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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

Primary Credit Analyst: Timucin Engin, Dubai (971) 4-372-7150; timucin.engin@standardandpoors.com Secondary Contacts: Emmanuel F Volland, Paris (33) 1-4420-6696; emmanuel.volland@standardandpoors.com Trevor Cullinan, Dubai (971) 4372-7113; trevor.cullinan@standardandpoors.com Paul-Henri M Pruvost, Dubai (971) 04-372-7175; paul-henri.pruvost@standardandpoors.com Nadim Amatouri, Dubai +971 (0)4 372 7157; nadim.amatouri@standardandpoors.com Goeksenin Karagoez, FRM, Paris (33) 1-4420-6724; goeksenin.karagoez@standardandpoors.com Nicolas Hardy, PhD, Paris (33) 1-4420-7318; nicolas.hardy@standardandpoors.com Stephanie Mery, Paris (33) 1-4420-7344; stephanie.mery@standardandpoors.com Clement Bonnin, Paris +33 1 44 20 67 03; clement.bonnin@standardandpoors.com

Table Of Contents
Healthy Economic Growth Likely To Continue Asset Quality Metrics Are Improving As Credit Losses Fall Low Interest Rates Weigh On Margins As Credit Loss Declines More Slowly Capitalization Likely To Remain A Rating Strength Appendix Related Criteria And Research

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014
Standard & Poor's Ratings Services considers banks in Gulf Cooperation Council (GCC) countries well-positioned in a scenario where the U.S. moves to gradually normalize its monetary policy. Gulf banks suffered during the 2008 global financial crisis, but have since gradually recovered. They benefit from adequate liquidity based on the highly liquid local deposit markets and improvements to corporate asset quality. We expect the region's healthy economic growth prospects for 2014, supported by high oil prices, to keep demand for bank credit high and enable local banks to increase their earnings. In our view, most banks in the key banking markets in the Gulf region are likely to have healthy funding profiles, with sound, high-quality capital, in 2014. This will enable them to continue to exhibit healthy credit growth funded by liquid local deposit markets. For example, we expect to see credit growth in Saudi Arabia of 10%15% in 2014. Lending in Qatar and Oman slowed during 2013 as demand from Oman's private sector diminished, while certain projects in Qatar suffered administrative delays. As these projects accelerate in 2014, we expect credit growth to make a commensurate recovery in Qatar. Meanwhile, in Kuwait and the United Arab Emirates (UAE), credit growth has started to recover in line with increasing corporate activity and healthy retail growth. Although low interest rates continue to limit Gulf banks' net interest margins, most banks have seen a gradual decline in loan losses. We expect this to continue to support earnings growth in 2014, but by less than in previous years. The Gulf region's dependence on the hydrocarbons sector remains a structural risk factor. Volatile commodity prices could have a significant impact on Gulf economies. In our view, certain restructured exposures in Kuwait and the United Arab Emirates (UAE) could also generate downside risks. However, we consider that the banks' strong capital levels largely mitigate these risks. As a result, we expect ratings to be broadly stable through 2014; of the 26 banks we rate in this region, 17 have a stable outlook (see chart 1 and Appendix 1).

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

Chart 1

Healthy Economic Growth Likely To Continue


The region's traditional strengths--strong fiscal positions, persistent current account surpluses, and limited dependence on external funding--are likely to continue to support sovereign creditworthiness, despite the weak global economic outlook. We expect the GCC countries to repeat the relatively robust economic growth they achieved last year in 2014. For example, we forecast real GDP growth rates in the region's three largest economies of 4.6% for Saudi Arabia, 4.5% for the Emirate of Abu Dhabi, and 2.0% for Kuwait. We also anticipate that hydrocarbon resources will continue to dominate the region's economies, despite attempts to diversify.

