• Retail credit quality – the new elephant in the room? With slowing economic growth and weak commodity prices, provisioning for SME loans has risen and our concerns have shifted to the likely second wave of provisioning, which we believe will originate in the retail segment. We urge caution in 2016 and highlight our preference for banks, which we believe have a track record of prudent risk management and strong shock absorption capacity. We reiterate our Buy ratings on FGB, ENBD and ADCB; of the UAE banks RAKB and ADIB have the highest retail exposure.
• Layoffs increase credit quality risks for retail loans… At end-3Q15 we were satisfied with the health of retail segment, despite the risks of borrower’s being over-leveraged, because employment trends were relatively stable. However, there are signs of growing redundancies in the UAE particularly in the financial and oil and gas sectors.
• …a segment which banks focused on in 2015 Retail loan growth (10.6%), outpaced overall loan growth (7.8%) in 2015. ENBD (17%) and ADCB (15%) posted the highest growth in retail loans in 2015. Provisioning in the retail banking segment is up across our coverage– UNB 134% YoY, DIB 117% YoY – but, we believe these provisions were driven mainly by delinquencies in the SME segment and general provisions. If we assume 4% of the banks’ retail loan portfolio is delinquent, the impact to 2016 pre-provision profit would be largest for ADIB and least for UNB. The banks expect 2016 to be more challenging than 2015 and are generally guiding for a higher cost of risk. We expect retail loan growth to moderate in 2016 as banks begin to tighten credit in this segment (figure 9).
• Weakening employment trends in banking and oil and gas sectors UAE banks, faced with growing pressure on profitability, have laid off or plan to lay-off staff (figure 3) and Monster’s (an online job portal) employment indices show that the oil and gas sector saw the steepest drop in job postings among all sectors in November 2015 (figure 4). However, even though certain sectors in the UAE face headwinds, the healthcare and retail sectors have seen strong growth. The indices also show that healthcare and retail sectors have seen a sharp increase in job postings.
• Will this retail default cycle be as bad 08-09? The credit bureau, which became fully operational last year provides greater transparency on the level of indebtedness in the retail sector. Since the crisis the central bank has beefed up retail regulations – well defined lending limits for retail loans in 2011 and LTVs for mortgage lending in 2013 - to mitigate the risks in the system. We believe that banks have taken necessary adjustments over the past six months to manage retail credit risks.

Shabbir Malik
Murad Ansari