Dubai: The full-year earnings of GCC banks point to improved profits, lower costs and substantial reduction in cost of risks positively impacting their profitability.

Positive endowment effect [the effect of higher interest rates on net interest margins (NIMs) as interest-generating assets are larger than interest-bearing liabilities] has also improved the bottomlines of many banks and is expected to continue into 2018 as most GCC countries are expected adjust interest rates in tandem with the Fed rates.

In 2017, endowment effects were modest across the region with negative impact in Saudi Arabia. Analysts expect the impact from higher interest rates on margins to improve next year.

“We estimate a positive [endowment] effect of higher interest rates of between 5 basis points [bps] in Saudi Arabia to 8bps in Qatar. We assume that local interbank rates will move in tandem with US rates, and local spreads are now within credit default swap (CDS) differentials, suggesting limited scope to further narrow,” said Jaap Meijer, Director of Equity Research at Arqaam Capital.

Early bank result from the UAE and rest of GCC confirms the positive trend in margins and profitability. Analysts say bad debt charges have already peaked in the UAE, while remain contained in the rest of the GCC.

“The overall bad debt charges are expected to improve by 50 bps year on year in 2017 in the UAE though remains the highest in the GCC at 141bps. The decline reflects a better functioning of the credit bureau, slight relaxation in lending standards to the troubled SME sector and a weaker dollar. We pencil in further reduction of 19 bps to 122bps in UAE,” Meijer said in a recent note.

Leading rating agencies expect to see stabilisation of the financial profiles and performance of region’s banks after two years of significant pressure.

While analysts expect to see further easing of liquidity and funding with improvement in asset quality metrics in 2018, there is a likely spike in cost of risk across the board due to factors other than new loan impairments.

“We think that GCC banks’ cost of risk will increase in 2018 because of the adoption of IFRS 9 [International Financial Reporting Standards] and the higher amount of restructured and [loans] past due, but not impaired loans sitting on their balance sheets. However, we also think that the general provisions that GCC banks have accumulated over the years will help a smooth transition to the new accounting standard,” said Mohammad Damak, a credit analyst at S&P Global Ratings.

New targets

Analysts expect a reorientation of fiscal targets in Saudi Arabia is likely to positively impact bank earnings next year. According to Arqaam’s analysis, Saudi banks are expected to show more than 13 per cent earnings growth in the fourth quarter of 2017 generating 5.5 per cent higher earnings for 2017, as cost of risk is better accrued during the year, banks have de-risked and liquidity in the system has improved.

Fiscal pressure easing as consolidation slows down and oil price recovers. The Saudi government has decided to follow the IMF’s recommendation to push back fiscal consolidation until 2023 instead of the initially planned 2020 in order to ease the strain on non-oil GDP growth. Spending is budgeted to increase in 2018 by 5.6 per cent, with the bulk coming from a 13.9 per cent increase in CapEx spending (25 billion Saudi riyals), which should help to stimulate the economy.

Challenges faced by the region to diversify economies and government finances, and regional political tensions common for all GCC sovereigns, but according to Moody’s, Bahrain, Oman and Qatar are more exposed than Kuwait, Saudi Arabia and the UAE.

“Individually, in the UAE, Saudi Arabia and Kuwait, which account for around 75 per cent of GCC banking assets, the outlook is stable, however Bahrain and Oman are more weakly positioned in respect to their fiscal position,” said Olivier Panis, a vice-president and senior credit officer at Moody’s.

Loan performance is expected to remain solid overall with non-performing loans (NPLs) edging higher in a context of sluggish economic activity in the range of 3 to 4 per cent. Sectors sensitive to fiscal consolidation such as contracting, construction, real estate, retail and SME will bear the brunt.

The slowdown in economic activity over the past two years only resulted in a slight increase in nonperforming loans (NPLs). As on September 30, 2017, NPLs to total loans for the rated GCC banks reached 3.1 per cent, compared with 2.9 per cent at year-end 2016. However, restructured loans and past due but not impaired loans saw a higher increase, reflecting corporate entities’ longer cash flow cycles.

“We expect NPL ratios to continue to deteriorate in the next six months and then progressively stabilise, mirroring the stabilisation of the GCC countries’ real economy. Our expectation discounts any unexpected materialisation of geopolitical risk or any other shock in the commodities market. Overall, we do not expect the NPL ratio to exceed 5 per cent in the next 12-24 months,” Damak said.