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

Chart 2

Benign operating environment is vulnerable to political risks and oil price shocks
We expect most Gulf banks to continue to benefit from healthy corporate activity and consumer consumption. The many infrastructure projects planned in the Gulf should translate into sustained streams of corporate lending over the next few years. Furthermore, high oil prices have provided GCC states with sizable fiscal surpluses and they have proven willing to increase their expenditure to forestall popular demands similar to those that have occurred in other countries in the Middle East and North Africa (MENA) since late 2010. There are two main risks to our base-case economic scenario--heightened geopolitical risk caused by regional security concerns; and a sharp drop in oil prices, which would affect the country's external and fiscal revenues. Our base case assumes that the average oil price for MENA sovereigns with significant hydrocarbon endowments will remain between $100-$105 per barrel during 2014, as stated in our latest sovereign report, "Standard & Poor's Revises Its Crude Oil And Natural Gas Price Assumptions, " published on Nov. 20, 2013. We expect lending growth to remain healthy and to see noticeable, if gradual, recovery in Kuwait, Qatar and the UAE.

Degree of change likely to vary across the region


United Arab Emirates. We are seeing signs of recovery and increased credit growth in the UAE, after four years of very limited growth. The market enjoys ample liquidity, and UAE banks are adopting a relatively open stance on credit extension, particularly in Dubai. The overall business mood in Dubai has improved visibly as the residential real estate

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

market has recovered over the past 18 months. Dubai recently won the bid to host the World Expo in 2020, and has announced several projects over the past few months. Central Bank data indicates that in the first nine months of 2013 UAE banks' gross loans increased by 7.5% and personal loans saw net growth of 9.3%. We expect credit in the sector to grow by at least 10%. Saudi Arabia. Credit growth has slowed down in 2013, and is likely to remain at 10%15% for 2014, as retail lending reverts to normal. It had been boosted by measures passed in 2011 and 2012 to bolster Saudi nationals' purchasing power after the political protests of the "Arab Spring." However, this fiscal stimulus is now losing steam. Kuwait. Confrontations between the Kuwaiti government and its parliament have had a knock-on effect on lending over the past few years. Lending growth in Kuwait is largely tied to government-related projects, most of which progressed slowly, if at all, while the confrontations continued. However, in 2013, we saw a modest increase in activity. By Oct. 31, 2013, year-to-date corporate lending to nonfinancial institutions had increased by 8.4%. Retail lending also remained strong at 10% for the same period. We expect a similar trend for Kuwait in 2014. Bahrain. We expect credit growth in Bahrain to continue to depend on the trade, manufacturing, and retail segments in 2014. Lending to these sectors grew by more than 10%, surpassing the average annual growth of 6.4% in total domestic credit. The composition of loan books benefitted from a sharp rise in mortgage lending, which grew by more than 20% in 2013. Consolidated figures from the central bank showed that in September 2013, the proportion of retail loans in the total loan book edged up by 2.5 percentage points to 36.5%, while construction loans decreased to 22%. Qatar. Administrative delays affecting certain projects caused lending growth in Qatar to slow throughout 2013, but we expect lending growth to recover as the delivery of infrastructure projects accelerates in 2014. Oman. Lending growth is likely to gradually decline in 2014, as the Central Bank tightens its restrictions on retail lending.

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

Chart 3

Asset Quality Metrics Are Improving As Credit Losses Fall


The reported nonperforming loans (NPL) to gross loans ratio for rated banks in the GCC region increased sharply in 2008 and 2009, but has been gradually declining since 2010. Several factors have contributed to the improvement, including a supportive economic environment. For example, Kuwaiti banks wrote off certain loans and restructured others. Restructurings also occurred in the UAE and in certain banks in Qatar. As the GCC corporate market has recovered over the past three years, fewer loans have become NPLs. Since 2009, aggregate credit losses for the rated banks have declined visibly; for most of these banks, this has been key to their earnings growth.

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

Chart 4

At the start of 2008, the Gulf banks rated by Standard & Poor's had loan-loss coverage of about 140%--this declined sharply to about 79% in 2009 as NPLs spiked and banks used their excess reserves to limit the impact of the NPLs. Since then, bank coverage levels have improved every year, exceeding 100% as of Sept. 30, 2013. Some of the region's central banks have encouraged this development by requiring the banks they supervise to increase their provisions, especially as concentration risks remain. We expect the aggregate NPL ratio for the rated GCC banks to improve slightly in 2014. However, because most rated banks are increasing their loan-loss reserve coverage levels to build up additional reserves, we do not anticipate the ratio of credit losses to average assets to decline as sharply in 2014 as it has in recent years.

