UAE banking sector continues to confound value seekers

UAE May CPI inflation rose 0.2% (1.4% annually) following five consecutive months of deflation, though as the breakdown goes, housing deflation persists (housing and related services such as utility prices constitute 39.3% of the UAE CPI basket) and thus price levels remain at the lower end of the GCC spectrum–a phenomenon which should continue to normalize through the remainder of the year but which will likely keep monetary policy accommodative.  Against this backdrop, Barclays notes, the once maligned banking sector continues to show improvement as interbank rates remain on their steadfast downward trend, “reflecting improving liquidity.”  That said per 1Q11 results the loan-to-deposit ratio fell to a 4 year low (99%) with “growth in credit to the private sector (3.2% y/y in April) [is] still in recovery mode” and appearing destined to remain that way for the near-term given recent restrictions on lending volumes and associated fees generated (historically ~2 – 4%/annum on retail portfolios) which should pinch those banks with the greatest retail exposure comparatively profoundly (per Kuwait's Global Investment House, “for personal loans, ‘aggressive' banks were lending at an average of 180 – 240x while ‘conservative' ones were at 72 – 84x the monthly salary; analysts there note that First Gulf Bank (FGB) would be most exposed given 34% retail/total loan and 20% retail fees/total income ratios, roughly double those of the peer group median).  Admittedly, pundits note, “these rules will benefit the banking system in the long run, the impact in the short-term will stifle credit growth and come at the worst time when banks are already struggling with corporate defaults and restructuring eating into the bottom-line.”  On a relative value scale the industry as a whole thus continues to lag the GCC universe, trading at [2012e] ~.95 p/b despite a ROE (~16%) that would imply some 30-40% upside (to that end, Kuwait's sector looks rich in comparison at ~1.95p/b, 14% ROE).  This, however, is likely testament to hitherto opaque nature of certain imminent restructurings–Dubai Holding holds around USD9.1bn (AED33bn), while the Al Jaber Group (AJG) of Abu Dhabi holds roughly USD1.6bn (AED6bn) worth of debtthat needs to be renegotiated–and the possibility of meaningful exposure.  That said on average the estimated impact on total income for 2011 is likely to be, on aggregate, under 2% for every AED500 of exposure, per analysts, meaning the three cheapest banks on an RV-scale (Abu Dhabi Commercial Bank, Emirates NBD and Union National Bank) could be especially ripe to converge, both within the domestic sector and the greater GCC region as a whole.  Yet others point out that overall elevated non-performing loans (NPL) are likely to persist (6.67 percent at the end of April, up from 6.25 last December, versus the GCC average range of 1.5 per cent in Qatar to 8.1 per cent in Kuwait at the end of 2010), a theory in part linked to the commercial property market per Raj Madha of Rasmala, an investment bank: “The commercial property market is taking a double hit from falling rent and falling occupancy levels, so even if occupancy levels on new buildings reach 50 percent, that would still mean cash flow to owners is down about 75 percent from expectations,” he noted in late May.