CREDIT RISK OF UAE BANKS

Supervised By: Dr. Hussein Al-Tamimi

Student Name: Morshed Abdulqader Parkook

Credit RISK analysis: an empirical study OF UAE BANKS

Student name: Morshed A. ParkookSupervisor Name: Dr. Hussein Al-Tamimi

 Abstract   Credit risk has been growing worldwide significantly in the past years and is getting emphasized in whole world including United Arab Emirates Credit risk has grown exponentially against the backdrop of dramatic economic, political, and technological change around the world. In this project, an attempt has been made to investigate whether UAE banks were affected by the recent financial crisis. The purpose of the study is to analyze the significance of some credit factors generally considered important by credit analysis experts. In addition, to find out which of these factors have been associated with the credit risk. The empirical part focuses on some large corporations in UAE, in order to see if they are good banks borrowers or not. The main conclusion of this project is that there is a strong relationship between corporate financial performance and credit risk. It is also found that Citibank and HSBC were the best prepared banks for credit risk. On the other hand, Etisalat was the best potential borrower, whereas Tabred was the worse one.  Key words: Credit analysis, Financial performance, UAE banks.

Research Methodology

• The purpose of the study The purpose of the study is to analyze the significance of some credit

factors generally considered important by credit analysis• The Scope of the study The study focuses on credit risk assessment in a representative

selection of UAE banks and corporations.• Sources of data Data were obtained from banks and corporations financial reports

(report of condition and income statement)• Hypotheses of the study In this study I predict that there is a really strong relationship between

corporate financial performance and credit risk banks may get in if the lend to the wrong borrower.

Credit RiskCredit risk: is the oldest form of risk in the financial markets. If credit can

be defined as “nothing but the expectation of a sum of money within some limited time,” then credit risk is the chance that this expectation will not be met.

Types: • A consumer or business does not make a payment due on a

mortgage loan, credit card.• A business does not pay a A/R (invoices) when due.• A business does not pay an employee's earned wages when due.• A business or government bond issuer does not make a payment on a

coupon or principal payment when due.• An insolvent insurance company does not pay a policy obligation• An insolvent bank won't return funds to a depositor. (FDIC !)

CREDIT RISK MANAGEMENT

• Credit risk is defined as the risk arising because borrowers may default on their obligations. Or The probability that some financial institution assets, especially its loans, will decline in value and perhaps become worthless (toxic assets)

• The concept of adverse selection and moral hazard provide a frame work for understanding the principals that financial institution managers must follow to minimize credit risk and make successful loans.

Principals Of Managing Credit Risk

• Screening and monitoring • prime lending (credibility)• Long-term customer relationships

– Loan commitments– Collateral– Compensating balances

• Credit rationing

Credit risk analysis methods3 Questions

1. Is the borrower creditworthy? The 5Cs of credit:

• Character• Capacity• Cash • Collateral• Conditions

Continue

2. Can the loan agreement be properly structured and documented?

3. Can the lender perfect its claim against the borrower’s earnings and any assets that may be pledged as collateral?

Collateral and popular assets pledged

Factors determining the growth and mix of loans

I. The profile of characteristics of the market area that lenders serves

II. Lender size

III.The experience and expertise of lenders officers

IV. The expected yield that each loan offers

V. Rules & Regulations (UAE real estate, and other rules)

Empirical Analysis

• Credit Risk of UAE banksCredit Risk Ratios→Annual analysis → 2008 2009 2008 2009

Emirates NBD 0.006 0.013 1.16 1.07CitiBank 0.035 0.18 0.73 0.56Dubai Commercial Bank 0.015 0.015 1.02 1.11Dubai Islamic Bank 0.0007 0.002 0.95 0.88Abu Dhabi Commercial Bank 0.014 0.032 1.29 1.35Abu Dhabi Islamic Bank 0.01 0.03 1.17 1.13United Arab Bank 0.004 0.007 1.1089 1.0732First Gulf Bank 0.007 0.02 1.07 1.04HSBC 0.012 0.064 0.82 0.75Fujairah National Bank 0.02 0.03 1.004 0.93Mean→ 0.0393 0.98932

Total loans/Total DepositsAnnual provision for loan losses/Total laons and leases

