Testing times

Testing times

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Few countries have achieved such a rapid and spectacular economic rise as the small Gulf state of Qatar. Fuelled by the discovery of some of the world’s largest gas reserves, the country, which gained independence in 1971, has developed into a regional economic powerhouse.

Today, Qatar boasts the highest gross domestic product per capita globally and has committed more than $200bn to a national development plan, while state funds have bought substantial but illiquid trophy assets in London particularly, and invested in blue chip companies worldwide.

The banking sector has been both a facilitator and beneficiary of this largesse as the government sought to diversify its economy away from dependence on energy, which has been both a boon and the bane of the wider economy. All major companies in any sector are at least partly state-owned.

But virtually all spending is funded via energy revenues or borrowings based on the implicit backing of Qatar’s vast reserves – and that’s where trouble could be brewing for the country’s banks.

Energy economy

Around 80% of Qatar’s liquefied natural gas (LNG) exports are made under longterm contracts, Fitch Ratings wrote in a September note. These contracts’ prices are based on oil but with a time lag so the effect of the lower oil price has therefore yet to be fully felt.

As crude has fallen by more than half from its 2014 peak, Qatar’s major LNG consumers have been seeking to renegotiate at drastically lower prices.

On 4 March, Moody’s placed Qatar’s Aa2 issuer rating and bonds on review for downgrade and warned it may do something similar to ratings of more than two dozen Gulf banks including Qatar National Bank (QNB) and Commercial Bank of Qatar. The review is expected to last two months.

Moody’s estimates energy accounted for three-quarters of Qatar’s exports, over 50% of GDP and more than 80% of government revenue between 2010 and 2014. And, such calculations were done based on LNG prices that are substantially higher than one could reasonably assume for the foreseeable future, not least after mid-April OPED meeting broke down without agreement on restricting supply. GDP growth turned negative in the final quarter of 2015, to -0.5% quarter-onquarter (announced 11 April 2016).

“While (Gulf) banks have modest direct exposure to the oil sector, we anticipate the significantly reduced level of government revenues will result in substantially lower government spending, declining corporate investment and softening consumption,” Moody’s wrote. “These, in turn, pose the risk of second-order negative implications on funding and liquidity as well as asset quality challenges.”

Public sector deposits at Qatari banks fell 6.7% monthon- month in January, according to QNB Financial Services’ Monthly Banking Update. That followed a 5.2% drop in December. Also, nonessential construction projects – the sector where most bank lending flows into – are being delayed or put on hold. If the economy slows, loan losses will inevitably rise.

Cairo-based investment bank EFG Hermes warns Qatari banks’ main challenge is the erosion of net interest margins because of reduced public sector deposits. That trend will likely hamper earnings growth until at least next year.

QNB dominance

Qatar’s banking system can be divided into two – state-run QNB and all other banks, which are also part or majorityowned by the government. QNB is the Middle East and North Africa’s largest bank by total assets, loans, deposits and profit. By all of these indicators it is also bigger than its four main domestic rivals combined: Qatar Islamic Bank, Commercial Bank of Qatar, Doha Bank and Masraf Al Rayan.

Foreign banks including Standard Chartered and BNP Paribas have a presence in Qatar and often extend finance to Qatari entities. On the retail side, it’s almost solely Qatari banks. QNB operates in about 27 countries across three continents, having expanded this decade. Previously, its banking model was based on taking deposits from state energy producer Qatar Petroleum and subsequently lending these out to other government-controlled entities such as telecom operator Ooredoo, and Qatar Airways. The system essentially facilitated sovereign borrowing and lending.

QNB’s current size and status as government lender of choice should give investors comfort, especially as its annual profit more than tripled from 2008 to 2015 to reach a record high of QAR11.26bn ($3.1bn) last year. But year on- year profit growth was just 7.7%, the smallest increase since 2001.

The bank is also increasingly reliant on large-scale non-government depositors, which is riskier because the likelihood of sudden, massive capital flight is much greater than for retail sector deposits, which are the safest and most stable source of funds.

As of March-end, 55% of QNB’s $111bn of deposits was from corporate clients, versus 16% from individuals. Two years earlier, these figures were 26% and 23% respectively. Deposits from the government and government agencies fell from 51% to 29% over the same period. Other banks have seen their deposit mix follow similar trends.

