Strategies to solve the problem in the construction and banking sector of the UAE from the fall in real estate prices

The shock caused on the demand side of the real estate market in Dubai (UAE) has caused a price drop in the real estate market of between 25%-35% compared to 2014 price levels. This situation has as a direct consequence that the construction industry in the United Arab Emirates is constantly moving in uncharted waters with many construction companies not able to meet their debt obligations.

by Thanos S. Chonthrogiannis

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To restore bankruptcy, state and private construction companies are forced to advance in agreements with their lenders-the credit institutions in the UAE for massive restructuring of their loans to their survival hoping that with this way they will avoid bankruptcy.

The UAE government to reverse the burdened climate announced some initiatives aimed at stimulating the domestic sector and upgrading the real estate market.

The large number of available properties has created an exaggeration on the supply side when there is an economic slowdown and investment uncertainty at global level. Investments made in properties in Dubai in previous years had as their main objective the future increase in prices, hopefully investors to reap some future time goodwill from their investment.

But the market and markets in general do not work in this way (e.g. constant price rises). The fact of the geopolitical tensions that exist in the Persian Gulf region which are likely to intensify in the future makes potential investors reluctant, while those who are property owners in the region are trying to find a way to sell at a much lower price with the aim of being rid of any investments.

Besides all these construction companies due to their high degree of lending and in order to survive avoiding bankruptcy, they sell in many cases unsold property at below cost prices to initially limit the damage to their investment portfolios. In addition, real estate companies seeing the constant decline in demand are further pushing down the property prices because they try to sell at much lower prices.

This combined wave of sellers trying to get rid of the properties in their possession will continue to fuel the fall in prices in the real estate market. Any potential investors-buyers who want to enter Dubai’s property market do not have time pressure and will first expect to lower prices even more than 50% compared to the 2014 prices before entering the market as buyers.

Blow to the banks of the UAE

The non-possibility of disengagement of construction companies from their properties that cannot be sold makes them unable to serve their loan liabilities (red loans-are loans that are not served for more than three months) constantly burdening the UAE banks which still have open wounds from the 2010 crisis that appeared in the real estate market.

Over time the volume of non-performing mortgage and business loans will increase by creating a blow to the banks’ balance sheets. Based on the announcements of Fitch Ratings (24/09/2019) the red loans (overdue loans) to the UAE banks reach a level of $23 billion, with many of them belongs to state-owned construction companies. The loans of construction companies and real estate companies constitute 20% of all loans to UAE banks. On the other hand, the Central Bank of the UAE announced that red loans make up 5% of all loans.

The options for Construction companies and Banks

For construction companies and real estate companies the options are specific:

1. They can keep properties in their portfolio without encountering loan problems in order to sell them in the future at better prices. However, as time passes, and a property is not sold so the investor will suspect that the property is not sold due to a problem that it may have.

2. They can get involved in long-term leasing to create cash-flows in their revenue portfolios, but without that means they will achieve the price they want. However, if in the real estate market is hard to sell then it is hard to rent or make long-term leasing.

3. Since they cannot serve their loans, they must sell at any price to stop being involved with their specific investments.

For banks and credit institutions in general:

The damage to banks’ balance sheets caused by non-performing loans that will swell over time should be eliminated:

α) either by “mowing” elements in the liabilities side of banks.

β) or by state-by-capitalisation. The per-capitalisation would cause a budget deficit in the UAE government’s annual budget. The fact that the UAE have a large reserve in foreign exchange reserves        with their continuous per-capitalizations of their banks will cause instability in their foreign exchange reserves. 

The final costs incurred with any application of the first two options (a) and (b) will be borne and will increase the budget deficit of the government of the UAE. It will essentially burden the taxpayer citizen.

The correct resolution of the problem

1. In the first place, a thorough check (audit) should be made on the balance sheets of all banks and of borrowing schemes operating in the territory of the UAE. The audited banks with a high percentage of red loans should proceed to their per-capitalisation in which their shareholders will participate. If the principal shareholder in them is State, the funds will come from it.

Next, a created credit scheme will then be used to be funded by the banks themselves. After, the most-capitalised (and problematic by audit) banks will transfer to this selected for redemption problematic credit scheme all the damage they present in their balance sheets, e.g. overdue loans, overdue mortgages, overdue construction business loans, etc. which they have in their loan portfolios.

Then a conversion will have to be made-a separation of this created credit scheme, in a ‘good’ and ‘bad’ bank. The good assets and liabilities of this “good” bank that will emerge will be shared among the other per-capitalised, due to overdue loans, banks. On the other hand, all losses and all overdue loans of the entire UAE banking system will be transferred to this “bad” bank.           

Then, in the “bad” bank should be restructured and re-valuation of all losses and overdue loans that will now have in its portfolio at current prices so that where there are overdue loans to be securitized with aim to become more attractive to interested prospective investors-funds.

With this gigantic securitization of problematic loans these loans will be changed hands and redeemed by investors at low prices that will allow them to delete a large part of overdue and problematic loans with a profit and discharging him from the debts of the individual or the debtor.

This type of flexibility (deletion of a large part of the debt) is not available to banks that have granted any problematic service loans to businesses and individuals because they cannot waive the collateral that accompanies a loan, e.g. an entrepreneur’s personal guarantees, nor accept loan deletions without the commitment of other assets of the debtor.

The proceeds from the sale of these overdue loans and losses of the “bad bank” will redirected fully and in total to the state as long as he participated with his funds in any of the banks in difficulty, so that these revenues mitigate the cost of burdening it from the per-capitalizations.

Thereafter and within a six-year horizon from the date of the per-capitalization of these problematic banks, the UAE government should proceed to the sale of these per-capitalised and now established banks in much better prices in order for the State to be able to collect a large portion of all of its funds that it used for the per-capitalization that borne by it.

In this way the UAE banking system will transfer the burdens of the past and will sanitized, proceeding to “cannibalism” essentially of the new created for this purpose bank to survive and to fully sanitized its existence.

By implementing this strategy does not mean that new overdue loans will not be created to these banks from current bank loans, if the fall of the prices in the real estate market continues due to geopolitical tensions and global economic slowdown etc. 

The disadvantage with this method is that social unrest can be created because with the securitization and sale of losses and overdue loans of the “bad” bank will begin to take part auctions and property foreclosures so that funds investors get their money back.

In this case, the social protection net of the state of the UAE should operate in not leaving any entrepreneur or individual without decent shelter and food while giving the opportunity to the citizen to start his life again from the beginning.

2.  As an alternative method the UAE government could apply to banks a strategy of an Asset Protection Scheme, which will limit red loans to the banks’ portfolio by $15 billion and will be based on a variation of the corresponding Asset Protection Scheme implemented in Italy.