Gulf banks are feeling the pinch of rapidly shrinking corporate loan margins, with some predicting a bounce in lending rates as soon as the first half of 2015 as the escalating price war bites into profitability.
Lenders are being forced to cut rates and loosen lending terms to secure business as local banks, flush with cash as their balance sheets recover from the global financial crisis, seek ways to earn a return on their money.
The conditions are a boon for the region’s companies, which have been able to negotiate cheap funding with longer terms and fewer covenants – for example, less collateral – from lenders desperate to maintain business relationships.
Dubai’s state-linked borrowers, many of whom were seen as pariahs by bankers when the emirate nearly defaulted five years ago, have been among the top beneficiaries; they have repeatedly been able to improve the rates at which they are borrowing.
Earlier this month, airport retailer Dubai Duty Free completed the second repricing of a $1.75 billion loan in just over a year, while also trimming the interest rate on a separate $750 million facility.
In July, ports operator DP World refinanced a loan to secure better pricing while tripling its size to $3 billion.
Bankers are questioning how much longer this can go on. Some are worried not so much by the shrinking profit margins on loans as by the relaxation of other terms, which they feel could set dangerous precedents in the market and increase risks for banks when economic conditions worsen.
“It has been a steady decline in margins over the last few quarters on both sides of the balance sheet for banks,” said Chiradeep Deb, head of corporate finance and syndications at Dubai’s Mashreq.
“What is however more worrying, and I guess as lenders we need to arrest the slide, is competition loosening up on facility terms in a drive to push asset growth.
“I would expect some corrective action to come through by the early part of 2015.”
Fluctuations in loan pricing trends are common around the world, but some factors unique to the Gulf seem to be distorting the market and making the current trend particularly sharp.
Abu Dhabi government-regulated entities have been less active in borrowing over the past few quarters, apparently because the emirate’s authorities have become somewhat more prudent about debt levels.
The pipeline of infrastructure projects expected in Qatar has been slower than expected to materialise, partly because of red tape. Qatar is likely to reschedule about 15 percent of its planned building projects for coming years to reduce waste and bottlenecks, sources familiar with government policy told Reuters in March.
Saudi Arabian banks are highly liquid but face restrictions on lending outside the kingdom. Many have also reached their lending limits for the most high-profile domestic names, making the competition for good-quality assets fierce.
“It’s not unusual in Saudi to negotiate with one bank and then another bank comes in at the last minute with better terms, and they end up taking a chunk or all of the financing,” said one lawyer in the kingdom.
In general, deposit growth has outpaced loan growth in many Gulf economies over the last few years; in the United Arab Emirates, for example, banks’ combined loan-to-deposit ratio has dropped from a November 2011 peak of 102 percent to 95.4 percent in July this year, according to the latest central bank data.
This has added to competition among banks to win loans – as has the return of some foreign banks to the region over the past year. Those banks retrenched in the Gulf during the global financial crisis and are now back, willing to lend cheaply in the hope of rebuilding relationships and securing fee-paying business such as foreign exchange and derivatives.
The competition has shrunk the average margin over the London interbank offered rate on a loan in the six-nation Gulf Cooperation Council to 164.12 basis points so far this year, from 211.49 bps last year, according to Thomson Reuters LPC data. That compares with a drop of just 3.7 bps in the Asia-Pacific region outside Japan.
Average loan pricing in the GCC is now at its lowest level since 135.56 bps in 2008.
To compensate, some banks have been trying to increase the proportions of current account and savings account (CASA) deposits in their funding bases, as this type of deposit costs them very little.
But the decline in lending rates has outpaced banks’ efforts to reduce their cost bases; net interest margins (NIMs) – the difference between the rate paid out on deposits and the rate charged for lending – have come under severe pressure.
The chief executive of National Bank of Abu Dhabi, the UAE’s biggest bank, warned in April that loan profitability had been driven down to the point where revenues would be impacted. He was speaking after NBAD’s NIM slipped to 1.84 percent at the end of March, from 1.98 percent at the end of 2013.
The trend has been fuelled by the fact that banks’ ample liquidity means some are now able to fund by themselves loans which, a few years ago, would have needed a large syndicate of banks to handle.
New syndicated lending in the Middle East dropped 45 percent year-on-year to $17.5 billion in the first six months of 2014, Thomson Reuters LPC data showed, even as system-wide bank lending increased.
Dealing with a single bank or a small club of banks often allows borrowers to increase the pressure on lenders to provide loans at ultra-low “relationship” rates.
Some recent deals have been eye-poppingly cheap. Borse Dubai, the emirate’s holding company for its stock exchanges, took out a $500 million, three-year loan from Dubai Islamic Bank in June at just 90 bps over Libor, a source familiar with the deal told Reuters. That replaced a maturing three-year loan which had been done at 210-220 bps.
Shrinking loan margins are not so far crippling Gulf banks’ overall earnings because the banks are benefiting from a reduction in bad loan-write offs and a revival of fee business due to strong economic growth in the region.
Combined net profits at listed UAE banks are forecast to rise 17 percent this year and a further 19 percent next year, according to analysts’ forecasts compiled by Thomson Reuters.
But the banks still face an uncomfortable question: at what point does lending become commercially unviable?
“Before, you’d crunch the numbers to work out the commercial price at which to lend and most banks would be around there, with one or two outliers underneath you,” explained a senior Gulf-based banker.
“Now, if you price commercially, you are the outlier and everyone is below you.”
There are some signs that a turning point may be approaching, as banks push back against borrowers’ demands.
For example, UAE utility Empower has been seeking to reprice a $600 million syndicated loan which it completed earlier this year to secure a 30 bps reduction in its funding cost of 205 bps, but so far a deal has not been done, a source with direct knowledge of the talks said. The company did not immediately respond to an emailed request for comment.
“Individual banks are already pushing for higher margins and getting their pricing optimised on loans to companies that lie towards the top end of their risk appetite,” said Stuart Anderson, Middle East head at Standard & Poor’s.
He added, however, that banks would continue to undercut each other when seeking to build relationships.
The main trigger for an increase in lending rates, and a normalisation of margins, is likely to be the U.S. interest rate hikes expected to begin as soon as in early 2015. Gulf central banks will follow these hikes because of their currency pegs to the dollar, and the ultra-loose liquidity distorting the loan market should eventually dissipate.
It may prove a painful process for banks stuck with assets paying extremely cheap rates, though.
“They are printing loan deals at rock-bottom rates even though they know they will be in the red when the cycle turns,” said another senior banker in the region.-Reuters