“With deposit haircuts and capital controls in Cyprus hitting the headlines, investors have been reminded of the fragile state of parts of the global banking system, raising renewed fears over peripheral Europe and the future of the Eurozone,” Dilawer Farazi portfolio manager at Invest AD Markets in his report on GCC outlook said.
“But the contrast to banks in the countries of the Gulf Cooperation Council (GCC) could not be starker. Despite exposure to troubled sectors such as real estate, which have resulted in an elevated level of non-performing loans over the last four years, strong capitalization has created a wide buffer for any further provisioning required. GCC banks are generally much better capitalized than banks in the United States or in Europe, with higher common equity Tier (CET) 1, Tier 1 and capital adequacy ratios.
“Qatari banks are the best capitalized given the capital injections they have received from the Qatar Investment Authority, and they are expected to raise even more capital in the next couple of years in anticipation of the large project financing needed in the country in the run-up to the 2022 FIFA World Cup.
“The UAE banking system has raised its combined capital adequacy ratio to 21.2 from 20.8 in 2010, while Saudi and Kuwaiti banks are also well capitalized, given their retained earnings amid muted loan growth in recent years. Omani banks are in a weaker capital position than their GCC peers as capital increases have failed to keep up with loan growth.
“Banks in the region have been examining ways to raise capital further, with Tier 1 and Tier 2 deals gaining traction, especially among UAE banks. Abu Dhabi Islamic Bank (ADIB) issued the first public Tier 1 perpetual sukuk deal from the GCC at the end of 2012 at 6.375% for a US$1 billion deal, to bring its capital ratios into line with the other UAE banks.
“Asset growth had resulted in ADIB’s Tier 1 ratio falling to 14.2% by 2011 from 17.9% in 2007, although this still compared favourably internationally, with the average Tier 1 ratio for European banks standing at 13.4 percent in 2011.
“By mid-March, when the next Tier 1 perpetual came to the market – from Dubai Islamic Bank (DIB) – the ADIB sukuk was trading at around 5.5% thanks to the rally in high-yielding securities as investors hunt for yield. The US$1 billion DIB deal priced at 6.25 percent.
Both the ADIB and DIB deals were done as Mudarabah sukuk structures and should be eligible as Basel III capital, although central banks have not yet issued specific guidelines on the treatment of hybrid issuance. Some analysts question whether the lack of loss absorption characteristics in this structure would impact the instruments’ eligibility, and if they are not eligible, they will be callable at 101.
“Abu Dhabi Commercial Bank (ADCB) and Emirates NBD have recently completed Tier 2 issues. The Emirates NBD deal resets from a fixed rate to a floater when it becomes callable in 2018, while the ADCB deal does not have any step ups. Going forward, such deals are unlikely to have step ups in their structures as the paper is unlikely to qualify under Basel III.
“NBAD repaid its outstanding Tier 2 debt with the Ministry of Finance as they did have step ups, which impacted how much they could use in their capital calculation. Only 80% was eligible for 2013, 60% in 2014, 40% in 2015 and 20% in 2015. The rating agencies differ on the way they approach subordinated debt from the region, and in particular how they view potential government support for the banking system. Fitch assumes a higher level of potential extraordinary sovereign support, given recent history of capital injection and the close relationships between the regions’s ruling families and the banking sector. The ratings agency typically rates subordinated debt one notch below the long-term issuer default rating – which is not the case for its ratings in other regions. However, Moody’s has put subordinated debt in the region on ratings watch negative following a change in the way it calculates ratings for subordinated debt globally. Few deals will be impacted by Moody’s review of ratings given the current group only consists of, Burgen Bank 2020s, Commercial Bank of Qatar 2019s. ADCB 2023s and Emirates NBD 2023s are not rated by Moody’s, while the DIB and ADIB Tier 1s are both unrated,” he said.
“We should expect to see a number of other GCC banks shore up capital this year, especially from the UAE and Qatar. With the global hunt for yield still on and private bankers offering leverage on some of these debt instruments, demand for this issuance is likely to remain robust,” he added.