(MENAFN- Capital Intelligence Ltd) Capital Intelligence Ratings (CI Ratings or CI) today announced that it has affirmed the Long-Term Foreign Currency Rating (LT FCR) and Short-Term Foreign Currency Rating (ST FCR) of Oman Arab Bank’s (OAB) at ‘BB’ and ‘B’, respectively. At the same time, CI Ratings has affirmed OAB’s Bank Standalone Rating (BSR) of ‘bb’, Core Financial Strength (CFS) rating of ‘bbb-’ and Extraordinary Support Level (ESL) of Moderate. The Outlook for the LT FCR and BSR remains Negative, which is in line with the Outlook for Oman’s sovereign rating.

The ESL assessment does not result in any uplift for the Bank’s LT FCR because the BSR is already at the sovereign level. While the government has a strong track record of providing assistance to banks in need, CI is of the opinion that its ability to support the banking sector has moderated further in 2020 due to its weakening fiscal position.

The Bank’s BSR is derived from a CFS rating of ‘bbb-’ and an Operating Environment Risk Anchor (OPERA) of ‘bb-’. The latter indicates moderate risk and takes into account the weakening of the operating environment due to Covid-19, the limited diversification of the Omani economy, increased government refinancing risk from higher dependence on foreign funding, low monetary policy flexibility and still elevated geopolitical risks.

The BSR and CFS rating are underpinned by OAB’s deep pool of customer deposits which continue to support its good loan-based liquidity position, the solid capital ratios with a high component of CET1/Tier 1 capital, its sound operating profit and moderately good credit loss absorption capacity. The ratings also reflect the Bank’s supportive major shareholder, Arab Bank Plc (Jordan), which continues to make available a sizeable line of credit. The strengthened business franchise in terms of a stronger Islamic banking capability and larger branch network following the acquisition of Alizz Islamic Bank (AIB) on 30 June 2020 also support the ratings. Oman’s well regulated banking environment and the measures introduced by the Central Bank of Oman (CBO) to support the banking sector through these testing times is also an important supporting factor for the Bank and the sector.

The main challenge for the Bank and the sector is the slow economic growth due to the continuing impact of Covid-19 and low oil prices, exacerbated by a cut in government expenditure arising from Oman’s weak fiscal position. Other concerns in common with most of its peers are the Bank’s sizeable Stage 2 loans, forbearance measures extended to borrowers that could threaten future asset quality, and moderately high customer concentrations in both the loan book and customer deposit base. Concentration levels however reflect the small size of the Omani market.

OAB remains largely a corporate bank with a sizeable and growing retail business operation. At end 2020, the consolidated loan book remained skewed towards the corporate segment, although the latter was diversified across a wide range of industries without any undue sector concentration risk. Borrower concentration arising from the small Omani market remains moderately high, in common with its peers. OAB strengthened its business franchise with the acquisition of AIB in June 2020 and is now the fifth largest bank in Oman in terms of total assets at end 2020.

The pandemic and the ensuing lockdown measures in Oman had a significant impact on business activities, leading to a weakening of asset quality across the banking sector. Together with AIB’s non-performing financings, OAB’s NPL (defined as Stage 3 exposures) ratio rose but remained close to the average for the banking sector. Loss coverage strengthened but was still less than robust, especially in view of the high level of Stage 2 loans. The Bank’s coverage ratio was also some way behind those of many of its peers. This could partly be a reflection of the good collateral cover held by the Bank against its impaired loans. OAB’s large Stage 2 loans are an area of concern given the tough market conditions. However, we note that this is an industry-wide occurrence and many of its peers also have sizeable Stage 2 exposures. The Bank also reported sizeable past due not impaired loans, although the largest proportion was in the under 30 days overdue bucket at end 2020.
In CI’s view, the forbearance measures introduced by the CBO in early 2020 to cushion the impact of the crisis on businesses in Oman are likely to have masked the banking sector’s actual asset quality. In this regard, the Bank has disclosed the value of loans that have benefited from forbearance measures and, based on this information, in our view, the deterioration of the loan book is likely to be manageable. The forbearance measures have since been extended to September this year and, consequently, CI anticipates a further weakening of loan asset quality metrics, although key indicators at OAB could remain fairly sound. The Bank’s solid capital as well as the plan to issue additional Tier 1 capital provides additional buffer. While operating profitability declined significantly in 2020 due to the year’s unusual economic circumstances, in our view, OAB’s credit loss absorption capacity is likely to recover going forward aided by a sound business franchise and expanded market share.