Banks name↓

BANKS CREDIT RISK ANALYSIS

Corporation's Credit risk analysis

• common size statement Common Size Statements Ratios →

Annual analysis → 2008 2009 2008 2009 2008 2009 2008 2009 2008 2009

Arabtec 0.53 0.51 0.08 0.07 0.6 0.53 0.22 0.29 0.11 0.07Gulf Navigation 0.019 0.035 0.213 0.138 0.023 0.018 0.55 0.57 0.003 0.011Aramex 0.19 0.17 0.19 0.24 0.06 0.06 0.78 0.79National Cement 0.053 0.061 0.05 0.05 0.05 0.08 0.92 0.9 0.029 0.033Dubai Refreshments company 0.19 0.15 0.02 0.19 0.2 0.22 0.76 0.72 0.114 0.094DU 0.091 0.105 0.16 0.09 0.31 0.38 0.32 0.29 0.007 0.004Tabreed 0.061 0.075 0.096 0.044 0.21 0.25 0.37 0.19 0.01 0.047

Dana Gas 0.04 0.06 0.07 0.06 0.03 0.04 0.66 0.67 0.019 0.063Etisalat 0.31 0.39 0.17 0.15 0.35 0.34 0.56 0.56 0.0029 0.0038Surooh 0.14 0.21 0.4 0.2 0.024 0.013 0.35 0.48 0.002 0.0009Abu Dhabi Ship Building Co 0.49 0.17 0.18 0.09 0.21 0.26 0.16 0.15 0.0075 0.0089Julphar 0.26 0.27 0.04 0.08 0.05 0.06 0.77 0.76 0.135 0.127Rak Cement 0.21 0.09 0.104 0.106 0.08 0.04 0.89 0.94 0.065 0.088Union Cement 0.16 0.12 0.019 0.042 0.04 0.03 0.91 0.95 0.12 0.11Mean (including both cities) 0.17257 0.11071 0.16579 0.59 0.0508154

Dubai Corporations

Abu Dhabi Corporations

A/R÷Total Assets Cash/Total Assets A/P÷Total Assets Equity/Total Assets Inventory/Total Assets

Corporations names↓

Corporation's Credit risk analysis

• Common Size Statements Ratios→

Cross sectional analysis

• Liquidity ratios : • Current ratio• Quick ratio

• Efficiency ratios• The inventory turnover ratio• The average collection period• Number of days for which inventory is tied up

• Profitability ratios: • Gross profit/ sales• Net profit/ sales

• Leverage ratio• Debt/ equity ratio• Interest coverage ratio

Ratio Analysis

2008 2009 2008 2009 2008 2009 2008 2009 2008 2009 2008 2009 2008 2009 2008 2009 2008 2009

Aramex 2.31 2.55 60.76 64.98 0.49 0.56 0.08 0.1 0.28 0.27 51.72 112.4Gulf Navigation 2.48 2.3 2.45 2.17 48.56 10.8 52.25 111.26 7.52 33.8 0.46 0.18 0.37 0.08 0.79 0.74 5.43 1.56National Cement 2.23 2.28 1.79 1.86 6.87 6.22 98.4 106.99 53.13 58.68 0.21 0.27 0.35 0.31 0.07 0.09Dubai Refreshments company 1.54 1.92 0.99 1.55 15.32 17.95 39.02 32.47 23.82 20.33 0.24 0.24 0.023 0.046 0.31 0.38 5.61 16.98DU 0.94 0.6 0.92 0.59 74.6 137.13 65.19 68.7 4.89 2.66 0.63 0.66 0.001 0.05 2.1 2.41 1.9 42.35Arabtec 1.039 1.17 0.89 1.061 9.56 11.83 187.08 222.78 38.18 30.85 0.15 0.17 0.11 0.077 3.47 2.34 46.06 12.24Tabreed 0.63 0.17 0.44 0.08 9.5 20.42 223.1 286.4 38.42 17.87 0.43 0.39 0.15 -16.7 1.72 4.33 2.35 -10.48

