(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 Bank of Sharjah (BOS) at ‘BBB+’ and ‘A2’, respectively. At the same time CI Ratings has affirmed BOS’ Bank Standalone Rating (BSR) of ‘bb+’ and Core Financial Strength (CFS) rating of ‘bb-’. The Outlook for the LT FCR and BSR remains Stable.
BOS’ LT FCR is set three notches above its BSR. This is heavily underpinned by the high likelihood of the Bank receiving extraordinary support from the UAE government in case of need. The UAE government (sovereign ratings: ‘AA-’/ ‘A1+’/ Stable) has demonstrated support in the past and has the means and willingness to continue to provide such support in the future. Additionally, BOS can also expect extraordinary support from the government of Sharjah, a founding shareholder. The latter demonstrated support in June 2023 by injecting AED800mn capital and raising its shareholding to 39% from 17%.
The Bank’s BSR is derived from a CFS rating of ‘bb-’ and an Operating Environment Risk Anchor (OPERA) of ‘bbb’. The CFS reflects the high level of Stage 2 loans, low (though improving) operating profitability, weak ROAA, and high customer concentrations in loans (in common with peers). In addition, earnings would be negatively impacted this year by a one-time impairment loss following the deconsolidation of the Lebanese subsidiary. The operating environment in the UAE is moderately challenging due to high interest rates and slow global recovery, although the economy is benefiting from favourable oil prices. The Bank’s credit strengths include an improving NPL ratio and full loan-loss reserve (LLR) cover, as well as comfortable liquidity and a stronger CAR following the capital increase.
Our OPERA assessment reflects the UAE’s continuing dependence on hydrocarbons, although less so than neighbouring countries, with the economic risk partially mitigated by the support of the wealthy emirate of Abu Dhabi. It also reflects the overall sound financial position of the banking sector.
BOS is a corporate and private banking institution with a small customer base comprising long-term relationships. However, this has led to high customer concentrations in loans, and the Bank is also more vulnerable to cyclical changes in the local economy compared to large banks with a more diversified business base. Its fully owned Lebanese subsidiary, Emirates Lebanon Bank (ELBank) has been adversely affecting consolidated financials since Lebanon’s eurobond default in 2020, and the application of IAS 29 (Financial Reporting in Hyperinflationary Economies) and IAS 21 (The Effects of Changes in Foreign Exchange Rates). BOS’ domestic business generates a profit and is growing, however its capital and earnings have been severely impacted by the consolidation of ELBank.
The investment portfolio consisting mainly of government of Sharjah sukuk has grown in recent years. Credit growth had decelerated some years ago partly due to capital constraints, but prospects have improved with the recent equity increase and the availability of a good pipeline of transactions that could generate strong fees. The NPL ratio has improved due to recoveries, write-offs and low NPL accretions; impaired loans are also more than fully covered by LLRs. Stage 2 loans have risen and are at a very high level. While there could be transfers to Stage 3 from Stage 2 over the next few years, we believe that these are likely to stay low given the improving local economy and the Bank’s good track record of low NPL accretions in recent years. However, the high level of Stage 2 loans is indicative of ongoing stress in the credit portfolio and is a major factor the CFS rating. Moreover, we also note that although income levels are rising, risk absorption capacity remains low.
The Bank’s UAE earnings had shrunk even before the 2020 Lebanese crisis due to asset quality issues related to a few customers in the domestic business, a sharply reduced risk appetite, and high funding costs. The narrow margins of the Lebanese subsidiary had also affected operating income over the years. However, the UAE business is now recovering with the easing of asset quality pressures. Both net interest income and non-interest income have grown strongly over the last two years contributing to the improvement in operating profitability, which nevertheless continues to be below the Bank’s historical average. Traditionally, the Bank’s margins have been narrow due to low retail activities and high cost of funds (reflecting wholesale borrowings and low CASA). However, operating costs are also low due to lean staffing and limited retail operations. We expect a further improvement in operating profitability given that capital constraints have eased. Hyperinflationary accounting on the Lebanese assets had negatively affected consolidated net profit in 2022 and ROAA is likely to remain negative in 2023 due to the impairment charge related to the deconsolidation of ELBank. However, the Bank expects a return to profitability in 2024. In our view earnings remain vulnerable to any deterioration in Stage 2 loan quality.
Loan-based liquidity ratios remain comfortable, and have been so historically, even during periods of disruptions in liquidity in the banking system. The Bank also maintains a high liquid asset ratio. It has a stable funding base and good access to corporate deposits within the country and wholesale funds in the international markets. There is dependence on corporate and government funding (reflecting its business model). Non-government deposits have low customer concentrations compared with peers, although still high in the global context. Loan growth is funded by the expansion of customer deposits. Wholesale funds are high compared to many peers; the Bank raised five-year money in early 2023, which will partly support repayment obligations. CI expects liquidity ratios to continue to be maintained at comfortable levels.
Capital ratios improved with the injection of new capital by the government in June 2023 and key ratios are above the regulatory minima with a small buffer. The expanded equity base has eased capital constraints on risk asset growth. While capital is not impaired by unprovided NPLs, it remains vulnerable to future asset quality shocks from Stage 2 loans. Ongoing support from the major shareholders is very likely. The Bank may need more capital, especially if impairment charges rise for any reason – it has board approvals in place for AT1 and Tier 2 debt capital issuance.
Rating Outlook
The Stable Outlook for the LT FCR and the BSR reflects CI’s expectation that the ratings are unlikely to change over the next 12 months. This is underpinned by the recent capital injection and improved prospects for growth. However, the large portfolio of Stage 2 loans, suggesting continuing credit stress, places downward pressures on asset quality and therefore ratings.
Rating Dynamics: Upside Scenario
An upgrade of the LT FCR and BSR or a change in the Outlook to Positive over the next 12 months appears remote at this stage. Apart from a much stronger capital position, this would require a significant reduction in Stage 2 loans, lower credit costs, and an improved operating profitability and ROAA and that could comfortably absorb future external shocks.
Rating Dynamics: Downside Scenario
A downgrade of the Bank’s LT FCR and BSR or a change in the Outlook to Negative is likely if key profitability, capital and asset quality metrics weaken. Any change in our assessment of the support level could also negatively impact the ratings.
Contact
Primary Analyst: Karti Inamdar, Senior Credit Analyst; E-mail: ...
Secondary Analyst: Darren Stubing, Senior Credit Analyst
Committee Chairperson: Agnes Seah, Senior Credit Analyst
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