Al Baraka Islamic Bank – Ratings Affirmed

(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 Bank Standalone Rating (BSR) of Al Baraka Islamic Bank (AIB or the Bank) at ‘B’ and ‘b-’, respectively. The Outlook for these ratings has been revised to Stable from Negative. At the same time, CI Ratings has affirmed AIB’s Short-Term Foreign Currency Rating (ST FCR) at ‘B’, and Core Financial Strength (CFS) rating at ‘b-’. The Extraordinary Support Level (ESL) remains at Moderate.

AIB’s LT FCR is set one notch higher than the BSR given the moderate likelihood of extraordinary support from the Central Bank of Bahrain (CBB). Although we deem the Bahraini government to be willing to provide extraordinary support (despite AIB’s lack of systemic importance), its financial capacity may be limited as indicated by Bahrain’s sovereign ratings (‘B+’/‘B’/Negative). The BSR is derived from a CFS rating of ‘b-’ and an adjusted Operating Environment Risk Anchor (OPERA) of ‘b’ which is lower than the OPERA of Bahrain (‘b+’) due to the Bank’s significant exposure to higher-risk Pakistan (OPERA ‘c+’). AIB is exposed to Pakistan almost exclusively via its foreign self-funding subsidiary Al Baraka Bank Pakistan (ABP) (unrated), which constituted a material 38% of consolidated assets in 2024 and is a significant revenue driver.

The Bank’s CFS rating is primarily supported by AIB’s currently satisfactory liquidity underpinned by customer deposit funding and adequate total CAR and balance sheet leverage ratio. The major credit challenges are high exposure to Pakistan (via subsidiary ABP) and concentrations in government sukuk (Pakistan and Bahrain), as well as recent net losses alongside historically weak net and operating profitability. The other rating constraints are weakened financing asset quality, and the difficult operating and geopolitical environments in both Pakistan and Bahrain compounded by high policy interest rates.

AIB is a comparatively small bank with limited market shares of Shari’a-compliant assets and deposits in each of Bahrain and Pakistan, despite a series of past mergers at subsidiary ABP. The Bank has a relatively long track record, but the business model − focused on corporate and, to a lesser extent, retail banking − is considered vulnerable given the balance sheet concentration risks and significant Pakistan exposure via ABP. The modestly sized balance sheet and consequently limited pricing power renders the business model also susceptible to keen competition in both markets. That said, AIB remains an important bank entity within the Al Baraka Banking Group (ABG) based in Bahrain.

The Bank’s high concentration of assets in low-rated Bahrain and Pakistan government sukuk is a rating constraint. Aggregate government sukuk exposure was equivalent to a high multiple of total equity in 2024, rendering regulatory capital vulnerable to possible impairment charges in the event of a sovereign distress scenario in Pakistan and/or Bahrain. Following the improvement seen a few years earlier, financing asset quality weakened moderately in 2023 and 2024, driven by growth in impaired corporate and retail facilities in Bahrain and, to a lesser degree, Pakistan. This was in part the result of higher profit rates (in an inflationary environment) and the resultant pressure on customer debt serviceability. More recently in Q1 25, the Bank saw a decline in NPFs in large part due to write-offs as well as the benefits of a curtailed financing policy. Given the ongoing credit risk in both Bahrain and Pakistan, as well as moderately high stage 2 financings, CI considers it likely that NPFs could resume growth in the near term. Although financing-loss reserves provided adequate coverage in 2024, there is very little cushion in the event of a significant increase in NPFs. Furthermore, AIB’s weakened capacity to absorb higher cost of risk through the P&L means that the modest capital buffer remains vulnerable.

In collaboration with its parent ABG, the Bank is currently in the process of increasing paid-up capital to the CBB’s regulatory minimum requirement of BHD100mn. Although headline capital ratios are adequate, they remain vulnerable to the effects of FX translation movements as well as P&L losses. CI notes that regulatory capital adequacy ratios benefit significantly from the favourable zero risk-weighting applied to sovereign sukuk and assets funded by Unrestricted Investment Accounts (URIAs). Although we deem the parent ABG still willing to provide capital support, its capacity to do so is rather uncertain given its own balance sheet constraints. The ongoing high negative internal capital generation rate means that overall capital flexibility is very weak and capital ratios could come under some pressure.

