Fitch Ratings-Dubai: Fitch Ratings has affirmed UAE-based Bank of Sharjah's (BOS) Long-Term Issuer Default Rating (IDR) at 'BBB+' with a Stable Outlook and Viability Rating (VR) at 'bb-'. A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
IDRs, SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF)
BOS's IDRs, SR and SRF reflect a high probability of support available to the bank from the UAE authorities if needed.
Fitch's view of support factors in the UAE's strong capacity to support the banking system, sustained by sovereign wealth funds and recurring revenue mostly from hydrocarbon production. Fitch also expects a high willingness from the authorities to support the banking sector. This has been demonstrated by the UAE authorities' long track record of supporting domestic banks, as well as close ties with and part government ownership links to a number of banks.
BOS's SRF is two notches below the UAE Domestic Systemically Important Banks' (D-SIB) Support Rating Floor of 'A' due to Fitch's view that BOS is less systematically important based on its approximate 1% market share of total assets in the UAE banking system at end-9M18 and the bank's niche corporate focus.
SPV and SENIOR DEBT
The senior unsecured notes issued by BOS Funding Limited (100% owned subsidiary) are rated in line with the bank's Long-Term IDRs because Fitch views the likelihood of default on any senior unsecured obligation issued by the SPV the same as that of the bank.
VR
BOS's VR reflects the bank's weak asset quality, high risk appetite, concentrations on both sides of the balance sheet and a nominal franchise. It also reflects adequate funding, healthy liquidity, acceptable management and adequate capital ratios.
BOS's VR has been constrained by the bank's vulnerable asset quality. Impaired loans and problem loans ratios remain high despite continued improvement. BOS's sizeable loan concentrations, although a common characteristic for UAE banks, increases the bank's sensitivity to event risk. Reserves for impaired loans remain high (144% of impaired loans at end-9M18), which Fitch views as appropriate for the bank's loan concentrations.
BOS demonstrates an above average risk appetite through an increasing allocation of its asset towards non-traditional banking activities and securities. During 2017, the bank's acquisition of a local property development company, as part of a remedial action, added to the sensitivity of the bank's capital to properties (16.5% of Fitch Core Capital (FCC) at end-9M18). In addition, the bank holds sizeable amounts of foreclosed assets on its balance sheets (58% of FCC at end-9M18) whose disposal can be challenging as markets can be illiquid and prices volatile. The bank's securities portfolio sees a high allocation towards equities (unquoted and quoted) which can result in sizeable impacts in OCI items. In 2016 and 2017, significant write-downs on the unquoted equities translated into large unrealized losses; but this was reduced in 2018. Market risk also stems from exposures to listed equities on local exchanges as the listed price may not be indicative of what the stock can be realised for due to low trading volumes.
BOS's capital ratios have declined significantly in recent years due to a combination of acquisitions, lower retained earnings and regulatory changes (transition to Basel 3 from Basel 2). BOS's capital metrics used to be well above peers and are now more in line with the UAE banking sector average (the Tier 1 ratio fell to 15.3% at end-9M18 from 21.2% at end-2016). Positively, the bank plans to issue a USD500 million AT1 instrument in 2019, which will help shore up its prudential ratios.
Fitch views BOS's funding profile as adequate with a stable customer deposits base providing the bulk of funding at the bank. At end-2017, the top 20 depositors accounted for around 20% of total customer deposits, which compares well with the sector average. BOS complements its deposit funding with two senior unsecured issues, demonstrating good access to capital markets when required. BOS's liquidity position is healthy with net liquid assets covering 29% of total customer deposits.
Earnings and profitability metrics have been variable and track below peers. Fitch's key earnings and profitability metric, Operating Profit/ Risk Weighted Assets, has demonstrated this variability, ranging from 1% to 2% in recent years. A combination of a narrowing net interest margin (attributable to an increase in the cost of funding and large holdings of liquid assets) and volatile asset quality explains why BOS's overall profitability has been and is likely to remain below the industry average.
ENVIRONMENT, SOCIAL AND GOVERNANCE SCORES
BOS has a governance structure relevance score of '4' in contrast to a typical relevance influence score of '3' for comparable banks reflecting concerns over the effectiveness of the board due to the length of service and a history of high related party lending. It also reflects executive management's important part of new loan and investment decision making; such decisions are also reviewed by the risk committee. Two independent board members were elected in 2018 and related-party lending has decreased, both of which should benefit the bank's governance framework going forward. Fitch will closely monitor the corporate governance structure.
RATING SENSITIVITIES
IDRs, SR AND SRF
BOS's IDRs, SR and SRF are sensitive to any change in Fitch's view of the creditworthiness of the UAE authorities and on their propensity to support the banking system or the bank.
SPV AND SENIOR DEBT
The two senior unsecured notes issued via BOS Funding Ltd are rated in line BOS's IDRs and are therefore subject to the same sensitivities.
VR
The VR could be downgraded if asset quality deteriorates and this impacts the bank's profitability and capital position. A lower capital allocation to non-traditional banking activities and improvement in asset quality indicators would support an upgrade.
The rating actions are as follows:
Bank of Sharjah:
Long-term IDR affirmed at 'BBB+'; Outlook Stable
Short-term IDR affirmed at 'F2'
VR affirmed at 'bb-'
Support Rating affirmed at '2'
Support Rating Floor affirmed at 'BBB+'
BOS Funding Limited:
Senior unsecured notes affirmed at 'BBB+'
USD1bn EMTN Programme affirmed at 'BBB+'/'F2'
Media Relations: Louisa Williams, London, Tel: +44 20 3530 2452, Email: louisa.williams@fitchratings.com
Additional information is available on www.fitchratings.com
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