Arqaam Capital

Tighter Monetary Policy and Liquidity Squeeze to Weigh on GCC Banks: Arqaam Capital

Tuesday, May 3, 2016

  • Bad loans have already started to increase, but banks earnings are cushioned by strong provisions
  • Banks to report double-digit RoE even under moderate stress scenarios
  • Price dislocation, restructuring and regulatory reforms to offer attractive investment opportunities

 

 

Headwinds from significant fiscal consolidation coupled with the repercussions of a tighter monetary policy and liquidity squeeze are two of the main challenges that banks in the Middle East & North Africa region will have to grapple with going forward according to a new research report entitled: MENA Financials-Selective Opportunities" released by Arqaam Capital, the emerging markets investment bank.

 

The report expects revenue growth for Gulf banks to be fairly limited as higher assets yields are being offset by a substantial increase in the cost of liquidity, with banks and governments having to source funding outside their home markets at wider spreads. Additionally, some Gulf banks, particularly in Qatar have to bring back substantial negative USD positions to below 25% of shareholders' equity, protecting the banks from a potential depeg.

 

Jaap Meijer, Managing Director, Research commented: "With credit growth slowing down, limited possibilities to boost Net Interest Margins and a market reduction in loan origination fees, banks are focusing on costs, though this is unlikely to provide a substantial cushion if the downturn were to worsen. Having said that, most banks have reported excellent quality of earnings with very rich build-up in general provisions. We estimate understatements in reported earnings of 10-25%    over the last few years."

 

"Under the stress scenario where we model for a 50bps increase in additions to loan loss reserves, commercial banks will continue to report double digit RoE, thanks to solid pre-provision profits, mainly reflecting fairly high NIMs by international standards and low operating costs. Encouragingly, most valuations have started to reflect this, despite the relief rally year- to- date of about 30%.' Jaap added

 

 The report also highlights that the reported Non Performing Loans (NPL) evolution is understating the underlying deterioration in asset quality. This is due to NPL write-offs and using some of the over-provisioning. As economies further slow down and lending standards further tighten, NPL formation should further accelerate. 

 

"We see only limited possibilities to cushion Profits and Loss statement from the worsening asset quality due to three reasons, namely the implementation of IFRS 9 rules by 2019, which forces banks to provision on expected losses rather than incurred losses, the relatively limited over-provisioning of existing NPLs given overall low NPL levels and the stress in the SME sector which is likely to start affecting larger corporates."

 

'Having said this, banks have been bolstering their balance sheets with rich general provisions, and have been understating earnings and capital ratios, with general provisions of 1-4% of Risk Weighted Assets. As a result P&Ls may not worsen as much - if they slowdown the pace of additions to general provisions or would be allowed to dip into them in periods of stress"

 

'We see ample opportunities for banks in the region with strong and sustainable growth in Economic Profit and Risk Adjusted Return on Capital generation. These banks will be better positioned to tap liquidity and to some extent capital, which should allow them to capture more market share as other banks may slam on the brakes. We also see deep value in some stocks with price dislocation and in certain banks where restructuring could unlock substantial shareholder value.  In addition, regulatory reforms can also present great opportunities as is the case for certain insurance companies in Saudi Arabia helped by a huge privatization drive and crackdown on poor underwriting and pricing practices." Jaap concluded  


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Arqaam Capital Limited
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Dubai International Financial Centre
PO Box 506687 Dubai
United Arab Emirates
Tel: +971 (0)4 507 1700