Fitch Ratings has affirmed the Long- and Short-term Issuer Default Ratings (IDR) of nine UAE banks and upgraded the Long-term IDR of one non-bank financial institution (Dunia Finance LLC) as part of its second 2015 peer review of the UAE banking sector.
Fitch has also affirmed all nine banks’ other ratings. A complete list of rating actions is available at the end of this rating action commentary.
Key rating drivers
Banks’ IDRS support ratings and support rating floors
The affirmation of the banks’ Long-term IDRs, Support Ratings (SRs) and Support Rating Floors (SRFs), reflects the extremely high probability of support available from the UAE authorities and the local governments, if required.
Fitch’s opinion of support is based on the ability and willingness of the UAE authorities to support the banking sector, which has been demonstrated by the UAE authorities’ long track record of supporting domestic banks, as well as close ties and ownership links with the local government at a number of banks. Fitch’s view of support also considers the UAE sovereign’s strong capacity to support the banking system, sustained by its sovereign wealth funds and revenues, mostly from its hydrocarbon production, and the moderate size of the UAE banking sector in relation to the country’s GDP.
Six of the banks – Abu Dhabi Islamic Bank (ADIB), Al Hilal Bank (AHB), Commercial Bank of Dubai (CBD), Dubai Islamic Bank (DIB), Mashreqbank (Mashreq) and Noor Bank (Noor) – have SRs of ‘1’, reflecting the extremely high probability of state support. Three banks – Bank of Sharjah (BOS), National Bank of Ras Al Khaimah (RAKBANK) and Sharjah Islamic Bank (SIB) – have a SR of ‘2’, reflecting lower, but still high, probability of state support. The SRs of ‘1’ for AHB and Noor also consider the significant government and / or ruling family ownership.
Fitch assesses each bank’s systemic importance relative to other banks in the banking system, and considers, among other things, market share and franchise.
The ‘A+’ SRF of the two Abu Dhabi banks – ADIB and AHB – are at the Abu Dhabi banks’ SRF for domestic systemically important banks (D-SIBs) of ‘A+’, reflecting their high systemic importance. Abu Dhabi banks’ D-SIB SRF is one notch higher than other UAE banks, due to Abu Dhabi’s superior financial flexibility (AA/Stable/F1+).
The ‘A’ SRFs of DIB and Mashreq are at the UAE D-SIB SRF of ‘A’, reflecting their D-SIB status in the UAE and in particular Dubai. CBD’s and Noor’s SRF is one notch below the UAE D-SIB SRF due to Fitch’s view that these are less systemically important based on smaller size and market share, and more niche franchises, compared with DIB and Mashreq. The SRFs for the remaining three banks are ‘BBB+’, two notches below the UAE D-SIB SRF, reflecting Fitch’s view of their lower relative systemic importance, due to smaller market shares and franchises.
The ADIB, AHB, DIB, Noor, SIB and Tamweel Sukuk Company Ltd (guaranteed by DIB) trust certificate issuance programmes, BOS Funding Limited, CBD (Cayman) Limited, RAKFUNDING CAYMAN LTD, and the senior unsecured notes issued under these entities are rated in line with their respective banks’ IDRs and are therefore subject to the same rating drivers.
The upgrade of Dunia’s Long-term IDR mainly reflects the institution’s improved funding profile, through the introduction of a significant base of non-puttable deposits and diversification of existing bank lines. It also reflects its growing franchise, and extra year of track record.
Dunia is a non-bank financial institution and the ratings do not factor in any state or institutional support. Its IDRs reflect strong loan growth, a track record of seven years and dependence on rate-sensitive concentrated corporate deposits. They also consider Dunia’s strong current capital ratios, sound profitability, adequate asset quality, solid financials and prospects and capable management.
Abu Dhabi, and by extension the UAE, is one of the largest economies in the GCC, with solid growth prospects supported by significant government spending on infrastructure projects, and an expanding non-oil private sector, particularly in Dubai. The banks all benefit from a solid operating environment as well as sound liquidity, capital ratios, and pre-impairment operating profit levels, which are able to absorb high credit costs, if necessary.
Asset quality metrics continue to improve, particularly in Dubai banks, which suffered the most from the poor performance of the real estate sector during the financial crisis and some large Dubai government-related entity (GRE) problem loans, although much of the improvement is due to strong loan growth. High loan and deposit concentration is a constraint on the VRs across the sector, but where exposure is directly to the government, Fitch considers it as less unfavourable.
ADIB’s VR reflects the bank’s underlying weak core capitalisation, weak but improving asset quality, considerable balance sheet concentrations and high related-party lending. The rating also considers the bank’s strong and resilient franchise, its capacity to absorb large losses through robust pre-impairment operating profit, and sound balance-sheet liquidity.
AHB’s VR reflects its small but growing franchise, limited track record, and risks associated with the high concentrations in both the financing book, as is evident from the deterioration in the impaired loan ratio and profitability metrics in 2014 due to a new group of large connected non-performing exposures, and the customer deposit base. The VR also considers AHB’s growing franchise and track record and adequate capitalisation.
BOS’s VR reflects the bank’s small franchise, high lending concentrations, weak but improving asset quality, and some risks over related-party loans and investments, which are common in the region. The VR also considers BOS’s satisfactory capitalisation and healthy liquidity.
CBD’s VR reflects the bank’s solid capitalisation and consistent profitability in recent years during challenging market conditions. The key constraints are the bank’s high impaired loan ratio and slightly lower reserve coverage compared with peers, although both are improving, particularly when also considering the bank’s other problematic loans (loans past due over 90 days but not impaired and restructured loans). CBD’s small niche franchise and the risks of operating largely in Dubai are also a constraint, albeit to a lesser extent.