AIB’s ratings are supported by a satisfactory liquidity and funding profile. The ratios of net financings to both customer deposits and stable funds have been rather stable over the past three years, and reflect a moderately sized financing portfolio. Liquidity continues to be underpinned by customer deposit funding, notably the retail variety. The bulk of liquid assets, however, remains deployed in government sukuk (primarily Bahrain and Pakistan). Bahrain government sukuk can be sold under repurchase agreements with the CBB, while Pakistan sovereign sukuk is freely traded in the secondary market in Pakistan under normal conditions. However, the liquidity available to AIB on a consolidated basis is considered less than that indicated by headline ratios given exchange controls in Pakistan.

Customer liabilities constituted the largest source of funding. Notwithstanding the growth seen in money terms in both markets in previous years, Bahrain remained the largest source of funding in 2024. Looking ahead, CI considers Pakistan will remain an important source of retail customer deposits in view of its population size and comparatively larger economy. Although historically there has been a relatively high degree of depositor concentrations, the Bahrain and Pakistan markets are currently liquid and deposits can be mobilised on the basis of price.

AIB’s historically weak profitability is considered to be a major rating constraint. Profitability at both the operating and net levels suffered a major setback in 2023-24, in large part due to weaker performance at the Bahrain operation. Notwithstanding the declines seen, operating income measured against average total assets remained adequate, reflecting reasonable revenue streams and a moderate net financing margin. That said, AIB’s severely weakened operating profitability – primarily due to a persistently large cost base − means that risk absorption capacity is impaired. Total equity is, therefore, highly vulnerable to additional losses. On a positive note, AIB saw operating profit return to mild positive territory in Q1 25 on the back of a rebound in fee income and lower cost base. Earnings quality is considered adequate. Barring a strong rebound in operating income, coupled with a significant reduction in the cost base, we anticipate AIB’s profitability to remain very weak and potentially volatile.

Bahrain’s OPERA is at a level indicative of high risk and is driven by substantial government debt, significant external financing needs and limited fiscal flexibility. Other risk factors are Bahrain’s relative dependence on hydrocarbon revenues, the small size of the economy, as well as geopolitical and institutional vulnerabilities. Industry risk is also deemed high in view of the large size of the banking sector. Bahrain currently has limited capacity to absorb economic and financial sector shocks, although the risks associated with high gross public financing needs are partially mitigated by demonstrated financial support from other GCC states (notably Saudi Arabia).

Pakistan is marred by high external risks in the context of low foreign exchange reserves, high external financing risks and large external adversities. Inflationary pressures remain very high due to elevated food and energy prices in addition to the currency depreciation. Although the economy is expected to grow by an average of 2.5% in FY24-25, growth remains unbalanced and socioeconomic vulnerabilities continue to prevail.

Rating Outlook

The revision of the Outlook for the LT FCR and BSR to Stable (from Negative) reflects CI’s view that the ratings are unlikely to change over the next 12 months. This is based on our expectation that the planned capital increase will be forthcoming, financing asset quality has stabilised at an adequate level, and operating profit is likely to return to mild positive territory in the short term.

Rating Dynamics: Upside Scenario

Although not our baseline scenario, the most likely upside scenario for the next 12 months would be for a revision of the ratings’ Outlook to Positive. This would need to be preceded by a sustained improvement in profitability and risk absorption capacity.

Rating Dynamics: Downside Scenario

The ratings and/or Outlook could be downgraded in case of a significant deterioration in AIB’s risk profile and/or the sovereign ratings for Pakistan and/or Bahrain deteriorate beyond our baseline scenario.

Contact

Primary Analyst: Morris Helal, Senior Credit Analyst; E-mail: ...
Secondary Analyst and Committee Chairperson: Rory Keelan, Senior Credit Analyst

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