(MENAFN- Capital Intelligence Ltd) Capital Intelligence Ratings (CI Ratings or CI) today announced that it has affirmed Iraqi Islamic Bank for Investment and Development’s (IIB) 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 also affirmed IIB’s Bank Standalone Rating (BSR) of ‘b-’ with a Stable Outlook, Core Financial Strength (CFS) rating of ‘bb-’, and Extraordinary Support Level (ESL) of Uncertain.
At the same time, CI has affirmed IIB’s Long- and Short-Term Ratings on the Iraq National Scale of ‘iqBBB+’ and ‘iqA2’, respectively, with a Stable Outlook. These are supported and constrained by the same factors as the CFS as outlined below.
CI considers the likelihood of sufficient and timely official support being made available to IIB 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. The Bank’s BSR and – since ESL is Uncertain – LT FCR are derived from a CFS rating of ‘bb-’ and the constraints imposed by the Operating Environment Risk Anchor (OPERA) of ‘c+’.
The CFS is supported by a solid equity base, including a high Tier 1 component, strong liquidity and still satisfactory profitability despite some volatility. The established Islamic banking franchise, including access to off-balance sheet government related business, also supports the CFS. Major factors constraining the CFS are the Bank’s high credit risk profile in the face of Iraq’s economic and political vulnerabilities (despite high oil prices), concentrations in assets and customer deposits, and high non-performing financing (NPF) ratio. The weak regulatory and supervisory framework is also a credit challenge, although this is gradually improving.
The OPERA is at a level indicative of a high degree 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. Although the Iraqi economy started to recover moderately in 2021 from the economic fallout of the pandemic – buoyed by higher oil prices − credit risk remains elevated. OPERA 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 rather weak.
Although IIB’s balance sheet remains small in money terms − as is the case with all other private sector banks in Iraq − its equity base is proportionately large in relation to the asset base. This underscores the fact that the Bank has yet to fully leverage equity. The business model and strategy focused on trade finance and corporate and retail banking has been well executed thus far, despite the ongoing challenging operating environment. Being among a handful of institutions authorised to open LCs for the account of government entities, the Bank is well placed to continue expanding its modest share of assets in the market. However, as the business model is currently reliant on trade finance, there is a significant degree of concentration risk inherent in assets (on and off-balance sheet) and deposits. This risk factor is largely a reflection of Iraq’s underdeveloped banking sector and undiversified economy. Although the concentrations elevate IIB’s credit risk profile, the latter is mitigated by solid capital and liquidity buffers.
IIB’s solid capitalisation is a major credit strength, particularly in view of the high probability of event risk in Iraq. The equity base funded a significant 30% of total assets, underscoring the fact that the Bank has yet to fully leverage the balance sheet. The ratings take into consideration the projected increase in leverage and consequent decline in capital adequacy ratios over the longer term. The high total CAR currently seen is partially due to the zero risk-weight applied to Central Bank of Iraq (CBI) balances – as compelled by the regulator. The solid capital base, including the high Tier 1 element, enables the Bank to withstand unforeseen losses and provides ample scope to further expand the business over the medium term. Meanwhile, notwithstanding a dip in 2021, IIB’s capacity to generate capital internally has improved in recent years, aided by sustained profitability as well retention of full net profit.
Liquidity has been consistently high, reflecting the still low share of net financings in total assets. The importance given to safeguarding liquidity is crucial in a banking system where the central bank is understood to perform lender of last resort function only in exceptional circumstances (at least for the private sector banks). In addition, there is no real domestic interbank market to support banks’ potential short-term funding requirements. The bulk of liquidity remains deployed in non-remunerative balances with CBI and other banks including correspondents abroad. The latter demonstrates a high degree of counterparty concentration risk. Liquid asset holdings increased in 9M 21 (after a contraction in the previous year) as surplus funds generated from growth in customer deposits were deployed into CBI balances. In the context of Iraq’s high sovereign credit risk, CBI balances produce significant concentration issues and may render IIB and other Iraqi banks vulnerable to a sovereign event.
The Bank’s high levels of liquidity partially mitigate the concentration risk derived from large customer deposits. Despite a recent decline, CI anticipates funding concentrations to prevail in the medium term given the current business model. As part of its funding strategy to diversify funding sources, IIB is leveraging its relationship with government ministries to expand ‘sticky’ retail customer deposits by offering payroll-based accounts to their employees. Over the longer term, this is expected to diversify customer deposits and provide a comparatively more stable funding base. This is important in Iraq given limited depositor confidence in the banking system, as well as the anticipated increase in competition.
Having experienced a setback a year earlier amid difficult economic conditions and the effects of the pandemic, IIB’s financing asset quality improved in 9M 21 driven by a significant increase in financing-loss reserve (FLR) coverage coupled with a moderate decline in NPFs. The latter was largely due to settlement of government arrears. While IIB has the scope to set aside provisions through P&L, the increase in FLRs was due to the transfer of reserves under equity. The improvement in coverage helped reduce the ratio of unprovided NPFs to total equity to a rather low 8%. That said, CI would consider a further increase in cover to 100% (or greater) a positive credit factor.
Although strong oil prices − coupled with the lifting of Covid-related restrictions − helped improve liquidity conditions in the economy, there are significant downside risks to Iraq’s economic outlook in the absence of accelerated structural reforms. These factors render all Iraqi banks – including IIB – vulnerable to asset quality pressures, particularly in light of high borrower and sector concentration risks. Although IIB’s headline NPF ratio remains high, this risk factor is partially mitigated by the low share of net financings in total assets (25%). Total equity also exceeded the net financing portfolio by a factor of 1.2x in 9M 21. The solid capital base remains an important credit risk mitigating factor.
IIB has been consistently profitable since 2015 − in contrast to almost all other Iraqi private sector banks − despite difficult operating conditions in the country. The Bank’s operating income generation capacity is considered satisfactory, although it has demonstrated some volatility in part due to limited sources of income, as well as high customer concentrations. CI notes that IIB would have in fact recorded net loss in 9M 21 had provisions been set aside through P&L. In common with peer banks, IIB’s operating income continues to be heavily skewed toward non-financing income, notably fees and commissions. This is largely a function of the very limited share of profit-earning assets – reflecting scarce avenues in which to profitably deploy surplus liquidity in Iraq. We expect the contribution of net financing income to operating income to grow over time as and when the financing portfolio gains critical mass, and other sources of profit earning assets are identified. Notwithstanding ongoing earnings challenges, CI considers IIB’s earnings quality and stability currently satisfactory in relation to the ratings.
Rating Outlook
The Outlook for both the LT FCR and BSR is Stable, indicating that the ratings are unlikely to change over the next 12 months. This reflects our view that IIB’s risk profile – as measured by key credit metrics – will more than likely be maintained at the current level, notwithstanding potential economic headwinds and ongoing geopolitical tensions.
Rating Dynamics: Upside Scenario
We do not expect a change in the ratings (or outlook) unless there was an improvement in our assessment of the Iraqi operating environment and the Bank’s financing asset quality – specifically a significant decline in NPFs and increased cover. This is currently seen as being unlikely within a 12 month timeframe.
Rating Dynamics: Downside Scenario
IIB’s ratings could be reduced by one notch over the next 12 months if the operating environment deteriorates beyond our baseline scenario and/or if the Bank’s credit risk profile weakens significantly.
Contact
Primary Analyst: Morris Helal, Senior Credit Analyst; E-mail: morris.helal@ciratings.com
Secondary Analyst: Rory Keelan, Senior Credit Analyst
Committee Chairperson: Agnes Seah, 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 FY2017-20 and Q3 21. 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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