|The UAE’s non-performing loans are among the largest among the largest economies in the Middle East and Africa, partly due to its high exposure to the construction industry.
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Bank sales of non-performing loan portfolios are becoming more common in the United Arab Emirates as lenders prioritize cleaning up their books and improved regulation makes such deals more attractive to buyers, according to market watchers.
Abu Dhabi Commercial Bank PJSC, or ADCB, is selling about $1.1 billion in bad loans, including personal and corporate loans and real estate assets, Bloomberg News reported in September. This would be the largest sale of a non-performing loan or NPL portfolio of its kind in the UAE, said Jaap Meijer, head of research at Dubai-based Arqaam Capital.
Local subsidiaries of international banks have made some moderately large sales of NPL portfolios, while transactions involving individual borrowers have been taking place for some time, Alvarez & Marsal Middle East CEO James Dervin said.
Still, a few of these deals, some of which have involved international investment firms, have been made public. One exception was UAE asset manager and investment bank SHUAA Capital PSC’s January 2021 AED 1.13 billion debt owed by Stanford Marine Group to various lenders.
“It’s not a deep market and deals are few and far between, which is why the ADCB sale is so important,” said Michael Rainey, a law firm at King & Spalding in Dubai.
Loan book cleaning
ADCB’s proposed loan sale will benefit the bank by giving it “a lower NPL figure without a negative impact on the income statement because the loans were either fully written off or fully provisioned on a net basis,” Meijer said. It also frees up management time to move the business forward instead of handling traditional tasks, as ADCB has been hit by several business failures in recent years, he said.
The most notable of these failures was Abu Dhabi’s NMC Health PLC, which admitted in 2020 that it had “materially misrepresented its debt position in its financial accounts”, according to ADCB’s annual report. The bank supported the motion to place NMC Health into administration and blamed the company and its related companies for much of its impairment. The ADCB declined a request for comment.
Data from S&P Global Market Intelligence shows the bank has already made progress in reducing its non-performing loan ratio, which stood at 4.91% in the second quarter, compared with 6.19% in the previous quarter and 6.26% a year ago.
ADCB’s Q2 NPL coverage of 48.5% was lower than peers First Abu Dhabi Bank PJSC, Emirates NBD Bank PJSC and Dubai Islamic Bank PJSC. Among the top five banks in the UAE, only Mashreqbank PSC had a lower NPL ratio than ADCB in the period 27.9%.
Market Intelligence data shows that the UAE’s NPL ratio is higher than many major economies in the Middle East and Africa.
UAE banks are exposed to very high credit risks, given the industry’s aggressive lending and underwriting practices and structurally high concentration in the real estate and construction sectors, according to S&P Global Ratings. Loan portfolios are typically concentrated in one name, and the banks also have significant exposures to some troubled government entities, the agency wrote in a report published in July.
Loan losses have historically been higher among UAE banks than in the rest of the GCC, Meijer said, although the strength of the economy means the formation of new non-performing loans is fairly limited. The ratings forecast UAE banks’ Stage 3, or non-performing loans, to be between 5.8% and 6.2% in 2022-2023, compared with 6.1% at the end of last year.
According to Dervin, the commercial rationale for banks selling non-performing loans is convincing. “Assuming that the sale price exceeds the write-down value, you not only improve financial performance, but you are also freed from the capital constraints associated with non-performing loans,” he said.
The likely discount that buyers can expect to receive from the face value of the loans depends on the specifics of the loan or loans in question, as well as external factors such as the jurisdiction and the strength of enforcement mechanisms in that jurisdiction, Dervin said.
A”A historically unhelpful legal system” and “negative attitudes to financial distress that often result in nothing more than a rearrangement of deck chairs” have been key factors in the slow development of the UAE’s distressed debt market, according to a July memo from law firm Mayer Brown.
The UAE’s recent mortgage and civil law allows for the concept of subrogation – a third party taking ownership of an existing debt – but it has not been used often and the requirements are “not particularly clear”, Mayer Brown wrote.
Instead, ddistressed debt buyers who do not have local lending licenses typically operate in the market on a “participation” basis, where the buyer gets rights to the debt, but the seller remains its legal owner.
“It as a mechanism is not unique to the region. This is a feature of developed markets where the seller and buyer trade in this way simply because they don’t want to make it public,” Dervin said, adding that in some countries, the lender’s ability to exit the position may be limited by the original loan documents or other regulatory aspects.
Rainey said US or European distressed debt funds considering buying NPL portfolios in the Middle East need to analyze all the regulatory challenges before even thinking about doing a deal.
“If you were to buy a non-performing loan, there might be a regulatory issue as to whether you can even hold such a loan because lending, including holding a third-party loan, is generally considered a regulated activity,” said Rainey.
A brighter future
Mayer Brown notes that significant progress has been made in recent years to address these issues, including the introduction of a new corporate insolvency regime.
In early 2020, India and the UAE agreed to make UAE court judgments on loan defaults enforceable in India. Historically, loans in the UAE have been secured by guarantees and commonly requested post-dated cheques, but recent legislative changes allow creditors to take collateral over a debtor’s floating assets, such as bank accounts and warehouse receipts, Rainey said.
In an ADCB sale, the lender may seek the UAE Central Bank’s blessing before closing the deal, Rainey noted. A positive result could increase the confidence of other banks and investors to make similar deals in the future.
“As regulation, recognition and legislative systems improve, the prospects for recovery will increase and so the potential attractiveness and viability of the market will increase,” Dervin said.
On October 25, 1 USD equaled 3.67 UAE Dirhams.