Al Mustashar Islamic Bank for Investment and Finance – Ratings Affirmed

(MENAFN- Capital Intelligence Ltd) Capital Intelligence Ratings (CI Ratings or CI) today announced that it has affirmed Al Mustashar Islamic Bank for investment and Finance’s (MIB) Long-Term Foreign Currency Rating (LT FCR) and Short-Term Foreign Currency Rating (ST FCR) of ‘B-’ and ‘B’, respectively. The Outlook for the LT FCR remains Stable. CI Ratings has affirmed MIB’s Bank Standalone Rating (BSR) of ‘b-’ with a Stable Outlook, Core financial Strength (CFS) rating of ‘b+’, and Extraordinary Support Level (ESL) of Uncertain.

At the same time, CI has affirmed MIB’s Long- and Short-Term Ratings on the Iraq National Scale of ‘iqBBB-’ and ‘iqA3’, respectively, with a Stable Outlook. These are supported and constrained by the same factors as the CFS as outlined below.

MIB’s BSR and – since ESL is Uncertain – LT FCR are derived from a CFS rating of ‘b+’ and the constraints imposed by the Operating Environment Risk Anchor (OPERA) of ‘c+’. The latter is a key rating constraint for all Iraqi banks. The CFS is supported by a very solid capital base including exceptionally low leverage, and good liquidity consisting of Central Bank of Iraq (CBI) balances and cash. The currently satisfactory financing asset quality is also a rating supporting factor. The principal factors constraining the CFS are MIB’s limited operating and lending history, increased credit risk profile − due to the effects of Covid-19 compounded by a difficult operating and security environment − and the small balance sheet coupled with significant concentration risk. The Bank’s earnings volatility and Iraq’s relatively weak bank regulatory and supervisory framework (though slowly improving) are also credit challenges.

Iraq’s OPERA is at a level indicative of a high level of risk. This reflects the volatility of the economy and underlying structural and fiscal weaknesses, as well as significant socioeconomic imbalances and deficiencies in the country’s political and institutional frameworks. It also takes into account the challenges inherent in a banking sector that is small, underdeveloped, and dominated by financially weak state-owned banks. Both the legal system and corporate governance standards are also comparatively weak. CI considers the likelihood of sufficient and timely official support being made available to MIB in the event of financial distress to be uncertain and, consequently, does not incorporate such support into the Bank’s LT FCR. Moreover, even if the government may be willing to provide extraordinary support in case of need, its financial capacity to do so is limited as indicated by our internal assessment of Iraq sovereign credit risk.

MIB is a relatively new Shari’a compliant bank (established in 2017) whose business model is focused on providing financing and trade finance (LCs and LGs), primarily to entities operating in the private and government sectors. Due to the still short track record, the balance sheet remains small in money terms and concentrated, and the business model has yet to be tested through the full economic cycle in Iraq. Currently, MIB’s balance sheet is very solidly capitalised, with regulatory capital composed of high-quality Tier 1 funds. This factor strongly supports the ratings, particularly in view of elevated risks amid the Covid-19 pandemic and heightened geopolitical tension. The high capitalisation provides a very strong buffer against unforeseen losses that may materialise, and ample scope to expand the business franchise over the medium term.

Given the Bank’s short history and limited access to diversified sources of funding, shareholders’ equity remains the largest component of funding by far. Total equity grew markedly in 9M 21 as a result of a IQD50bn capital injection to comply with regulatory paid-up capital requirements. In turn, the ratio of total equity to total assets reached a high 80% at end-September 2021. The next and final IQD50bn contribution is scheduled to take place via a rights issue in the current quarter.

The Bank’s good liquidity is a key rating supporting factor. The bulk of liquid assets remain deployed in CBI balances and cash. There are at present very limited avenues in which to profitably invest excess liquidity in the Iraqi banking system. As the CBI is understood to perform a lender of last resort function only in exceptional cases (at least for the private sector banks), the preservation of liquidity is vital for Iraqi banks. The sector also lacks a real interbank market that can provide short-term liquidity to institutions. These risk factors − coupled with limited depositor confidence in the banking system – elevate systemic liquidity risks in CI’s opinion. Potential funding and liquidity risk is strongly mitigated by MIB’s significant pool of liquid assets and very low balance sheet leverage.

