It has not been an easy few months for major financial institutions, particularly in the West. When not revealing huge losses and major provisions, their bosses have been grilled by politicians and humiliated on television. They have had to turn to taxpayers to bail them out and lay off staff. Some banks have been forced into shotgun marriages, at times weakening even further what were once robust institutions. Many are now trading on the stock market at a fraction of their value just a year ago. It has been difficult for banks in the UAE too, but as most banks have now released their preliminary financial results for last year the fog of uncertainty that prevented analysts from assessing their health has been lifted. What has been uncovered is a banking sector that seems to have come through the final quarter of last year - in which stock markets declined and financial institutions worldwide generally went haywire - in a state of relative health. Although most local banks saw their net profits decline last year compared with 2007, nearly every bank still made a profit. Few of the large western lenders were so fortunate. "So far, the profitability is very good," says John Tofarides, a ratings analyst at Moody's Investors Service in Dubai. "And better than elsewhere." Of the five large banks based in Abu Dhabi, four have reported an increase in annual net profits. The exception is Abu Dhabi Commercial Bank (ADCB), which posted a 35 per cent decline. Dubai banks also remained profitable, although less so than those in the capital. The final quarter proved punishing for the entire sector as the financial crisis set in. "The fourth quarter was the litmus test," says Andrew Gilmour, an economist at the Samba Financial Group. "All of the banks are going to be retrenching, balancing their books, deleveraging." In general, the Dubai-based banks were hit slightly harder than those based in Abu Dhabi. Nearly every Dubai-based bank reported a lower net profit for last year compared with 2007, whereas only ADCB in the capital reported a decline in profit. The trend makes sense, according to economists, given that Abu Dhabi's banks are less dependent on the foreign funds that dried up towards the end of last year, and the property sector. "The Dubai banks have more exposure to the real estate market here, either directly or indirectly," says Eckart Woertz, an economist at the Gulf Research Center. Overall, the biggest problem for UAE banks was the extra loan loss provisions they took in the fourth quarter - emergency funds set aside for an expected rise in defaults. Some banks also suffered losses on their investment portfolios, especially on the stock markets. Investbank, a local corporate and retail bank based in Sharjah, reported a 98 per cent decline in net profits for last year, following losses on local and international markets. If stocks and property values continue to decline this year, analysts say banks could again suffer similar losses. The truth is, however, that analysts will not know the full story of what happened last year in the local banking sector until the banks release their complete financial statements, within the next month or two. At that point, it will become clearer which banks are more exposed to those parts of the economy that are likely to deteriorate in the year ahead, particularly the property market. Until more data become available, analysts paint an optimistic, although mixed picture of the sector's outlook for the year. The good news: as most bankers are eager to say, in times like these taking extra provisions is prudent, and signals strength on the part of the bank. Although net profits might have been higher had the banks not taken extra provisions last year, they would have been hit doubly hard in the months ahead if more and more borrowers, as expected, miss payments on their loans. The bad news: What we saw in the fourth quarter of last year probably was not the last bout of unusually large provision-taking. Although some banks set aside hundreds of millions of dirhams, economists tend to agree that with house prices on the decline and economic activity steadily losing momentum in the GCC, loan quality is likely to get worse before it gets better. That means even more provisions will be necessary this year, and even lower net profits. "With loan-loss provisioning, we know that the fourth quarter of 2008 was just the beginning of the story. The asset quality contraction is definitely going to be reflected in the first and second quarter of 2009," says M.R. Raghu, the head of research at the investment firm Markaz. Moreover, one of the main factors that kept local banks profitable last year was the three quarters of highly profitable activity that came before the financial crisis hit the region last September. That buffer will not be there this year. Thankfully, the Government has indicated it is ready to provide significant help to the banking sector. In the past few months, the Federal Government has promised as much as Dh120 billion (US$32.67bn) for local banks, Dh50bn of which has already been infused into the banking system in the form of long-term deposits. The individual emirates have also provided aid, with Abu Dhabi injecting Dh16bn into five banks based in the capital last month. No similar move has yet been taken by Dubai, although the Government there has pledged to use the first $10bn of its recent bond issuance to help state-owned property developers, which should in turn help the banks who lend to them. Overall, perhaps the biggest factor affecting the performance of banks this year will be the extent to which borrowers increasingly default on their loans. If the rise in loan delinquencies exceeds banks' preparations, then they could suffer further declines in profitability. Banks must walk a fine line between being too cautious and not cautious enough. "We expect a sharp increase in the provisioning," Mr Raghu says. Banks have started doing that in the fourth quarter, he says, and he expects it to continue in the first and second quarters of this year. "Any increase in loan-loss provisioning will definitely impact your bottom line. The overall banking system is going to be experiencing a sharp drop in profitability," he says. In other words, it's not going to be an easy year for all of the banks in the region, but in the circumstances, it could be much worse. firstname.lastname@example.org
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