DIB’s VR reflects the bank’s underlying weak, but improving, asset quality, exposure to problem financing, sizeable loan concentrations and renegotiated loan book, and consequent vulnerability to event risk and potentially large losses.
The rating continues to be underpinned by the bank’s strong domestic franchise, comfortable liquidity and funding, predominantly due to its large and stable deposit base and high proportion of liquid assets. Its adequate capacity to absorb losses through robust pre-impairment operating profit is also supportive of the VR.
Mashreq’s VR reflects the bank’s underlying weak, but improving, asset quality and consequent vulnerability to event risk and potentially large losses, through sizeable loan concentrations and renegotiated loan book, particularly to Dubai GRE exposures. It also reflects corporate governance risks regarding the bank’s board composition.
The rating continues to be underpinned by the bank’s strong and resilient franchise, its capacity to absorb large losses through diversified recurring earnings and capital, and comfortable liquidity position primarily due to its large and stable, albeit concentrated, deposit base.
The VR reflects Noor’s small but growing franchise, limited track record, weak asset quality, high, but declining, concentration in the financing book, and in this respect low capital levels. The VR also considers Noor’s adequate liquidity, growing and more diversified customer base, improving profitability, and diversified income stream.
RAKBANK’s VR is constrained by the bank’s fairly small franchise (1.5% of UAE banking assets), and higher risk and higher reward retail model relative to other UAE banks. The rating also reflects strong profitability and performance metrics throughout the global financial crisis and the subsequent downturn in the UAE economy. We also consider RAKBANK’s leading retail business, high revenue generation capability, and healthy capitalisation. Balance sheet liquidity is supported by a large stable customer deposit base and holdings of liquid assets.
SIB’s VR reflects constraints from its modest franchise, high lending concentrations, and some risks over large related-party exposures. However, it also factors in SIB’s strong capital ratios, resilient profitability and sound funding profile.
BANKS’ IDRs, SUPPORT RATINGS AND SUPPORT RATING FLOORS
The banks’ SRs and SRFs are sensitive to a reduction in the perceived ability or willingness of the UAE authorities or local governments to provide support to the banking sector, or a change in Fitch’s view of support in the UAE. Given the robust economy, the authorities’ strong track record of support for local banks and no plans for resolution legislation at this stage, downward pressure is considered low.
Where the banks’ IDRs are driven by sovereign support, they would be sensitive to a change in their SRs or SRFs through a change to the sovereign rating.
The ADIB, AHB, DIB, Noor, SIB and Tamweel trust certificate issuance programmes, BOS Funding Limited, CBD (Cayman) Limited, RAKFUNDING CAYMAN LTD, and the senior unsecured notes issued by these entities, are subject to the same sensitivities.
Further funding structure diversification and more liquid assets could be rating-positive for Dunia, while failure to renew its committed credit lines could result in a downgrade. The ratings could be also downgraded if credit losses mount without compensation from higher margins, resulting in a decline in profitability and, potentially, capitalisation.
Asset quality deterioration and rapid loan expansion, and subsequent reduction in capital ratios, would be the most likely drivers of negative actions of the VRs of banks in this peer group. Reduced concentration in loans and deposits could be beneficial for the VRs.
Fitch believes that ADIB’s VR remains sensitive to deterioration in asset quality, capital or profitability. Further reductions in core capital ratios are likely to be negative for the rating.
A sustained improvement in asset quality and capital ratios could lead to an upgrade in ADIB’s VR.
Further evidence of its strategy implementation and a longer track record could be a positive rating driver, but is unlikely in the short term. Downside risk could arise if asset quality metrics continue to deteriorate, further impacting the bank’s profitability and capitalisation.
Upside potential to BOS’s VR is somewhat limited, given the bank’s weak asset quality indicators. The VR could be downgraded if asset quality deteriorates and this impacts the bank’s profitability and capital position.
A downgrade of CBD’s VR would be likely if a significant deterioration in asset quality leads to weaker capital ratios. An upgrade of the VR may result from further recovery of problem loans and strengthening of the franchise.
Fitch believes that DIB’s VR remains sensitive to deterioration in asset quality that affects the bank’s capital or profitability. The effect of continued high loan growth poses a risk to the bank’s capital ratios. Significant and sustained improvement in asset quality could lead to an upgrade of DIB’s VR.
Fitch believes that Mashreq’s VR remains sensitive to deterioration in asset quality, particularly regarding the repayment of the large Dubai GRE loans, which have the potential to result in a sharp increase in impairment charges and affect the bank’s capital ratios. The effect of continued high loan growth is also a risk to the bank’s capital ratios.
An upgrade could result from further improvement in asset quality and a track record of repayment of restructured loans.
Upside for the VR could arise from improvements in asset quality, particularly repayment of the large Dubai GRE exposures, and in capital. Further evidence of Noor implementing its strategy and building a track record with no material deterioration in the bank’s risk indicators would also contribute to an upgrade.
The VR may be downgraded on material deterioration in asset quality further impacting the bank’s profitability and capitalisation.
RAKBANK’s VR could be negatively affected if the bank’s strong growth materially affects capital levels or its expansion in unsecured SME lending leads to materially larger credit losses. However, risks to asset quality are counterbalanced in the interim by the bank’s strong capital position. The rating could be upgraded if the bank fully addresses its issues in funding and liquidity and further diversifies its business profile.
Upside potential to SIB’s VR is limited by the bank’s concentrated financing portfolio and fairly small franchise within the UAE banking sector. Downside risk to SIB’s VR could arise from deterioration in asset quality affecting the bank’s profitability and eroding capital beyond a comfortable level, especially considering the high proportion of capital invested in real estate.