Dubai, UAE — GCC banks are staring at weaker performances after a strong first half this year. According to S&P Global Ratings, earnings for most GCC banks will reach nearly pre-pandemic levels by year-end 2022, owing to high oil prices and rising interest rates, which will support their creditworthiness.
S&P forecasts a more visible strengthening of regional banks’ interest margins and a manageable increase in risk cost in the second half, despite lingering effects from the COVID-19 pandemic via loans that benefited from support measures and were then restructured. These factors will have a net positive effect on bank earnings.
Among the four largest GCC markets, Kuwaiti and Saudi banks performed the best, while Qatari and UAE banks are taking a little longer to recover.
Saudi Arabia: Stronger profitability
According to the report prepared by Zeina Nasreddine, Primary Credit Analyst at S&P, and other analysts, Saudi banks’ financial performance has almost recovered to pre-COVID-19 levels.
The report expects an average return on assets (ROA) of 2.0% in 2022 compared with 2.1% in 2019. Credit to the private sector expanded 8.5% over the first half, owing to stronger-than-expected mortgage growth.
The strong economic rebound also kept aggregated cost of risk low, at about 46 basis points (bps), and the share of Stage 3 loans broadly flat, estimated at about 2%. In addition, banks’ nonperforming loan (NPL) coverage stood at 160%-170% in 2022.
Also, higher credit growth momentum will continue into the second half. The credit growth is expected to reach about 15% in 2022.
S&P expects corporate lending to boost loan growth. The gradual rise in interest rates will boost Saudi bank margins by year’s end. The second-half risk costs is also expected to rise to 70-80 bps as post-pandemic loans are reclassified. The systemwide ROA should stabilize at 1.9%-2.1% by 2022.
On the other hand, global slowdown and higher rates could affected Saudi banks. The risk of U.S. and European recessions, along with higher interest rates, could pressure the operating environment, especially if oil prices drop.
Qatar: Slower growth
S&P expects private sector credit growth of 5% in 2022, less than half the average rate seen over the previous three years.
Consumption lending is likely to see the strongest growth, buoyed by the World Cup at the end of the year and positive sentiment stemming from high natural gas prices. However, government construction projects, the main growth spur previously, have mostly been completed, which is shown in banks’ first-half performance.
Overall credit could reduce slightly if lending to the government continues to decline in the second half, which we view as likely given our projected fiscal surplus of about 12% of GDP.
Banks’ significant exposure to the wealthy public sector will continue to support solid asset quality. S&P projections anticipate that central bank rate hikes, following those by the U.S. Federal Reserve, could pressure some Qatari borrowers, with a marginal effect overall.
Kuwait: Supportive environment
Higher oil prices and the economic recovery have supported faster lending growth and lower cost of risk. Banks’ stronger earnings were mainly due to a further reduction in cost of risk and higher lending growth of 9% year-on-year in the first half.
First-half 2022 margins were lower than expected due to liability repricing and lending competition. Improved operations boosted noninterest income. Higher inflation and the resumption of some costs as the pandemic wanes led to a 10% increase in operating costs compared with first-half 2021, offsetting higher revenue.
Momentum may slow in the second half, with some NPL formation. Cost of risks are expected to decline to 85 bps in 2022 from 90 bps in 2021, partly due to adequate NPL provision coverage (nearly 200%).
The report expects residential and retail real estate prices to recover, but market concerns could hurt banks’ asset quality. At June 30, 2022, real estate and construction accounted for 25% of bank lending.
Similarly, the investment sector (primarily rental apartments for expats) is slowly recovering from the correction experienced over the past year related to an exodus of expats amid COVID-19 fallout. We expect this to continue in the next 12-24 months spurred by the stronger economic outlook and, to a certain degree, expats returning.
UAE: NPLs to remain contained
Higher interest rates will support banking sector profitability in the UAE. Banks’ performance improved in first-half 2022 on the back of lower cost of risk and higher interest rates.
The Central Bank of the UAE measures during COVID-19 helped the system through a period of stress, limiting the increase in NPLs. At the same time, the macroeconomic environment has started to improve thanks to higher oil prices and recovery in the non-oil sector.
Better operating conditions led to higher lending growth in first-half 2022 compared with 2021, although this could be tempered by increasing interest rates in the second half. S&P expects the trend of higher interest rates and lower cost of risk to continue supporting banks’ profitability.
The report also expect asset quality to stabilize. NPL increases will remain contained as the economy improves and corporate activity recovers. On June 30, 2022, Stage 3 loans as a percentage of gross loans stood at 5.6%, compared with 6.1% at year-end 2021. Stage 2 loans stood at 6.0% for the first half. The construction sector and some small and midsize enterprises will take longer to recover and be the chief contributors to NPL formation.
Real estate prices have recovered but remain below 2014’s peak. In the past few months, we’ve seen strong demand for residential real estate, demonstrated by a surge in transaction numbers, price increases, and record presales for developers. At the same time, Russia-Ukraine conflict reportedly boosts real estate demand.
Uncertain prospects in 2023
The report concluded that GCC banks’ strong momentum so far in 2022 may not be enough to shield them from adverse developments in 2023.
According to S&P assumptions, global oil prices are expected to average $85 per barrel next year compared with $100 per barrel for the remainder of 2022.
Moreover, S&P Global Ratings now sees the chance of a U.S. recession, as determined by the National Bureau of Economic Research, at 45% in the next 12 months (40%-50% and closer to 50% heading into 2023 as cumulative rate hikes take hold), in addition to Europe’s escalating geopolitical risks and high inflation, which could mean weaker economic growth. This would harm global growth and put pressure on commodity prices, with repercussions for the GCC region and its banks.