Dana Gas 3.76 3.67 3.25 3.31 3.13 5.15 266 304 116.6 70.8 0.39 0.5 0.18 0.1 0.49 0.48 1.98 2.3Etisalat 0.81 0.83 0.8 0.82 160.19 113.18 67.75 55.04 2.27 3.22 0.5 0.55 0.27 0.27 0.76 0.76 11.62 15.4Surooh 1.4 1.56 1.4 1.6 124.6 234.4 234.6 336.4 2.93 1.55 0.62 0.3 0.48 0.16 1.8 1.2 23.2 5.03Abu Dhabi Ship Building Co 2.08 2.2 2.06 2.18 65.4 58.5 37.05 125.82 5.58 6.23 0.24 1.59 0.12 0.7 2.51 2.44 20.77 17.69Julphar 2.23 2.62 1.58 1.92 2.77 3.27 255.9 242.06 131.76 111.6 0.57 0.59 0.214 0.16 0.29 0.31Rak Cement 3.46 5.67 2.87 5.66 7.26 3.72 161.75 92.67 50.27 98.12 0.21 0.26 0.19 0.25 0.12 0.05 412.87 260.97Union Cement 3.89 7.68 2.36 4.57 6.16 4.12 78.8 95.66 59.25 88.6 0.19 0.19 0.14 0.09 0.094 0.049 38.29 90.84

Mean (including both cities) 2.51571 2.105 48.20692 153.23 41.87 0.46071 -1.02193 1.132071 47.2733

Efficiency ratioFinancial ratios→

Dubai Corporations

Abu Dhabi Corporations

Gross profit/ sales net profit/ salesProfitability ratios

Debt/ equity ratio interest coverage ratioLeverage ratio

Current ratio Quick ratioLiquidity ratios

Inventory turn over ratio

Corporations names↓

average collection period number of days for which inventory is tied up

Continue Cross sectional analysis

Empirical finding

• If you remember the previous findings, we mentioned that the best two are Surooh and Etisalat. In this section we found that the best firm is also Etisalat in addition to Abu Dhabi Ship Building Company. And the worse one is Tabreed.

(Altman) Z-scoreThe Z-score formula for predicting bankruptcy was published in 1968 by Edward I. Altman. The formula may be used to predict the probability that a firm will go into bankruptcy within two years.

Z-scores are used to predict corporate defaults and an easy-to-calculate control measure for the financial distress status of companies in academic studies.

The Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company.

(Altman) Z-score• if (Z< 1.81) the firm will default. If Z (1.81:2.675), the

firm will either default or not. If (Z> 2.675), the firm will not default.

Using Z score→

Yearly analysis→ 2008 2009Arabtec 1.46 1.79Gulf Navigation 1.35 0.85Aramex 2.35 2.82National Cement 0.95 1.2Dubai Refreshments company 3.15 3.17DU 2.97 1.82Tabreed 0.27 -1.2

Dana Gas 0.84 1.09Etisalat 2.16 4.71Surooh 1.7 1.43Abu Dhabi Ship Building Co 1.14Julphar 1.68 2.59Rak Cement 2.01 1.28Union Cement 2.28 1.74

Mean 1.74

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

Abu Dhabi Corporations

Dubai Corporations

Corporations names↓

Empirical finding

Arabtec

Gulf Nav

igation

Aramex

National

Cemen

t

Dubai Refr

eshmen

ts co

mpany DU

Tabree

d

Dana G

as

Etisal

at

Suro

oh

Abu Dhabi S

hip Building C

o

Julphar

Rak Cem

ent

Union Cemen

tMea

n

-2

-1

0

1

2

3

4

5

6

Using Z score→

Risk Premium analyzing

• The higher the rate of return will lead to higher the probability of default and high credit risk for lender points of view.

• Keep in mind also that factors other than credit risk also affect the premium. Financial market participants often mention liquidity of a debt issue as being important for the premium.

Beta

• Beta is a relative measure of the systematic return of the stock to the overall market. Stocks with Betas greater than 1.0 are highly volatile and have a positive correlation with the market; such stocks are termed aggressive securities. Stocks with Betas less than 1.0 are either more stable than the average or have a low correlation with the market or both (defensive securities).

• Stocks with a negative Beta move in the direction opposite to that of the market.

Empirical finding Remember the higher the Beta the higher is the risk.

Conclusions

• Our finding showed to us that the best firms are: Etisalat, Surooh and Abu Dhabi Ship Building. The worst firm only is Tabreed.

• Regarding the banks, we showed that Citibank and HSBC are the lowest credit risk encountered banks.

• (Business credit instrument and derivatives, business credit insurance, Credit default swap. )

• Recovery and real-estate issue .(See http://www.zawya.com/story.cfm/sidZAWYA20110501055100/Is_Dubai_Back) • No FDIC !