Although new outlets have been added, MIB’s still small branch network restricts the gathering of customer deposits. This is compounded by the fact that deposit growth is vulnerable to volatility due to the high probability of event risk in Iraq. As the Bank leverages its equity looking ahead, and as new branches and products are added, we expect the contribution of customer deposits to total funding to increase. Depositor concentrations remain high, reflecting the still fairly small customer deposit base.

Asset quality is currently deemed to be satisfactory. As would be expected for a bank with a limited track record and unseasoned portfolio, there had been no impaired financings until recently. In 9M 21, however, a small number of financings were categorised as non-performing but these equated to a mere 0.4% of the gross portfolio. Given the elevated credit risk prevailing in the economy, we anticipate that as new customers are added − and the financing portfolio matures – additional non-performing and restructured financings will form as part of the normal business cycle. Indeed, Iraq’s increased credit vulnerabilities – exacerbated by the effects of Covid despite high oil prices – render financing asset quality vulnerable in view of MIB’s high borrower and sector concentration risks in real estate. Although these risk factors are likely to reduce over time as the financing portfolio matures, CI expects concentration risk to persist reflecting Iraq’s undiversified economy.

Notwithstanding the brisk lending seen since establishment, the proportion of net financings to total assets remained modest and is projected to remain below 45% in the medium term. Meanwhile, balances with the CBI raise concentration risk issues in the context of Iraq’s high sovereign credit risk. Any sovereign credit event may therefore impact MIB (and other Iraqi banks) through impairment charges. The Bank’s solid equity base is a crucial mitigating factor in this regard.

MIB was very profitable in 2019-20 despite the short track record. Profitability at both operating and net levels was in fact stronger than at almost all other private sector banks in Iraq. In 9M 21, however, net profit and ROAA declined significantly as a result of lower credit-related fees and commissions and FX income, as well as a narrower net financing margin. Revenue streams have demonstrated volatility, particularly non-financing income. Although CI considers this a credit challenge, the volatility stems from the Bank’s short track record, concentrated business model and still narrow product mix. That said, the financing portfolio continues to generate a relatively steady revenue stream, benefiting operating income generation and earnings quality. Although MIB has demonstrated good cost control, a significant fall in operating income pushed up the cost to income ratio to a less than favourable level in 9M 21.

Rating Outlook

The Outlook for the ratings is Stable, indicating that they are unlikely to change over the next 12 months. This reflects our view that despite the difficult operating environment and Iraq’s credit vulnerabilities, MIB is expected to maintain its current credit risk profile. Although additional non-performing financings are projected to form in the short term, this is outweighed by the Bank’s strong capital and liquidity buffers.

Rating Dynamics: Upside Scenario

While not our current expectation, the Outlook for the ratings could change to Positive if Iraq’s operating environment risk improves and provided MIB’s key risk metrics are maintained. However, any upward revision to the ratings is unlikely until the Bank has had a considerably longer track record.

Rating Dynamics: Downside Scenario

MIB’s ratings could be reduced by one notch over the next 12 months if asset quality deteriorates considerably beyond what is anticipated. The ratings could also be lowered by one notch should our internal assessment of Iraq’s sovereign credit risk deteriorate.

*A National Rating summarises the repayment risk of an entity relative to other entities within the same economy. It is not an absolute measurement of risk. National Ratings are not directly comparable across borders.


Contact

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

About the Ratings

The credit ratings have been issued by Capital Intelligence Ratings Ltd, P.O. Box 53585, Limassol 3303, Cyprus.

The following information sources were used to prepare the credit ratings: public information and information provided by the rated entity. Financial data and metrics have been derived by CI from the rated entity’s financial statements for FY2018-20 and 9M 2021. CI may also have relied upon non-public financial information provided by the rated entity and may also have used financial information from credible, independent third-party data providers. CI considers the quality of information available on the rated entity to be satisfactory for the purposes of assigning and maintaining credit ratings. CI does not audit or independently verify information received during the rating process.

The principal methodologies used to determine the ratings are the Bank Rating Methodology, dated 3 April 2019 (see and the National Scale Ratings Criteria for Iraq, dated 15 March 2020 (see Information on rating scales and definitions, the time horizon of rating outlooks, and the definition of default can be found at Historical performance data, including default rates, are available from a central repository established by ESMA (CEREP) at

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