(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 Commercial Bank International (CBI) at ‘BBB+’ and ‘A2’ respectively. At the same time, CI Ratings has affirmed CBI’s Bank Standalone Rating (BSR) of ‘bbb-’, Core financial Strength (CFS) rating of ‘bb’ and Extraordinary Support Level (ESL) of High. The Outlook for the LT FCR and BSR remains Stable.
Although CBI continues to display weak financial metrics, its LT FCR is set two notches above the BSR to reflect the high level of extraordinary support the Bank is expected to receive from Qatar National Bank (QNB), a 40% shareholder. QNB’s demonstrated support in the past was crucial to strengthening CBI’s financial fundamentals at the time it began a major structural transformation (QNB is rated ‘AA’/Stable by CI). Support is also available from the UAE government (rated ‘AA-’/Stable by CI).
The Bank’s BSR is derived from a CFS rating of ‘bb’ and an Operating Environment Risk Anchor (OPERA) of ‘bbb’. The CFS affirmation is underpinned by continuing sound capital ratios and the expectation of an equity increase through a rights issue later this year. In recent years, investments in staffing, technology, products and services have strengthened the Bank’s business foundation. However, any major improvement in earnings will be dependent on the planned increase in capital. Satisfactory liquidity is a supporting factor; however, key ratios remain tighter than the sector median, despite an improvement in H1 24. The Bank’s continuing weak asset quality along with a low loan-loss reserve (LLR) coverage weigh heavily on the CFS rating, along with weak profitability, an impaired capital base due to a high level of unprovided NPLs, and high customer concentrations in loans and deposits. In addition, the operating environment continues to be moderately challenging due to the slow global recovery, although the UAE’s economy continues to benefit from favourable oil prices. Geopolitical risks have also risen in recent months.
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.
The Bank’s current business model focused on top quality, large corporate entities, high net worth retail customers, investments and digitisation could result in better earnings quality in the future. Recent loan growth has been driven by exposures to the government, government-related entities (GREs) and financial institutions, partly to conserve capital. CBI currently has less than 1% share of total assets in the banking sector; however the successful completion of its rights issue this year could aid future business growth.
The weak loan asset quality is a major credit challenge – a sizeable portion of the loan book is either impaired or in Stage 2. Stage 3 loans are primarily legacy loans that are being actively pursued in courts by a remedial team. CI understands that several accounts are in advanced stages of negotiations and could be resolved. The high NPL ratio is also partially a result of low loan growth over the last several years due to the lack of capital. Recent increases in NPLs are primarily due to transfers from Stage 2 (the latter has consequently declined), while transfers from Stage 1 to 3 have been nil or minimal, reflecting the good quality of new lending. We understand that the Bank has recognised impairments at an early stage and its asset recognition standards are conservative, in line with UAE central bank requirements.
CBI’s LLR coverage continues to be very low. Since the Bank is required to hold the excess of provisions calculated as per central bank norms over IFRS 9 under capital, the actual LLR coverage ratio was 48% in H1 24, which is still very low. However the aggregate of provisions and the value of collateral exceed total NPLs. Since CI views collateral as only a partial risk mitigant and an insufficient substitute for cash provisions, the low coverage ratio has a significant negative impact on the Bank’s CFS. The central bank is likely to introduce new norms that would require collateral to be fully discounted over a fixed period. This could strain future earnings, but it would strengthen LLR coverage. At present, income generation is weak, and earnings are not sufficient to absorb asset quality shocks, however this could change with the equity injection.
Profitability metrices are presently weak. A change in the business model which now focuses on lending to top-tier corporate customers, including governments and GREs, has resulted in lower interest yields. In addition, business growth has been slow due to the delay in raising capital. Unlike peer banks, CBI did not benefit from the rising interest rate environment seen over the recent past as clearly demonstrated by its steadily falling margins y due to its corporate banking focus and persistently high cost of funds. With the exit of expensive structured deposits in the third quarter of 2023 and a stronger focus on CASA this year, we expect funding costs to moderate. Also, a capital increase will allow the Bank greater flexibility to book higher margin non-government related assets. H1 24 saw a good increase in profit before tax, with provision writebacks and lower operating costs offsetting reduced operating income.
In recent periods, investments in the business have led to a high cost-to-income ratio (CIR). We expect the CIR to fall to more acceptable levels with the growth in income. It could take a few years for the ROAA to strengthen to satisfactory levels, particularly if the central bank requires more aggressive discounting of collateral on impaired loans. This could leave the Bank’s earnings vulnerable in the interim
Loan-based liquidity ratios are satisfactory and improved in H1 24 with the growth in customer deposits, but continue to be tighter than the average for the sector. While customer deposit growth was modest overall in 2023, this was partly due to the retirement of expensive structured deposits in the wholesale banking division. However, this was offset by the expansion of deposits in the retail banking division on the back of several new product launches. Customer deposits rose strongly y-o-y in H1 24, while wholesale borrowings declined. Medium-term borrowings and short-term interbank liabilities are at acceptable levels. In common with peers, customer concentrations in the deposit base are high but have been declining steadily in recent years. Funding support from QNB is available in case of need. Liquid asset buffers are good.
Capital ratios have improved and are above the regulatory minima with a moderate buffer, but below the median ratio for the banking sector. The Bank also has a good balance sheet leverage ratio. Capital is however constrained by the high level of NPLs that are not covered by loan-loss provisions. After some years of delay, CBI’s AED889mn rights issue is likely to be completed in the second half of this year. This will support the Bank’s plans for future growth and enable it to meet the new minimum capital requirement set by the regulator. Going forward, CBI plans to grow capital by continuing to retain all profits, the latter benefiting from expected NPL recoveries and the sale of non-core assets (real estate held by subsidiaries).
Rating Outlook
The Stable Outlook reflects our expectation that the ratings will not change over the next 12 months, and is substantially underpinned by the Bank’s strong ownership and the expectation of an increase in capital before the end of this year.
Rating Dynamics: Upside Scenario
An upgrade of the BSR and LT FCR or the assignment of a Positive Outlook is likely if there is a significant improvement in the Bank’s standalone profile. This could come from a solid, sustainable strengthening of the Bank’s asset quality and net earnings along with enhanced capital buffers.
Rating Dynamics: Downside Scenario
A change in the Outlook to Negative or a one-notch downgrade of the Bank’s LT FCR and BSR is possible if capital is not increased, or asset quality and profitability metrics deteriorate over the next 12 months.
Contact
Primary Analyst: Karti Inamdar, Senior Credit Analyst; E-mail: ...
Secondary Analyst: Darren Stubing, Senior Credit Analyst
Committee Chairperson: Morris Helal, Senior Credit Analyst
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