Ratings of Ahli Bank (Oman) Affirmed

(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 Ahli Bank (AB) in Oman at ‘BB’ and ‘B’, respectively. At the same time, CI Ratings has affirmed AB’s Bank Standalone Rating (BSR) of ‘bb’ and Core financial Strength (CFS) rating of ‘bbb-’. The Bank’s LT FCR and BSR Outlook remains Negative, in common with all other Omani banks. The Bank’s FCRs and Outlook are currently set at the same level as Oman’s sovereign ratings (‘BB’/’B’/Negative), and remain closely correlated with the sovereign’s creditworthiness. Since AB’s LT FCR is at the sovereign rating level, the Extraordinary Support Level (ESL) of Moderate precludes any uplift from the BSR. Notwithstanding the sovereign’s weaker fiscal capacity, CI is of the opinion that moderate levels of support from the government will continue to be available to AB (and the banking sector) in case of need.

The BSR is derived from a CFS rating of ‘bbb-’ and an Operating Environment Risk Anchor (OPERA) of ‘bb-’. The CFS reflects the Bank’s prudent lending policy and still low NPL ratio, good CAR including recent capital increase, and sound profitability despite the downward trend. Ahli United Bank’s (AUB) significant ownership interest in AB also supports the rating. AUB is well represented on the board of directors and on the board’s risk, executive and audit sub-committees. The main constraints on the rating are the challenging operating environment and high credit risk in the economy due to the impact of Covid-19, the tight loan to deposit ratio (LDR), and the high customer concentrations in funding (although improved) and lending. The relatively low and volatile non-interest income (non-II) is also a challenge – although to a lesser degree.

OPERA denotes moderate risk and takes into account the weakening of the operating environment due to the impact of the pandemic (though recently countered by higher oil prices), the limited diversification of the Omani economy, and increased government refinancing risk from higher dependence on foreign funding. It also reflects low monetary policy flexibility and still elevated geopolitical risks.

AB is a well-managed institution and has a good track record despite being among the smaller banks in the Omani banking system. The sound risk management practices are a legacy of the erstwhile technical and management services agreement with AUB – the latter remains AB’s strategic shareholder with 35% of shares. Although customer concentrations persist − in common with other Omani banks − management have developed a successful business model and strategy capable of withstanding difficult economic conditions. The loan portfolio is currently well balanced between corporate and personal lending, reflecting a prudent credit policy that has diversified the book away from housing loans. AB’s sound loan asset quality is a credit strength, notwithstanding the Covid-related pressures. As is the case with other Omani banks, AB saw a sharp increase in NPLs in 2020 (albeit from a low base) due to the economic disruptions and elevated credit risk caused by the pandemic. In 9M 21, however, NPL growth slowed markedly as pandemic lockdown restrictions were lifted and liquidity conditions improved buoyed by high oil prices. Moreover, restructured loans remained at a low level.

That said, loan asset quality pressures at all Omani banks are likely to have been obscured by regulatory forbearance measures. As and when these expire at end-2021, AB could see potential new NPLs emerge in the short term, particularly given the high level of stage 2 loans. In this regard, the Bank has the capacity to set aside significantly higher provisions through the P&L in case of need. The sound capital buffer is also a risk mitigating factor.

The balance sheet remains well capitalised and includes a high Tier 1 component. AB’s consistently strong capitalisation and capital flexibility firmly support the ratings. The oversubscribed OMR30mn CET 1 rights issue in March 2021 has reversed the downward trend seen in total CAR, as well as in CET1 and Tier 1 ratios. The capital infusion will provide the resources to sustain business expansion over the short- to medium-term and strengthen the capital buffer. Notwithstanding a decline in internal capital generation in 2020 – largely due to the Covid-related drop in earnings and a dividend payment – the Bank continues to demonstrate good capital flexibility. Also, the shareholders have subscribed to all rights issues over the years in a clear demonstration of ordinary support. Balance sheet leverage – as measured by the ratio of total equity to total assets – remained good at 13.8%.