A key strength of the Bank is its large base of customer deposits, which continues to support its good liquidity profile. Its net loans to customer deposits ratio remained the best among many of its peers and wholesale borrowings continued to be very low. The latter, in turn, has contributed to a good net broad liquid asset ratio for the Bank. The sound liquidity buffer is also reflected in the net stable funding ratio and the liquidity coverage ratio, which were maintained well above regulatory minima. A related vulnerability at OAB, even after the acquisition, is the high concentration of government deposits. A mitigant is the historical ‘stickiness’ of these deposits. As government funds account for a sizeable proportion of the banking system’s total deposits, these will continue to be an important source of funding for the sector. Consequently OAB and its peers will likely remain vulnerable to government withdrawal risk. In this regard, CI has noted that to meet its financing needs, the government has thus far resorted to drawing down fiscal reserves and borrowing from domestic and international markets rather than withdrawing its deposits from the banking sector. The recent rebound in oil prices could also ease the pressure, however slightly, on Oman’s fiscal position.

OAB’s consolidated capital ratios were fairly solid by international standards at end 2020. While they were some way behind the peer group averages, they were well above regulatory minimums. The quality of capital is also good, with a high proportion of CET1/Tier 1 capital. The Bank’s balance sheet leverage slipped marginally but remained at a good level at end 2020. In common with many of its peers, OAB’s internal capital generation rate turned negative in 2020 due largely to lower retained earnings on account of the payment of dividend for 2019. That said, no dividend was declared for the year 2020. Another major positive for the Bank is its plan to raise additional Tier 1 capital in the next few months which would strengthen capital ratios to even more solid levels as well as providing additional buffer for the potential weakening loan asset quality given the elevated credit environment.

In terms of earnings, as with the sector, OAB’s performance in 2020 was significantly impacted by the contraction of the economy, forbearance measures of Covid-19, and CBO’s directives to reduce fees. Net interest income (NII) declined due to a narrowing of the net interest margin (NIM) with the fall in US benchmark rates and the waiver of interest on loans to various Omani citizens. Unlike many of its peers, the Bank’s fee and commission income rose with the consolidation of AIB and this compensated for the fall in NII, leading to an overall moderate increase in operating income. However operating profit and efficiency ratios were both impacted by the significant increase in operating expenses after the takeover of AIB’s staff and branches. A substantially higher impairment charge also reduced net profit noticeably in 2020. The ROAA fell to a modest level in common with many of its peers. It should also be noted that OAB’s profitability ratios for 2020 were also impacted by the acquisition of AIB as only six months of AIB’s earnings were included in the consolidated numbers. Going forward, earnings are likely to be constrained by the continued pressure on NIM, reduced economic activities due to partial lockdowns that may be required this year, and a potentially high level of provisioning that will be needed in light of the difficult environment.

Rating Outlook

The Negative Outlook indicates that the ratings are likely to be lowered by one notch in the next 12 months and is in line with the Negative Outlook for the sovereign rating. It also captures the potential impact of the elevated credit risk environment – due to slow economic growth and the ongoing Covid-19 pandemic − on the Bank’s financial profile.
 
Rating Dynamics: Upside Scenario

There is limited upside to the Bank’s ratings as indicated by the Negative Outlook. A revision of the Outlook to Stable would need to be preceded by a similar rating action on the sovereign’s credit ratings, all other factors remaining unchanged.

Rating Dynamics: Downside Scenario

Although not our base case, the ratings could be downgraded by more than one notch in the next 12 months if the operating environment deteriorates further, negatively impacting the Bank’s solvency, liquidity profile and asset quality, or if the sovereign’s creditworthiness weakens by more than expected, resulting in a rating change of more than one notch over the period.


Contact

Primary Analyst: Agnes Seah, Senior Credit Analyst; E-mail: agnes.seah@ciratings.com
Secondary Analyst: Karti Inamdar, Senior Credit Analyst
Committee Chairperson: Morris Helal, Senior Credit Analyst

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