COVID-19 impact: A bumpy ride ahead for UAE banks as risks begin to filter into earnings

Despite the overall negative outlook, analysts expect some of the banking sector stocks to perform well due to attractive dividends, pandemic getting under control the country, economy opening up and the steepening of US yield curve.

According to a recent Bank of America Merrill Lynch (BofA) research note, the UAE banks continue to face pronounced risks, underpinned by a confluence of factors including a slowdown in economic activity (asset quality concerns), weaker oil prices and margin pressures from rate cuts.

“We see the impact of these factors becoming more visible in the forthcoming 2Q20 earnings season, with a significant pick up in impairments and a sharp contraction in net interest margins (NIMs). We lower our 2020-22 earnings forecasts in reflection of a sharper pick up in Impairments than previously assumed as well as an even more pronounced contraction in margins,” said Hootan Yazhari, an analyst with BofA Merrill Lynch in a note.

While the UAE is facing a challenged outlook, BofA Merrill Lynch sees a number of factors that could mark a change. “In particular, we highlight the improved outlook for oil prices, the encouraging pattern in COVID-19 infections, the resumption of key economic sectors including tourism and retail, forthcoming foreign ownership limits (FOL) changes and attractive dividends,” said Yazhari.

BofA Merrill Lynch expects the steepening of the US yield curve hints at potential bottoming of net interest margins for the UAE banks, which witnessed a sharp decline in last 3 quarters following the rate cuts.

While Emirates NBD and FAB are likely to benefit from the improving operating environment BofA Merrill Lynch said they prefer local bank with strong, well-capitalised balance sheets (capacity for dividends); healthy free cash flow generation underpinned by more diversified income streams; ample liquidity; prominent Government shareholdings and attractive valuations.