Notwithstanding the Covid-related dip seen in 2020 primarily due to a marked increase in credit provisions, AB’s still sound earnings profile supports the ratings. Despite trending downward (in common with peer banks), the Bank’s capacity to generate operating income continues to be sound and resilient, driven by a high level of recurring net interest income and, to a much lesser extent, fees and commissions. Although cost of funding has increased, the net interest margin remains at a level comparable with the sector average. The increase in oil prices bodes well for business prospects and, in turn, profitability. Sources of non-II, however, are modest and include volatile items such as securities gains. This fact points to a somewhat less diversified business model than that seen at the larger Omani banks. Nonetheless, fees and commissions remain the largest component of non-II. Aided by very good cost control, operating profitability has demonstrated a fair degree of resilience and is capable of absorbing higher risk charges if necessary. AB has the sector best cost-to-income ratio.

A credit vulnerability in our view is AB’s concentrated customer deposit base, as is the case with other Omani banks. Notwithstanding the moderately increased share of CASA – and concurrent decline in large time deposits − concentration risk remains high. The large deposits however relate to mostly government and public sector entities, and these have historically been stable. Nonetheless, we consider liquidity risk rather pronounced as large depositors search for yield amid the current challenging operating environment exacerbated by the pandemic. These entities however can be relied upon to provide deposits depending on the rate of interest.

Customer deposits are the largest source of funding with this fact being a rating driver. The Bank also supplements its resources by borrowing medium term funds when necessary. In the current economic environment, term bilateral debt can be a cheaper source of funding than time deposits, and also lends support to stable funding. The current modest liquidity is a credit challenge, and reflects the comparatively large share of loans in total assets. AB remains focused on raising funds in a cost-effective manner on the basis of business requirements and within acceptable regulatory parameters. Despite a tight LDR ratio, both the LCR and NSFR are at satisfactory levels and above the regulatory minima. In general, the Omani market is a liquid one and customer deposits can be readily mobilised despite keen competition. In case of need, government securities can be pledged to raise funding on a secured basis (repos).

Rating Outlook

The Negative Outlook reflects our expectation that the ratings will be lowered by one notch in the next 12 months, and mirrors the sovereign’s negative outlook. The Outlook for AB’s ratings captures the challenging operating environment in Oman, as well as, in the case of the LT FCR, the weakening of the government’s financial capacity to provide support in the event of need.

Rating Dynamics: Upside Scenario

Given the Negative Outlook, there is limited upside to the Bank’s ratings. A revision of the Outlook to Stable would need to be preceded by a similar rating action on the sovereign, 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 more rapidly than expected, weakening the Bank’s key credit metrics, or if the sovereign’s creditworthiness weakens by more than envisaged.

KFH’s Proposed Merger with AUB

In July 2018, AUB disclosed that it had been approached by Kuwait-based Kuwait Finance House (KFH) to consider a merger proposal to create a major regional banking institution. Subsequently, a mutually acceptable fair exchange ratio for their shares based on valuation studies conducted by international investment banking advisors was agreed. This was followed by regulatory approvals including from the Central Bank of Bahrain and Central Bank of Kuwait. Given the circumstances related to Covid-19, the two Boards of Directors agreed in Q2 20 to postpone acquisition procedures until December 2020. On 1 December 2021, AUB announced that in coordination with KFH and regulatory authorities, its board of directors agreed to the update of financial and legal due diligence studies and the resumption of all connected procedures related to the acquisition. This includes the assessment of the impact of such studies on the final share exchange ratio.

Contact

Primary Analyst: Morris Helal, Senior Credit Analyst; E-mail: morris.helal@ciratings.com
Secondary Analyst: Karti Inamdar, Senior Credit Analyst
Committee Chairperson: Rory Keelan, Senior Credit Analyst

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