“In 2015, loan growth in conventional banking was largely funded by international deposits. This may not be sustainable in the long-term,” says Malik Zahir, senior portfolio manager at Securities & Investment Company (SICO) in Bahrain. The composition and duration of the funding mix in Qatari banks indicates that if the current liquidity squeeze persists, their net interest margins are likely to contract.”

Shortly after rival Doha Bank revealed near-flat annual profit for 2015, chief executive R Seetharaman issued a grim outlook for the sector: “With the current set of challenges – commodities falling, currencies bottoming out – it’s going to be tough.”

Sovereign issuance

There are other signs Qatar’s finance system is feeling the strain. In early April, the central bank sold QAR1.5bn ($412m) of treasury bills, its first successful sale this year after it had cancelled similar auctions in each of the three previous months.

“It used to be that government paper could be issued at very low spreads. It was very expensive for investors and fantastic for issuers, but now we’re seeing that trend reverse,” says Fahd Iqbal, head of Middle East research at Credit Suisse.

Three-month interbank lending rates for Qatar and the UAE increased in the second half of 2015, with a sudden spike in Qatar’s rates in November. This lasted about two weeks, indicating funding pressure. In 2016, UAE interbank rates have eased a little, whereas in Qatar rates have risen.

Qatar’s Central Bank governor in February attempted to bolster confidence by saying authorities would use fiscal policy and money market operations to prevent a banking system liquidity squeeze, if required. He also dismissed concerns that liquidity had slumped to problematic levels.

Commercial loans

EFG Hermes predicts Qatari banks’ loan growth will slow to around 10% in 2016 from 13% a year earlier, with loan books still expanding. Loans related to infrastructure investments attached to hosting the 2022 World Cup has kept books expanding despite a spluttering economy.

“Qatar will continue to be one of the most solid markets for loan growth in the (Gulf),” says Elena Sanchez, EFG Hermes banking analyst. She says overall credit quality remained healthy despite signals some sectors face difficulties.

“Trends have been resilient, so far, but in an environment of lower liquidity, we expect some sectors – such as real estate and contracting – to show signs of stress,” says Sanchez, adding there could be a “slight” increase in provisioning costs this and next year.

She expects Qatari banks may have to bolster their capital as they adapt to the more stringent Basel III regulations, singling out Commercial Bank and Doha Bank as domestic lenders with the lowest core equity Tier-1 ratio; this pair must slow down asset growth to retain their capital.

Doha Bank also has weakening asset quality, its non-performing loan ratio was 3.3% at 2015-end versus 3% in September, according to NBK Capital.

The bottom line at some other lenders is also under strain. Commercial Bank’s 2015 annual profit fell by a quarter and Islamic bank Masraf Al Rayan’s 3.6% rise in annual profit last year was its smallest since 2009.

“Although the overall credit quality has broadly remained stable, we should expect delinquencies in contracting loans and personal loans in conventional banks to increase,” added SICO’s Zahir.

Qatari banks such as QNB and Commercial Bank have expanded abroad, but these lenders will likely be more risk-adverse, with QNB’s deal to pay $3bn for Turkey’s unit Finansbank expected to be the last major acquisition for some time.

“Almost all Gulf banks were chasing growth outside the region, but the ones I’ve spoken to recently now say their focus is more domestic,” says Credit Suisse’s Iqbal. “Those with foreign operations will continue to manage those assets but I wouldn’t expect them to increase their foreign exposure while oil prices remain so uncertain and also given current trends.

“NPLs are increasing, as will provisions for quite some time and funding costs are under pressure. Banks in the region are in defensive mode.”

Domestically, Al Khaliji Commercial Bank, Ahli Bank and International Bank of Qatar are said to be exploring a merger to be better equipped to cope with lower commodities prices.

Stock market

Qatar’s stock market, like those in the United Arab Emirates and Saudi Arabia, slumped to a multiyear low in January as investors fretted over the early-year oil price plunge, but Doha’s benchmark subsequently gained 19% to April 10 as the oil price partially recovered.

The market’s resilience is partly because of passive fund flow as Qatar joined various merging market indexes in recent times, although on a net basis there has been an outflow of foreign money over the past year.

“I’m more bearish on Qatar than the UAE and Saudi Arabia,” added Iqbal. “We’ve seen earnings forecasts reduced for most Gulf markets, but not Qatar. Fund managers have talked about this year being a difficult time, not just for investments but also through rising redemptions.”


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