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

Chart 5

Low Interest Rates Weigh On Margins As Credit Loss Declines More Slowly
Interest rates were low in 2012 and 2013, putting margins under pressure; we do not expect this to change in 2014. Margins are predicted to be flat or to fall slightly, although some countries may see some improvement. In Qatar, competition on the lending and deposit side depressed margins to relatively low, but manageable, levels in 2013. Meanwhile, in the UAE, the recent focus on credit growth caused margins to be largely flat or slightly improved. Reported credit losses--specific and general provisions, net of recoveries--to revenues have gradually declined since 2009. For many Gulf banks, the decline fueled earnings growth during this period, while increased lending volumes helped to mitigate the impact of lower net interest margins. Aggregate return on average assets for rated GCC banks exceeded 2% for the first nine months of 2013, and we do not expect any further meaningful change in 2014.
Table 1

Rated Banks' Return On Asset Analysis


(%) Net interest income to average assets (1) Fee income to average assets (2) 2007 2008 2009 2010 2011 2012 2013* 2.4 0.8 2.6 0.8 2.7 0.8 2.6 0.7 2.5 0.7 2.4 0.7 2.5 0.6

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

Table 1

Rated Banks' Return On Asset Analysis (cont.)


+ Other non-interest income average assets (3) = Operating revenues over average assets (1 + 2 + 3) - Operating cost over average assets - Credit losses over average assets - Other items over average assets = Return on average assets *Equity leverage (average common equity to average total assets) = Return on average common equity *First three quarters. Source: Financial statements of the banks. 0.7 3.9 1.4 0.5 (0.6) 2.6 8.4 21.6 0.5 3.9 1.4 1.2 (0.2) 1.5 8.7 13.1 0.5 3.9 1.3 1.0 (0.0) 1.6 8.7 13.9 0.4 3.8 1.3 0.8 (0.1) 1.7 8.2 14.0 0.4 3.7 1.4 0.6 (0.2) 1.9 7.8 15.0 0.4 3.6 1.3 0.6 (0.2) 1.9 7.8 14.4 0.8 3.8 1.3 0.5 (0.3) 2.2 8.0 18.0

GCC banks continue to operate with very healthy funding and liquidity metrics
Absence of recourse to external debt remains a key distinguishing aspect in the GCC. This puts Gulf banks in a strong position to weather any market volatility that could occur as the U.S. normalizes its monetary policy. Excluding Qatar, all Gulf banking systems enjoy a net external asset base position. Gulf banks traditionally fund themselves through domestic deposit markets at attractive rates; except for Bahrain's wholesale banks for which foreign funding plays a more important role. Deposit growth has grown faster than new lending. Indeed, the net loans to deposits ratio, which peaked at 94% for the rated Gulf banks in 2008, gradually declined to 86% in 2012 and 2013. The U.S. Federal Reserve has announced only a gradual tapering of bond purchases ($75 billion per month, rather than $85 billion from January 2014). It plans to keep monetary policy accommodative through 2014. We therefore anticipate that financial conditions will continue to be favorable, but expect to see bouts of market volatility as the change in policy takes effect. This could have a knock-on effect on the amount and pricing of the liquidity available to banks in general.

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

Chart 6

Capitalization Likely To Remain A Rating Strength


We anticipate that GCC banks' capitalization will remain stable into 2014, as it has been since 2011. It compares well with capitalization at global banks. Standard & Poor's risk-adjusted capital (RAC) framework, which we use to measure banks' capital adequacy, indicates that the simple average RAC ratio before adjustments for rated GCC banks stood at 12.5% at year-end 2012 (see chart 7) and is likely to remain at this level over 2013-2014. This ratio was about five percentage points higher than the equivalent ratio at the 100 largest rated banks on Dec. 31, 2012.

