Fitch: Bahraini banks maintain healthy underlying profitability despite some major write-downs

The performance of Bahraini banks in 2007 benefited from its buoyant operating environment, reflected in estimated real GDP growth of 7% and high oil prices, leading to rising Gulf government spending. However, threats to the economy could arise from rapid loan growth, a possible regional property market bubble, inflation and pressure on regional USD currency pegs.

In Q108 and 2007, two major Bahraini wholesale banks, Arab Banking Corporation (ABC, 'BBB+'/Rating Watch Negative) and Gulf International Bank (GIB, 'A'/Stable), suffered extremely large cumulative impairment charges (ABC: USD902m; GIB: USD976m), mainly for investments in structured investment vehicles (SIVs) and collateralised debt obligations (CDOs) with exposure to US subprime residential mortgage-backed securities. These charges led GIB to report an operating loss of USD758m in 2007 (Q108 operating profits: USD22m). ABC reported a 59% decline in operating profits in 2007 (USD92m), but an operating loss in Q108 (USD563m).

Given adverse market conditions, further write-downs for structured credit investments are possible, but are not expected to be as large as those already incurred. Both ABC and GIB maintained adequate levels of capitalisation through this turmoil due to capital injections from their shareholders: GIB announced a USD1bn rights issue in Q407 and ABC announced a USD1bn rights issue in Q208. BBK ('A-' (A minus)/Stable) also suffered impairment charges in 2007 (USD64m), mainly from SIV investments, but these charges were absorbed by operating profits and supported by additional capital from a rights issue (USD133m).

Exceptionally large losses at ABC and GIB overshadowed generally healthy core operating profitability at most Bahraini banks in 2007, driven by rapid loan growth with generally stable margins, growth in fee income from rising business volumes, and steady cost efficiency. This led most banks to report higher pre-impairment operating profits from core business lines.

Despite rapid credit expansion, most banks continued to enjoy stable, satisfactory asset quality and low levels of loan impairment charges in 2007. Nevertheless, rapid loan growth is a concern, with many banks reporting growth well in excess of 20% in 2007; problems are likely to arise when the credit cycle turns. Most banks have exposure to the property market, where a possible asset price bubble could cause systemic problems, though the Bahraini market appears to be less overheated compared with certain other GCC markets.

The outlook for Bahraini retail banks such as Ahli United Bank ('A-' (A minus)/Stable), BBK, and National Bank of Bahrain ('A'/Stable), remains good; profitability trends are expected to remain positive while asset quality and capital are sustained at satisfactory levels. However, exceptionally large losses cause significant concern about ABC's and GIB's franchises, profitability, funding and prospects.

This concern resulted in Fitch placing ABC's IDRs and Support Rating Floor on Rating Watch Negative in Q208, reflecting the agency's concerns that the level of ongoing willingness by ABC's major shareholders to provide support to the bank in the future, in case of need, may have weakened slightly. In both ABC's and GIB's cases, Fitch downgraded their Individual ratings to 'C/D' from 'C'.