(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 National Bank of Umm Al Qaiwain (NBQ) at ‘A-’ and ‘A2’, respectively. At the same time, CI Ratings has affirmed NBQ’s Bank Standalone Rating (BSR) of ‘bbb’, Core financial Strength (CFS) rating of ‘bbb’ and Extraordinary Support Level (ESL) of High. The Outlook for the LT FCR and BSR is Stable.
NBQ’s LT FCR is set two notches above the BSR and reflects the ESL of High. CI expects the Bank to receive extraordinary support from the UAE government (sovereign ratings: ‘AA-’/‘A1+’/Stable) in case of need. The government has demonstrated such support in the past and, in CI’s view, has the means and willingness to continue to do so in the future. Additionally, NBQ can also expect support from the government of Umm Al Quwain, a founding shareholder.
NBQ’s BSR is derived from a CFS rating of ‘bbb’ and an Operating Environment Risk Anchor (OPERA) of ‘bbb’. The CFS reflects the Bank’s long track record of generating strong earnings, very solid capital ratios and good liquidity. Principal challenges are high (though declining) NPLs, low loan-loss reserve (LLR) coverage (partially mitigated by substantial collateral and capital), customer concentrations in loans and deposits, and sector concentration in real estate/construction. Slow global economic growth and increased geopolitical risks in the region are also challenges (although the UAE economy is doing well) along with the Bank’s undiversified business base, low market share and small balance sheet size.
The 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. The banking sector remained strong in 2023, with high levels of capitalisation and moderately low NPLs, fuelled by UAE’s improving macroeconomic performance and high hydrocarbon prices. .
NBQ’s current strategies focus on using its large capital base to grow its balance sheet and market share, and diversify its business in terms of customer segments, products, services and income streams. This is essential to protect the franchise over the coming years in a consolidating and very competitive market. For decades the Bank had followed a very conservative strategy emphasising the preservation of capital and liquidity. It also generated good earnings and rewarded shareholders generously despite the disadvantages of small size and a narrow business base. However, its share of business in the UAE has shrunk over the years and it is currently among the smallest commercial banks in the country.
NBQ aims to grow its wholesale banking book in the coming years with a focus on lending to governments (federal and Emirati), GREs, large corporates and multinationals via bilateral arrangements and through syndications in a wide range of sectors. This will help to reduce the present sector concentration in real estate and construction. The Bank is also looking to expand its cash-flow-based lending and reduce the proportion of asset-based financing on its books. This is expected to raise the proportion of short-term loans and improve the overall risk profile of the credit portfolio. The Bank has a large due from banks portfolio which is of good quality, and a moderate sized investment book comprising mainly equities of blue-chip banks and companies in the UAE and a small bond portfolio. There are customer concentrations in the loan portfolio, in common with peer banks.
The high NPL ratio has improved over the last few years due to recoveries and write-offs and is now better than the sector median. The Stage 2 loans to gross loans ratio is at a reasonable level. The NPL ratio could decline further with the anticipated growth in gross loans and given the good quality of new credits. The LLR coverage ratio is low and below the sector median; this is partly mitigated by the sizeable collateral cover. Including impairment reserves in capital (being the excess of provisions calculated as per central bank rules over IFRS), the coverage ratio was 74% in H1 24. NBQ’s reported coverage ratio which includes the value of collateral was 344% at end-H1 24.
Other redeeming factors are the steady, though slow, pace of recoveries over the years through court action, and the large capital base and good operating profits that provide a sizeable additional buffer. Provisioning expenses could rise in the future if the central bank requires all banks to discount the value of collateral held against impaired loans. In our view, the Bank would be able to absorb additional provisioning requirements fairly comfortably given its strong income generation.
NBQ’s profitability ratios, which have historically been good, strengthened further in 2023 and Q1 24, reflecting the growth in lending, a wider net interest margin (NIM), good cost efficiency ratio and rising non-interest income (non-II). The Bank’s strong and better than peer group average NIM is mainly attributed to its low funding cost (one of the lowest in the banking sector), which in turn reflects its large capital base, almost negligible borrowings, and a moderately good CASA ratio. Rising interest rates therefore have a strong positive impact on income generation. The Bank’s small fee income base is augmented by other income such as trading gains and dividend income. NBQ is introducing new initiatives that could boost fee income in the future and partly offset the impact of a possible decline in interest rates later this year or next year. The Bank’s ROAA is among the highest in the banking sector, however, income sources are not diversified and dependent on corporate banking activities. That said, we note that profitability metrics have shown resilience even during difficult periods over many years.
Liquidity ratios continue to be strong and stable. A high capital base supports the overall strong liquidity giving NBQ one of the lowest net loans to stable funds ratios in the banking sector. Deposit growth matched credit expansion last year. In common with most banks, customer concentration in the deposit base is high. However, major funding sources, including related party and government deposits, have proved to be stable even during stressed liquidity conditions in the past. While the CASA ratio declined last year due to the high interest rate environment, it remains at a moderate level in line with other banks with small retail franchises. Borrowings are presently negligible although the Bank has raised funds through the capital markets in the past.
Capital ratios are very strong and among the best in the industry. Capital is also only slightly impaired by unprovided NPLs. While dividend payouts have been generous, this is acceptable given the high capital ratios. The Basel III leverage ratio is also very high. The Bank can raise Tier 1 and Tier 2 debt in the future if required. Capital can also be increased by reducing dividend payouts as has been done in the past. However, capital is currently more than sufficient to power a substantial increase in risk weighted assets (RWAs). NBQ’s capital ratios are expected to stay strong given its high earnings and despite a possible rise in risk assets over the next few years.
Rating Outlook
The Stable Outlook on the LT FCR and BSR indicates a better than even chance that the ratings will not change over the next 12 months. We expect key financial parameters to be maintained at least at current levels.
Rating Dynamics: Upside Scenario
An upgrade in the LT FCR and BSR or a change in the Outlook to Positive over the next 12 months would require a strengthening in the Bank’s standalone profile. This could come from a significant improvement in asset quality, lower customer concentrations, a more diversified business base and a larger balance sheet.
Rating Dynamics: Downside Scenario
Though a remote possibility, a one-notch downgrade of the LT FCR and BSR or a change in the Outlook to Negative would be likely in the event of a deterioration in the Bank’s credit profile. This could be caused by a significant weakening of asset quality or profitability that the Bank may not be able to correct in a reasonable period.
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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