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

Chart 7

We think that GCC banks' RAC ratios will remain fairly stable over the next 18 to 24 months because we expect diminishing provisions to enable net income generation to match the banks' robust growth. RAC ratios are also likely to be supported by continued reshaping of investment portfolios to favor sovereign domestic or high-quality regional corporate issuances. Finally, we do not expect regional regulators to relax their strict stance on maintaining regulatory capital ratios at higher levels than those prescribed by Basel II and III.

Appendix
Table 2

Components Of Standard & Poor's Ratings On Gulf Banks


Country Kuwait Kuwait Kuwait Kuwait Abu Dhabi Abu Dhabi Bank National Bank of Kuwait S.A.K. Gulf Bank Burgan Bank Kuwait Finance House National Bank of Abu Dhabi Mashreqbank Anchor bbb bbb bbbbbbbbbbbbSACP abb+ bb+ bb a bbbICR A+ BBB+ BBB+ AAABBB+ Support notches Outlook 2 Stable 3 Positive 3 Stable 5 Negative 2 Stable 2 Stable

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Robust Regional Economies And Healthy Funding Profiles Enable Gulf Banks To Maintain Growth In 2014

Table 2

Components Of Standard & Poor's Ratings On Gulf Banks (cont.)


Abu Dhabi Abu Dhabi Abu Dhabi Commercial Bank Sharjah Islamic Bank bbbbbbaaaaaaaabbbbb bbbbb+ bbbbbb bbb bbb bbb bbb bbb bbba a bbb+ a aaaa bbb+ bb+ bbb b+ bbbbbb+ bbbbbbbbb+ bbbA BBB+ A+ A+ AA+ A A A A+ BBB+ BB+ BBB+ BB+ BBBAAAA+ A3 Stable 2 Stable 1 Stable 1 Stable 1 Stable 1 Stable 1 Positive 1 Positive 1 Positive 1 Stable 0 Stable 0 Negative 1 Positive 3 Watch Neg 0 Stable 1 Stable 3 Negative 3 Stable 3 Stable 3 Stable

Saudi Arabia Samba Financial Group Saudi Arabia Riyad Bank Saudi Arabia The Saudi Investment Bank Saudi Arabia The National Commercial Bank Saudi Arabia The Saudi British Bank Saudi Arabia Banque Saudi Fransi Saudi Arabia Arab National Bank Saudi Arabia Al Rajhi Bank Bahrain Bahrain Bahrain Bahrain Bahrain Oman Qatar Qatar Qatar Qatar Ahli United Bank B.S.C. Al Baraka Banking Group B.S.C. Gulf International Bank B.S.C. BMI Bank B.S.C. Arab Banking Corp. B.S.C. BankMuscat S.A.O.G. The Commercial Bank of Qatar Doha Bank Q.S.C. Qatar National Bank Qatar Islamic Bank (S.A.Q)

Source: Standard & Poor's. Ratings as of Jan. 27, 2014. SACP--Stand-alone credit profile. ICR--Issuer credit rating.

Related Criteria And Research


Banking Industry Country Risk Assessment: United Arab Emirates, Jan. 21, 2014 UAE Banking Sector Outlook 2014: An Uptick in Lending and Economic Activity Signal Continued Profitable Growth, Jan. 21, 2014 Credit FAQ: How The UAE's Lending Caps Affect Domestic Banks, Government Entities, And The Capital Markets, Jan. 13, 2014 Diverging Fortunes Prevail As Stability Eludes Some MENA Sovereigns, Dec. 17, 2013 Banking Industry Country Risk Assessment: Oman, Oct. 31, 2013 Gulf Islamic Banks Continue To Grow Faster Than Their Conventional Peers, But Profitability Rates Are Converging, Oct. 2, 2013 Banking Industry Country Risk Assessment: Qatar, July 11, 2013 Gulf Banks' Capital Positions Compare Well With Those Of Global Banks, June 26, 2012
Additional Contact: Financial Institutions Ratings Europe; FIG_Europe@standardandpoors.com

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