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Al Baraka Islamic Bank’s ratings affirmed

Outlook for Foreign Currency Ratings revised to ‘Negative’.

Capital Intelligence (CI), the international credit rating agency, announced today that it has affirmed Bahrain-based Al Baraka Islamic Bank’s (AIB) Financial Strength Rating (FSR) at ‘BB’, on ‘Stable’ Outlook, supported by its strong ownership, comfortable liquidity premised on customer deposit funding, and the improvement in the capital adequacy ratio (CAR).

The FSR remains constrained by sovereign risk exposure in Pakistan (through ‘AlBaraka Bank Pakistan’), where economic conditions remain difficult despite some improvement, and a relatively high non-performing financings (NPFs) ratio and low loss-reserve cover. Also constraining the FSR is the Bank’s ongoing very weak profitability at both the operating and net levels. AIB’s Long and Short-Term Foreign Currency Ratings are maintained at ‘BB+’ and ‘A3’, respectively. The Support Level of ‘2’ is affirmed on the grounds of the high likelihood of support from the parent. In view of the ‘Negative’ Outlook CI assigned to the Kingdom of Bahrain’s Sovereign Ratings in April 2015, and the resultant downward pressure it places on the ratings of all the banks in the system, a ‘Negative’ Outlook is appended to AIB’s Foreign Currency Ratings.

AIB is a subsidiary of the Bahraini Public Shareholding Company ‘AlBaraka Banking Group’, which operates Islamic banking subsidiaries in the MENA region and further afield. AIB is still a small bank by all measures in Bahrain, but claims a rather significant market share of Islamic banking assets in Pakistan. Following settlements and write-offs in the preceding year, NPFs rose in 2014 due to one large account. Coverage of NPFs by financing-loss reserves also weakened in the same year. As a result, the proportion of unprovided NPFs to free capital increased, and returned to the level seen a few years earlier. Although economic growth in Bahrain and Pakistan is expected to continue recovering, credit risk remains elevated and this may translate into additional new NPFs in the near to medium-term. Notwithstanding the secured nature of a majority of AIB’s facilities, it is CI’s view that stronger loss-reserve coverage for NPFs is necessary in order to provide a buffer against existing impaired facilities, as well as for latent credit risk. This is particularly the case since the Bank’s capacity to build provisions is severely constrained by its very weak operating profitability.

Although gross income grew further lifted by a rebound in net profit sharing, a larger rate of increase in total operating expenses due to branch expansion and IT investment produced a decline in what was already very weak operating profitability. Net profit growth recovered however, though from a very low base and after successive decreases in the previous three years, thanks to a considerably lower provision charge. AIB’s ROAA (return on average assets) remained very weak, while the paltry operating profitability materially restricts its risk absorption capacity. Although management has projected some improvement in profitability ratios over the medium-term as a result of higher financing volumes, CI expects metrics to remain weak.

The Bank’s liquidity position continued to be comfortable, with a considerable amount of that liquidity primarily generated from customer deposits. However, a majority of liquidity was invested in marketable Pakistan government Sukuk, and to lesser extent in Bahrain government Sukuk. The customer deposit base comprised largely Unrestricted Investment Accounts and was reasonably diversified. Following a significant decline in CAR a year earlier, the CAR improved in 2014 as a result of a subordinated debt issue (Tier 2) at the Pakistan subsidiary. The rate of internal capital generation remained meager due to weak net profitability.

Incorporated in Bahrain in 1984, AIB operates as a retail Islamic bank under a license granted by the Central Bank of Bahrain (CBB). AIB is a 91.1% owned subsidiary of ABG, which is majority owned by prominent businessman Shaikh Saleh Abdulla Kamel in Saudi Arabia and Dallah Al Baraka Holding Company (E.C.). The latter is a subsidiary of the Jeddah-based conglomerate Dallah Al-Baraka Group. The principal activities of AIB include the provision of demand and investment accounts, and finance and investment on the basis of Murabaha, Mudaraba, Musharaka and Ijara. AIB’s Pakistan subsidiary operates 110 branches, situated in the major cities. In Bahrain, banking operations are conducted from the head office and six branches. AIB’s total assets at end 2014 were USD1,835mn and total capital was USD170mn.