating-600018601

http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_1002450


Average Long-Term* Ratings (Asset-Weighted) – Moody’s Rated Banks**

Exhibit 25

Ratings data as of September 28, 20181.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0 19.0 20.0 21.0

AaaAa3A3Baa3Ba3B3Caa3

*Because not all rated banks necessarily have the same rating class outstanding, rating included in 'Long-Term Rating' column is determined by an internal algorithm, which is describedhere.**Includes all banks assigned a BCA, plus one or more Long-Term Ratings.


http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_114614


Endnotes1 Of these, 13 are domestically owned and one is a foreign bank (HSBC Bank MIddle East Ltd.). HBME relocated its place of incorporation and head office

from Jersey (JFSC) to the Dubai International Financial Center (DIFC) on 30 June 2016

2 The Central Bank of the UAE and consolidated financials of Moody's rated banks

3 Alliance of the 14 OPEC countries plus 10 other oil-producing nations, including Russia, Mexico and Kazakhstan

4 A PMI reading under 50 represents a contraction

5 Free zones are offshore areas within Dubai

6 Tangible Common Equity = (Common shares + retained earnings and related reserves + treasury stock + foreign currency translation) minus (Goodwilland other Intangible Assets) minus (Deferred Tax Assets) plus (Impact of Cap on Deferred Tax Assets). We measure capital by TCE to ensure global dataavailability.

7 Our baseline forecasts are based on econometric models and a set of assumptions. Probabilities of default per asset class are derived from our forecasts forproblem loans, and general assumptions on loan book growth and write-off rates that have been adapted to the particular circumstances of the system.The model includes macroeconomic variables such as real GDP growth, unemployment, inflation and exchange rate. For investments and securities heldto maturity (government, corporate and other securities), we use idealised tables based on current ratings. In line with our Rating Methodology, we donot book losses on available-for-sale securities. We assume that securities in the trading book do not generate profit or losses. In general, we assume thatpre-provision income, risk-weighted assets and adjusted tangible assets grow as a function of the size of the economy, although we test and adjust theseassumptions against their recent and likely evolution. Dividend pay-out ratios are kept constant throughout the forecasting period, or adjusted to includereasonable changes in banks’ dividend policies.

8 For a full description of our stress testing approach see Stress Testing Banks: A Globally Comparable Approach. Our approach is based on a 1-in-25-yearevent and consists of three main components: loan losses calculated using a multiplier approach; security losses calculated using idealised loss rates basedon the ratings of the bonds held to maturity or available for sale or calculated using an expected shortfall approach for bonds in the trading book as well asequity securities; stressed pre-provision income, based on haircuts on net interest income (33%) and on non-trading, non-interest income (75%). We alsotake a static balance-sheet assumption, maintaining RWA or operating expenses constant

9 Note: The Macro Profile is a rating input used to determine each bank’s Baseline Credit Assessment. It is designed to capture the system-wide factors thatare predictive of the propensity of banks to fail. For more information, please consult Moody’s Bank Rating Methodology.


https://www.moodys.com/research/Banks-Global-Stress-Testing-Banks-A-Globally-Comparable-Approach--PBC_1044659


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